SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[x] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 For the fiscal year ended December 31, 2001
[ ] 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
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TRIAD GUARANTY INC.
(Exact name of registrant as specified in its charter)
DELAWARE 56-1838519
(State or other jurisdiction of (I.R.S.Employer Identification No.)
incorporation or organization)
101 SOUTH STRATFORD ROAD, SUITE 500
WINSTON-SALEM, NORTH CAROLINA 27104
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (336) 723-1282
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
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COMMON STOCK, PAR VALUE $.01 PER SHARE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / / .
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. J
The aggregate market value of the voting stock held by nonaffiliates of the
registrant as of February 1, 2002, computed by reference to the last reported
price at which the stock was sold on such date, was $285,662,790.
The number of shares of the registrant's common stock, par value $.01 per share,
outstanding as of February 1, 2002, was 13,727,823.
Portions of the following documents Part of this Form 10-K into which
are incorporated by reference into the document is incorporated
this Form 10-K: by reference:
TRIAD GUARANTY INC.
Proxy Statement for 2002 Annual Meeting Part III
of Stockholders
PART I
ITEM 1. BUSINESS.
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Triad Guaranty Inc. is a holding company which, through its wholly-owned
subsidiary, Triad Guaranty Insurance Corporation ("Triad"), provides private
mortgage insurance ("MI") coverage in the United States to residential mortgage
lenders and investors. Triad Guaranty Inc. and its subsidiaries are collectively
referred to as the "Company." The "Company" when used within this document
refers to the holding company and/or one or more of its subsidiaries, as
appropriate.
Private mortgage insurance, also known as mortgage guaranty insurance, is
issued in most home purchases and refinancings involving conventional
residential first mortgage loans to borrowers with equity of less than 20%. If
the homeowner defaults, private mortgage insurance reduces, and in some
instances eliminates, the loss to the insured lender. Private mortgage insurance
also facilitates the sale of low down payment mortgage loans in the secondary
mortgage market, principally to the Federal Home Loan Mortgage Corporation
("Freddie Mac") and the Federal National Mortgage Association ("Fannie Mae").
Under risk-based capital regulations applicable to most financial institutions,
private mortgage insurance also reduces the capital requirement for such lenders
on residential mortgage loans with equity of less than 20%. In addition,
mortgage insurance is purchased by investors and lenders who seek additional
default protection or capital relief on loans with equity of greater than 20%.
Private mortgage insurance has traditionally involved underwriting and
insuring an individual loan. This type of mortgage insurance is known as
"traditional flow" mortgage insurance and will be referred to as such throughout
this document. In 2001, the Company began participating in structured bulk
transactions which involve underwriting and insuring a group of loans. This type
of mortgage insurance is known as "bulk" mortgage insurance and will be referred
to as such throughout this document.
Triad was formed in 1987 as a wholly-owned subsidiary of Primerica
Corporation and began writing private mortgage insurance in 1988. In September
1989, Triad was acquired by Collateral Mortgage, Ltd. ("CML"), a mortgage
banking and real estate lending firm located in Birmingham, Alabama. In 1990,
CML contributed the outstanding stock of Triad to its affiliate, Collateral
Investment Corp. ("CIC"), an insurance holding company.
The Company was incorporated by CIC in Delaware in August 1993, for the
purpose of holding all the outstanding stock of Triad and to undertake the
initial public offering of the Company's Common Stock, which was completed in
November 1993. CIC currently owns 19.6% and CML owns 18.8% of the outstanding
Common Stock of the Company.
The principal executive offices of the Company are located at 101 South
Stratford Road, Suite 500, Winston-Salem, North Carolina 27104. Its telephone
number is (336) 723-1282.
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TYPES OF MORTGAGE INSURANCE PRODUCTS
There are two principal types of private mortgage insurance coverage:
"primary" and "pool."
PRIMARY INSURANCE
Primary insurance provides mortgage default protection on individual loans
and covers unpaid loan principal, delinquent interest, and certain expenses
associated with the default and subsequent foreclosure (collectively, the "claim
amount"). The claim amount, to which the appropriate coverage percentage is
applied, generally ranges from 110% to 115% of the unpaid principal balance of
the loan. The Company's obligation to an insured lender with respect to a claim
is determined by applying the appropriate coverage percentage to the claim
amount. Under its master policy, the Company has the option of paying the entire
claim amount and taking title to the mortgaged property or paying the coverage
percentage in full satisfaction of its obligations under the insurance written.
Primary insurance can be placed on many types of loan instruments and generally
applies to loans secured by mortgages on owner occupied homes.
The Company offers primary coverage generally from 6% to 45% of the claim
amount, with most coverage from 12% to 35% as of December 31, 2001. The coverage
percentage provided by the Company is selected by the insured lender, subject to
the Company's underwriting approval, usually in order to comply with investor
requirements to reduce investor loss exposure on loans they purchase.
Fannie Mae and Freddie Mac are the ultimate purchasers of a large
percentage of the loans insured by the Company. Generally they require a
coverage percentage that will reduce their loss exposure on loans they purchase
to 75% or less of the property's value at the time the loan is originated. Since
1999, Fannie Mae and Freddie Mac have accepted lower coverage percentages for
certain categories of mortgages when the loan is approved by their automated
underwriting services. The reduced coverage percentages limit loss exposure to
80% or less of the property's value at the time the loan is originated.
The Company's premium rates vary depending upon the loan-to-value (LTV)
ratio, loan type, mortgage term, coverage amount, documentation required, and
use of property, which all affect the perceived risk of a claim on the insured
mortgage loan. Generally, premium rates cannot be changed after issuance of
coverage. The Company, consistent with industry practice, generally utilizes a
nationally based, rather than a regional or local, premium rate structure,
although special risk rates are utilized as well.
With respect to its traditional flow mortgage insurance, the premiums are
paid by either the borrower (borrower-paid) or the lender (lender-paid). Under
the Company's borrower-paid plan, mortgage insurance premiums are paid by the
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mortgage borrower to the mortgage lender or servicer, which in turn remits the
premiums to the Company. Under the Company's lender-paid plan, mortgage
insurance premiums are charged to the mortgage lender or loan servicer, which
pays the premium to the Company. The lender builds the mortgage insurance
premium into the borrower's interest rate. During 2001, approximately 82% of the
Company's traditional flow insurance was written under its borrower-paid plan
and 18% was written under its lender-paid plan.
Premiums may be remitted to the Company monthly, annually, or in one single
payment. The monthly premium payment plan involves the payment of one or two
months' premium at the mortgage loan closing. Thereafter level monthly premiums
are collected by the loan servicer for monthly remittance to the Company. The
Company also offers a plan under which the first monthly mortgage insurance
payment is deferred until the first loan payment is remitted to the Company.
This deferred monthly premium product decreases the amount of cash required from
the borrower at closing, therefore making home ownership more affordable.
Monthly premium plans represented approximately 93% of insurance written (88% of
traditional flow insurance written) in 2001.
The annual premium payment plan requires a first-year premium paid at
mortgage loan closing with annual renewal payments, which are generally less
than the first year premium, paid thereafter. Renewal payments are collected
monthly from the borrower and held in escrow by the mortgage lender or servicer
for annual remittance to the Company in advance of each renewal year.
The single premium payment plan requires a single payment paid at loan
closing. The single premium payment can be financed by the borrower by adding it
to the principal amount of the mortgage or can be paid in cash at closing by the
borrower.
POOL INSURANCE
Pool insurance generally has been offered by private mortgage insurers to
lenders as an additional credit enhancement for certain mortgage-backed
securities and provides coverage for the full amount of the net loss on each
individual loan included in the pool, subject to a provision limiting aggregate
losses to a specified percentage of the total original balances of all loans in
the pool. The Company does not offer this traditional form of pool insurance.
The Company participates on a limited basis in modified pool insurance
programs on loans purchased by Freddie Mac. Modified pool insurance provides
coverage for a specified percentage of the claim amount for each loan insured,
subject to an overall stop-loss provision applicable to the entire pool of loans
insured. At December 31, 2001, modified pool insurance programs represented less
than 1% of the Company's insurance in force.
STRUCTURED BULK TRANSACTIONS
The Company participates in structured bulk transactions. Structured bulk
transactions involve insuring a group of loans where the insured loans have
individual loan level coverage and frequently include an aggregate stop-loss
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limit applied to the entire group of insured loans. Insurance issued in
structured bulk transactions is generally either primary or, where the loan
already has primary coverage, supplemental.
Structured bulk transactions are generally initiated by secondary mortgage
market participants where mortgage insurance is used as a credit enhancement.
The Company is provided loan-level information on the group of loans and, based
on the risk characteristics of the entire group of loans and the requirements of
the secondary mortgage market participant, the Company will submit a price for
insuring the entire group of loans. The Company competes against other mortgage
insurers in this process. During 2001, structured bulk transactions represented
approximately 36% of the Company's insurance written for the year. Although the
Company expects to continue to be competitive in the structured bulk transaction
market, it is difficult to predict the Company's volume of business during 2002
due to the relatively small number of transactions that encompass this market
(as opposed to the traditional flow market), the competitive nature of the
market, and the unknown loan composition of the market.
The bulk market can be divided into three broad segments: the prime segment
(fully underwritten loans, high credit scores, low LTV's), the Alternative - A
segment (generally high credit score, low LTV loans that have been underwritten
with reduced documentation), and the sub-prime segment (higher risk loans with
lower credit scores). During 2001, approximately 80% of the Company's bulk
insurance written was in the prime segment and approximately 20% was in the
Alternative - A segment. The Company does not participate in the sub-prime
segment of the bulk market.
RISK SHARING PRODUCTS
The Company offers mortgage insurance programs designed to allow lenders to
share in the risks of mortgage insurance. One such program is the captive
reinsurance program. Under the captive reinsurance program, a reinsurance
company, generally an affiliate of the lender, assumes a portion of the risk
associated with the lender's insured book of business in exchange for a
percentage of the premium. Typically, the reinsurance program is an excess of
loss arrangement with a maximum exposure for the captive reinsurance company.
These captive reinsurance programs may also be in the form of a quota share
arrangement. In addition, the Company has insurance in force under programs
which increases a lender's share of the risk of loss on an insured book of
business and provides for a fee to the lender for this increased risk.
Approximately 35% of the Company's insurance in force at December 31, 2001 was
subject to risk sharing programs.
Regulatory and industry issues exist regarding the future of risk-sharing
programs currently being marketed within the mortgage insurance industry.
Management is unable to predict the impact of the regulatory issues on these
products.
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CANCELLATION OF INSURANCE
Mortgage insurance coverage cannot be canceled by the Company except for
nonpayment of premium or certain material violations of the master policy, and
remains renewable at the option of the insured lender. Generally, mortgage
insurance is renewable at a rate fixed when the insurance on the loan was
initially issued.
Insured lenders may cancel insurance at any time at their option. Pursuant
to the Homeowners Protection Act, most loans made on or after July 29, 1999 are
required to have their private mortgage insurance canceled automatically by
lenders when the outstanding loan amount is 78% or less of the property's
original purchase price and certain other conditions are met. A borrower may
request that a loan servicer cancel insurance on a mortgage loan when the loan
balance is less than 80% of the property's current value, but loan servicers are
generally restricted in their ability to grant such requests by secondary market
requirements as well as by certain other regulatory restrictions.
Mortgage insurance coverage can also be cancelled when an insured loan is
refinanced. If the Company provides insurance on the refinanced mortgage, the
policy on the refinanced home loan is considered new insurance written.
Therefore, continuation of the Company's coverage from a refinanced loan to a
new loan results in both a cancellation of insurance and new insurance written.
The percentage of insurance written from refinanced loans was 35.8%, 13.2%, and
25.0% in 2001, 2000, and 1999, respectively.
To the extent canceled insurance coverage in areas experiencing economic
growth is not replaced by new insurance in such areas, the percentage of the
Company's book of business in economically weaker areas may increase. This
development may occur during periods of heavy mortgage refinancing. Refinanced
loans in regions experiencing economic growth are less likely to require private
mortgage insurance, while borrowers in economically distressed areas are less
likely to qualify for refinancing because of depreciated real estate values. The
percentage of the Company's insurance in force at the end of the previous year
that was canceled during 2001, 2000, and 1999 was 32.4%, 17.4%, and 22.9%,
respectively. The high cancellation rate in 2001 was a result of low mortgage
rates available throughout the year. The cancellations have not had a material
impact on the geographic dispersion of the Company's risk in force.
CUSTOMERS
Residential mortgage lenders such as mortgage bankers, mortgage brokers,
commercial banks and savings institutions are the principal customers of
traditional flow insurance written by the Company. At December 31, 2001,
approximately 67% of the Company's traditional flow risk in force came from
mortgage bankers, 16% from commercial banks, 13% from mortgage brokers, and 3%
from savings institutions. At December 31, 2000, approximately 62% of the
Company's traditional flow risk in force came from mortgage bankers, 18% from
mortgage brokers, 16% from commercial banks, and 4% from savings institutions.
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To obtain primary insurance from the Company written on a traditional flow
basis, a mortgage lender must first apply for and receive a master policy from
the Company. The Company's approval of a lender as a master policyholder is
based, among other factors, upon evaluation of the lender's financial position
and demonstrated adherence to sound loan origination practices.
The master policy sets forth the terms and conditions of the Company's
mortgage insurance policy. The master policy does not obligate the lender to
obtain insurance from the Company, nor does it obligate the Company to issue
insurance on a particular loan. The master policy provides that the lender must
submit individual loans for insurance to the Company and the loan, subject to
certain underwriting criteria, must be approved by the Company to effect
coverage (except in the case of delegated underwriting and when the originator
has the authority to approve coverage within certain guidelines). The Company
had 7,337 master policyholders at December 31, 2001, compared to 7,190 at
December 31, 2000.
The Company's ten largest customers were responsible for 42.3%, 30.0%, and
31.0% of traditional flow risk in force at December 31, 2001, 2000, and 1999,
respectively. No single customer of the Company (including branches and
affiliates of that customer) accounted for revenues greater than 10% of total
revenues for 2001. The largest single customer of the Company accounted for
13.7%, 6.6%, and 9.2% of traditional flow risk in force at December 31, 2001,
2000, and 1999, respectively.
The mortgage lending industry continues to experience consolidation and a
greater percentage of origination volume is being generated by the large
lenders. The top 30 lenders in the United States, as ranked by mortgage
origination volume, accounted for approximately 73% of originated mortgage
volume in 2001 compared to 66% in 2000. As a result of this continued
consolidation, the number of lenders making decisions as to which insurer to
select for mortgage insurance is being reduced. The Company could be adversely
affected if one of its large customers is consolidated with a lender with which
the Company is not approved to do business or if one of its large lenders
terminates its relationship with the Company for any reason. Currently the
Company is approved to do business with 19 of the top 30 lenders and production
from these lenders accounted for approximately 66% of the Company's traditional
flow insurance written in 2001 compared to 33% in 2000.
Structured bulk transactions are generally initiated by secondary mortgage
market participants such as underwriters of mortgage-backed securities.
SALES AND MARKETING
The Company currently markets its insurance products through a sales force,
including sales management, of approximately 45 professionals and an exclusive
commissioned general agency serving a specific geographic market. The Company is
licensed to do business in 46 states and the District of Columbia and has
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license applications pending in three states. The Company will continue to
evaluate geographic expansion opportunities as well as the need for additional
sales representation.
During 2001, the Company's sales force was divided into five sales regions,
each with its own manager. These regional managers reported to a senior
executive who oversaw all sales activities for the Company, including those of
the national account market representatives. This reporting structure allowed
the senior executive in charge of all sales activities to focus time on large,
national accounts while remaining in control of all other sales activities.
Effective January 1, 2002, the number of sales regions was reduced from five to
two.
The success of the Company is dependent upon the services of its sales
force and its general agency. For 2001, the Company's commissioned general
agency produced approximately 9% of the Company's traditional flow insurance
written while the salaried account executives and the national account
representatives produced the remainder.
The marketing department's mission is to develop and implement programs in
support of the Company's sales objectives. A variety of tools are used to
achieve this goal including direct mail, public relations, marketing materials,
internal/external publications, convention trade shows, and the World Wide Web.
A national advertising and public relations campaign designed to raise corporate
visibility to lenders and investors is also being utilized to achieve this goal.
CONTRACT UNDERWRITING
The Company provides fee-based contract underwriting services that enable
customers to improve the efficiency of their operations by outsourcing all or
part of their mortgage loan underwriting. Contract underwriting involves
examining a prospective borrower's information contained in a lender's mortgage
application file and making a determination whether the borrower is approved for
a mortgage loan subject to the lender's underwriting guidelines. This service is
provided for loans that require mortgage insurance as well as loans that do not
require mortgage insurance.
Contract underwriting services have become increasingly important to
lenders as they seek to reduce fixed costs. Accordingly, contract underwriting
significantly contributes to the Company's mortgage insurance production. The
Company provides contract underwriting services through its own employees as
well as independent contractors. If the Company becomes unable to maintain and
provide a sufficient number of qualified underwriters, the Company's operations
could be materially adversely affected.
COMPETITION AND MARKET SHARE
The Company and other private mortgage insurers compete directly with
federal and state governmental and quasi-governmental agencies, principally the
Federal Housing Administration ("FHA"). These agencies sponsor government-backed
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mortgage insurance programs which accounted for approximately 37% of high LTV
loans in 2001 and 41% in 2000. In addition to competition from federal agencies,
the Company and other private mortgage insurers face competition from
state-supported mortgage insurance funds, some of which are either independent
agencies or affiliated with state housing agencies. Indirectly, the Company also
competes with certain mortgage lenders which forego private mortgage insurance
and self-insure against the risk of loss from defaults on all or a portion of
their low down payment mortgage loans.
Fannie Mae and Freddie Mac have the ability to modify the required level of
mortgage insurance coverage which should be maintained by lenders on loans for
resale to the secondary market. If Fannie Mae or Freddie Mac reduced the amount
of private mortgage insurance coverage required or adopted private mortgage
insurance substitutes, there could be an adverse affect on the Company's
financial condition and results of operations.
Various proposals are periodically discussed by Congress and certain
federal agencies to reform or modify the FHA. Management is unable to predict
the scope and content of such proposals, or whether any such proposals will be
enacted into law, and if enacted, the effect on the Company.
The private mortgage insurance industry consists of eight active mortgage
insurance companies including Triad, Mortgage Guaranty Insurance Corporation,
General Electric Mortgage Insurance Corporation, PMI Mortgage Insurance Co., CMG
Mortgage Insurance Co., United Guaranty Residential Insurance Company, Republic
Mortgage Insurance Company, and Radian Guaranty Inc. Triad is the seventh
largest private mortgage insurer based on 2001 market share and, according to
industry data, had a 3.6% share of net new primary insurance written in 2001
compared to 2.7% in 2000. The Company's market share for 2001 included net new
primary insurance written related to bulk transactions. The Company wrote no new
insurance in 2000 attributable to bulk transactions.
Management believes the Company competes with other private mortgage
insurers principally on the basis of personalized and professional service, a
strong management and sales team, responsive and versatile technology, and
innovative products.
UNDERWRITING PRACTICES
The Company considers effective risk management to be critical to its
long-term financial stability. Market analysis, prudent underwriting, the use of
automated risk evaluation models, auditing, and customer service are all
important elements of the Company's risk management process.
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UNDERWRITING PERSONNEL
The Company's Senior Vice President of Risk Management and Senior Vice
President of Underwriting have been in their positions since shortly after the
Company was founded and report directly to the President. In addition to a
centralized underwriting department in the home office, the Senior Vice
President of Underwriting is responsible for the Company's regional offices in
Arizona, California, Colorado, Georgia, Illinois, Ohio, Pennsylvania, and Texas.
The Senior Vice President of Risk Management is responsible for assessing the
risk factors used by the Company in its underwriting procedures and for the
quality control function.
The Company employed an underwriting staff of 44 at December 31, 2001. The
Company's field underwriters and underwriting managers are limited in their
authority to approve programs for certain mortgage loans. The authority levels
are tied to underwriting position, knowledge, and experience and relate
primarily to loan amounts and property type. All loans insured by the Company
are subject to quality control reviews.
The Company also utilizes various non-employee underwriters to perform
contract underwriting services. The number can vary substantially depending on
the need for this service.
RISK MANAGEMENT APPROACH
The Company evaluates risk based on historical performance of risk factors
and utilizes automated underwriting systems in the risk selection process to
assist the underwriter with decision making. This process evaluates the
following categories of risk:
o MORTGAGE LENDER. The Company reviews each lender's financial
statements and management experience before issuing a master policy.
The Company also tracks the historical risk performance, including
loan level risk characteristics, of all customers that hold a master
policy. This information is factored into determining the loan
programs the Company approves for various lenders. The Company assigns
delegated underwriting authority only to lenders with substantial
financial resources and established records of originating good
quality loans.
o PURPOSE AND TYPE OF LOAN. The Company analyzes five general
characteristics of a loan to evaluate its level of risk: (i) LTV
ratio; (ii) purpose of the loan; (iii) type of loan instrument; (iv)
level of documentation; and, (v) type of property. Generally, the
Company seeks loan types with proven track records for which an
assessment of risk can be readily made and the premium received
sufficiently offsets that risk. Loan types that do not have a proven
track record are charged a higher premium, as are other loans which
have been shown to carry higher risks, such as adjustable rate
mortgages ("ARMs") and loans having higher LTV ratios. Certain
categories of loans are not actively pursued by the Company because
such loans are deemed to have a disproportionate amount of risk,
including scheduled negatively amortizing ARMs, investment properties,
and subprime loans.
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o INDIVIDUAL LOAN AND BORROWER. Except to the extent that the Company's
delegated underwriting program and Freddie Mac's and Fannie Mae's
automated underwriting services are being utilized, the Company
evaluates insurance applications based on analysis of the borrower's
ability and willingness to repay the mortgage loan and the
characteristics and value of the mortgaged property. The analysis of
the borrower includes reviewing the borrower's housing and total debt
ratios as well as the borrower's Fair, Isaac and Co., Inc. ("FICO")
credit score, as reported by credit rating agencies. Loans may be
submitted under the Stick With Triad program provided the loans meet
the program requirements. Within this program, the degree to which the
borrower must meet certain underwriting standards, as well as the
amount of documentation required, is a function of the credit score.
(For further description of the Stick With Triad program, see
Underwriting Process below.) In the case of delegated underwriting,
compliance with program parameters is monitored by periodic audits of
delegated business. With the automated underwriting services provided
by Freddie Mac and Fannie Mae, lenders are able to obtain approval for
mortgage guaranty insurance with any participating mortgage insurer.
Triad works with both agencies in offering insurance services through
their systems, while monitoring the risk quality of loans insured
through such systems.
o GEOGRAPHIC SELECTION OF RISK. The Company places significant emphasis
on the condition of the regional housing markets in determining
marketing and underwriting policies. Using both internal and external
data, the Company's risk management department continually monitors
the economic conditions in the Company's active and potential markets.
UNDERWRITING PROCESS FOR TRADITIONAL FLOW BUSINESS
The Company accepts applications for insurance under three basic programs:
a traditional fully-documented program, a credit-score driven reduced
documentation program, and a delegated underwriting program which allows a
lender's underwriters to commit insurance to a loan based on strict, agreed upon
underwriting guidelines. The Company also accepts loans approved through Feddie
Mac's or Fannie Mae's automated underwriting systems.
The Company generally utilizes nationwide underwriting guidelines to
evaluate the potential risk of default on mortgage loans submitted for insurance
coverage. These guidelines have evolved over time and take into account the loss
experience of the entire private mortgage insurance industry. They also are
largely influenced by Freddie Mac and Fannie Mae underwriting guidelines. The
Company believes its guidelines generally are consistent with those used by
other private mortgage insurers with respect to the types of loans that the
Company will insure. Specific underwriting guidelines applicable to a given
local, state, or regional market are modified to address concerns resulting from
the Company's review of regional economies and housing patterns.
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Subject to the Company's underwriting guidelines and exception approval
procedures, the Company expects its internal and contract underwriters to
utilize their experience and business judgement in evaluating each loan on its
own merits. Accordingly, the Company's underwriting staff has discretionary
authority to insure loans which deviate in certain minor respects from the
Company's underwriting guidelines. More significant exceptions are subject to
management approval. In all such cases, compensating factors must be identified.
The predominant reason for such deviations involves instances where the
borrower's debt-to-income ratio exceeds the Company's guidelines. To compensate
for exceptions, the Company's underwriters give favorable consideration to such
factors as excellent borrower credit history, the availability of satisfactory
cash reserves after closing, and employment stability.
In addition to the borrower's willingness and ability to repay the loan,
the Company believes that mortgage default risk is affected by a variety of
other factors, including the borrower's employment status. Insured mortgage
loans made to self-employed borrowers are perceived by the Company to have
higher risk of claim, all other factors being equal, than loans to borrowers
employed by third parties. The Company's percentage of risk in force involving
self-employed borrowers was 1.8% at December 31, 2001 and 2.4% at December 31,
2000.
The Company's Stick With Triad program featuring the Slam Dunk Loan SM
approval process allows lenders to submit insurance applications with reduced
documentation. Under this program, Triad issues a certificate of insurance based
on the borrower's FICO credit score or the approval of the loan through Fannie
Mae's or Freddie Mac's automated underwriting system. The Company issues a
certificate of insurance without the standard underwriting process if certain
program parameters are met and the borrower has a credit score above established
thresholds. Documentation submission requirements for non-automated underwritten
loans vary depending on the borrower's credit score. The Stick With Triad
program represented approximately 45% of the Company's traditional flow
commitments in 2001 and 65% in 2000. The decline is primarily a result of
increased participation in the Company's delegated underwriting program. The
Company randomly and through adverse selection audits lenders' files on loans
submitted under the Stick With Triad program.
The Company's delegated underwriting program, in addition to the Company's
risk management strategies, utilizes extensive quality control practices
including reunderwriting, reappraisal, and similar procedures following issuance
of the policy. Standards for type of loan, property type, and credit history of
the borrower are established consistent with the Company's risk strategy. The
program has allowed the Company to serve a greater number of the larger,
well-established mortgage originators. The Company's delegated underwriting
program accounted for 49% of traditional flow commitments received in 2001
compared to 23% in 2000 and 17% in 1999. Many lenders who are not part of the
delegated underwriting program participate in the Stick With Triad underwriting
program. The performance of loans insured under the delegated underwriting
program has been comparable to the Company's non-delegated business.
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The Company utilizes its underwriting staff as well as contract personnel
to provide contract underwriting services to customers. For a fee, Triad
underwrites applications for secondary market compliance, while at the same time
assessing the application for mortgage insurance, if applicable. In addition,
the Company offers Fannie Mae's Desktop Originator(R) and Desktop
Underwriter(R), as well as the personnel to conduct the underwriting tasks, as a
service to its contract underwriting customers. The Company also offers its
contract underwriting customers direct access to Freddie Mac's Loan
Prospector(R). These products, which are designed to streamline and reduce costs
in the mortgage origination process, supply the Company's customers with fast
and accurate service regarding loan compliance and Fannie Mae's or Freddie Mac's
decision for loan purchase or securitization.
UNDERWRITING STRUCTURED BULK TRANSACTIONS
The Company employs a risk review process in underwriting structured bulk
transactions that is designed to identify the loans which pose the greatest risk
of nonperformance. High risk loans are identified based on an analysis of
multiple risk factors including, but not limited to, credit score,
loan-to-value, documentation type, loan purpose, and loan amount. The pertinent
risk characteristics of each loan are evaluated to determine the impact on the
transaction's frequency and severity of loss and persistency. The Company may
utilize an outside due diligence firm in this process as well as mortgage risk
analysis systems such as Standard & Poor's Levels. The Company's pricing for
structured bulk transactions is commensurate with a transaction's risk profile.
The Company also employs an audit procedure to test the integrity of the loan
level data provided to Triad. The risk review and audit procedure may result in
a request by the Company to remove certain loans from the transaction.
OTHER RISK MANAGEMENT
A comprehensive audit plan determines whether underwriting decisions being
made are consistent with the policies, procedures, and expectations for quality
set forth by management. All areas of business activity which involve an
underwriting decision are examined, with emphasis on new products, new
procedures, contract underwritten loans, delegated loans, new employees, new
master policyholders, and new branches of an existing master policyholder. The
process used to identify categories of loans selected for audit begins with
identification and evaluation of certain defined and verifiable risk elements.
Each loan is then tested against these elements to identify loans which fail to
meet prescribed policies or an identified norm. The procedure allows the
Company's management to identify concerns, not only at the loan level, but also
portfolio concerns which may exist within a given category of business.
TECHNOLOGY
Triad's TAXI - Transactions Across the Internet - allows qualified
customers to view, update, and process certain data within their borrowers'
13
private mortgage insurance records. TAXI is an internet-based service. Business
areas that can be addressed through TAXI include applying for mortgage
insurance, contract underwriting through eU Xpress, loan servicing, claims and
default processing, and risk-sharing performance.
eU Xpress is an internet-based service that automates the contract
underwriting and mortgage insurance commitment process. The Company introduced
eU Xpress in 2002. eU Xpress is accessed through TAXI and provides an interface
with automated underwriting systems.
FINANCIAL STRENGTH RATING
Credit ratings generally are considered an important element in a mortgage
insurer's ability to compete for new business, indicating the insurer's present
financial strength and capacity to pay future claims. Certain national mortgage
lenders and a large segment of the mortgage securitization market, including
Fannie Mae and Freddie Mac, generally will not purchase high LTV mortgages or
mortgage-backed securities unless the insurer issuing private mortgage insurance
coverage has a financial strength rating of at least "AA-" by either Standard &
Poor's Ratings Services ("S&P") or Fitch Ratings ("Fitch") or a rating of at
least "Aa3" from Moody's Investors Service ("Moody's"). Fannie Mae and Freddie
Mac require mortgage guaranty insurers to maintain two ratings of "AA-" or
better. Triad is rated "AA" by both S&P and Fitch and "Aa3" by Moody's. Private
mortgage insurers are not rated by any other independent nationally-recognized
insurance industry rating organization or agency (such as the A.M. Best
Company).
S&P defines insurers rated "AA" as having very strong financial security
characteristics, differing only slightly from those rated higher. Fitch defines
insurance companies rated "AA" as possessing strong capacity to meet
policyholder and contract obligations, risk factors are modest, and the impact
of any adverse business and economic factors is expected to be very small.
Moody's defines insurers rated "Aa" as offering exceptional financial security
but appearing to have somewhat larger long-term risks than companies rated
"Aaa". Ratings from S&P and Fitch are modified with a "+" or "-" sign to
indicate the relative position of a company within its category. Moody's uses
numeric modifiers to refer to the ranking within a group - with "1" being the
highest and "3" being the lowest.
When assigning a financial strength rating, S&P, Fitch, and Moody's
generally consider: (i) the specific risks associated with the mortgage
insurance industry, such as regulatory climate, market demand, growth, and
competition; (ii) management depth, corporate strategy, and effectiveness of
operations; (iii) historical operating results and expectations of current and
future performance; and, (iv) long-term capital structure, the ratio of debt to
equity, the ratio of risk to capital, near-term liquidity, and cash flow levels,
as well as any reinsurance relationships and the financial strength ratings of
such reinsurers. Ratings are based on factors relevant to policyholders, agents,
insurance brokers, and intermediaries. Such ratings are not directed to the
protection of investors and do not apply to any securities issued by the
Company.
14
Rating agencies issue financial strength ratings based, in part, upon a
company's performance sensitivity to various economic depression scenarios. In
determining capital levels required to maintain a company's rating, the rating
agencies allow the use of different forms of capital including statutory
capital, reinsurance and debt. In January 1998, the Company completed a $35
million private offering of notes due January 15, 2028. The notes, which are
rated "A" by S&P and "A+" by Fitch, were issued to provide additional capital
considered in the rating agency's depression models.
S&P, Fitch, and Moody's will periodically review Triad's rating, as they do
with all rated insurers. Ratings can be withdrawn or changed at any time by a
rating agency. A reduction in the Company's rating by S&P, Fitch, or Moody's
could materially impact the ability of the Company to write new business.
REINSURANCE
The use of reinsurance as a source of capital and as a risk management tool
is well established within the mortgage insurance industry. Reinsurance does not
legally discharge an insurer from its primary liability for the full amount of
the risk it insures, although it does make the reinsurer liable to the primary
insurer. There can be no assurance that the Company's reinsurers will be able to
meet their obligations under the reinsurance agreements.
RISK-SHARING ARRANGEMENTS
Triad's product offerings include captive mortgage reinsurance programs
whereby an affiliate of a lender reinsures a portion of the insured risk on
loans originated or purchased by the lender. Triad entered the captive
reinsurance market in 1999 with the LEAPSM (Lower Entry- Additional
Profitability) program. The LEAP program is an excess of loss mortgage
reinsurance program that provides lenders an opportunity to share in the risk
and return of mortgage insurance on loans the lender originates or services.
Under LEAP, the lender may elect a risk band with a flexible entry and exit
point. LEAP also permits cessions greater than the 25% industry standard
arrangements that existed prior to this program. Ceded premium under captive
reinsurance agreements represented 6.6% of direct written premiums in 2001
compared to 2.1% in 2000.
In November 1999, Triad formed Triad Re Insurance Corporation ("Triad Re")
as a wholly-owned sponsored captive reinsurance company domiciled in Vermont.
Triad Re was formed to allow small and mid-sized lenders to participate in
captive reinsurance arrangements with reduced up-front capital costs and without
co-mingling its risk with other lenders. Triad Re was initially capitalized in
February 2000, with regulatory capital of $1.0 million. As of December 31, 2001,
approximately $8 million of Triad's risk in force had been ceded to sponsored
captive reinsurer cells under participating agreements with Triad Re.
15
Triad's captive reinsurance agreements provide for trust arrangements
whereby the captive reinsurer is the grantor of the trust and Triad is the
beneficiary of the trust. Trusts are established to support the reinsurers'
obligations under the reinsurance agreements. The trust agreement includes
covenants regarding minimum and ongoing capitalization, required reserves,
authorized investments, and withdrawal of assets and is funded by ceded premium
and investment earnings on trust assets as well as capital contributions by the
reinsurer.
The Company also has in place reinsurance agreements with non-affiliated
reinsurers in association with certain of the Company's non-captive risk sharing
programs. The reinsurance agreements are excess of loss contracts whereby the
reinsurer will indemnify the Company with respect to losses covered as defined
by the reinsurance agreements. In 2001, 2.1% of the Company's direct written
premium was ceded to reinsurers under these agreements as compared to 1.9% in
2000.
At the end of 2001, 34.6% of Triad's insurance in force had been insured
under some type of risk-sharing arrangement as compared to 24.8% at the end of
2000. Risk-sharing arrangements represented 57.9% of Triad's traditional
insurance written in 2001 as compared to 42.9% in 2000.
OTHER REINSURANCE
Certain premiums and losses are assumed from and ceded to non-affiliated
insurance companies under various quota share reinsurance agreements. The ceding
agreement principally provides the Company with increased capacity to write
business and achieve a more favorable geographic dispersion of risk. Less than
0.1% of Triad's risk in force at December 31, 2001, and direct premiums written
in 2001 were ceded in quota share arrangements to non-affiliated reinsurance
companies.
Pursuant to deeper coverage requirements imposed by Fannie Mae and Freddie
Mac, certain loans eligible for sale to such agencies with a loan-to-value ratio
over 90% require insurance with a coverage percentage of 30% or more. Certain
states limit the amount of risk a mortgage insurer may retain with respect to
coverage of an insured loan to 25% of the claim amount, and, as a result, the
deeper coverage portion of such insurance must be reinsured. To minimize
reliance on third-party reinsurers and to permit the Company to retain the
premiums and related risk on deeper coverage business, Triad reinsures this
deeper coverage business with its wholly-owned subsidiary, Triad Guaranty
Assurance Corporation ("TGAC"). As of December 31, 2001, TGAC had assumed
approximately $67.4 million in risk from Triad.
The Company continues to maintain excess of loss reinsurance arrangements
designed to protect the Company in the event of a catastrophic level of losses.
In the first quarter of 2001, the Company voluntarily cancelled an excess of
loss reinsurance contract maintained with a non-affiliated reinsurer. Also in
16
the first quarter of 2001, the Company entered into a new agreement with a
third-party reinsurer to provide excess of loss reinsurance coverage under terms
similar to the cancelled agreement. The Company currently maintains $125 million
of excess of loss reinsurance through non-affiliated reinsurers that have
financial strength ratings of "AA" or better from Standard & Poor's.
DEFAULTS AND CLAIMS
DEFAULTS
The claim process on private mortgage insurance begins with the insurer's
receipt of notification from the lender of a default on an insured's loan.
Default is defined in the primary master policy as the failure by the borrower
to pay, when due, an amount at least equal to the scheduled monthly mortgage
payment under the terms of the mortgage. The master policy requires lenders to
notify the Company of default on a mortgage payment within 10 days of either (i)
the date on which the borrower becomes four months in default or (ii) the date
on which any legal proceeding affecting the loan commences, whichever occurs
first. Notification is required within 45 days of default if it occurs when the
first payment is due. The incidence of default is affected by a variety of
factors including, but not limited to, change in borrower income, unemployment,
divorce, illness, the level of interest rates, and general borrower
creditworthiness. Defaults that are not cured generally result in a claim to the
Company. Borrowers may cure defaults by making all delinquent loan payments or
by selling the property and satisfying all amounts due under the mortgage.
The following table shows default statistics as of December 31, 2001, and
the preceding four year ends:
DEFAULT STATISTICS
December 31
-----------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Number of insured loans in force........................ 159,400 123,046 108,623 97,222 82,682
Number of loans in default.............................. 1,420 740 690 518 388
Percentage of loans in default (default rate)........... 0.89% 0.60% 0.64% 0.53% 0.47%
Dollar amount of insured loans in default (000's).......$164,283 $77,423 $67,802 $50,882 $37,828
Dollar amount of direct risk (gross of reinsurance)
with respect to insured loans in default (000's)........ $43,678 $20,743 $18,108 $13,216 $9,249
Reserve per delinquent loan............................. $12,669 $20,253 $21,378 $23,442 $23,094
CLAIMS
Claims result from defaults that are not cured. The frequency of claims
does not directly correlate to the frequency of defaults due, in part, to the
Company's loss mitigation efforts and the borrower's ability to overcome
17
temporary financial setbacks. The likelihood that a claim will result from a
default, and the amount of such claim, principally depend on the borrower's
equity at the time of default and the borrower's (or the lender's) ability to
sell the home for an amount sufficient to satisfy all amounts due under the
mortgage, as well as the effectiveness of loss mitigation efforts. The ability
to mitigate a claim is affected by the local housing market, interest rates,
employment growth, the housing supply, and the borrower's desire to avoid
foreclosure. During the default period, the Company works with the insured as
well as the borrower in an effort to either reinstate the loan or sell the
property for an amount which results in a reduced claim prior to foreclosure.
The payment of claims is not evenly spread through the coverage period.
Relatively few claims are paid during the first two years following issuance of
insurance. A period of rising claim payments follows, which, based on industry
experience, has historically reached its highest level in the third through
sixth years after the loan origination. Thereafter, the number of claim payments
made has historically declined at a gradual rate, although the rate of decline
can be affected by local economic conditions. There can be no assurance that the
historical pattern of claims will continue in the future.
Generally, the Company does not pay a claim for loss under the master
policy if the application for insurance for the loan in question contains
fraudulent information, material omissions, or misrepresentations which increase
the risk characteristics of the loan. The Company's master policy also excludes
any cost or expense related to the repair or remedy of any physical damage
(other than "normal wear and tear") to the property collateralizing an insured
mortgage loan. Such physical damage may be caused by accident, natural
occurrence or otherwise.
Under the terms of the master policy, the lender is required to file a
claim with the Company no later than 60 days after it has acquired good and
marketable title to the underlying property through foreclosure. A primary
insurance claim amount includes (i) the amount of unpaid principal due under the
loan; (ii) the amount of accumulated delinquent interest due on the loan
(excluding late charges) to the date of claim filing; (iii) expenses advanced by
the insured under the terms of the master policy, such as hazard insurance
premiums, property maintenance expenses and property taxes to the date of claim
filing; and, (iv) certain foreclosure and other expenses, including attorneys
fees. Such claim amount is subject to review and possible adjustment by the
Company. Depending on the applicable state foreclosure law, an average of about
12 months elapses from date of default to payment of claim on an uncured
default. The Company's experience indicates that the claim amount on a policy
generally ranges from 110% to 115% of the unpaid principal amount of a
foreclosed loan.
Within 60 days after the claim has been filed, the Company has the option
of either (i) paying the coverage percentage specified on the certificate of
insurance (usually 12% to 35% of the claim), with the insured retaining title to
18
the underlying property and receiving all proceeds from the eventual sale of the
property, or (ii) paying 100% of the claim amount in exchange for the lender's
conveyance of good and marketable title to the property to the Company, with the
Company selling the property for its own account. The Company chooses the claim
settlement option believed to cost the least. In general, the Company settles
claims by paying the coverage percentage of the claim amount. At December 31,
2001, the Company held two properties with a combined net realizable value of
$162,331 which were acquired by electing to pay 100% of the claim amount.
LOSS MITIGATION
Once a default notice is received, the Company attempts to mitigate its
loss. Through proactive intervention with insured lenders and borrowers, the
Company has been successful in reducing the number and severity of its claims
for loss. Loss mitigation techniques include pre-foreclosure sales, property
sales after foreclosure, advances to assist distressed borrowers who have
suffered a temporary economic setback, and the use of repayment schedules,
refinances, loan modifications, forbearance agreements, and deeds-in-lieu of
foreclosure. Such mitigation efforts typically result in a savings to the
Company over the percentage coverage amount payable under the certificate of
insurance. Through loss mitigation efforts, the Company paid out approximately
58% of its potential exposure on claims in 2001 compared to 68% in 2000 and 66%
in 1999.
LOSS RESERVES
The Company establishes reserves to provide for the estimated costs of
settling claims on loans reported in default and estimates of loans in default
which have not been reported. Consistent with industry accounting practices, the
Company does not establish loss reserves for future claims on insured loans
currently not in default. Although the Company believes that overall reserve
levels at December 31, 2001, are adequate to meet future obligations, due to the
inherent uncertainty of the reserving process there can be no assurance that
reserves will prove to be adequate to cover ultimate loss developments.
In determining the liability for unpaid losses related to outstanding
defaults, the Company establishes loss reserves on a case-by-case basis using
estimated claim rates (frequency) and claim amounts (severity) to estimate
ultimate losses. The Company relies on historical experience in the estimation
of claim rates and claim amounts. The Company also establishes reserves for the
estimated costs of settling claims ("loss adjustment expenses" or "LAE"), which
include, but are not limited to, legal fees and general expenses of
administering the claims settlement process, and for losses and loss adjustment
expenses incurred from defaults which have occurred but have not yet been
reported to the insurer ("Incurred But Not Reported" or "IBNR").
Management periodically reviews the loss reserve process in order to
improve its estimate of ultimate losses. During the third quarter of 2001,
management refined its methodology for setting loss reserves for outstanding
19
defaults and for IBNR defaults. The enhancements made to the reserving process
incorporate a more multi-dimensional analytical form, which gives effect to
current economic conditions and profiles delinquencies by such factors as policy
year, geography, and chronic late payment characteristics in addition to
profiling them by age.
The Company's reserving process is based upon the assumption that past
experience, adjusted for the anticipated effect of current economic conditions
and projected future economic trends, provides a reasonable basis for estimating
future events. However, estimation of loss reserves is a difficult and inexact
process. Economic conditions that have affected the development of loss reserves
in the past may not necessarily affect development patterns in the future in
either a similar manner or degree. Due to the inherent uncertainty in estimating
reserves for losses and loss adjustment expenses, there can be no assurance that
reserves will be adequate to cover ultimate loss developments on loans in
default, currently or in the future. The Company's profitability and financial
condition could be adversely affected to the extent that the Company's estimated
reserves are insufficient to cover losses on loans in default.
20
The following table represents a reconciliation of the beginning and ending
loss reserves (net of reinsurance) for the periods indicated:
Reconciliation of Losses and Loss Adjustment Expense Reserves
Year Ended December 31
----------------------
(in thousands)
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Reserve for losses and LAE, net of related reinsurance
recoverables, at beginning of year........................... $14,976 $14,723 $12,116 $ 8,909 $ 5,974
Add losses and LAE incurred in respect of defaults occurring in:
Current year (1)........................................ 14,219 11,229 9,322 7,953 6,023
Prior years (1) (2)..................................... (5,200) (3,642) (2,211) (944) (846)
------- ------- ------- ------- ------
Total incurred losses and LAE................................ 9,019 7,587 7,111 7,009 5,177
Deduct losses and LAE paid in respect of defaults occurring in:
Current year............................................ 286 574 236 267 210
Prior years............................................. 5,727 6,760 4,268 3,535 2,032
------- ------- ------- ------- ------
Total payments............................................... 6,013 7,334 4,504 3,802 2,242
Reserve for losses and LAE, net of related reinsurance
recoverables, at end of year ................................ 17,982 14,976 14,723 12,116 8,909
Reinsurance recoverables on unpaid losses and LAE, at
the end of year ............................................. 9 11 28 27 51
------- ------- ------- ------- ------
Reserve for unpaid losses and LAE, before deduction
of reinsurance recoverables on unpaid losses, at
end of year.................................................. $17,991 $14,987 $14,751 $12,143 $8,960
======= ======= ======= ======= ======
- ---------------------
<FN>
(1) Includes loss and LAE reserves relating to loans which are in default but
for which default notices have not been received.
(2) Indicates a cumulative redundancy in loss reserves at the beginning of each
period. Redundancies result from overestimating ultimate claim amounts.
</FN>
The top section of the above table shows losses incurred on insurance
policies with respect to defaults which occurred in the current and prior
periods. The amount of losses incurred relating to defaults occurring in the
current period represents the estimated amount to be ultimately paid on defaults
occurring in that period. The amount of losses incurred relating to defaults
occurring in prior periods represents an adjustment made in the current period
for defaults which were included in the loss reserve at the end of the prior
period.
21
The middle section of the above table shows claims paid on insurance
policies with respect to defaults which occurred in the current period and in
prior periods, respectively. Since it takes, on average, about 12 months for a
default which is not cured to eventually develop into a paid claim, most losses
paid relate to defaults occurring in prior periods.
ANALYSIS OF DIRECT RISK IN FORCE
A foundation of the Company's business strategy is proactive risk
selection. The Company analyzes its portfolio in a number of ways to identify
any concentrations of risk or imbalances in risk dispersion. The Company
believes that the quality of its insurance portfolio is affected predominantly
by (i) the quality of loan originations (including the strength of the borrower
and the marketability of the property); (ii) the attributes of loans insured
(including LTV ratio, purpose of the loan, type of loan instrument and type of
underlying property securing the loan); (iii) the seasoning of the loans
insured; (iv) the geographic dispersion of the underlying properties subject to
mortgage insurance; and, (v) the quality and integrity of lenders from which the
Company receives loans to insure.
22
LENDER AND PRODUCT CHARACTERISTICS
The following table reflects the percentage of direct gross risk in force
(as determined on the basis of information available on the date of mortgage
origination) by the categories indicated on December 31, 2001 and 2000:
Direct Risk in Force
December 31
-----------
Product Type: 2001 2000
---- ----
Primary................................................ 100.0% 100.0%
Pool................................................... 0.0% 0.0%
Total.................................................. 100.0% 100.0%
====== ======
Direct Primary Risk in Force
December 31
-----------
2001 2000
---- ----
Direct Risk in Force (dollars in millions)............. $4,582 $3,760
Lender Concentration (excludes bulk):
Top 10 lenders (by original applicant)................. 42.3% 30.0%
LTV:
95.01% and above....................................... 2.3% 2.5%
90.01% to 95.00%....................................... 41.4% 50.7%
90.00% and below....................................... 56.3% 46.8%
------ ------
Total.................................................. 100.0% 100.0%
====== ======
Loan Type:
Fixed.................................................. 86.2% 94.9%
ARM (positive amortization) (1)........................ 13.8% 5.1%
ARM (potential negative amortization) (2).............. 0.0% 0.0%
ARM (scheduled negative amortization) (2).............. 0.0% 0.0%
Other.................................................. 0.0% 0.0%
------ ------
Total.................................................. 100.0% 100.0%
====== ======
Mortgage Term:
15 years and under..................................... 3.8% 3.2%
Over 15 years.......................................... 96.2% 96.8%
------ ------
Total.................................................. 100.0% 100.0%
====== ======
Property Type:
Noncondominium (principally single-family detached).... 95.2% 96.2%
Condominium............................................ 4.8% 3.8%
------ ------
Total.................................................. 100.0% 100.0%
====== ======
Occupancy Status:
Primary residence...................................... 95.9% 98.1%
Second home............................................ 1.7% 1.2%
Nonowner occupied...................................... 2.4% 0.7%
------ ------
Total.................................................. 100.0% 100.0%
====== ======
Mortgage Amount:
$200,000 or less....................................... 70.8% 82.3%
Over $200,000.......................................... 29.2% 17.7%
------ ------
Total.................................................. 100.0% 100.0%
====== ======
- ------------------
(1) Refers to loans where payment adjustments are the same as mortgage interest
rate adjustments.
(2) Scheduled negative amortization is defined by the Company as the increase in
loan balance that will occur if interest rates do not change. Loans with
potential negative amortization will not have increasing principal balances
unless interest rates increase.
23
An important determinant of claim incidence is the relative amount of
borrower's equity in the home (which at the time of origination is the down
payment). For the industry as a whole, historical evidence indicates that claim
incidence on loans having a LTV ratio in excess of 90% is greater than claim
incidence on loans with LTV ratios equal to or less than 90%. The Company
believes the higher premium rates charged on high LTV loans adequately reflects
the additional risk.
Approximately 2.3% of the Company's risk in force is comprised of loans
with an LTV greater than 95%. These high LTV loans are offered primarily to low
and moderate income borrowers. The Company believes that these "affordable
housing" loans have higher risks than its other insured business and has often
attracted borrowers with weak credit histories, generally resulting in higher
loss ratios. In keeping with the Company's established risk strategy, the
Company has not aggressively solicited this segment of the industry. The Company
does not routinely delegate the underwriting of high LTV loans.
In 2000 the State of Illinois Insurance Department, as well as the
insurance departments of several other states, began to permit mortgage insurers
to write coverage on loans in excess of 97% up to 100% and, in certain
instances, up to 103%. This determination was made in response to the
development by certain entities in the mortgage securitization market, including
Fannie Mae and Freddie Mac, of programs that allowed LTV's in excess of 97%.
These programs are designed to accommodate the credit-worthy borrower who lacks
the ability or interest to provide a down payment on a home. The Company accepts
loans with LTV's greater than 97% on a limited basis.
The Company actively pursues only positively amortizing ARMs with industry
standard caps. Payments on these loans adjust fully with interest rate
adjustments. To date, the performance of the Company's ARM loans has been
consistent with that of its fixed rate portfolio. However, since historical
claim frequency data on ARMs has not yet been tested during a prolonged period
of economic stress, there can be no assurance that claim frequency on ARMs may
not eventually be higher, particularly during a period of rising interest rates
combined with decreasing housing prices. In its normal course of operations, the
Company's existing underwriting policy does not permit coverage of ARMs with
"scheduled" negative amortization. ARMs with "potential" negative amortization
characteristics due to possible interest rate increases and borrower payment
option changes are accepted under limited conditions for approved lenders.
Historical evidence indicates that higher-priced properties experience
wider fluctuations in value than moderately priced residences. These
fluctuations exist primarily because there is a smaller pool of qualified buyers
for higher-priced homes which, in turn, reduces the likelihood of achieving a
quick sale at fair market value when necessary to avoid a default.
The Company believes that 15-year mortgages present a lower level of risk
than 30-year mortgages, primarily as a result of the faster amortization and the
more rapid accumulation of borrower equity in the property. Accordingly, the
Company charges lower premium rates on these loans than on comparable 30-year
mortgages.
24
The Company believes that the risk of claim is also affected by the type of
property securing the insured loan. In management's opinion, loans on
single-family detached housing are subject to less risk of claim incidence than
loans on other types of properties. The Company believes that attached housing
types, particularly condominiums and cooperatives, are a higher risk because in
most areas condominiums and cooperatives tend to be more susceptible to downward
fluctuations in value than single-family detached dwellings in the same market.
Loans on primary residences that were owner occupied at the time of loan
origination constituted approximately 96% of the Company's risk in force at
December 31, 2001. Because management believes that loans on non-owner occupied
properties represent a substantially higher risk of claim incidence and are
subject to greater value declines than loans on primary homes, the Company does
not actively pursue these loans.
The Company's book of business is less mature than that of the private
mortgage insurance industry as a whole, with the Company's direct risk in force
having a weighted average life of 2.6 years at December 31, 2001 and 2.8 years
at December 31, 2000, compared to an estimated industry average of 3.1 years at
December 31, 2001.
25
The following table shows the percentage of direct risk in force as of
December 31, 2001, for policies written from 1988 through 2001, as well as the
cumulative loss ratio (calculated as losses paid divided by premiums written, in
each case for a particular certificate year) which has developed through
December 31, 2001, for the policies written during the years indicated and
excludes the effects of reinsurance:
Certificate Percent Cumulative Ratio of Losses
Year Direct Risk in Force of Total Paid to Premiums Written(1)
----------- -------------------- -------- ---------------------------
(in millions)
1988 $ 0.5 0.0% 15.3%
1989 0.6 0.0 24.0
1990 1.3 0.0 18.7
1991 5.4 0.1 11.9
1992 16.7 0.4 8.5
1993 53.3 1.2 5.2
1994 49.0 1.1 9.8
1995 83.9 1.8 11.7
1996 134.5 2.9 11.7
1997 272.6 5.9 7.2
1998 666.9 14.6 3.3
1999 621.6 13.6 2.4
2000 649.2 14.2 2.5
2001 2,026.0 44.2 0.0
--------- -----
Total $ 4,581.5 100.0%
========= =====
- ---------------
(1) Claim activity is not spread evenly throughout the coverage period of the
book of business. Based on the Company's and the industry's historical
experience, claims incidence is highest in the third through sixth years after
loan origination, and relatively few claims are paid during the first two years
after loan origination. Thus, the cumulative loss experience of recent
certificate years is not indicative of ultimate losses.
26
GEOGRAPHIC DISPERSION
The following tables reflect the percentage of direct risk in force on the
Company's book of business (by location of property) for the top ten states and
the top ten metropolitan statistical areas ("MSAs") as of December 31, 2001:
Top Ten States Top Ten MSAs
----------------------------- --------------------------------------
December 31 December 31
2001 2001
----------- -----------
California 14.9% Chicago, IL 6.1%
Florida 7.5 Los Angeles/Long Beach, CA 3.3
Texas 7.3 Atlanta, GA 3.2
Illinois 6.7 Phoenix/Mesa, AZ 2.4
Georgia 6.2 Houston, TX 1.9
North Carolina 5.7 Riverside/San Bernardino, CA 1.5
Pennsylvania 4.0 Philadelphia, PA 1.5
Colorado 3.6 Denver, CO 1.4
Arizona 3.4 Dallas, TX 1.4
Virginia 3.3 Oakland, CA 1.4
---- ----
Total 62.6% Total 24.1%
===== =====
While the Company continues to diversify its risk in force geographically,
a prolonged regional recession, particularly in its high concentration areas,
such as the Southeastern, Western, Middle Atlantic, and upper Mid-Western
states, or a prolonged national economic recession, could significantly increase
loss development.
INVESTMENT PORTFOLIO
Income from its investment portfolio is one of the Company's primary
sources of cash flow to support its operations and claims payments. The Company
has an investment advisory agreement with CML for management of its portfolio.
The Company follows an investment policy which requires: (i) 80% of its
investment portfolio (together with cash assets) to consist of cash, short-term
investments, and debt securities (including redeemable preferred stocks) which,
at the date of purchase, were rated investment grade by a nationally recognized
rating agency (e.g.,"BBB-" or better by S&P), and (ii) at least 50% of its
27
investment portfolio (together with cash assets) to consist of cash, cash
equivalents, and securities which, at the date of purchase, were rated one of
the two highest investment grades by a nationally recognized rating agency.
At December 31, 2001, the Company's total investment portfolio had a fair
market value of $277.2 million and did not include any real estate or mortgage
loans. The investment portfolio was composed of approximately 89% fixed maturity
securities, 4% equities, and 7% short-term investments.
Liquidity is sought through cash equivalent investments and through
diversification and investment in publicly traded securities. The Company
attempts to maintain a level of liquidity and a duration in its investment
portfolio consistent with its business outlook and the expected timing,
direction, and degree of changes in interest rates. As of December 31, 2001, no
investment in the securities of any single issuer (other than the U.S.
government and its agencies) exceeded 2% of the Company's investment portfolio.
The Company's investment policies and strategies are subject to change
depending upon regulatory, economic, and market conditions and the existing or
anticipated financial condition and operating requirements, including the tax
position, of the Company.
The following table shows the results of the Company's investment portfolio
for the periods indicated:
Investment Portfolio Results
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Average investments (1)................ $252,508,660 $212,029,383 $183,987,661 $151,711,923 $103,804,750
Pre-tax net investment income.......... $ 14,764,536 $ 12,645,321 $ 10,545,663 $ 9,289,026 $ 6,234,142
Effective pre-tax yield (1)............ 5.8% 6.0% 5.7% 6.1% 6.0%
Tax-equivalent yield (2)............... 8.0% 8.2% 7.7% 7.9% 8.0%
Pre-tax realized gain on sale of
investments................... $ 296,974 $ 285,849 $ 1,153,191 $ 880,502 $ 34,330
- ---------------------
<FN>
(1) Based on historical cost adjusted for amortization and accretion of premium and discount.
(2) Based on book value and the Company's marginal tax rate.
</FN>
28
The diversification of the Company's investment portfolio at December 31,
2001, is shown in the table below:
Investment Portfolio Diversification
December 31, 2001
-----------------------------------------------
Amortized Cost Fair Value Percent (1)
-------------- ---------- -------
Available-for-sale securities:
Fixed maturity securities:
U. S. government obligations................. $ 12,164,542 $ 12,645,657 4.6%
Mortgage-backed bonds........................ 253,277 277,834 0.1
State and municipal bonds.................... 177,780,714 178,047,417 64.2
Corporate bonds.............................. 55,463,919 55,014,611 19.8
------------ ------------
Total fixed maturities................... 245,662,452 245,985,519
Equity securities.............................. 11,308,230 12,476,030 4.5
------------ ------------
Total available-for-sale securities...... 256,970,682 258,461,549
Short-term investments......................... 18,738,590 18,738,590 6.8
------------ ------------ -----
$275,709,272 $277,200,139 100.0%
============ ============ =====
- ---------------------
<FN>
(1) Percentage of fair value.
</FN>
The following table shows the scheduled maturities at December 31, 2001, of
the fixed maturity securities held in the Company's investment portfolio:
Investment Portfolio Scheduled Maturity
December 31, 2001
--------------------------
Fair Value Percent
---------- -------
One year or less................................ $1,968,163 0.8%
After one year through five years............... 23,344,601 9.5
After five years through ten years.............. 38,171,721 15.5
After ten years though twenty years............. 120,818,081 49.1
After twenty years.............................. 61,405,119 25.0
Mortgage-backed securities (1).................. 277,834 0.1
------------ -----
Total................................. $245,985,519 100.0%
============ =====
---------------------
(1)Substantially all of these securities are guaranteed by U.S. Government
Agencies.
29
The following table shows the ratings of the Company's investment portfolio
as of December 31, 2001 and December 31, 2000:
Investment Portfolio by Rating
December 31, 2001 December 31, 2000
------------------------ --------------------------
Rating(1) Fair Value Percent Fair Value Percent
---------- ------- ---------- -------
Fixed maturities:
U.S. Treasury and U.S. agency bonds..... $ 12,923,491 5.3% $ 5,217,023 2.6%
AAA..................................... 119,417,729 48.5 79,443,654 39.0
AA...................................... 28,573,877 11.6 27,253,100 13.4
A....................................... 42,723,692 17.4 51,479,757 25.1
BBB..................................... 26,086,166 10.6 23,359,844 11.5
BB...................................... 9,348,004 3.8 8,000,251 3.9
B....................................... 4,420,279 1.8 5,418,940 2.7
C....................................... 215,060 0.1 57,000 0.0
D....................................... 120,250 0.0 168,983 0.1
NR...................................... 2,156,971 0.9 3,526,100 1.7
------------- ----- ------------- -----
Total fixed maturities............. $ 245,985,519 100.0% $ 203,924,652 100.0%
============= ===== ============= =====
Equities:
AAA..................................... $ 358,556 2.9% $ 483,125 4.3%
AA...................................... 2,301,250 18.4 0 0.0
A....................................... 4,860,365 39.0 7,038,892 63.5
BBB..................................... 1,403,732 11.2 970,568 8.8
BB...................................... 631,515 5.1 0 0.0
B....................................... 2,920,612 23.4 2,595,940 23.4
------------- ----- ------------- -----
Total equities.................... $ 12,476,030 100.0% $ 11,088,525 100.0%
------------- ===== ------------- =====
Total portfolio.................................. $ 258,461,549 $ 215,013,177
============= =============
- ---------------------
<FN>
(1) Current ratings as assigned by the NRSRO (Nationally Recognized Statistical
Rating Organization). The NRSRO includes the following nationally recognized
rating agencies: S&P, Moody's, and Fitch.
</FN>
30
REGULATION
DIRECT REGULATION
The Company's insurance subsidiaries are subject to comprehensive, detailed
regulation, principally for the protection of policyholders and their borrowers
rather than for the benefit of investors, by the insurance departments of the
various states in which each insurer is licensed to transact business. Although
their scope varies, state insurance laws in general grant broad powers to
supervisory agencies or officials to examine companies and to enforce rules or
exercise discretion touching almost every significant aspect of the insurance
business. These include the licensing of companies to transact business, and
varying degrees of control over claims handling practices, reinsurance
requirements, premium rates, the forms and policies offered to customers,
financial statements, periodic financial reporting, permissible investments, and
adherence to financial standards relating to statutory surplus, dividends, and
other criteria of solvency intended to assure the satisfaction of obligations to
policyholders.
All states have enacted legislation that requires each insurance company in
a holding company system to register with the insurance regulatory authority of
its state of domicile and furnish to the regulator financial and other
information concerning the operations of companies within the holding company
system that may materially affect the operations, management, or financial
condition of the insurers within the system. Generally, all transactions within
a holding company system between an insurer and its affiliates must be fair and
reasonable and the insurer's statutory policyholders' surplus following any
transaction with an affiliate must be both reasonable in relation to its
outstanding liabilities and adequate for its needs. Most states also regulate
transactions between insurance companies and their parents and/or affiliates.
There can be no assurance that state regulatory requirements will not become
more stringent in the future and have an adverse effect on the Company.
Because the Company is an insurance holding company and Triad is an
Illinois domiciled insurance company, the Illinois insurance laws regulate,
among other things, certain transactions in the Company's Common Stock and
certain transactions between Triad and the Company or affiliates. Specifically,
no person may, directly or indirectly, offer to acquire or acquire beneficial
ownership of more than 10% of any class of outstanding securities of the Company
or its subsidiaries unless such person files a statement and other documents
with the Illinois Director of Insurance and obtains the Director's prior
approval. In addition, material transactions between Triad and the Company or
affiliates are subject to certain conditions, including that they be "fair and
reasonable." These restrictions generally apply to all persons controlling or
under common control with the insurance companies. "Control" is presumed to
exist if 10% or more of Triad's voting securities is owned or controlled,
directly or indirectly, by a person, although the Illinois Director may find
that "control" in fact does or does not exist where a person owns or controls
either a lesser or greater amount of securities. Other states in addition to
Illinois may regulate affiliated transactions and the acquisition of control of
the Company or its insurance subsidiaries.
31
Triad is required by Illinois insurance laws to provide for a contingency
reserve in an amount equal to at least 50% of earned premiums in its statutory
financial statements. Such reserves must be maintained for a period of 10 years
except in circumstances where high levels of losses exceed regulatory
thresholds. The contingency reserve, designed to provide a cushion against the
effect of adverse economic cycles, has the effect of reducing statutory surplus
and restricting dividends and other distributions by Triad. At December 31,
2001, Triad had statutory policyholders' surplus of $105.3 million and a
statutory contingency reserve of $193.7 million. At December 31, 2000, Triad had
statutory policyholders' surplus of $101.0 million and a statutory contingency
reserve of $150.8 million. Triad's statutory earned surplus was $21.6 million at
year-end 2001 and $17.3 million at year-end 2000, reflecting growth in statutory
net income greater than the increase in the statutory contingency reserve.
The insurance laws of Illinois provide that Triad may pay dividends only
out of statutory earned surplus and further establish standards limiting the
maximum amount of dividends which may be paid without prior approval by the
Illinois Director. Under such standards, Triad may pay dividends during any
12-month period equal to the greater of (i) 10% of the preceding year-end
statutory policyholders' surplus or (ii) the preceding year's net income. In
addition, insurance regulatory authorities have broad discretion to limit the
payment of dividends by insurance companies.
Although not subject to a rating law in Illinois, premium rates for
mortgage insurance are subject to regulation in most states to protect
policyholders against the adverse effects of excessive, inadequate, or unfairly
discriminatory rates and to encourage competition in the insurance marketplace.
Any increase in premium rates must be justified, generally on the basis of the
insurer's loss experience, expenses, and future trend analysis. The general
mortgage default experience also may be considered.
TGAC was organized as a subsidiary of Triad under the insurance laws of the
state of Illinois in December 1994, and as an Illinois domiciled insurer, is
subject to all Illinois insurance regulatory requirements applicable to Triad.
Triad Re was organized as a subsidiary of Triad under the insurance laws of
the state of Vermont in November 1999, and as a Vermont domiciled insurer, is
subject to Vermont insurance regulatory requirements.
Triad, TGAC, and Triad Re are each subject to examination of their affairs
by the insurance departments of every state in which they are licensed to
transact business. The Illinois Insurance Director and Vermont Insurance
Commissioner periodically conduct financial examinations of insurance companies
domiciled in their states. The most recent examinations of Triad and TGAC were
issued by the Illinois Insurance Department on February 3, 2000, and covered the
period January 1, 1995, through December 31, 1998. No material recommendations
were made as a result of these examinations.
32
A number of states generally limit the amount of insurance risk which may
be written by a private mortgage insurer to 25 times the insurer's total
policyholders' surplus. This restriction is commonly known as the
risk-to-capital requirement.
Mortgage insurers are generally restricted by state insurance laws and
regulations to writing residential mortgage guaranty insurance business only.
This restriction generally prohibits Triad from using its capital resources in
support of other types of insurance and restricts its noninsurance business.
However, noninsurance businesses of the Company would not generally be subject
to regulation under state insurance laws.
Regulation of reinsurance varies by state. Except for Illinois, Wisconsin,
New York, Ohio, and California, most states have no special restrictions on
reinsurance that would apply to private mortgage insurers other than standard
reinsurance requirements applicable to property and casualty insurance
companies. Certain restrictions, including reinsurance trust fund or letter of
credit requirements, apply under Illinois law to domestic companies and under
the laws of several other states to any licensed company ceding business to
unlicensed reinsurers. If a reinsurer is not admitted or approved, the company
doing business with the reinsurer cannot take credit in its statutory financial
statements for the risk ceded to such reinsurer absent compliance with the
reinsurance security requirements. In addition, some states in which Triad does
business have limited private mortgage insurers to a maximum policy coverage
limit of 25% of the insured's claim amount and require coverages in excess of
25% to be reinsured through another licensed mortgage insurer.
The National Association of Insurance Commissioners ("NAIC") adopted a
risk-based capital ("RBC") formula designed to help regulators identify
property/casualty insurers in need of additional capital. The RBC formula
establishes minimum capital needs based upon risks applicable to individual
insurers, including asset risks, off-balance sheet risks (such as guarantees for
affiliates and contingent liabilities), and credit risks (such as reinsurance
ceded and receivables). The NAIC and the Illinois Department of Insurance
currently do not require mortgage guaranty insurers to file RBC analysis in
their annual statements.
As the dominant purchasers and sellers of conventional mortgage loans and
beneficiaries of private mortgage guaranty insurance, Freddie Mac and Fannie Mae
impose requirements on private mortgage insurers in order for such insurers to
be eligible to insure loans sold to such agencies. Freddie Mac's current
eligibility requirements impose limitations on the types of risk insured,
standards for geographic and customer diversification of risk, procedures for
claims handling, acceptable underwriting practices, and financial requirements
which generally mirror state insurance regulatory requirements. These
requirements are subject to change from time to time. Freddie Mac most recently
modified its eligibility guidelines in June 2000. The new guidelines include
financial requirements for captive reinsurance transactions in general and
additional financial requirements for captive arrangements that permit premium
cessions greater than 25%. Fannie Mae also has eligibility requirements,
although such requirements are not published. Triad is an approved mortgage
33
insurer for both Freddie Mac and Fannie Mae and meets all eligibility
requirements. There can be no assurance, however, that such requirements or the
interpretation of the requirements will not change or that Triad will continue
to meet such requirements. In addition, to the extent Fannie Mae or Freddie Mac
assumes default risk for itself that would otherwise be insured, changes current
guarantee fee arrangements, allows alternative credit enhancements, alters or
liberalizes underwriting guidelines on low down payment mortgages it purchases,
or otherwise changes its business practices or processes with respect to such
mortgages, private mortgage insurers may be affected. Triad could be
particularly adversely affected if changes in eligibility requirements regarding
captive arrangements that permit premium cessions greater than 25% were to
impede Triad's ability to offer this form of captive reinsurance.
Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac both
accept reduced mortgage insurance coverage from lenders that deliver loans
approved by the GSEs' automated underwriting services, Desktop Underwriter and
Loan Prospector, respectively. Generally, Fannie Mae's and Freddie Mac's reduced
mortgage insurance coverage options provide for: (i) across-the-board reductions
in required MI coverage on 30-year fixed-rate loans recommended for approval by
the GSEs' automated underwriting services to the levels in effect in 1994; (ii)
reduction in required MI coverage for loans with only a 5% down payment (a 95%
LTV) from 30% to 25% of the mortgage loan covered by MI; and, (iii) reduction in
required MI coverage for loans with a 10% down payment (a 90% LTV loan) from 25%
to 17% of the mortgage loan covered by MI. In addition, the GSEs have
implemented other programs that further reduce MI coverage upon the payment of
an additional fee by the lender. Under this option, a 95% LTV loan will require
18% of the mortgage loan to have mortgage insurance coverage. Similarly, a 90%
LTV loan will require 12% of the mortgage loan to have mortgage insurance. In
order for the homebuyer to have MI at these levels, such loans would require a
payment at closing or a higher note rate.
Certain national mortgage lenders and a large segment of the mortgage
securitization market, including Fannie Mae and Freddie Mac, generally will not
purchase mortgages or mortgage-backed securities unless the private mortgage
insurance on the mortgages has been issued by an insurer with a financial
strength rating of at least "AA-" from S&P or Fitch or a rating of at least
"Aa3" from Moody's. Fannie Mae and Freddie Mac require mortgage guaranty
insurers to maintain two ratings of "AA-" or better. Triad has a financial
strength rating of "AA" from S&P and Fitch and a rating of "Aa3" from Moody's.
S&P, Fitch, and Moody's include Triad's consolidated operations and financial
position in determining the rating. There can be no assurance that Triad's
rating, the method by which this rating is determined, or the eligibility
requirements of Fannie Mae and Freddie Mac will not change.
The Real Estate Settlement and Procedures Act of 1974 ("RESPA") applies to
most residential mortgages insured by Triad, and related regulations provide
that the provision of services involving mortgage insurance is a "settlement
34
service" for purposes of loans subject to RESPA. Subject to limited exceptions,
RESPA prohibits persons from accepting anything of value for referring real
estate settlement services to any provider of such services. Although many
states prohibit mortgage insurers from giving rebates, RESPA has been
interpreted to cover many non-fee services as well.
Various lawsuits filed in US district court in Augusta, Georgia as well as
other jurisdictions against each of the national mortgage insurers, including
the Company, assert that defendant mortgage insurers have violated RESPA
guidelines by offering pool insurance, captive reinsurance, contract
underwriting, and other services at preferential below market prices as an
illegal inducement to persuade lenders to use those mortgage insurers for
primary insurance coverage. The lawsuits seek class action status. Three
mortgage insurers have entered into settlements of the lawsuits. In August 2000,
Triad filed a motion for summary judgement in the case which was granted on
February 13, 2001. The summary judgement was overturned by the 11th Circuit
Court of Appeals in January 2002. In overturning the judgement, the court
addressed the applicability of the McCarron-Ferguson Act (regarding federal
preemption of state law) to the case; it did not address the merits of the case.
The Company believes the reversal was based on factual error and a motion for
rehearing has been filed. Triad believes that its products and services comply
with RESPA as well as all other applicable laws and regulations. While the
ultimate outcome of the RESPA litigation is uncertain, the litigation is not
expected to have a material adverse affect on the financial position of the
Company.
Most originators of mortgage loans are required to collect and report data
relating to a mortgage loan applicant's race, nationality, gender, marital
status, and census tract to HUD or the Federal Reserve under the Home Mortgage
Disclosure Act of 1975 ("HMDA"). The purpose of HMDA is to detect possible
discrimination in home lending and, through disclosure, to discourage such
discrimination. Mortgage insurers are not required pursuant to any law or
regulation to report HMDA data, although under the laws of several states
mortgage insurers are currently prohibited from discriminating on the basis of
certain classifications. The active mortgage insurers, through their trade
association, the Mortgage Insurance Companies of America ("MICA"), have entered
into an agreement with the Federal Financial Institutions Examinations Council
("FFIEC") to report the same data on loans submitted for insurance as is
required for most mortgage lenders under HMDA.
Upon request by an insured, Triad must cancel the mortgage insurance for a
mortgage loan. Fannie Mae and Freddie Mac guidelines, as well as several
existing and proposed state statutes, contain various provisions which give
borrowers the right to request cancellation of borrower-paid mortgage insurance
when specified conditions are met.
The Homeowners Protection Act of 1998, effective July 29, 1999, provides
for certain termination and cancellation requirements for borrower-paid mortgage
insurance and requires mortgage lenders to periodically update borrowers about
their private mortgage insurance. Under the legislation, borrowers may generally
35
request termination of mortgage insurance once the LTV reaches 80%, provided
that certain conditions are met. The legislation further requires lenders to
automatically cancel borrower-paid private mortgage insurance when home equity
reaches 78% if certain conditions are met. The legislation also requires lenders
to notify borrowers that they have private mortgage insurance and requires
certain disclosures to borrowers of their rights under the law. Because most
mortgage borrowers who obtain private mortgage insurance do not achieve 20%
equity in their homes before the homes are sold or the mortgages refinanced, the
Company has not lost and does not expect to lose a significant amount of its
insurance in force due to the enactment of this legislation.
INDIRECT REGULATION
The Company, Triad, and Triad's subsidiaries are also indirectly, but
significantly, impacted by regulations affecting purchasers of mortgage loans,
such as Freddie Mac and Fannie Mae, and regulations affecting governmental
insurers, such as the FHA and the Department of Veterans Affairs ("VA"), as well
as lenders. Private mortgage insurers, including Triad, are highly dependent
upon federal housing legislation and other laws and regulations which affect the
demand for private mortgage insurance and the housing market generally. For
example, housing legislation enacted in 1992 permits up to 100% of borrower
closing costs to be financed by loans insured by FHA, a significant increase
from the previous 57% limit. Also, in April 1994, HUD reduced the initial
premium (payable at loan origination) for FHA insurance from 3.0% to 2.25%. FHA
loan limits are adjusted in response to changes in the Freddie Mac/Fannie Mae
conforming loan limits. Currently, the maximum individual loan amount that the
FHA can insure is $261,609. The maximum individual loan amount the VA can insure
presently is $203,000. The maximum loan amounts that the FHA and VA can insure
are subject to adjustment and may increase in the future. Any future legislation
that increases the number of persons eligible for FHA or VA mortgages could have
an adverse effect on Triad's ability to compete with the FHA or VA.
Pursuant to the Financial Institutions Reform, Recovery, and Enforcement
Act of 1989 ("FIRREA"), the Office of Thrift Supervision ("OTS") issued
risk-based capital rules for savings institutions. These rules establish a lower
capital requirement for a low down payment loan that is insured with private
mortgage insurance, as opposed to remaining uninsured. Furthermore, the
guidelines for real estate lending policies applicable to savings institutions
and commercial banks provide that such institutions should require appropriate
credit enhancement in the form of either mortgage insurance or readily
marketable collateral for any high LTV mortgage. To the extent FIRREA's
risk-based capital rules or the guidelines for real estate lending policies
applicable to savings institutions and commercial banks are changed in the
future, some of the benefits of FIRREA and the guidelines for real estate
lending policies to the mortgage insurance industry, including Triad, may be
curtailed or eliminated.
In July 2001, the Office of Federal Housing Enterprise Oversight (OFHEO)
released its initial risk-based capital rules for Fannie Mae and Freddie Mac.
The regulation provided a more preferential capital credit for insurance from a
"AAA" rated private mortgage insurer than for insurance from a "AA" rated
private mortgage insurer. In December 2001, OFHEO announced proposed revisions
36
to the risk-based capital rules for Fannie Mae and Freddie Mac. Among the
proposed revisions, the new rule reduced, but did not eliminate, the capital
charge differential between insurance from a "AAA" rated private mortgage
insurer and insurance from a "AA" rated private mortgage insurer. In addition,
the proposed phase-in period was extended from five years to ten years. The rule
was finalized in February 2002 and became effective in March. The continued
presence of a capital charge differential could adversely affect Triad. Triad is
evaluating various business approaches and options available to address the
capital differential contained in the rule. What response, if any, Triad makes
and the ultimate impact of the regulation on Triad is unknown at this time.
Fannie Mae and Freddie Mac each provide their own automated underwriting
system to be used by mortgage originators selling mortgages to them. These
systems, which are provided by Triad as a service to the Company's contract
underwriting customers, streamline the mortgage process and reduce costs. The
increased acceptance of these products is driving the automation of the process
by which mortgage originators sell loans to Fannie Mae and Freddie Mac, a trend
which is expected to continue. As a result, Fannie Mae and Freddie Mac could
develop the capability to become the decision maker regarding selection of a
private mortgage insurer for loans sold to them, a decision traditionally made
by the mortgage originator. The Company, however, is not aware of any plans to
do so. The concentration of purchasing power that would be attained if such
development in fact occurred could adversely affect, from the Company's
perspective, the terms on which mortgage insurance is written on loans sold to
Fannie Mae and Freddie Mac.
Additionally, proposals have been advanced which would allow Fannie Mae and
Freddie Mac additional flexibility in determining the amount and nature of
alternative recourse arrangements or other credit enhancements which they could
utilize as substitutes for private mortgage insurance. The Company cannot
predict if or when any of the foregoing legislation or proposals will be
adopted, but if adopted and depending upon the nature and extent of revisions
made, demand for private mortgage insurance may be adversely affected. There can
be no assurance that other federal laws affecting such institutions and entities
will not change, or that new legislation or regulation will not be adopted.
In 1996, the Office of the Comptroller of the Currency ("OCC") granted
permission to national banks to have a reinsurance company as a wholly-owned
operating subsidiary for the purpose of reinsuring mortgage insurance written on
loans originated, purchased, or serviced by such banks. Several subsequent
applications by banks to offer reinsurance have been approved by the OCC
including at least one request to engage in quota share reinsurance. The OTS,
which regulates thrifts and savings institutions, has approved applications for
such captive arrangements as well. The reinsurance subsidiaries of national
banks or savings institutions could become significant competitors of the
Company in the future.
In November 1999, the Gramm-Leach-Bliley Act, also known as the Financial
Services Modernization Act of 1999, became effective and allows holding
companies of banks also to own a company that underwrites insurance. As a result
37
of this Act, banking organizations that previously were not allowed to be
affiliated with insurance companies may now do so. Management does not know to
what extent this expanded opportunity for banks will be utilized or how it will
affect the mortgage insurance industry. However, the evolution of federal law
making it easier for banks to engage in the mortgage guaranty business through
affiliates may subject mortgage guaranty insurers to more intense competition
and risk-sharing with bank lender customers.
38
EMPLOYEES
As of December 31, 2001, the Company employed 209 persons. Employees are
not covered by any collective bargaining agreement. The Company considers its
employee relations to be satisfactory.
EXECUTIVE OFFICERS
The executive officers of the Company are as follows:
Name Position Age
- ---- -------- ---
William T. Ratliff, III Chairman of the Board of 48
the Company and Triad
Darryl W. Thompson President, Chief Executive 61
Officer, and Director of the
Company and Triad
Ron D. Kessinger Executive Vice President and 47
Chief Financial Officer of the
Company and Triad
Henry B. Freeman Senior Vice President of Triad 52
Earl F. Wall Senior Vice President, Secretary, 44
and General Counsel of the
Company and Triad
Michael R. Oswalt Senior Vice President, Treasurer, 40
and Principal Accounting Officer
of the Company and Triad
39
WILLIAM T. RATLIFF, III has been the Chairman of the Board of the Company
since 1993. Mr. Ratliff has also been Chairman of the Board of Triad since 1989,
President of CIC since 1990 and was President and General Partner of CML from
1987 to 1995. Since 1995, he has served as President of Collat, Inc., CML's
corporate general partner. Mr. Ratliff has been Chairman of New South Federal
Savings Bank ("New South") since 1986 and President and Director of New South
Bancshares, Inc., New South's parent company, since 1994. From March 1994, until
December 1996, Mr. Ratliff served as President of Southwide Life Insurance
Corp., of which he had been Executive Vice President since 1993. Mr. Ratliff
joined CML in 1981 after completing his doctoral degree with a study of planning
processes in an insurance company. Previously, he trained and worked as an
educator, counselor, and organizational consultant.
DARRYL W. THOMPSON has been the President, Chief Executive Officer and a
Director of the Company since 1993. Mr. Thompson has also been President, Chief
Executive Officer, and a Director of Triad since its inception in 1987. From
1986 to 1989, Mr. Thompson also served as President and Chief Executive Officer
of Triad Life Insurance Company, which sold mortgage insurance products. From
1976 to 1985, Mr. Thompson served as Senior Vice President/Southeast Division
Manager of MGIC. Mr. Thompson joined MGIC in 1972.
RON D. KESSINGER has been Executive Vice President and Chief Financial
Officer of the Company since December 1999. Mr. Kessinger has been Chief
Financial Officer of Triad since November 1999 and Executive Vice President of
Insurance Operations of Triad since June 1996. Mr. Kessinger was Vice President
of Claims and Administration of Triad from January 1991 to June 1996. From 1985
to 1991, Mr. Kessinger was employed by Integon Mortgage Guaranty Insurance
Corporation, most recently serving as Vice President of Operations. Prior to
joining Integon Mortgage Guaranty Insurance Corporation, Mr. Kessinger was
employed by the parent company of Integon Mortgage Guaranty Insurance
Corporation.
HENRY B. FREEMAN has been Senior Vice President of Risk Management of Triad
since January 1999, and was a Vice President from 1987 till 1999. From 1981 to
1987, Mr. Freeman was employed by Home Guaranty Insurance Corporation, where he
was Vice President of Underwriting and Claims from 1982 to 1985 and Vice
President of Risk Management from 1985 to 1987.
40
EARL F. WALL has been Senior Vice President of Triad since November 1999,
General Counsel of Triad since January 1996, and Secretary since June 1996. Mr.
Wall was Vice President of Triad from 1996 till 1999. Mr. Wall has been Senior
Vice President of the Company since December 1999, and Secretary and General
Counsel of the Company since September 1996. Mr. Wall was Vice President of the
Company from 1996 to 1999. From 1982 to 1995, Mr. Wall was employed by Integon
in a number of capacities including Vice President, Associate General Counsel,
and Director of Integon Life Insurance Corporation and Georgia International
Life Insurance Corporation, Vice President, and General Counsel of Integon
Mortgage Guaranty Insurance Corporation, and Vice President, General Counsel,
and Director of Marketing One, Inc.
MICHAEL R. OSWALt has been Senior Vice President and Treasurer of the
Company since December 1999. Mr. Oswalt has been a Senior Vice President and
Treasurer of Triad since November 1999. Mr. Oswalt was Controller of the Company
from March 1994 to October 2001 and he was Controller of Triad from June 1996 to
October 2001. Mr. Oswalt was Vice President of the Company and Triad from
December 1994 to December 1999. Mr. Oswalt previously served as Vice President
and Controller of CIC and Southwide Life Insurance Corp. from February 1994,
until June 1996. From January 1993, to February 1994, Mr. Oswalt was employed by
Complete Health Services, Inc. where he performed internal audit services. From
1991 to 1993, Mr. Oswalt was employed by Arthur Andersen & Co. Prior to joining
Arthur Andersen & Co., Mr. Oswalt was employed by Deloitte & Touche from 1988 to
1991. Mr. Oswalt is a certified public accountant.
Officers of the Company serve at the discretion of the Board of Directors
of the Company.
ITEM 2. PROPERTIES.
- ------- -----------
As of December 31, 2001, the Company leases office space in its
Winston-Salem headquarters and its eleven underwriting offices located
throughout the country comprising approximately 56,000 square feet under leases
expiring between 2002 and 2008 and which require annual lease payments of
approximately $1.2 million in 2002. With respect to all facilities, the Company
has, or believes it will be able to obtain, lease renewals on satisfactory
terms. The Company believes its existing properties are well utilized and are
suitable and adequate for its present circumstances.
The Company maintains mid-range and micro-computer systems from its
corporate data center located in its headquarters building to support its data
processing requirements for accounting, claims, marketing, risk management, and
underwriting. The Company has in place back-up procedures in the event of
emergency situations.
41
ITEM 3. LEGAL PROCEEDINGS.
- ------- ------------------
The Company is involved in litigation in the ordinary course of business.
No pending litigation is expected to have a material adverse affect on the
financial position of the Company.
Triad is a defendant in Patton v. Triad. This action was commenced on June
30, 2000 with the filing of a complaint in Federal District Court for the
Southern District of Georgia seeking class action status on behalf of a
nationwide class of home mortgage borrowers. The complaint alleges that Triad
violated the Real Estate Settlement Procedures Act ("RESPA") by entering into
transactions with lenders (including captive mortgage reinsurance and contract
underwriting) that were not properly priced, in return for the referral of
mortgage insurance. In August 2000, Triad filed a motion for summary judgement
in the case which was granted on February 13, 2001. The summary judgement was
overturned by the 11th Circuit Court of Appeals in January 2002. In overturning
the judgement, the court addressed the applicability of the McCarron-Ferguson
Act (regarding federal preemption of state law) to the case; it did not address
the merits of the case. The Company believes the reversal was based on factual
error and a motion for rehearing has been filed. While the ultimate outcome of
the RESPA litigation is uncertain, the litigation is not expected to have a
material adverse affect on the financial position of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
- ------- ----------------------------------------------------
None.
42
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
- ------- AND RELATED STOCKHOLDER MATTERS.
--------------------------------
The Company's Common Stock trades on The Nasdaq Stock Market(R) under the
symbol "TGIC." At December 31, 2001, 13,691,672 shares were issued and
outstanding. The following table sets forth the highest and lowest closing
prices of the Company's Common Stock, $0.01 par value, as reported by Nasdaq
during the periods indicated.
2001 2000
---- ----
High Low High Low
---- --- ---- ---
First Quarter......... $35.438 $26.688 $22.625 $14.875
Second Quarter........ $40.000 $30.125 $23.438 $18.250
Third Quarter......... $39.750 $29.650 $29.750 $21.500
Fourth Quarter ....... $36.530 $30.400 $34.250 $26.250
As of March 12, 2002, the number of stockholders of record of Company
Common Stock was approximately 400. In addition, there were an estimated 3,400
beneficial owners of shares held by brokers and fiduciaries.
Payments of future dividends are subject to declaration by the Company's
Board of Directors. The dividend policy is dependent also on the ability of
Triad to pay dividends to the Company. Because of regulatory dividend
restrictions by the Illinois Department of Insurance and Triad's need to
maintain capital levels required by rating agencies, the Company has no present
intention to pay dividends.
43
ITEM 6. SELECTED FINANCIAL DATA.
- ------- ------------------------
Year Ended December 31
---------------------------------------------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Income Statement Data (for period ended): (Dollars in thousands, except per share amounts)
Premiums written:
Direct.................................. $ 95,551 $ 76,867 $ 65,381 $ 52,974 $ 40,083
Assumed..................................... 4 8 11 13 20
Ceded....................................... (10,557) (4,993) (1,665) (1,090) (1,772)
----------- ----------- ----------- ----------- -----------
$ 84,998 $ 71,882 $ 63,727 $ 51,897 $ 38,331
=========== =========== =========== =========== ===========
Earned premiums.................................. $ 84,356 $ 71,843 $ 63,970 $ 52,822 $ 38,522
Net investment income............................ 14,765 12,645 10,546 9,289 6,234
Realized investments gains ...................... 297 286 1,153 880 34
Other income..................................... 1,892 37 13 14 8
----------- ----------- ----------- ----------- -----------
Total revenues.............................. 101,310 84,811 75,682 63,005 44,798
Net losses and loss adjustment expenses.......... 9,019 7,587 7,111 7,009 5,177
Interest expense on debt......................... 2,771 2,770 2,780 2,554 --
Amortization of deferred policy acquisition cost. 11,712 8,211 6,955 5,955 4,120
Other operating expenses (net of acquisition
cost deferred)........................... 18,136 16,008 15,061 12,435 10,257
----------- ----------- ----------- ----------- -----------
Income before income taxes....................... 59,672 50,235 43,775 35,052 25,244
Income taxes..................................... 18,413 15,237 13,365 10,678 8,002
----------- ----------- ----------- ----------- -----------
Net income....................................... $ 41,259 $ 34,998 $ 30,410 $ 24,374 $ 17,242
=========== =========== =========== =========== ===========
Basic earnings per share ................... $ 3.05 $ 2.63 $ 2.28 $ 1.83 $ 1.30
Diluted earnings per share ................. $ 2.95 $ 2.55 $ 2.23 $ 1.76 $ 1.26
----------- ----------- ----------- ----------- -----------
Weighted average common and common share
equivalents outstanding
Basic .................................. 13,545,725 13,321,901 13,312,104 13,342,749 13,291,160
Diluted................................. 13,977,435 13,726,088 13,640,716 13,843,382 13,713,538
Balance Sheet Data (at year end):
Total assets (1)............................ $ 396,455 $ 328,377 $ 263,141 $ 230,512 $ 155,272
Total invested assets....................... $ 277,200 $ 232,025 $ 191,564 $ 177,301 $ 119,877
Losses and loss adjustment expenses......... $ 17,991 $ 14,987 $ 14,751 $ 12,143 $ 8,960
Unearned premiums........................... $ 7,650 $ 6,933 $ 6,831 $ 7,055 $ 7,988
Long-term debt ............................. $ 34,473 $ 34,467 $ 34,462 $ 34,457 $ --
Stockholders' equity........................ $ 246,070 $ 199,831 $ 157,072 $ 137,531 $ 111,781
Statutory Ratios (2):
Loss ratio.................................. 10.7% 10.6% 11.1% 13.3% 14.2%
Expense ratio............................... 39.9% 37.4% 40.5% 42.3% 42.5%
----------- ----------- ----------- ----------- -----------
Combined ratio.............................. 50.6% 48.0% 51.6% 55.6% 56.7%
=========== =========== =========== =========== ===========
GAAP Ratios:
Loss ratio.................................. 10.7% 10.6% 11.1% 13.3% 13.4%
Expense ratio............................... 35.1% 33.7% 34.5% 35.4% 37.5%
----------- ----------- ----------- ----------- -----------
Combined ratio.............................. 45.8% 44.3% 45.6% 48.7% 50.9%
=========== =========== =========== =========== ===========
Other Statutory Data (dollars in millions) (2):
Direct insurance in force................... $ 21,726.0 $ 15,123.5 $ 13,038.0 $ 11,256.6 $ 9,176.7
Direct risk in force (gross)................ $ 4,581.5 $ 3,760.0 $ 3,222.5 $ 2,777.4 $ 2,231.4
Risk-to-capital............................. 15.0:1 14.8:1 15.4:1 16.2:1 19.3:1
- ----------------
<FN>
(1) Periods prior to 1999 have been restated to reflect reclassification of Tax and Loss bonds.
(2) Based on statutory accounting practices and derived from consolidated statutory financial statements of Triad.
</FN>
44
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------ FINANCIAL CONDITION AND RESULTS OF OPERATION
--------------------------------------------
RESULTS OF OPERATIONS
2001 COMPARED TO 2000
Net income for 2001 increased 17.9% to $41.3 million from $35.0 million in
2000. This improvement was led by a 17.4% increase in earned premiums and a
16.8% increase in net investment income. Net income for 2001 also included the
receipt of a nonrecurring payment of approximately $1.9 million related to the
voluntary cancellation of an excess of loss reinsurance contract. The payment
was reported as other income in the first quarter of 2001.
Net income per share on a diluted basis increased 15.8% to $2.95 for 2001
from $2.55 per share for 2000. Operating earnings per share were $2.94 for 2001
compared to $2.54 for 2000, an increase of 15.8%. Operating earnings per share
exclude approximately $297,000 of net realized investment gains in 2001 and
$286,000 in 2000. Operating earnings in 2001 include approximately $0.09 per
share related to the nonrecurring payment.
Insurance written for 2001 was $13.3 billion compared to $4.4 billion in
2000, an increase of 199%. Insurance written for the fourth quarter of 2001
increased 254% to $4.8 billion from $1.3 billion in the fourth quarter of 2000.
Traditional flow production was $8.5 billion in 2001 compared to $4.4 billion in
2000, an increase of 92.6%. For the fourth quarter, traditional flow production
in 2001 increased 115% to $2.9 billion from $1.3 billion in 2000. The increase
in insurance written from traditional flow production was driven primarily by
new and expanding relationships with national lenders, strong demand for
risk-sharing arrangements, and a lower interest rate environment which increased
refinance activity and overall mortgage origination activity.
Insurance written for 2001 also included approximately $4.7 billion ($1.9
billion in the fourth quarter) attributable to structured bulk transactions. For
the comparable periods of 2000, there was no insurance written attributable to
these transactions. Structured bulk transactions involve insuring a group of
loans where the insured loans have individual loan level coverage and frequently
include an aggregate stop-loss limit applied to the entire group of insured
loans. The bulk market can be divided into three broad segments: the Prime
segment (fully underwritten loans, high credit scores, low LTVs), the
Alternative - A segment (generally high credit score, low LTV loans that have
been underwritten with reduced documentation), and the Sub-prime segment (higher
risk loans with lower credit scores). The Company does not participate in the
Sub-prime segment of the market.
Consolidation within the mortgage origination industry and Triad's
continued focus on national lenders has resulted in a greater percentage of
production volume being concentrated among a smaller customer base. The loss of
one or more of these significant customers could have a significant adverse
effect on the Company's business. However, to date, the Company's market share
45
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------ FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
-----------------------------------------------------------
has continued to increase. According to industry data, Triad's national market
share of net new primary insurance written increased to 3.6% for all of 2001
(4.0% for the fourth quarter) from 2.7% for all of 2000. Net new primary
insurance written excludes insurance placed upon loans more than 12 months after
loan origination, insurance placed upon loans already covered by primary
mortgage insurance, and insurance placed upon loans where lender exposure is
effectively reduced below defined minimums. This treatment is consistent with
the new definitions adopted by the Company and the industry in the third quarter
of 2001 regarding the computation of new insurance written for market share
purposes. The Company's market share reported for 2000 did not include any bulk
transactions, as the Company wrote no new insurance in 2000 attributable to
these transactions. Total direct insurance in force reached $21.7 billion at
December 31, 2001, compared to $15.1 billion at December 31, 2000, an increase
of 43.7%.
Total direct premiums written were $95.6 million for 2001, an increase of
24.3% compared to $76.9 million for 2000. Net premiums written increased by
18.2% to $85.0 million in 2001 from $71.9 million for 2000. Earned premiums
increased 17.4% to $84.4 million for 2001 from $71.8 million for 2000. This
growth in written and earned premium resulted from record levels of insurance
written offset by the impact of a declining persistency rate due to a high level
of mortgage refinancings.
Growth in direct premiums written was partially offset by an increase in
ceded premiums written. Driven primarily by increases in risk-sharing
arrangements and also by excess of loss reinsurance, ceded premiums written
increased 111% to $10.6 million from $5.0 million in 2000. The Company's premium
cede rate (the ratio of ceded premiums written to direct premiums written) was
11.0% for 2001 compared to 6.5% for 2000. Approximately 37.3% of insurance
written (57.9% excluding bulk transactions) during 2001 is subject to captive
mortgage reinsurance and other risk-sharing arrangements compared to 42.9% of
insurance written in 2000. Management anticipates ceded premiums will continue
to increase as a result of the expected increase in risk-sharing programs.
Refinance activity was 35.8% (43.3% in the fourth quarter) of insurance
written in 2001 compared to 13.2% (15.2% in the fourth quarter) in 2000.
Persistency, or the amount of insurance in force remaining from one-year prior,
was 67.6% at December 31, 2001, compared to 82.6% at December 31, 2000. The
increase in refinance activity and the decrease in persistency are reflective of
the current low interest rate environment.
Net investment income for 2001 was $14.8 million, a 16.8% increase over
$12.6 million in 2000. This increase is the result of growth in the average
balance of invested assets by $40.5 million to $252.5 million for the year ended
December 31, 2001, from $212.0 million for 2000. The growth in invested assets
46
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------ FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
-----------------------------------------------------------
is attributable to normal operating cash flow. The pre-tax yield on average
invested assets decreased to 5.8% for 2001 as compared to 6.0% for all of 2000,
reflecting the current low interest rate environment. The portfolio's
tax-equivalent yield was 8.0% for 2001 versus 8.2% for 2000. Based on fair
value, approximately 72% of the Company's fixed maturity portfolio at December
31, 2001, was composed of state and municipal tax-preferred securities as
compared to approximately 70% at December 31, 2000. At December 31, 2001, based
on fair value, approximately 93% of the Company's fixed maturity portfolio was
either a U.S. government or U.S. agency obligation or was rated investment grade
by at least one nationally recognized securities rating organization compared to
approximately 92% of the Company's fixed maturity portfolio at December 31,
2000.
In the first quarter of 2001, the Company recognized a nonrecurring
incentive payment of approximately $1.9 million related to voluntary
cancellation of an excess of loss reinsurance contract maintained by the Company
with a non-affiliated reinsurer. This payment was accounted for as other income.
The Company also established excess of loss reinsurance coverage through a
separate third-party reinsurer in the first quarter of 2001 under terms similar
to the cancelled agreement.
Net losses and loss adjustment expenses (net of reinsurance recoveries)
increased by 18.9% in 2001 to $9.0 million from $7.6 million in 2000. This rise
reflects increased levels of insurance in force. The Company's loss ratio (the
ratio of net incurred losses to earned premiums) was 10.7% for 2001 compared to
10.6% for 2000. The loss ratio was 13.2% for the fourth quarter of 2001 compared
to 10.6% for the fourth quarter of 2000. As of December 31, 2001, there were no
incurred losses related to the Company's bulk business.
As of December 31, 2001, approximately 76% of the Company's insurance in
force was originated in the last 36 months. Management believes, based upon its
experience and industry data, that claims incidence for it and other private
mortgage insurers is generally highest in the third through sixth years after
loan origination. Although the claims experience on insurance written in
previous years has been quite favorable, management does not expect losses to
remain at the low levels currently reported. The Company expects its incurred
losses to increase as a greater amount of its insurance in force reaches its
anticipated highest claim frequency years. Furthermore, changes in the economic
environment could accelerate paid and incurred loss development. Due to the
inherent uncertainty of future premium levels, losses, economic conditions, and
other factors that affect earnings, it is impossible to predict with any degree
of certainty the impact of such higher claim frequencies on future earnings.
Amortization of deferred policy acquisition costs increased by 42.6% to
$11.7 million in 2001 from $8.2 million for 2000. The increase in amortization
reflects growth in deferred policy acquisition costs related to the expansion of
the Company's insurance in force and accelerated amortization due to higher
cancellations from refinance activity in 2001.
47
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------ FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
-----------------------------------------------------------
Other operating expenses increased 13.3% to $18.1 million for 2001 from
$16.0 million for 2000. This increase in expenses is primarily attributable to
personnel, technology amortization, and equipment costs required to support the
Company's product development, system enhancements, and expanded production. The
expense ratio (ratio of the amortization of deferred policy acquisition costs
and other operating expenses to net premiums written) for 2001 was 35.1%
compared to 33.7% for 2000.
The effective tax rate for 2001 was 30.9% compared to 30.3% in 2000. The
increase in the effective tax rate was due to a lower percentage of pre-tax
income being generated from tax-preferred securities as well as the recognition,
on a taxable basis, of previously deferred income. Management expects the
Company's effective tax rate to remain at about the same annual rate as long as
yields from new funds invested in tax-preferred securities remain favorable in
relation to fully taxable securities.
2000 COMPARED TO 1999
Net income for 2000 increased 15.1% to $35.0 million from $30.4 million in
1999. This improvement was attributable primarily to a 12.3% increase in earned
premiums, a 19.9% increase in net investment income, and an improved combined
loss and expense ratio for all of 2000.
Net income per share on a diluted basis increased 14.4% to $2.55 for 2000
from $2.23 per share for 1999. Included in 2000 earnings per share is $0.01 per
share of net realized investment gains compared to $0.06 per share in 1999.
Operating earnings per share, which exclude net realized investment gains, were
$2.54 for 2000 compared to $2.17 for 1999, an increase of 16.6%.
Insurance written was $4.4 billion for 2000, an increase of less than 1%
from 1999 levels. For the fourth quarter, insurance written increased 50.8% to
$1.3 billion in 2000 from $892 million in 1999. For 2000, insurance written was
driven by expanded relationships with national lenders as well as innovative
product offerings. According to industry data, Triad's national market share of
net new primary insurance written, which excluded insurance placed upon loans
more than 12 months after loan origination, increased to 2.7% for all of 2000
(3.1% in the fourth quarter) from 2.3% for all of 1999. Total direct insurance
in force reached $15.1 billion at December 31, 2000, compared to $13.0 billion
at December 31, 1999, an increase of 16.0%.
Total direct premiums written were $76.9 million for 2000, an increase of
17.6% compared to $65.4 million for 1999. Net premiums written increased by
12.8% to $71.9 million in 2000 from $63.7 million for 1999. Earned premiums
increased 12.3% to $71.8 million for 2000 from $64.0 million for 1999. This
48
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------ FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
-----------------------------------------------------------
growth in written and earned premium resulted from both new insurance production
in 2000 and an improvement in the Company's persistency. The growth in direct
premiums written was offset somewhat by the increase in ceded premiums written.
Driven primarily by increases in risk-sharing arrangements and excess of loss
reinsurance, ceded premiums written for 2000 increased 200% to $5.0 million from
$1.7 million in 1999. Approximately 42.9% of insurance written in 2000 was
subject to captive mortgage reinsurance and similar arrangements compared to
22.9% in 1999.
Refinance activity was 13.2% (15.2% in the fourth quarter) of insurance
written in 2000 compared to 25.0% (11.5% in the fourth quarter) in 1999,
reflecting the continued rise in interest rates through the first six months of
the year. Persistency, or the amount of insurance in force remaining from
one-year prior, was 82.6% at December 31, 2000, compared to 77.1% at December
31, 1999.
Net investment income for 2000 was $12.6 million, a 19.9% increase over
$10.5 million in 1999. This increase in investment income was the result of
growth in the average book value of invested assets by $28.0 million to $212.0
million for the year ended December 31, 2000, from $184.0 million for 1999. The
growth in invested assets was attributable to normal operating cash flow. The
pre-tax yield on average invested assets increased to 6.0% for 2000 as compared
to 5.7% for all of 1999. The portfolio's tax-equivalent yield was 8.2% for 2000
versus 7.7% for 1999. Approximately 69% or $139.9 million of the Company's fixed
maturity portfolio at December 31, 2000, was composed of state and municipal
tax-preferred securities as compared to approximately 71% or $124.4 million at
December 31, 1999.
The Company realized net investment gains of approximately $286,000 during
2000 compared to $1.2 million in 1999. For the fourth quarter of 2000, the
Company realized net investment losses of approximately $1.4 million, which were
primarily attributable to a repositioning of the fixed maturity portfolio.
Net losses and loss adjustment expenses (net of reinsurance recoveries)
increased by 6.7% in 2000 to $7.6 million from $7.1 million in 1999. This
increase reflected the growing amount of the Company's insurance in force and
the resulting recognition of a greater amount of insurance in force reaching its
highest claim frequency years.
The Company's loss ratio was 10.6% for 2000 compared to 11.1% for 1999. The
loss ratio was 10.6% for the fourth quarter of 2000 compared to 7.8% for the
fourth quarter of 1999. The Company's favorable loss ratio reflected the low
level of delinquencies compared to the number of insured loans and the fact that
approximately 75% (79% at year-end 1999) of the Company's insurance in force was
originated in the prior 36 months.
Amortization of deferred policy acquisition costs increased by 18.1% to
$8.2 million in 2000 from $7.0 million for 1999. The increase in amortization
49
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------ FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
-----------------------------------------------------------
reflected a growing balance of deferred policy acquisition costs to amortize as
the Company continued to build its total insurance in force.
Other operating expenses increased 6.3% to $16.0 million for 2000 from
$15.1 million for the same period in 1999. This increase in expenses was
primarily attributable to advertising, personnel, and facilities and equipment
costs required to support the Company's product development, technology
enhancements, geographic expansion, and production. Amortization of the
Company's policy administration system began in December of 2000 and accounted
for approximately $129,000 of other operating expenses.
The expense ratio for 2000 was 33.7% compared to 34.5% for 1999.
Contributing to this improvement was the higher level of written premiums in
2000 partially offset by the increase in expenses.
The effective tax rate for 2000 was 30.3% compared to 30.5% in 1999. For
the fourth quarter of 2000, the effective tax rate was 29.6%. The lower fourth
quarter rate was primarily the result of a higher percentage of pre-tax income
being generated from tax-preferred securities.
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of operating funds consist primarily of premiums
written and investment income. Operating cash flow is applied primarily to the
payment of claims, interest, expenses, and taxes.
The Company generated positive cash flow from operating activities for 2001
of $43.8 million compared to $32.7 million for 2000. The increase in Triad's
operating cash flow reflects the growth in premiums and investment income,
nonrecurring income related to the cancellation of the excess of loss
reinsurance contract, the effects of tax benefits resulting from stock option
exercises, and a decrease in paid losses partially offset by the increase in
underwriting expenses.
The Company's business does not routinely require significant capital
expenditures other than for enhancements to its computer systems and technology
capabilities. Positive cash flows are invested pending future payments of claims
and expenses. Cash flow shortfalls, if any, could be funded through sales of
short-term investments and other investment portfolio securities.
The parent Company's cash flow is dependent on interest income and payments
from Triad including cash dividends, management fees, and interest payments
under surplus notes. The insurance laws of the State of Illinois impose certain
restrictions on dividends from Triad. These restrictions, based on statutory
50
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------ FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
-----------------------------------------------------------
accounting practices, include requirements that dividends may be paid only out
of statutory earned surplus and limit the amount of dividends that may be paid
without prior approval of the Illinois Insurance Department. The Illinois
Insurance Department permits expenses of the parent company to be reimbursed by
Triad in the form of management fees.
Consolidated invested assets were $277.2 million at December 31, 2001,
compared to $232.0 million at December 31, 2000. Fixed maturity securities and
equity securities classified as available-for-sale totaled $258.5 million at the
end of 2001. Net unrealized investment gains were $1.2 million on equity
securities and $323,000 on fixed maturity securities at December 31, 2001. Based
on fair value, the fixed maturity portfolio consisted of approximately 72%
municipal securities, 23% corporate securities, and 5% U.S. government
obligations at December 31, 2001.
Fixed maturity securities represented approximately 89% of the Company's
invested assets at December 31, 2001, and the fair value of these fixed rate
securities generally bears an inverse relationship to changes in prevailing
market interest rates. The Company's long-term debt bears interest at a fixed
rate of 7.9% per annum, and as a result, the fair value of this debt is
sensitive to changes in prevailing interest rates. A 10% relative increase or
decrease in market interest rates that affect the Company's financial
instruments would not have a material impact on earnings during the next fiscal
year, and would not materially affect the fair value of the Company's financial
instruments.
The Company's loss reserves increased to $18.0 million at December 31,
2001, compared to $15.0 million at December 31, 2000. Reserves are established
for reported insurance losses and loss adjustment expenses based on when notices
of default on insured mortgage loans are received. Reserves are also established
for estimated losses incurred on notices of default not yet reported by the
lender. Consistent with industry practices, the Company does not establish loss
reserves for future claims on insured loans which are not currently in default.
Reserves are established by management using estimated claim rates
(frequency) and claim amounts (severity) to estimate ultimate losses. Because
the estimate for loss reserves is sensitive to our estimates of claims frequency
and severity, we perform sensitivity analyses to test the reasonableness of the
best estimate generated by our loss reserve estimation process. These
sensitivity analyses allow us to use alternative assumptions related to claims
frequency and claims severity to develop a range of reasonably possible loss
reserve outcomes that we can use to challenge our best estimate. Our loss
reserve estimation process and our sensitivity analyses support the
reasonableness of our best estimate of loss reserves recorded as a liability in
our financial statements.
Management periodically reviews the loss reserve process in order to
improve its estimate of ultimate losses on loans currently in default.
Adjustments to reserve estimates are reflected in the financial statements in
51
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------ FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
-----------------------------------------------------------
the periods in which the adjustments are made. During the third quarter of 2001,
management refined its methodology for setting loss reserves. The enhancements
made to the reserving process incorporate a more multi-dimensional analytical
form that gives effect to current economic conditions and profiles delinquencies
by such factors as policy year, geography, and chronic late payment
characteristics in addition to profiling them by age. The growth in loss
reserves is the result of the increase in reported defaults and the maturing of
the Company's risk in force mitigated by favorable trends in the frequency and
severity of paid losses. The Company expects loss reserves will continue to
grow, reflecting changing economic conditions and the growth and aging of its
insurance in force. The Company's delinquency ratio, the ratio of delinquent
insured loans to total insured loans, was 0.89% at December 31, 2001, compared
to 0.60% at December 31, 2000. Net paid losses and loss adjustment expenses for
2001 were $6.0 million compared to $7.3 million for 2000, a decline of 18.0%. As
of December 31, 2001, there were no reported delinquencies or claims paid
related to the Company's bulk business.
Total stockholders' equity increased to $246.1 million at December 31,
2001, from $199.8 million at December 31, 2000. This increase resulted primarily
from net income of $41.3 million and from additional paid-in capital of $6.3
million resulting from the exercise of employee stock options and the related
tax benefit, offset somewhat by a decline in net unrealized gains on invested
assets classified as available-for-sale of $1.4 million (net of income tax).
Triad's total statutory policyholders' surplus increased to $105.5 million
at December 31, 2001, from $101.0 million at December 31, 2000. This increase
resulted primarily from statutory net income of $55.4 million, offset by
increases in the statutory contingency reserve of $43.0 million and the $2.6
million effect of adopting new statutory accounting principles that went into
effect on January 1, 2001. Triad's statutory earned surplus was $21.8 million at
December 31, 2001, compared to $17.3 million at December 31, 2000, reflecting,
primarily, growth in statutory net income greater than the increase in the
statutory contingency reserve and the impact of the new statutory accounting
principles. The balance in the statutory contingency reserve was $193.7 million
at December 31, 2001, compared to $150.8 million at December 31, 2000.
Triad's ability to write insurance depends on the maintenance of its
financial strength ratings and the adequacy of its capital in relation to risk
in force. A significant reduction of capital or a significant increase in risk
may impair Triad's ability to write additional insurance. A number of states
also generally limit Triad's risk-to-capital ratio to 25-to-1. As of December
31, 2001, Triad's risk-to-capital ratio was 15.0 -to-1 as compared to 14.8-to-1
at December 31, 2000, and 11.2-to-1 for the industry as a whole at December 31,
2000, the latest industry data available.
52
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------ FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
-----------------------------------------------------------
Triad is rated "AA" by both Standard & Poor's Ratings Services and Fitch
Ratings and "Aa3" by Moody's Investors Service.
In July 2001, the Office of Federal Housing Enterprise Oversight (OFHEO)
released its initial risk-based capital rules for Fannie Mae and Freddie Mac.
The regulation provided a more preferential capital credit for insurance from a
"AAA" rated private mortgage insurer than for insurance from a "AA" rated
private mortgage insurer. In December 2001, OFHEO announced proposed revisions
to the risk-based capital rules for Fannie Mae and Freddie Mac. Among the
proposed revisions, the new rule reduced, but did not eliminate, the capital
charge differential between insurance from a "AAA" rated private mortgage
insurer and insurance from a "AA" rated private mortgage insurer. In addition,
the proposed phase-in period was extended from five years to ten years. The rule
was finalized in February 2002 and became effective in March 2002. The continued
presence of a capital charge differential could adversely affect Triad. Triad is
evaluating various business approaches and options available to address the
capital differential contained in the rule. What response, if any, Triad makes
and the ultimate impact of the regulation on Triad is unknown at this time.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Management's Discussion and Analysis and this Report contain
forward-looking statements relating to future plans, expectations, and
performance which involve various risks and uncertainties, including but not
limited to the following: interest rates may increase from their current levels;
housing transactions and mortgage issuance may decrease for many reasons
including changes in interest rates or economic conditions; the Company's market
share may change as a result of changes in underwriting criteria or competitive
products or rates; the amount of insurance written could be affected by changes
in federal housing legislation, including changes in the Federal Housing
Administration loan limits and coverage requirements of Freddie Mac and Fannie
Mae; the Company's financial condition and competitive position could be
affected by legislation impacting the mortgage guaranty industry specifically
and the financial services industry in general; rating agencies may revise
methodologies for determining the Company's financial strength ratings and may
revise or withdraw the assigned ratings at any time; decreases in persistency,
which are affected by loan refinancings in periods of low interest rates, may
have an adverse effect on earnings; the amount of insurance written and the
growth of insurance in force or risk in force as well as the performance of the
Company may be adversely impacted by the competitive environment in the private
mortgage insurance industry, including the type, structure, and pricing of
products and services offered by the Company and its competitors; with
consolidation occurring among mortgage lenders and the Company's concentration
of insurance in force generated through relationships with significant lender
customers, the loss of a significant customer may have an adverse effect on
earnings; the Company's performance may be impacted by changes in the
performance of the financial markets and general economic conditions. Economic
53
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------ FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
-----------------------------------------------------------
downturns in regions where Triad's risk is more concentrated could have a
particularly adverse effect on Triad's financial condition and loss development.
The United States is in an economic downturn that could decrease demand for
mortgage insurance and cause loss experience to suffer.
New OFHEO risk-based capital rules for Fannie Mae and Freddie Mac could
severely limit the ability of Triad to compete with "AAA" rated private mortgage
insurers. The ultimate effect of the new rules on Triad and the mortgage
insurance industry in general is not known at this time and will not be known
until Fannie Mae and Freddie Mac determine their requirements under the rules.
Accordingly, actual results may differ from those set forth in the
forward-looking statements. Attention is also directed to other risk factors set
forth in documents filed by the Company with the Securities and Exchange
Commission.
54
ITEM 7 (A). QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISKS.
- ----------- ------------------------------------------------------------
The response to this item is submitted on page 51 of this report under the
section titled "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
- ------- --------------------------------------------
The Financial Statements and Supplementary Data are presented in a separate
section of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
- ------ ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
---------------------------------------------------
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
- -------- ---------------------------------------------------
Information regarding directors and nominees for directors of the Company
is included in the Company's Proxy Statement for the 2002 Annual Meeting of
Stockholders, and is hereby incorporated by reference.
For information regarding the executive officers of the Company, reference
is made to the section entitled "Executive Officers" in Part I, Item 1 of this
Report.
ITEM 11. EXECUTIVE COMPENSATION.
- -------- -----------------------
This information is included in the Company's Proxy Statement for the 2002
Annual Meeting of Stockholders, and is hereby incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
- -------- ---------------------------------------------------------------
This information is included in the Company's Proxy Statement for the 2002
Annual Meeting of Stockholders, and is hereby incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
- -------- -----------------------------------------------
This information is included in the Company's Proxy Statement for the 2002
Annual Meeting of Stockholders, and is hereby incorporated by reference.
55
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT
- ------- SCHEDULES, AND REPORTS ON FORM 8-K.
-----------------------------------
(a) (1) and (2) The response to this portion of Item 14 is submitted as a
separate section of this report.
(a) (3) Listing of Exhibits - The response to this portion of Item 14 is
submitted as a separate section of this report.
(b) Reports on Form 8-K.
No reports on form 8-K were filed during the quarter ended December
31, 2001.
(c) Exhibits - The response to this portion of Item 14 is submitted as a
separate section of this report.
(d) Financial Statement Schedules - The response to this portion of Item
14 is submitted as a separate section of this report.
56
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on the 21st day of
March, 2002.
By /s/ Darryl W. Thompson
-------------------------------------
Darryl W. Thompson
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on the 21st day of March, 2002 by the following
persons on behalf of the Registrant in the capacities indicated.
SIGNATURE TITLE
/s/ William T. Ratliff, III Chairman of the Board
-----------------------------------
William T. Ratliff, III
/s/ Darryl W. Thompson President, Chief Executive Officer,
----------------------------------- and Director
Darryl W. Thompson
/s/ Ron D. Kessinger Executive Vice President and Chief
----------------------------------- Financial Officer
Ron D. Kessinger
/s/ Michael R. Oswalt Senior Vice President, Treasurer,
----------------------------------- and Principal Accounting Officer
Michael R. Oswalt
/s/ David W. Whitehurst Director
-----------------------------------
David W. Whitehurst
/s/ Robert T. David Director
-----------------------------------
Robert T. David
/s/ Raymond H. Elliott Director
-----------------------------------
Raymond H. Elliott
57
ANNUAL REPORT ON FORM 10-K
ITEM 8, ITEM 14(a)(1) and (2), (3), (c), and (d)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
INDEX TO EXHIBITS
CONSOLIDATED FINANCIAL STATEMENTS
FINANCIAL STATEMENT SCHEDULES
CERTAIN EXHIBITS
YEAR ENDED DECEMBER 31, 2001
TRIAD GUARANTY INC.
WINSTON-SALEM, NORTH CAROLINA
58
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
(Item 14(a) 1 and 2)
CONSOLIDATED FINANCIAL STATEMENTS Page
--------------------------------- ----
Report of Independent Auditors................................... 62
Consolidated Balance Sheets at December 31, 2001 and 2000........ 63 - 64
Consolidated Statements of Income for each of the three
years in the period ended December 31, 2001.................. 65
Consolidated Statements of Changes in Stockholders' Equity
for each of the three years in the period ended
December 31, 2001............................................. 66
Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 2001................... 67
Notes to Consolidated Financial Statements....................... 68 - 86
FINANCIAL STATEMENT SCHEDULES
-----------------------------
Schedules at and for each of the three years in the period
ended December 31, 2001
Schedule I - Summary of Investments - Other Than Investments
in Related Parties.......................................... 87
Schedule II - Condensed Financial Information of Registrant... 88 - 92
Schedule IV - Reinsurance..................................... 93
All other schedules are omitted since the required information is not present or
is not present in amounts sufficient to require submission of the schedules, or
because the information required is included in the consolidated financial
statements and notes thereto.
59
Index To Exhibits
(Item 14(a) 3)
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------ ----------------------
3.1 Certificate of Incorporation of the Registrant, as amended (5)
(Exhibit 3.1)
3.2 By-Laws of the Registrant (1) (Exhibit 3(b))
4.1 Form of Common Stock certificate (1) (Exhibit 4(a))
4.2 Indenture Between Triad Guaranty Inc. and Banker's Trust Co.(6)
(Exhibit 4.2)
10.1 1993 Long-Term Stock Incentive Plan (1)(3) (Exhibit 10(a))
10.3 Agreement for Administrative Services among Triad Guaranty Insurance
Corporation and Collateral Investment Corp. and Collateral
Mortgage, Ltd. (1) (Exhibit 10(c))
10.4 Investment Advisory Agreement between Triad Guaranty Insurance
Corporation and Collateral Mortgage, Ltd. (1) (Exhibit 10(d))
10.6 Registration Agreement among the Registrant, Collateral Investment
Corp. and Collateral Mortgage, Ltd. (2) (Exhibit 10.6)
10.7 Employment Agreement between the Registrant and Darryl W. Thompson
(2)(3) (Exhibit 10.7)
10.10 Employment Agreement between the Registrant and Henry B. Freeman (2)
(3) (Exhibit 10.10)
10.11 Employment Agreement between the Registrant and Ron D. Kessinger (2)
(3) (Exhibit 10.11)
10.16 Economic Value Added Incentive Bonus Program (Senior Management)
(4) (Exhibit 10.16)
10.17 Amendment to Employment Agreement between the Registrant and
Darryl W. Thompson (3)(4) (Exhibit 10.17)
60
10.19 Amendment to Employment Agreement between the Registrant and
Henry B. Freeman (3)(4) (Exhibit 10.19)
10.20 Amendment to Employment Agreement between the Registrant and
Ron D. Kessinger (3)(4) (Exhibit 10.20)
10.21 Excess of Loss Reinsurance Agreement between Triad Guaranty
Insurance Corporation, Capital Mortgage Reinsurance Company, and
Federal Insurance Company. (7) (Exhibit 10.21)
10.22 Excess of Loss Reinsurance Agreement between Triad Guaranty
Insurance Corporation and Ace Capital Mortgage Reinsurance
Company. (8) (Exhibit 10.22)
21.1 Subsidiaries of the Registrant (7) (Exhibit 21.1)
23.1 Consent of Ernst & Young LLP (Exhibit 23.1)
- -----------------
* Filed Herewith.
(1) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the Registrant's Registration Statement on Form S-1 filed
October 22, 1993 and amendments thereto.
(2) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the 1993 Form 10-K.
(3) Denotes management contract or compensatory plan of arrangement required to
be filed as an exhibit to this report pursuant to Item 601 of Regulation
S-K.
(4) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the 1996 Form 10-K.
(5) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the June 30, 1997 Form 10-Q.
(6) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the 1997 Form 10-K.
(7) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the 1999 Form 10-K.
(8) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the 2000 Form 10-K.
61
Report of Independent Auditors
Board of Directors
Triad Guaranty Inc.
We have audited the accompanying consolidated balance sheets of Triad Guaranty
Inc. and subsidiaries as of December 31, 2001 and 2000, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 2001. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Triad Guaranty
Inc. and subsidiaries at December 31, 2001 and 2000, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States.
/s/ERNST & YOUNG LLP
Greensboro, North Carolina
January 17, 2002
62
Triad Guaranty Inc.
Consolidated Balance Sheets
December 31
2001 2000
---------------------------------
Assets
Invested assets:
Securities available-for-sale, at fair value:
Fixed maturities (amortized cost:
2001-$245,662,452; 2000-$201,780,191) $ 245,985,519 $ 203,924,652
Equity securities (cost: 2001-$11,308,230;
2000-$9,630,441) 12,476,030 11,088,525
Short-term investments 18,738,590 17,012,080
---------------------------------
277,200,139 232,025,257
Cash 853,341 1,512,578
Real estate 162,331 99,482
Accrued investment income 3,196,203 2,896,977
Deferred policy acquisition costs 25,943,676 22,815,422
Property and equipment, at cost less accumulated
depreciation (2001-$6,120,403; 2000-$3,867,336) 11,169,443 9,234,757
Prepaid federal income tax 62,619,166 49,374,666
Reinsurance recoverable 5,233 5,587
Other assets 15,305,627 10,411,877
---------------------------------
Total assets $ 396,455,159 $ 328,376,603
=================================
63
December 31
2001 2000
---------------------------------
Liabilities and stockholders' equity
Liabilities:
Losses and loss adjustment expenses $ 17,990,583 $ 14,986,988
Unearned premiums 7,649,994 6,933,259
Amounts payable to reinsurer 2,445,222 1,288,712
Current taxes payable 40,114 85,062
Deferred income taxes 74,773,407 60,651,647
Unearned ceding commission 2,323,922 1,481,691
Long-term debt 34,473,035 34,467,285
Accrued interest on debt 1,274,972 1,274,972
Accrued expenses and other liabilities 9,414,354 7,375,503
---------------------------------
Total liabilities 150,385,603 128,545,119
Commitments and contingencies (Notes 5, 7, and 14)
Stockholders' equity:
Preferred stock, par value $.01 per share -
authorized 1,000,000 shares, no shares
issued and outstanding - -
Common stock, par value $.01 per share -
authorized 32,000,000 shares, issued
and outstanding 13,691,672 shares at
December 31, 2001, and 13,351,694 at
December 31, 2000 136,917 133,517
Additional paid-in capital 69,057,458 62,723,667
Accumulated other comprehensive income,
net of income tax liability of $521,803
at December 31, 2001, and $1,262,863 at
December 31, 2000 974,811 2,351,065
Deferred compensation (117,167) (135,041)
Retained earnings 176,017,537 134,758,276
---------------------------------
Total stockholders' equity 246,069,556 199,831,484
---------------------------------
Total liabilities and stockholders' equity $ 396,455,159 $ 328,376,603
=================================
See accompanying notes.
64
Triad Guaranty Inc.
Consolidated Statements of Income
Year ended December 31
2001 2000 1999
------------------------------------------------
Revenue:
Premiums written:
Direct $ 95,550,936 $ 76,867,728 $ 65,380,631
Assumed 4,011 7,776 11,377
Ceded (10,556,497) (4,993,059) (1,665,179)
------------------------------------------------
Net premiums written 84,998,450 71,882,445 63,726,829
Change in unearned premiums (642,199) (39,355) 242,971
------------------------------------------------
Earned premiums 84,356,251 71,843,090 63,969,800
Net investment income 14,764,536 12,645,321 10,545,663
Net realized investment gains 296,974 285,849 1,153,191
Other income 1,892,142 36,785 13,039
------------------------------------------------
101,309,903 84,811,045 75,681,693
Losses and expenses:
Losses and loss adjustment expenses 9,019,907 7,562,228 7,121,002
Reinsurance recoveries (596) 25,009 (9,686)
------------------------------------------------
Net losses and loss adjustment expenses 9,019,311 7,587,237 7,111,316
Interest expense on debt 2,770,750 2,770,307 2,779,915
Amortization of deferred policy acquisition costs 11,711,737 8,210,776 6,955,273
Other operating expenses (net of acquisition costs
deferred) 18,136,351 16,008,210 15,060,376
------------------------------------------------
41,638,149 34,576,530 31,906,880
------------------------------------------------
Income before income taxes 59,671,754 50,234,515 43,774,813
Income taxes:
Current 186,790 14,996 24,166
Deferred 18,225,703 15,221,544 13,340,340
------------------------------------------------
18,412,493 15,236,540 13,364,506
------------------------------------------------
Net income $ 41,259,261 $ 34,997,975 $ 30,410,307
================================================
Earnings per common and common equivalent share:
Basic $ 3.05 $ 2.63 $ 2.28
Diluted $ 2.95 $ 2.55 $ 2.23
================================================
Shares used in computing earnings per common and
common equivalent share:
Basic 13,545,725 13,321,901 13,312,104
Diluted 13,977,435 13,726,088 13,640,716
================================================
See accompanying notes.
65
Triad Guaranty Inc.
Consolidated Statements of Changes in Stockholders' Equity
Accumulated
Additional Other
Common Paid-In Comprehensive Deferred Retained
Stock Capital Income Compensation Earnings Total
--------------------------------------------------------------------------------------
Balance at December 31, 1998 $ 134,089 $ 61,538,613 $ 3,907,920 $ $ 71,950,718 $ 137,531,340
Net income - - - - 30,410,307 30,410,307
Other comprehensive income - net of
tax:
Change in unrealized gain (loss) - - (8,631,695) - - (8,631,695)
------------
Comprehensive income 21,778,612
Issuance of 34,500 shares of common
stock under stock option plans 345 199,928 - - - 200,273
Tax effect of exercise of
non-qualified stock options - 129,706 - - - 129,706
Purchase and subsequent retirement of
146,000 shares of common stock (1,460) - - - (2,600,724) (2,602,184)
Issuance of 5,825 shares of
restricted stock 58 104,065 - (104,123) - -
Amortization of deferred
compensation - - - 34,709 - 34,709
---------------------------------------------------------------------------------------
Balance at December 31, 1999 133,032 61,972,312 (4,723,775) (69,414) 99,760,301 157,072,456
Net income - - - - 34,997,975 34,997,975
Other comprehensive income - net of
tax:
Change in unrealized gain (loss) - - 7,074,840 - - 7,074,840
-------------
Comprehensive income 42,072,815
Issuance of 41,500 shares of common
stock under stock option plans 415 471,157 - - - 471,572
Tax effect of exercise of
non-qualified stock options - 129,768 - - - 129,768
Issuance of 7,000 shares of
restricted stock 70 150,430 - (150,500) - -
Amortization of deferred
compensation - - - 84,873 - 84,873
--------------------------------------------------------------------------------------
Balance at December 31, 2000 133,517 62,723,667 2,351,065 (135,041) 134,758,276 199,831,484
Net income 41,259,261 41,259,261
Other comprehensive income - net of
tax:
Change in unrealized gain - - (1,376,254) - - (1,376,254)
-------------
Comprehensive income 39,883,007
Issuance of 336,628 shares of common
stock under stock option plans 3,366 2,870,441 - - - 2,873,807
Tax effect of exercise of
non-qualified stock options - 3,362,883 - - - 3,362,883
Issuance of 3,350 shares of
restricted stock 34 100,467 - (100,501) - -
Amortization of deferred
compensation - - - 118,375 - 118,375
--------------------------------------------------------------------------------------
Balance at December 31, 2001 $ 136,917 $ 69,057,458 $ 974,811 $ (117,167) $ 176,017,537 $ 246,069,556
======================================================================================
See accompanying notes.
66
Triad Guaranty Inc.
Consolidated Statements of Cash Flows
Year ended December 31
2001 2000 1999
-------------------------------------------------
Operating activities
Net income $ 41,259,261 $ 34,997,975 $ 30,410,307
Adjustments to reconcile net income to net cash provided by
operating activities:
Loss and unearned premium reserves 3,720,330 337,609 2,384,911
Accrued expenses and other liabilities 1,359,326 1,167,424 2,033,465
Current taxes payable (44,948) 14,790 24,485
Amounts due to/from reinsurer 1,082,328 931,198 875,266
Accrued investment income (299,226) (305,365) (332,734)
Policy acquisition costs deferred (14,839,991) (11,119,321) (10,846,591)
Amortization of policy acquisition costs 11,711,737 8,210,776 6,955,273
Net realized investment gains (296,974) (285,849) (1,153,191)
Provision for depreciation 2,246,404 859,879 720,456
Accretion of discount on investments (3,127,733) (1,577,713) (1,046,470)
Deferred income taxes 18,225,703 15,221,544 13,340,340
Prepaid federal income taxes (13,244,500) (13,959,000) (10,159,000)
Unearned ceding commission 842,231 1,081,170 (220,640)
Other assets (4,819,214) (2,992,907) (2,158,206)
Other operating activities 55,639 136,214 (50,215)
-------------------------------------------------
Net cash provided by operating activities 43,830,373 32,718,424 30,777,456
Investing activities
Securities available-for-sale:
Purchases - fixed maturities (76,932,533) (51,835,382) (45,489,517)
Sales - fixed maturities 36,575,935 23,279,996 26,280,714
Purchases - equities (4,998,592) (1,663,169) (3,216,099)
Sales - equities 3,899,373 5,608,372 5,035,504
Purchases of property and equipment (4,181,090) (4,179,374) (3,191,320)
-------------------------------------------------
Net cash used in investing activities (45,636,907) (28,789,557) (20,580,718)
Financing activities
Retirement of common stock - - (2,602,184)
Proceeds from exercise of stock options 2,873,807 471,572 200,273
-------------------------------------------------
Net cash provided by (used in) financing activities 2,873,807 471,572 (2,401,911)
Net change in cash and short-term investments 1,067,273 4,400,439 7,794,827
Cash and short-term investments at beginning of year 18,524,658 14,124,219 6,329,392
-------------------------------------------------
Cash and short-term investments at end of year $ 19,591,931 $ 18,524,658 $ 14,124,219
=================================================
Supplemental schedule of cash flow information
Cash paid during the period for:
Income taxes and United States Mortgage
Guaranty Tax and Loss Bonds $ 13,269,557 $ 13,959,208 $ 10,158,677
Interest 2,765,000 2,765,000 2,775,017
See accompanying notes.
67
1
Triad Guaranty Inc.
Notes to Consolidated Financial Statements
December 31, 2001
1. ACCOUNTING POLICIES
NATURE OF BUSINESS
Triad Guaranty Inc. (the "Company") is a holding company which, through its
wholly-owned subsidiary, Triad Guaranty Insurance Corporation ("Triad"),
provides private mortgage insurance coverage in the United States to mortgage
lenders or investors to protect the lender or investor against loss from
defaults on low down payment residential mortgage loans.
BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States,
which vary in some respects from statutory accounting practices which are
prescribed or permitted by the various insurance departments.
CONSOLIDATION
The consolidated financial statements include the amounts of Triad Guaranty Inc.
and its wholly-owned subsidiary, Triad Guaranty Insurance Corporation ("Triad")
and Triad's wholly-owned subsidiaries, Triad Guaranty Assurance Corporation
("TGAC") and Triad Re Insurance Corporation ("Triad Re"). Triad Re, a sponsored
captive reinsurance company, is domiciled in Vermont and began operations in
2000. All significant intercompany accounts and transactions have been
eliminated.
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes. Actual results
could differ from those estimates.
INVESTMENTS
Securities classified as "available-for-sale" are carried at fair value, and
unrealized gains and losses on such securities, net of tax, are reported as a
separate component of accumulated other comprehensive income. The Company does
not have any securities classified as "held-to-maturity" or "trading."
68
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
1. ACCOUNTING POLICIES (CONTINUED)
Fair value generally represents quoted market value prices for securities traded
in the public market or prices analytically determined using bid or closing
prices for securities not traded in the public marketplace. Realized investment
gains or losses are determined on a specific identification basis. Short-term
investments are defined as short-term, highly liquid investments both readily
convertible to known amounts of cash and having maturities of three months or
less upon acquisition by the Company.
The Company writes covered call options on certain equity securities it owns as
a yield enhancement vehicle. Call options convey to the option holder the right
to buy (call) a certain stock at or before a specified date for a contracted
price (strike price) from the Company. The contract can expire without being
exercised in the event that the price of the underlying stock is below the
strike price. In this case, the fee received for granting the option is
recognized as a realized gain. The Company has no credit risk related to these
covered call options. The Company's financial risk in this activity is limited
to the increase of the market price of the security in excess of the sum of the
option's strike price and the fee received for the option. The options are
carried at fair value as other liabilities on the accompanying Consolidated
Balance Sheets, with changes in the fair value of these options reported as
realized gains or losses. The liability recorded for these options was $145,500
and $5,938 at December 31, 2001 and 2000, respectively.
DEFERRED POLICY ACQUISITION COSTS
The costs of acquiring new business, principally commissions and certain policy
underwriting and issue costs, which vary with and are primarily related to the
production of new business, are deferred. Amortization of such policy
acquisition costs is charged to expense in proportion to premium revenue
recognized over the estimated policy life. The Company reviews the persistency
of policies in force and makes appropriate adjustments to reflect policy
cancellations.
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost and is amortized principally on a
straight-line basis over the estimated useful lives, generally three to five
years, of the depreciable assets. Property and equipment primarily consists of
furniture and equipment and computer hardware and software.
69
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
1. ACCOUNTING POLICIES (CONTINUED)
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
Reserves are provided for the estimated costs of settling claims in respect of
loans reported to be in default and estimates of loans in default which have not
been reported to the Company. Consistent with industry accounting practices, the
Company does not establish loss reserves for future claims on insured loans that
are not currently in default. Loss reserves are established by management using
historical experience and by making various assumptions and judgments about
claim rates (frequency) and claim amounts (severity) to estimate ultimate losses
to be paid on loans in default. The Company's reserving methodology gives effect
to current economic conditions and profiles delinquencies by such factors as
age, policy year, geography, and chronic late payment characteristics. The
estimates are continually reviewed and, as adjustments to these liabilities
become necessary, such adjustments are reflected in current operations.
REINSURANCE
Certain premiums and losses are assumed from and ceded to other insurance
companies under various reinsurance agreements. Reinsurance premiums, loss
reimbursement, and reserves related to reinsurance business are accounted for on
a basis consistent with that used in accounting for the original policies issued
and the terms of the reinsurance contracts. The Company may receive a ceding
commission in connection with ceded reinsurance. If so, the ceding commission is
earned on a monthly pro rata basis in the same manner as the premium and is
recorded as a reduction of other operating expenses.
INCOME TAXES
The Company uses the asset and liability method of accounting for income taxes.
Under the asset and liability method, deferred tax assets, net of a valuation
allowance, and deferred tax liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
Triad purchases ten-year non-interest bearing United States Mortgage Guaranty
Tax and Loss Bonds ("Tax and Loss Bonds") in lieu of paying federal income
taxes. Purchases of these Tax and Loss Bonds are treated as prepaid federal
70
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
1. ACCOUNTING POLICIES (CONTINUED)
income taxes because the payment for Tax and Loss Bonds is essentially a
prepayment of federal income taxes that will become due in ten years when the
Tax and Loss Bonds mature. Current income tax expense is primarily associated
with the maturing of a portion of Triad's Tax and Loss Bonds.
INCOME RECOGNITION
The Company writes policies that are guaranteed renewable contracts at the
borrower's option on single premium, annual premium, and monthly premium bases.
The Company does not have the option to reunderwrite these contracts. For annual
payment policies, the first year premium exceeds the renewal premium. Premiums
written on annual policies are earned on a monthly pro rata basis. Single
premium policies covering more than one year are amortized over the estimated
policy life in accordance with the expiration of risk. Premiums written on a
monthly basis generally are earned when received.
STOCK OPTIONS
The Company grants stock options to employees and directors for a fixed number
of shares with an exercise price equal to or greater than the fair value of the
shares at the date of grant. The Company accounts for stock option grants in
accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees,
and accordingly, recognizes no compensation expense for the stock option grants.
EARNINGS PER SHARE
Basic and diluted earnings per share are based on the weighted-average daily
number of shares outstanding. For diluted earnings per share, the denominator
includes the dilutive effect of employee stock options on the weighted-average
shares outstanding. There are no other reconciling items between the denominator
used in basic earnings per share and diluted earnings per share. The numerator
used in basic earnings per share and diluted earnings per share is the same for
all periods presented.
71
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
1. ACCOUNTING POLICIES (CONTINUED)
COMPREHENSIVE INCOME
The only element of other comprehensive income applicable to the Company is
changes in unrealized gains and losses on securities classified as
available-for-sale, which is displayed in the following table, along with
related tax effects.
2001 2000 1999
-------------------------------------------
Unrealized (losses) gains arising
during the period,
before taxes ($1,820,340) $ 11,170,218 ($12,126,338)
Income taxes 637,119 (3,909,576) 4,244,218
-------------------------------------------
Unrealized (losses) gains arising
during the period, net of taxes (1,183,221) 7,260,642 (7,882,120)
-------------------------------------------
Less reclassification adjustment:
Gains realized in net income 296,974 285,849 1,153,191
Income taxes (103,941) (100,047) (403,616)
-------------------------------------------
Reclassification adjustment for
gains realized in net income 193,033 185,802 749,575
-------------------------------------------
Other comprehensive income ($1,376,254) $ 7,074,840 ($ 8,631,695)
===========================================
72
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
2. INVESTMENTS
The amortized cost and the fair value of investments are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-----------------------------------------------------------------
At December 31, 2001
Available-for-sale securities:
Fixed maturity securities:
Corporate $ 55,463,919 $1,879,711 $2,329,019 $ 55,014,611
U.S. Government 12,164,542 545,823 64,708 12,645,657
Mortgage-backed 253,277 24,557 - 277,834
State and municipal 177,780,714 3,483,169 3,216,466 178,047,417
-----------------------------------------------------------------
Total 245,662,452 5,933,260 5,610,193 245,985,519
Equity securities 11,308,230 1,448,566 280,766 12,476,030
-----------------------------------------------------------------
Total $256,970,682 $7,381,826 $5,890,959 $258,461,549
=================================================================
At December 31, 2000
Available-for-sale securities:
Fixed maturity securities:
Corporate $ 47,986,616 $ 949,415 $2,952,735 $ 45,983,296
U.S. Government 12,933,975 332,841 28,503 13,238,313
Mortgage-backed 933,215 48,030 - 981,245
State and municipal 139,926,385 4,880,661 1,085,248 143,721,798
-----------------------------------------------------------------
Total 201,780,191 6,210,947 4,066,486 203,924,652
Equity securities 9,630,441 2,022,360 564,276 11,088,525
-----------------------------------------------------------------
Total $211,410,632 $8,233,307 $4,630,762 $215,013,177
=================================================================
73
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
2. INVESTMENTS (CONTINUED)
The amortized cost and estimated fair value of investments in fixed maturity
securities, at December 31, 2001, are summarized by stated maturity as follows:
Available-for-Sale
-------------------------------
Fair
Amortized Cost Value
-------------------------------
Maturity:
One year or less $ 1,936,681 $ 1,968,163
After one year through five years 22,896,460 23,344,601
After five years through ten years 38,385,623 38,171,721
After ten years 182,190,411 182,223,200
Mortgage-backed securities 253,277 277,834
-------------------------------
Total $ 245,662,452 $ 245,985,519
===============================
Realized gains and losses on sales of investments are as follows:
Year ended December 31
2001 2000 1999
-----------------------------------------
Securities available-for-sale:
Fixed maturity securities:
Gross realized gains $ 1,203,327 $ 225,989 $ 468,368
Gross realized losses (1,484,922) (2,255,251) (613,015)
Equity securities:
Gross realized gains 940,170 2,560,569 1,430,241
Gross realized losses (417,397) (401,663) (208,956)
Covered call options:
Gross realized gains 113,360 162,849 129,864
Gross realized losses (57,564) (6,644) (53,311)
-----------------------------------------
Net realized gains $ 296,974 $ 285,849 $ 1,153,191
=========================================
Net unrealized appreciation (depreciation) on fixed maturity securities changed
by $(1,821,394), $11,543,909, and $(12,923,040), in 2001, 2000, and 1999,
respectively; the corresponding amounts for equity securities were $(290,284),
$(665,174), and $(350,244).
74
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
2. INVESTMENTS (CONTINUED)
Major categories of the Company's net investment income are summarized as
follows:
Year ended December 31
2001 2000 1999
-----------------------------------------
Income:
Fixed maturities $14,188,304 $11,754,951 $ 9,863,671
Preferred stocks 467,702 490,002 392,297
Common stocks 156,388 230,446 268,091
Cash and short-term investments 495,375 635,272 465,544
-----------------------------------------
15,307,769 13,110,671 10,989,603
Expenses 543,233 465,350 443,940
-----------------------------------------
Net investment income $14,764,536 $12,645,321 $10,545,663
=========================================
At December 31, 2001 and 2000, investments with an amortized cost of $6,645,745
and $6,537,653, respectively, were on deposit with state insurance departments
to satisfy regulatory requirements.
3. DEFERRED POLICY ACQUISITION COSTS
An analysis of deferred policy acquisition costs is as follows:
Year ended December 31
2001 2000 1999
-----------------------------------------
Balance at beginning of year $ 22,815,422 $ 19,906,877 $ 16,015,559
Acquisition costs deferred:
Sales compensation 5,928,610 5,218,844 5,361,233
Underwriting and issue expenses 8,911,381 5,900,477 5,485,358
-----------------------------------------
14,839,991 11,119,321 10,846,591
Amortization of acquisition expenses 11,711,737 8,210,776 6,955,273
-----------------------------------------
Net increase 3,128,254 2,908,545 3,891,318
-----------------------------------------
Balance at end of year $ 25,943,676 $ 22,815,422 $ 19,906,877
=========================================
75
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
4. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity for the reserve for losses and loss adjustment expenses for 2001, 2000,
and 1999 is summarized as follows:
2001 2000 1999
---------------------------------------
Reserve for losses and loss
adjustment expense at January 1,
net of reinsurance recoverables $14,976,180 $14,723,192 $12,115,934
Incurred losses and loss adjustment
expenses net of reinsurance
recoveries(principally in respect
of default notices occurring in):
Current year 14,218,882 11,229,124 9,322,142
Redundancy on prior years (5,199,571) (3,641,887) (2,210,826)
----------------------------------------
Total incurred losses and loss
adjustment expenses 9,019,311 7,587,237 7,111,316
Loss and loss adjustment expense
payments net of reinsurance
recoveries (principally in
respect of default notices
occurring in):
Current year 285,876 573,874 236,250
Prior years 5,727,800 6,760,375 4,267,808
---------------------------------------
Total loss and loss adjustment
expense payments 6,013,676 7,334,249 4,504,058
---------------------------------------
Reserve for losses and loss adjustment
expenses at December 31, net of
reinsurance recoverables of
$8,768, $10,808, and $28,156
in 2001, 2000, and 1999,
respectively $17,981,815 $14,976,180 $14,723,192
=======================================
The foregoing reconciliation shows a redundancy in reserves has emerged for each
of the years presented. These redundancies resulted principally from settling
case-basis reserves on default notices occurring in prior years for amounts less
than expected or reducing incurred but not reported reserves.
76
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
5. COMMITMENTS
The Company leases certain office facilities and equipment under operating
leases. Rental expense for all leases was $1,656,706, $1,398,586, and $1,154,671
for 2001, 2000, and 1999, respectively. Future minimum payments under
noncancellable operating leases at December 31, 2001, are as follows:
2002 $1,439,763
2003 1,204,502
2004 1,013,700
2005 814,005
2006 769,063
Thereafter 965,180
----------
$6,206,213
==========
6. FEDERAL INCOME TAXES
Income tax expense differed from the amounts computed by applying the Federal
statutory income tax rate to income before taxes as follows:
2001 2000 1999
---------------------------------------
Income tax computed at
statutory rate $20,885,114 $17,582,080 $15,321,185
Increase (decrease) in
taxes resulting from:
Tax-exempt interest (3,104,966) (2,640,938) (2,095,576)
Other 632,345 295,398 138,897
---------------------------------------
Income tax expense $18,412,493 $15,236,540 $13,364,506
=======================================
77
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
6. FEDERAL INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant portions
of deferred tax assets and deferred tax liabilities at December 31, 2001 and
2000, are presented below:
2001 2000
-----------------------------
Deferred tax liabilities
Statutory contingency reserve $ 67,534,711 $ 51,025,055
Deferred policy acquisition costs 9,080,287 7,985,398
Unrealized investment gain 521,803 1,262,863
Other 3,352,700 2,859,749
-----------------------------
Total deferred tax liabilities 80,489,501 63,133,065
Deferred tax assets
Exercise of employee stock options 4,539,069 1,176,185
Unearned premiums 603,570 535,471
Capital loss carryforward - 280,356
Losses and loss adjustment expenses 437,182 368,630
Other 136,273 120,776
-----------------------------
Total deferred tax assets 5,716,094 2,481,418
-----------------------------
Net deferred tax liability $ 74,773,407 $ 60,651,647
=============================
At December 31, 2001 and 2000, Triad was obligated to purchase approximately
$1,228,000 and $537,000, respectively, of Tax and Loss Bonds.
78
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
7. INSURANCE IN FORCE, DIVIDEND RESTRICTION, AND STATUTORY RESULTS
At December 31, 2001, approximately 56% of Triad's net risk in force was
concentrated in eight states, with 15% in California, 7% each in Florida,
Illinois, and Texas, 6% each in Georgia and North Carolina, and 4% each in
Colorado and Pennsylvania. While Triad continues to diversify its risk in force
geographically, a prolonged recession in its high concentration areas could
result in higher incurred losses and loss adjustment expenses.
Insurance regulations limit the writing of mortgage guaranty insurance to an
aggregate amount of insured risk no greater than twenty-five times the total of
statutory capital and surplus and the statutory contingency reserve. The amount
of net risk for insurance in force at December 31, 2001 and 2000, as presented
below, was computed by applying the various percentage settlement options to the
insurance in force amounts based on the original insured amount of the loan.
Triad's ratio is as follows:
2001 2000
-----------------------------------
Net risk $4,471,704,928 $3,738,596,850
===================================
Statutory capital and surplus $ 105,306,174 $ 101,045,355
Contingency reserve 193,746,529 150,762,722
-----------------------------------
Total $ 299,052,703 $ 251,808,077
===================================
Risk-to-capital ratio 15.0 to 1 14.8 to 1
===================================
Triad and its wholly-owned subsidiaries, TGAC and Triad Re, are each required
under their respective domiciliary states' insurance code to maintain a minimum
level of statutory capital and surplus. Triad, an Illinois domiciled insurer, is
required under the Illinois Insurance Code (the "Code") to maintain minimum
capital and surplus of $5,000,000.
The Code permits dividends to be paid only out of earned surplus and also
requires prior approval of extraordinary dividends. An extraordinary dividend is
any dividend or distribution of cash or other property, the fair market value of
which, together with that of other dividends or distributions made within a
period of twelve consecutive months, exceeds the greater of (a) ten percent of
statutory surplus as regards policyholders, or (b) statutory net income for the
calendar year preceding the date of the dividend. Consolidated net income as
determined in accordance with statutory accounting practices was $55,448,185,
$47,830,174, and $40,019,488 for the years ended December 31, 2001, 2000, and
1999, respectively. At December 31, 2001, the amount of the
79
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
7. INSURANCE IN FORCE, DIVIDEND RESTRICTION, AND STATUTORY RESULTS (CONTINUED)
Company's equity that can be paid out in dividends to the stockholders is
$21,590,246, which is the earned surplus of Triad on a statutory basis.
The NAIC revised the Accounting Practices and Procedures Manual in a process
referred to as Codification. The revised manual was effective January 1, 2001.
The domiciliary states of Triad and its subsidiaries adopted the provisions of
the revised manual. The revised manual has changed, to some extent, prescribed
statutory accounting practices and resulted in changes to the accounting
practices that Triad and its subsidiaries use to prepare their statutory-basis
financial statements. Triad recorded a $2,561,388 reduction in surplus in its
statutory-basis financial statements during 2001 as the cumulative effect of
changes in accounting principles from the adoption of Codification.
8. RELATED PARTY TRANSACTIONS
The Company pays unconsolidated affiliated companies for management, investment,
and other services. The total expense incurred for such items was $433,167,
$398,872, and $353,432 in 2001, 2000, and 1999, respectively. In addition, the
Company provides certain investment accounting, reporting, and maintenance
functions for an affiliate. Income earned during 2001, 2000, and 1999,
respectively, for such services was $23,487, $21,780, and $17,444. Management
believes that the income and expenses incurred for such services approximate
costs that the Company and affiliates would have incurred if those services had
been provided by unaffiliated third parties.
9. EMPLOYEE BENEFIT PLAN
Substantially all employees participate in the Company's 401(k) Profit Sharing
Plan. Under the plan, employees elect to defer a portion of their wages, with
the Company matching deferrals at the rate of 50% of the first 8% of the
employee's salary deferred. The Company contributed $353,004, $301,281, and
$281,728 to the plan for the years ended December 31, 2001, 2000, and 1999,
respectively.
10. REINSURANCE
Certain premiums and losses are assumed from and ceded to other insurance
companies under various reinsurance agreements. The ceding agreements
principally provide Triad with increased capacity to write business and achieve
a more favorable geographic dispersion of risk.
80
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
10. REINSURANCE (CONTINUED)
Reinsurance activity for the years ended December 31, 2001, 2000, and 1999,
respectively, is as follows:
2001 2000 1999
----------------------------------------------
Earned premiums ceded $10,481,961 $4,930,445 $1,645,655
Losses ceded 596 (25,009) 9,686
Earned premiums assumed 5,485 9,106 13,866
Losses assumed 1,056 8,514 30,057
The Company cedes business to captive reinsurance subsidiaries of certain
mortgage lenders ("captives") primarily under excess of loss reinsurance
agreements. Generally, reinsurance recoverables on loss reserves and unearned
premiums ceded to these captives are backed by trust funds or letters of credit.
The Company also maintains excess of loss reinsurance agreements designed to
protect the Company in the event of a catastrophic level of losses. Throughout
2001, the Company maintained $125 million of excess of loss reinsurance through
non-affiliated reinsurers.
In 2001, the Company recognized a nonrecurring incentive payment of $1,863,000
related to voluntary cancellation of an excess of loss reinsurance contract
maintained by the Company with a non-affiliated reinsurer. This payment is
included as other income in the accompanying Consolidated Statement of Income
for 2001. The Company also established excess of loss reinsurance coverage
through a separate third-party reinsurer in 2001 under terms similar to the
cancelled agreement.
Reinsurance contracts do not relieve Triad from its obligations to
policyholders. Failure of the reinsurer to honor its obligation could result in
losses to Triad; consequently, allowances are established for amounts deemed
uncollectible. Triad evaluates the financial condition of its reinsurers and
monitors credit risk arising from similar geographic regions, activities, or
economic characteristics of its reinsurers to minimize its exposure to
significant losses from reinsurer insolvency.
11. LONG-TERM STOCK INCENTIVE PLAN
In August 1993, the Company adopted the 1993 Long-Term Stock Incentive Plan (the
"Plan"). Under the Plan, certain directors, officers, and key employees are
eligible to be granted various stock-based awards. The number of shares of
81
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
11. LONG-TERM STOCK INCENTIVE PLAN (CONTINUED)
common stock which may be issued or sold or for which options or stock
appreciation rights may be granted under the Plan is 2,600,000 shares.
Information concerning the stock option plan is summarized below:
Weighted-
Number of Option Average
Shares Price Exercise Price
-------------------------------------------
1999
Outstanding, beginning of year 1,178,607 $ 4.58 - 49.08 $13.11
Granted 204,840 17.00 - 23.24 22.05
Exercised 34,500 4.58 - 10.17 5.81
Canceled 14,500 17.88 - 38.27 30.86
Outstanding, end of year 1,334,447 4.58 - 49.08 14.48
Exercisable, end of year 1,069,218 4.58 - 49.08 11.72
2000
Outstanding, beginning of year 1,334,447 4.58 - 49.08 14.48
Granted 193,875 18.56 - 28.00 26.91
Exercised 41,500 4.58 - 27.88 11.36
Canceled 2,100 17.00 - 41.94 23.19
Outstanding, end of year 1,484,722 4.58 - 49.08 16.17
Exercisable, end of year 1,257,142 4.58 - 49.08 14.41
2001
Outstanding, beginning of year 1,484,722 4.58 - 49.08 16.17
Granted 169,950 29.65 - 39.00 36.33
Exercised 336,628 4.58 - 27.88 8.54
Canceled 9,270 8.92 - 41.94 23.06
Outstanding, end of year 1,308,774 4.58 - 49.08 20.71
Exercisable, end of year 1,097,213 4.58 - 49.08 18.56
82
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
11. LONG-TERM STOCK INCENTIVE PLAN (CONTINUED)
Information concerning stock options outstanding and exercisable at December 31,
2001 is summarized below:
Outstanding Exercisable
- ------------------------------------------------- --------------------------
Weighted- Weighted- Weighted-
Average Average Average
Number of Exercise Remaining Number of Exercisable
Shares Option Price Price Life Shares Price
- ------------------------------------------------ --------------------------
355,600 $ 4.58 - 8.92 $ 6.19 2.35 355,600 $ 6.19
229,398 10.17 - 18.56 13.15 4.87 212,754 12.79
500,401 20.07 - 34.80 25.22 7.31 376,284 23.76
164,100 37.75 - 39.75 39.02 8.06 93,300 39.04
59,275 41.94 - 49.08 48.26 6.08 59,275 48.26
--------- ---------
1,308,774 1,097,213
========= =========
At December 31, 2001, 1,890,102 shares of the Company's common stock were
reserved and 581,328 shares were available for issuance under the Plan.
The options issued under the Plan in 2001, 2000, and 1999 vest over three years.
Certain of the options will immediately vest in the event of a change in control
of the Company. Options granted under the Plan terminate no later than 10 years
following the date of grant.
Pro forma information required by Financial Accounting Standards Board Statement
No. 123, Accounting for Stock-Based Compensation, has been estimated as if the
Company had accounted for stock-based awards under the fair value method of that
Statement. The fair value of options granted in 2001, 2000, and 1999 was
estimated at the date of the grant using a Black-Scholes option pricing model
with the following weighted-average input assumptions: risk-free interest rate
of 4.86% for 2001, 5.3% for 2000, and 6.5% for 1999; dividend yield of 0.0%;
expected volatility of .40 for 2001, .42 for 2000, and .42 for 1999; and a
weighted-average expected life of the option of seven years.
83
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
11. LONG-TERM STOCK INCENTIVE PLAN (CONTINUED)
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's stock options have characteristics significantly different from
those of traded options, and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its employee stock options.
The following table summarizes the fair value of options granted in 2001, 2000,
and 1999:
Weighted-Average Weighted-Average
Exercise Price Fair Value
Type of Option 2001 2000 1999 2001 2000 1999
- --------------------------------------------------------------------------------
Stock Price = Exercise Price $31.89 $22.38 $17.49 $11.14 $8.17 $6.74
Stock Price < Exercise Price $39.00 $27.95 $23.24 $ 8.81 $6.70 $5.96
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. Had compensation
expense for stock options been recognized using the fair value method on the
grant date, net income and earnings per share on a pro forma basis would have
been (in thousands, except for earnings per share information):
2001 2000 1999
-------------------------------------
Net income - as reported $41,259 $34,998 $30,410
Net income - pro forma $40,375 $34,107 $29,675
Earnings per share - as reported:
Basic $ 3.05 $ 2.63 $ 2.28
Diluted $ 2.95 $ 2.55 $ 2.23
Earnings per share - pro forma:
Basic $ 2.98 $ 2.56 $ 2.23
Diluted $ 2.89 $ 2.48 $ 2.18
84
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
12. LONG-TERM DEBT
In January of 1998, the Company completed a $35 million private offering of
notes due January 15, 2028. Proceeds from the offering, net of debt issue costs
of $547,102, totaled $34,452,898. The notes, which represent unsecured
obligations of the Company, bear interest at a rate of 7.9% per annum and are
non-callable.
13. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying values and fair values of financial instruments as of December 31,
2001 and 2000 are summarized below:
2001 2000
------------------------- -------------------------
Carrying Fair Carrying Fair
Value Value Value Value
------------------------- -------------------------
Financial Assets
Fixed maturity securities
available-for-sale $245,985,519 $245,985,519 $203,924,652 $203,924,652
Equity securities
available-for-sale 12,476,030 12,476,030 11,088,525 11,088,525
Financial Liabilities
Long-term debt 34,473,035 36,673,000 34,467,285 36,778,000
The fair values of cash and short-term investments approximate their carrying
values due to their short-term maturity or availability.
The fair values of fixed maturity securities and equity securities have been
determined using quoted market prices for securities traded in the public market
or prices using bid or closing prices for securities not traded in the public
marketplace.
The fair value of the Company's long-term debt is estimated using discounted
cash flow analysis based on the Company's current incremental borrowing rates
for similar types of borrowing arrangements.
14. CONTINGENCIES
A lawsuit has been filed against the Company in the ordinary course of the
Company's business. In the opinion of management, the ultimate resolution of
this pending litigation will not have a material adverse effect on the financial
position or results of operations of the Company.
85
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
15. UNAUDITED QUARTERLY FINANCIAL DATA
The following is a summary of the unaudited quarterly results of operations for
the years ended December 31, 2001 and 2000 (in thousands except per share data):
2001 Quarter
--------------------------------------
First Second Third Fourth Year
----------------------------------------------
Net premiums written $19,812 $19,777 $20,822 $24,587 $84,998
Earned premiums 19,683 20,143 20,517 24,013 84,356
Net investment income 3,477 3,657 3,804 3,827 14,765
Net losses incurred 2,203 2,134 1,519 3,163 9,019
Underwriting and other expenses 7,378 7,660 8,051 9,530 32,619
Net income 10,920 9,830 10,338 10,171 41,259
Basic earnings per share .82 .73 .76 .74 3.05
Diluted earnings per share .79 .71 .73 .72 2.95
2000 Quarter
--------------------------------------
First Second Third Fourth Year
----------------------------------------------
Net premiums written $17,063 $17,718 $18,293 $18,808 $71,882
Earned premiums 17,144 17,836 18,071 18,792 71,843
Net investment income 2,926 3,067 3,156 3,496 12,645
Net losses incurred 1,596 2,060 1,932 1,999 7,587
Underwriting and other expenses 6,804 6,723 6,482 6,980 26,989
Net income 8,652 8,486 9,484 8,376 34,998
Basic earnings per share .65 .64 .71 .63 2.63
Diluted earnings per share .63 .62 .69 .61 2.55
86
Schedule I
Summary of Investments - Other Than Investments in Related Parties
Triad Guaranty Inc.
December 31, 2001
Amount at
Which Shown
Amortized Fair in Balance
Type of Investment Cost Value Sheet
------------------------------------
(dollars in thousands)
Fixed maturity securities,
available-for-sale:
Bonds:
U.S. Government obligations............ $ 12,164 $ 12,646 $ 12,646
Mortgage-backed securities............. 253 278 278
State and municipal bonds.............. 177,781 178,048 178,048
Corporate bonds........................ 53,613 53,202 53,202
Public utilities....................... 1,851 1,812 1,812
-------- -------- --------
Total 245,662 245,986 245,986
-------- -------- --------
Equity securities, available-for-sale:
Common stocks:
Bank, Trust, and Insurance........... 511 641 641
Industrial & miscellaneous........... 3,915 4,841 4,841
Preferred stock ......................... 6,882 6,994 6,994
-------- -------- --------
Total................................... 11,308 12,476 12,476
-------- -------- --------
Short-term investments...................... 18,739 18,739 18,739
-------- -------- --------
Total investments other than investments
in related parties......................... $275,709 $277,201 $277,201
======== ======== ========
87
Schedule II - Condensed Financial Information of Registrant
Condensed Balance Sheets
Triad Guaranty Inc.
(Parent Company)
December 31
2001 2000
---- ----
(dollars in
thousands)
Assets:
Fixed maturities, available-for-sale............. $ 9,071 $ 6,563
Equity securities, available-for-sale............ 501 -
Notes receivable from subsidiary................. 25,000 25,000
Investment in subsidiaries....................... 244,464 200,952
Cash and short-term investments.................. 1,371 1,302
Accrued investment income........................ 1,261 1,221
Deferred income taxes............................ 99 389
Other assets..................................... 120 216
-------- --------
Total assets..................................... $281,887 $235,643
======== ========
Liabilities and stockholders' equity:
Liabilities:
Current taxes payable............................ $ 70 $ 70
Long-term debt................................... 34,473 34,467
Accrued interest on long-term debt............... 1,275 1,275
-------- --------
Total liabilities................................ 35,818 35,812
Stockholders' equity:
Common stock..................................... 137 134
Additional paid-in capital....................... 69,057 62,723
Accumulated other comprehensive income........... 975 2,351
Deferred compensation............................ (117) (135)
Retained earnings................................ 176,017 134,758
-------- --------
Total stockholders' equity.......................... 246,069 199,831
-------- --------
Total liabilities and stockholders' equity.......... $281,887 $235,643
======== ========
See notes to condensed financial statements.
88
Schedule II - Condensed Financial Information of Registrant
Condensed Statements of Income
Triad Guaranty Inc.
(Parent Company)
Year Ended December 31
------------------------------
2001 2000 1999
---- ---- ----
(dollars in thousands)
Revenues:
Net investment income.................. $3,000 $2,908 $2,875
Realized investment gains (losses).... (266) (373) (124)
------- ------- -------
2,734 2,535 2,751
Expenses:
Interest on long-term debt............ 2,771 2,770 2,780
Operating expenses.................... 396 90 35
------- ------- -------
Income (loss) before federal income
taxes and equity in undistributed
income of subsidiaries................. (433) (325) (64)
Income taxes:
Current............................... (121) - 24
Deferred.............................. 172 (129) (46)
------- ------- -------
51 (129) (22)
------- ------- -------
Income (loss) before equity in
undistributed income of subsidiaries.... (484) (196) (42)
Equity in undistributed income
of subsidiaries......................... 41,743 35,194 30,452
------- ------- -------
Net income............................... $41,259 $34,998 $30,410
======= ======= =======
See notes to condensed financial statements.
89
Schedule II - Condensed Financial Information of Registrant
Condensed Statements of Cash Flows
Triad Guaranty Inc.
(Parent Company)
Year Ended December 31
--------------------------
2001 2000 1999
---- ---- ----
Operating Activities (dollars in thousands)
Net income...........................................$41,259 $34,998 $30,410
Adjustments to reconcile net income to
net cash provided by (used in)
operating activities:
Equity in undistributed income of
subsidiaries..................................(41,743) (35,194) (30,452)
Accrued investment income...................... (40) (15) 19
Other assets................................... 96 (216) -
Deferred income taxes.......................... 172 (129) (46)
Current tax payable............................ - - 25
Accretion of discount on investments........... (52) (60) (86)
Amortization of deferred compensation.......... 118 85 34
Amortization of debt issue costs............... 6 5 5
Realized investment gain on securities......... 266 373 124
Accrued expenses and other liabilities......... - - (25)
------ ------ ------
Net cash provided by (used in) operating
activities..................................... 82 (153) 8
Investing Activities
Securities available-for-sale:
Fixed maturities:
Purchases................................. (5,756) (2,951) (3,682)
Sales..................................... 3,369 2,501 6,282
Equity securities:
Purchases................................. (500) - -
Sales..................................... - - 284
------ ------ ------
Net cash (used in) provided
by investing activities........................ (2,887) (450) 2,884
Financing Activities
Proceeds from exercise of stock options.......... 2,874 472 200
Retirement of common stock....................... - - (2,602)
------ ------ ------
Net cash provided by (used in) financing
activities..................................... 2,874 472 (2,402)
Increase in cash and short-term investments....... 69 (131) 490
Cash and short-term investments at
beginning of year.............................. 1,302 1,433 943
------ ------ ------
Cash and short-term investments at end
of year......................................... $1,371 $1,302 $1,433
====== ====== ======
See notes to condensed financial statements.
90
Schedule II - Condensed Financial Information of Registrant
Triad Guaranty Inc.
(Parent Company)
Supplementary Notes
NOTE 1
In the parent company financial statements, the Company's investment in its
subsidiaries is stated at cost plus equity in undistributed earnings of the
subsidiaries. The Company's share of net income of its subsidiaries is included
in income using the equity method. The accompanying Parent Company financial
statements should be read in conjunction with the Consolidated Financial
Statements and Notes to Consolidated Financial Statements included as part of
this Form 10-K.
NOTE 2
Triad Guaranty Inc. (the "Company") is a holding company which, through its
wholly-owned subsidiary, Triad Guaranty Insurance Corporation ("Triad"),
provides private mortgage insurance coverage in the United States to mortgage
lenders to protect the lender against loss from defaults on low down payment
residential mortgage loans.
NOTE 3
The amortized cost and the fair value of investments held by the parent
company are as follows (dollars in thousands):
Gross Gross
Amortized Unrealized Unrealized Fair
At December 31, 2001 Cost Gains Losses Value
--------------------------------------------
Available-for-sale securities:
Fixed maturity securities:
Corporate $8,795 $159 $553 $8,401
Municipal 669 1 - 670
------ ------ ------ ------
Total 9,464 160 553 9,071
Equity Securities 500 1 - 501
------ ------ ------ ------
Total $9,964 $161 $553 $9,572
====== ====== ====== ======
Gross Gross
Amortized Unrealized Unrealized Fair
At December 31, 2000 Cost Gains Losses Value
--------------------------------------------
Available-for-sale securities:
Fixed maturity securities:
Corporate $7,292 $93 $822 $6,563
------ ------ ------ ------
Total 7,292 93 822 6,563
Equity Securities - - - -
------ ------ ------ ------
Total $7,292 $93 $822 $6,563
====== ====== ====== ======
91
Schedule II - Condensed Financial Information of Registrant
Triad Guaranty Inc.
(Parent Company)
Supplementary Notes
NOTE 3 (CONTINUED)
Major categories of the parent company's investment income are summarized
as follows (dollars in thousands):
Year ended December 31
2001 2000 1999
------------------------------
Income:
Fixed maturities $ 770 $ 664 $ 645
Equity securities 19 - 18
Cash and short-term investments 45 55 42
Note receivable from subsidiary 2,225 2,225 2,225
--------------------------------
3,059 2,944 2,930
Expenses 59 36 55
--------------------------------
Net investment income $3,000 $2,908 $2,875
================================
NOTE 4
In January of 1998, the Company completed a $35 million private offering of
notes due January 15, 2028. Proceeds from the offering, net of debt issue costs
of $547,102, totaled $34,452,898. The notes, which represent unsecured
obligations of the Company, bear interest at a rate of 7.9% per annum and are
non-callable.
92
Schedule IV - Reinsurance
Triad Guaranty Inc.
Mortgage Insurance Premium Earned
Years Ended December 31, 2001, 2000 and 1999
Ceded To Assumed Percentage of
Gross Other From Other Net Amount Assumed
Amount Companies Companies Amount to Net
-------------------------------------------------------------------
(dollars in thousands)
2001....... $94,833 $10,482 $ 5 $84,356 0.0%
======= ======= === =======
2000....... $76,764 $ 4,930 $ 9 $71,843 0.0%
======= ======= === =======
1999....... $65,602 $ 1,646 $14 $63,970 0.0%
======= ======= === =======
93