1
EXHIBIT 99.3
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands except share amounts)
September 30, 2000 December 31, 1999
------------------ -----------------
(unaudited)
ASSETS
Investments:
Fixed maturities, held to maturity, at amortized cost (market value
$160,904 and $181,474) $ 157,202 $ 177,607
Fixed maturities, available for sale, at market (amortized cost $819,406
and $778,751) 813,934 745,963
Other invested assets 11,055 10,935
Common stock, at market (cost $498) 839 839
Short-term investments 87,449 34,657
----------- -----------
Total Investments 1,070,479 970,001
Cash and cash equivalents 1,562 2,558
Accrued interest receivable 13,694 18,977
Investment in affiliates 139,938 108,001
Premiums receivable 15,248 22,959
Furniture, fixtures and equipment 8,342 10,206
Deferred policy acquisition costs 126,270 119,213
Federal income taxes recoverable 6,073 6,713
Prepaid federal income tax 24,709 24,797
Deferred income taxes - net 67,634 68,587
Prepaid reinsurance premiums 6,663 8,772
Reinsurance recoverable on unpaid losses 264 2,286
Receivable from affiliates 1,316 1,170
Goodwill -- 24,196
----------- -----------
Other assets 71,440 65,496
----------- -----------
TOTAL ASSETS $ 1,553,632 $ 1,453,932
=========== ===========
LIABILITIES, DEFERRED CREDIT AND SHAREHOLDERS' EQUITY
LIABILITIES
Losses and loss adjustment expenses $ 66,087 $ 51,970
Reinsurance payable on paid losses and loss adjustment expenses 6,797 8,997
Deferred premium revenue 355,342 346,088
Accrued profit commissions 2,814 2,554
Long-term debt 75,000 75,000
Short-term debt 174,382 113,941
Payable to affiliates 5,230 --
Accrued expenses and other liabilities 44,915 41,078
----------- -----------
TOTAL LIABILITIES 730,567 639,628
----------- -----------
DEFERRED CREDIT 122,250 138,000
----------- -----------
SHAREHOLDERS' EQUITY
Common stock-$.10 par value, Authorized-100,000,000 shares,
issued-40,158,025 and 40,007,404 shares 4,016 4,001
Additional paid-in capital 254,763 253,109
Retained earnings 480,688 477,715
Accumulated other comprehensive loss (6,066) (25,935)
Treasury stock (32,586) (32,586)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY 700,815 676,304
----------- -----------
TOTAL LIABILITIES, DEFERRED CREDIT AND SHAREHOLDERS' EQUITY $ 1,553,632 $ 1,453,932
=========== ===========
See notes to unaudited consolidated financial statements.
2
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands except per share amounts)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2000 1999 2000 1999
---- ---- ---- ----
REVENUES
Net premiums written $ 22,551 $ 28,928 $ 92,712 $ 93,358
Decrease (increase) in deferred premium
revenue 3,450 (4,031) (11,363) (18,064)
--------- --------- --------- ---------
Premiums earned 26,001 24,897 81,349 75,294
Net investment income 16,344 15,274 47,277 42,762
Net realized gains (losses) on sale of
investments 101 (140) (1,357) (4,480)
Assignment revenue (751) 12,215 9,125 28,521
Other income (597) (1,271) 2,588 4,940
--------- --------- --------- ---------
Total revenues 41,098 50,975 138,982 147,037
--------- --------- --------- ---------
EXPENSES
Losses and loss adjustment expenses 2,071 3,837 22,699 9,223
Policy acquisition costs 10,617 8,915 31,127 27,022
Profit commissions 230 155 1,237 711
Other operating expenses - insurance 5,233 3,912 14,061 12,114
- non-insurance 15,772 14,914 79,875 41,332
--------- --------- --------- ---------
Total expenses 33,923 31,733 148,999 90,402
--------- --------- --------- ---------
Income (loss) from operations 7,175 19,242 (10,017) 56,635
Equity in net income of affiliates 1,691 4,460 21,128 17,026
Minority interest -- -- 253 --
Foreign currency losses (50) (27) (98) (33)
Interest expense (4,168) (3,070) (12,302) (7,998)
--------- --------- --------- ---------
Income (loss) before income taxes 4,648 20,605 (1,036) 65,630
Income tax (benefit) expense (10,924) (1,790) (10,880) 1,587
--------- --------- --------- ---------
Net income $ 15,572 $ 22,395 $ 9,844 $ 64,043
========= ========= ========= =========
Basic earnings per share $ 0.41 $ 0.59 $ 0.26 $ 1.69
========= ========= ========= =========
Diluted earnings per share $ 0.40 $ 0.57 $ 0.25 $ 1.64
========= ========= ========= =========
Basic weighted average shares outstanding 38,182 38,031 38,163 37,981
========= ========= ========= =========
Diluted weighted average shares outstanding 38,782 39,027 38,659 39,074
========= ========= ========= =========
See notes to unaudited consolidated financial statements.
3
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
(In thousands except share and per share amounts)
(unaudited)
Outstanding Common
Stock Treasury Stock
----------------------- ----------------------
Additional
Paid-in
Shares Amount Shares Amount Capital
------ ------ ------ ------ -------
Balance, December 31, 1998 39,812,937 $ 3,981 1,950,794 $ (32,586) $ 249,851
Comprehensive income:
Net income for the period -- -- -- -- --
Unrealized foreign currency translation
adjustment (net of tax of $625) -- -- -- -- --
Unrealized losses during the period
(net of tax of $19,324) -- -- -- -- --
Reclassification adjustment for realized losses
included in net income (net of tax of $1,580) -- -- -- -- --
Total comprehensive income -- -- -- -- --
Dividends paid ($0.18 per share) -- -- -- -- --
Exercise of stock options 183,600 18 -- -- 2,083
========== ========== ========== ========== ==========
Balance, September 30, 1999 39,996,537 $ 3,999 1,950,794 $ (32,586) $ 251,934
========== ========== ========== ========== ==========
Accumulated
Other Comprehensive Income
---------------------------------------
Foreign
Currency Unrealized
Unearned Translation Gains Retained
Compensation Adjustment (Losses) Earnings Total
------------ ---------- -------- -------- -----
Balance, December 31, 1998 $ (493) $ 714 $ 22,965 $ 418,214 $ 662,646
Comprehensive income:
Net income for the period -- -- -- 64,043 --
Unrealized foreign currency translation
adjustment (net of tax of $625) -- (1,161) -- -- --
Unrealized losses during the period
(net of tax of $19,324) -- -- (32,654) -- --
Reclassification adjustment for realized losses
included in net income (net of tax of $1,580) -- 21 2,912 -- --
Total comprehensive income -- -- -- -- 33,161
Dividends paid ($0.18 per share) -- -- -- (6,840) (6,840)
Exercise of stock options -- -- -- -- 2,101
========== ========== ========== ========== ==========
Balance, September 30, 1999 $ (493) $ (426) $ (6,777) $ 475,417 $ 691,068
========== ========== ========== ========== ==========
See notes to unaudited consolidated financial statements.
4
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000
(In thousands except share and per share amounts)
(unaudited)
Outstanding Common
Stock Treasury Stock
---------------------- ----------------------
Additional
Paid-in
Shares Amount Shares Amount Capital
------ ------ ------ ------ -------
Balance, December 31, 1999 40,007,404 $ 4,001 1,950,794 $ (32,586) $ 253,109
Comprehensive income:
Net income for the period -- -- -- -- --
Unrealized gains during the period
(net of tax of $8,329) -- -- -- -- --
Reclassification adjustment for realized losses
included in net income (net of tax $475) -- -- -- -- --
Total comprehensive income -- -- -- -- --
Dividends declared ($0.18 per share) -- -- -- -- --
Exercise of stock options 148,700 15 -- -- 1,625
Issuance of common shares 1,921 -- -- -- 29
========== ========== ========== ========== ==========
Balance, September 30, 2000 40,158,025 $ 4,016 1,950,794 $ (32,586) $ 254,763
========== ========== ========== ========== ==========
Accumulated
Other Comprehensive Income
---------------------------------------
Foreign
Currency Unrealized
Unearned Translation Gains Retained
Compensation Adjustment (Losses) Earnings Total
------------ ---------- -------- -------- -----
Balance, December 31, 1999 $ (493) $ (2,207) $ (23,235) $ 477,715 $ 676,304
Comprehensive income:
Net income for the period -- -- -- 9,844 --
Unrealized gains during the period
(net of tax of $8,329) -- -- 18,987 -- --
Reclassification adjustment for realized losses
included in net income (net of tax $475) -- -- 882 -- --
Total comprehensive income -- -- -- -- 29,713
Dividends declared ($0.18 per share) -- -- -- (6,871) (6,871)
Exercise of stock options -- -- -- -- 1,640
Issuance of common shares -- -- -- -- 29
========== ========== ========== ========== ==========
Balance, September 30, 2000 $ (493) $ (2,207) $ (3,366) $ 480,688 $ 700,815
========== ========== ========== ========== ==========
See notes to unaudited consolidated financial statements.
5
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
Nine Months Ended September 30,
-------------------------------
2000 1999
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 9,844 $ 64,043
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization, net (3,924) (7,286)
Write-off of goodwill 22,051 --
Net realized losses 1,357 4,480
Equity in net income of affiliates (21,128) (17,026)
Loss on sale of assets 1,390 --
Change in assets and liabilities:
Premiums and other receivables 7,711 11,541
Accrued interest receivable 5,283 (1,648)
Accrued expenses and other liabilities 1,544 23,019
Deferred policy acquisition costs (7,057) (14,994)
Deferred premium revenue, net 11,363 18,063
Accrued profit commissions 260 (128)
Losses and loss adjustment expenses, net 13,940 4,334
Payable to (receivable from) affiliates 5,084 (25,632)
Payable for securities -- 17,870
Other assets (1,221) (34,027)
Income taxes, net (21,960) (1,625)
--------- ---------
Net cash provided by operating activities 24,537 40,984
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (687) (4,368)
Proceeds from sales and maturities of investments 251,585 273,968
Purchase of investments (266,352) (350,927)
Purchase of partnership interests -- (13,720)
(Purchases) sales of short-term investments, net (52,793) 4,570
Other, net (119) --
Investment in affiliates (14,700) (2,497)
--------- ---------
Net cash used in investing activities (83,066) (92,974)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital stock 1,670 2,101
Short-term debt 60,441 51,660
Dividends paid (4,578) (4,557)
--------- ---------
Net cash provided by financing activities 57,533 49,204
--------- ---------
Net change in cash and cash equivalents (996) (2,786)
Cash and cash equivalents, beginning of period 2,558 5,542
--------- ---------
Cash and cash equivalents, end of period $ 1,562 $ 2,756
=========
SUPPLEMENTAL DISCLOSURE OF CERTAIN NON-CASH TRANSACTIONS: September 30, 2000
------------------
Sale of interest in investment in affiliate including accrued interest $ 3,954
========
Consideration received - note receivable $ 3,954
========
See notes to unaudited consolidated financial statements.
6
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
PERIODS ENDED SEPTEMBER 30, 2000 AND 1999
(UNAUDITED)
1. BASIS OF PRESENTATION - MERGER AGREEMENT
BASIS OF PRESENTATION:
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q under Rules and
Regulations of the Securities and Exchange Commission and do not include all of
the information and disclosures required by generally accepted accounting
principles. These statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Annual Report on Form
10-K/A for the year ended December 31, 1999 (the "1999 Form 10-K/A") of Enhance
Financial Services Group Inc. ("Enhance Financial").
The accompanying unaudited consolidated financial statements have not
been audited by independent auditors in accordance with generally accepted
auditing standards. However, in the opinion of management, such financial
statements include all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly the financial position and results of
operations of Enhance Financial and its subsidiaries (collectively the
"Company"). The results of operations for the nine months ended September 30,
2000 may not be indicative of the results that may be expected for the year
ending December 31, 2000.
Certain of the 1999 amounts have been reclassified to conform to the
current period(s) presentation.
MERGER AGREEMENT:
On November 13, 2000, Enhance Financial and Radian Group Inc.
("Radian") entered into an agreement (the "Merger Agreement') providing for the
merger (the "Merger") of Enhance Financial with a wholly owned subsidiary of
Radian. The Merger Agreement provides for Enhance Financial shareholders at the
effective time of the Merger to receive .22 share of Radian common stock for
each share of Enhance Financial common stock owned by them. Consummation of the
Merger is subject to the satisfaction by each party of several conditions,
including the approval of Enhance Financial and Radian shareholders, for which
special meetings of shareholders are to be called as soon as practicable.
The board of directors voted unanimously at a meeting held November 12,
2000 to approve the Merger and to recommend its approval to shareholders. At
that meeting, the board received the opinion of Morgan Stanley Dean Witter &
Company ("Morgan Stanley") that the Merger price was fair to the Enhance
Financial shareholders from an economic point of view.
Enhance Financial's entry into the Merger Agreement was the culmination
of its efforts, for which it had retained Morgan Stanley in February 2000 to
assist it, to identify and review strategic options to increase shareholder
value.
Radian provides private mortgage insurance coverage in the United
States on residential mortgage loans.
The closing prices of Enhance Financial common stock and Radian common
stock on November 13, 2000, the last trading day prior to the announcement of
the execution of the Merger Agreement, were$13-13/16 and $64-3/16, respectively.
7
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
PERIODS ENDED SEPTEMBER 30, 2000 AND 1999
(UNAUDITED)
The Merger Agreement requires that Enhance Financial pay Radian a
"break-up fee" of $20.0 million if the Enhance Financial board of directors
withdraws its recommendation to shareholders that they approve the transaction,
the shareholders fail to approve the transaction and the Company is sold to
another party within twelve months thereafter (which fee increases to $25.0
million if the Company is sold to any of certain specified competitors of
Radian). In addition, if Radian terminates the Merger Agreement for any of
certain other specified reasons as permitted by the Merger Agreement, Radian
will be entitled to reimbursement of its expenses in the transaction up to $5.0
million.
On September 28, 2000, Enhance Financial and Residential Funding
Corporation ("GMAC-RFC") had entered into an agreement providing for the sale to
GMAC-RFC of Enhance Financial's wholly owned partnership (the "Partnership")
which, in turn, holds a 46% interest in Credit-Based Asset Servicing and
Securitization LLC ("C-BASS") and REMIC interests in securitizations. Enhance
Financial and GMAC-RFC are each permitted to terminate the agreement if Enhance
Financial enters into another agreement providing for the sale by Enhance
Financial of the Partnership (including through the sale of the Company as an
entirety) to another party. Enhance Financial is required to pay GMAC-RFC a
"break-up fee" of $4 million if either party tenders a notice of termination
prior to consummation of the sale. Pursuant to the terms of the Merger
Agreement, Enhance Financial is required to provide such notice prior to the
consummation of the Merger.
Under the Merger Agreement, if the merger does not take place because
necessary conditions (including shareholder approvals) are not fulfilled by June
30, 2001, because of a breach by Radian or under similar circumstances, the
Company can require Radian to purchase the Company's 46% interest in C-BASS for
a purchase price equal to 90% of the consideration GMAC-RFC would have been
required to pay for the Partnership (approximately $90 million).
The Company has realized approximately $24.8 million of tax benefits
relating to REMIC residuals owned by the Partnership. If the Company sells those
REMIC residuals or the Partnership, the Company will be subject to taxes which
could be as much as $24.8 million, essentially as a recapture of that amount of
the tax benefits it has received. If the merger does not take place, the Company
would likely sell C-BASS, directly or by selling the Partnership. Because the
sale contemplated by the Merger Agreement would be of C-BASS, not of the
Partnership, it should not result in a tax related to the REMIC residuals.
However, a sale of the Company's interest in C-BASS may require consents from
other owners of interests in C-BASS, which would not be required if the Company
sold the Partnership. Therefore, it is possible the only way the Company would
be able to sell its interest in C-BASS would be by selling the Partnership. A
sale of the Partnership would result in the taxes of as much as $24.8 million
related to the REMIC residuals.
The Merger Agreement was the result of the Company's efforts, commenced
in February 2000, to identify and review strategic options to increase
shareholder value. These efforts were, in turn, partly an outgrowth of a
decision by Moody's Investor Service, Inc. ("Moody's) in August 1999 to
downgrade the senior long term debt rating of Enhance Financial from Aa3 to A2
and the insurance financial strength rating of Enhance Financial's largest
insurance subsidiary, Enhance Reinsurance Company ("Enhance Re"), from Aaa to
Aa2. In February 2000, Moody's placed such debt and insurance financial strength
ratings under review for possible further downgrade. It is possible that Moody's
or the Company's other rating agencies may further downgrade Enhance Financial's
long term debt rating and the financial strength rating of Enhance Re. See Note
13 of Notes to Consolidated Financial Statements in the 1999 Form 10-K/A for
related issues and potential consequences as the foregoing may relate to the
Company's reinsurance contracts. The Company is continuing to address its
liquidity shortage, and its ability to meet its debt obligations and commitments
pending consummation of the Merger. See Notes 7 and 8 regarding issues related
to two non-insurance subsidiaries of Enhance Financial. Pending consummation of
the Merger, the financial flexibility of the Company is limited.
2. DIVIDENDS DECLARED
In the first nine months of 2000, Enhance Financial declared cash
dividends of $.18 per share totaling $6,870,693. As a result of the net loss
incurred in the second quarter 2000, the Company was prohibited by the terms of
its bank credit agreement from declaring and paying a dividend to its
shareholders for the third quarter 2000 and is similarly constrained with
respect to a fourth quarter 2000 dividend. The dividend in the third quarter of
$2,292,523 was accrued during the third quarter and subsequently paid in October
2000 after the Company obtained a waiver from its bank lenders therefor.
However, the Company does not anticipate requesting a waiver from the bank
lenders to pay a dividend to its shareholders for the fourth quarter 2000.
3. COMMON STOCK
During the first nine months of 2000, Enhance Financial made no common
stock purchases.
8
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
PERIODS ENDED SEPTEMBER 30, 2000 AND 1999
(UNAUDITED)
4. COMPREHENSIVE INCOME
Comprehensive income for the three months and nine months ended
September 30, 2000 and 1999 is shown in the table below (in millions). Other
comprehensive income consists of unrealized gains and losses on available for
sale securities, foreign currency translation adjustments and unearned
compensation.
Three-months ended Nine-months ended
September 30, September 30,
- --------------------------------------------------------------------------------
2000 1999 2000 1999
- --------------------------------------------------------------------------------
Net income $ 15.5 $ 22.4 $ 9.8 $ 64.0
Other comprehensive income:
Increase (decrease) in unrealized
appreciation of investments 9.7 (18.0) 27.3 (51.9)
Applicable income taxes (3.3) 7.4 (8.3) 19.3
Reclassification adjustments for realized
(gains) losses in net income (0.1) 0.2 1.4 4.5
Applicable income taxes 0.1 (0.1) (0.5) (1.6)
Foreign currency translation losses: -- -- -- (1.7)
Applicable income taxes -- -- -- 0.6
------------------------------------
Comprehensive income $ 21.9 $ 11.9 $ 29.7 $ 33.2
====================================
5. INCOME TAXES
The Company files a consolidated federal income tax return with its
includable subsidiaries. Subject to the provisions of a tax sharing agreement,
income tax allocation is based upon separate return calculations.
The Company has not recorded a deferred federal tax liability for the
nine-month periods ended September 30, 2000 and September 30, 1999 of $10.5
million (aggregate $24.9 million for the nine months ended September 30, 2000
and $14.4 million for the nine months ended September 30, 1999), respectively,
for the tax benefits associated with the Company's investment in a portfolio of
residual mortgage-backed securities that consist of residual interests in real
estate mortgage investment conduits ("REMICs") acquired in April 1999 because
the Company believes that the tax law provides a means, through the use of a tax
strategy, by which income tax benefits associated with this portfolio will not
result in future tax obligations, and the Company intends to use such means.
For the nine-month period ended September 30, 2000, the Company
realized $10.5 million of tax benefits and $0.3 million of investment income
from the portfolio of REMICs.
For the nine-month period ended September 30, 2000, the Company
realized tax benefits of $10.9 million on a loss of $1.0 million. The tax
benefit includes $10.5 million realized from the REMICs. The effective tax rate
would have been 36.7% excluding the REMIC benefit.
For the comparable period of 1999, the Company had an effective tax
rate of 2.4%, which included $14.4 million of tax benefits realized from REMICs.
The effective rate would have been 24.4% excluding the REMIC benefit.
9
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
PERIODS ENDED SEPTEMBER 30, 2000 AND 1999
(UNAUDITED)
As discussed in Note 6 of Notes to Consolidated Financial Statements in
the 1999 Form 10-K/A, one of the prior owners of the REMICs was audited by the
Internal Revenue Service ("IRS") for taxable years during which such owner owned
the REMICs. Upon completion of that audit, the IRS determined that certain tax
strategies adopted by the prior owner with respect to the REMICs were improper
and should be disallowed. The prior owner disputed the IRS's determination and
filed suit in the United State Tax Court to overturn the IRS's audit adjustments
relating to the REMICs. In August 2000, the prior owner and the IRS reached a
settlement in their Tax Court litigation and the Tax Court entered a series of
stipulated decisions regarding the settlement. The stipulated decisions appear
to be a concession by the IRS of the incorrectness of its audit determination
that certain tax strategies adopted by the prior owner with respect to the
REMICs were improper and should be disallowed. After reviewing the stipulated
decisions, the Company's counsel has advised the Company that, at the present
time, it is not appropriate to conclude that the settlement or any potential
future IRS action will affect the Company's ability to realize the expected tax
benefits associated with the REMICs. Nonetheless, given the private nature of
the settlement, the lack of clarity regarding the basis for the settlement, and
the uncertainties regarding the IRS's potential future action, there can be no
complete assurance that the settlement or any potential future IRS action will
not have a material adverse effect on the tax benefits that the Company expects
to realize from the REMICs.
6. NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, "Accounting for Derivatives Instruments and Hedging Activities,"
which becomes effective for the Company January 1, 2001. This pronouncement
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. The Company will be required to recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. The accounting for a change in fair value of a
derivative in earnings or other comprehensive income will depend on the intended
use of the derivative and the resulting designation. The Company is currently
reviewing the impact of the implementation of SFAS No. 133 on its financial
statements.
In September 2000, the FASB issued SFAS No. 140 "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"
which superceded SFAS No. 125. With respect to certain disclosure requirements,
SFAS No. 140 is effective subsequent to December 15, 2000, with full compliance
for its requirements by April 2001.
SFAS No. 140 provides among other disclosure requirements, rules
relating to Special Purpose Entities. The Company is currently reviewing the
impact of the implementation of SFAS No. 140 on its financial statements.
10
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
PERIODS ENDED SEPTEMBER 30, 2000 AND 1999
(UNAUDITED)
7. SINGER ASSET FINANCE COMPANY, L.L.C. ("SINGER")/ENHANCE LIFE BENEFITS LLC
("ELB")
As part of its review of strategic alternatives, the Company assessed
the continuing value or impairment of goodwill recorded at approximately $22.1
million as of June 30, 2000, attributable to its wholly owned subsidiaries,
Singer and ELB. The strategic analysis, which was performed by an investment
banking firm, established that there is negligible investor interest in
purchasing these companies and that it is unlikely that the Company would
recover at minimum its recorded goodwill. In conjunction with this assessment,
the Company also completed a long-term cash flow analysis. Additionally, Singer
and ELB have continued to incur losses and generate negative cash flows
throughout the first nine months of 2000. Accordingly, the Company determined as
of June 30, 2000 that the entire recorded value of goodwill has been impaired
and should be charged off, which charges has been included in non-insurance
operating expenses.
The Company is finalizing a plan to wind down, sell or otherwise
dispose of the Singer and ELB business activities, operations and assets while
meeting Singer's and ELB's servicing and financial obligations. A provision of
$7.5 million has been recorded at September 30, 2000 to reflect severance and
termination costs and other related wind-down costs, which charge has been
included in non-insurance operating expenses. Additionally in October 2000, the
Company sold certain assets and intangibles of ELB and has recorded an estimated
loss of $1.4 million, which charge has been included in non-insurance operating
expenses). As the Company continues to finalize this plan, it may incur further
restructuring charges.
The Company is also analyzing and evaluating those of its obligations
that may remain in the event of run-off. This process includes the analysis and
evaluation of the fixed and contingent exposures of Enhance Financial, Singer,
ELB and the Company's non-consolidated entities (i.e. trusts and other special
purpose entities) under servicing agreements, debt obligations and credit
agreements. Enhance Financial has provided performance guarantees (in some cases
with a direct performance obligation) to the respective lenders on behalf of
Singer, ELB and related trusts, special purpose companies, etc. which were
formed in conjunction with a number of securitizations. The guarantees relate to
Singer and ELB's roles as originators and/or servicers of the securitized
assets. Additionally, Enhance Financial has provided other forms of programmatic
support, including the down-stream funding of tax credits related to the
securitization of assignable state lottery awards and the guarantee of certain
interest rate swap transactions entered into in connection with a number of the
securitizations and to hedge interest rate risk to assets in the pipeline. In
addition, Enhance Financial has indemnified many of Singer's and ELB's lenders
against non-credit-related losses resulting from any breach of Singer's or ELB's
representations, warranties or covenants.
Enhance Financial will be responsible for servicing, in some cases for
15 years or longer, permanently financed securitized assets originated by Singer
and ELB having an aggregate value of approximately $590.0 million and an
additional $158.0 million currently placed in warehouse lines maturing before
the end of 2000. In connection with Singer's lottery servicing obligations,
related cash liquidity reserves of the Company totaling $7.5 million at
September 30, 2000, which, while not pledged as credit support with respect to
the assets, are at risk in the event of an uncured default by Singer or Enhance
Financial.
11
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
PERIODS ENDED SEPTEMBER 30, 2000 AND 1999
(UNAUDITED)
Enhance Financial is obligated to fund federal and state tax credits
related to lottery payments, either which Enhance Financial utilizes in
connection with its tax obligations or for which Enhance Financial applies for
refunds, through 2016 as follows (in millions):
Year Tax Credits
---- -----------
2000 $25.2 ($17.9 funded through September 30)
2001 25.2
2002 24.5
2003 23.0
2004 21.7
Thereafter 138.8
At September 30, 2000, Enhance Financial has guaranteed Singer's
performance under interest rate swap agreements with a notional amount of $40.0
million. The fair market value of these swaps was approximately $(261,000).
Deferred hedge losses as of September 30, 2000 totaled approximately $655,000.
Offsetting this liability was approximately $43.0 million of lottery receivables
residing in the pipeline or in an off-balance sheet warehouse.
At September 30, 2000, Singer has arranged for approximately $158.0
million of over-collateralized debt, financed through two off-balance sheet
warehouse lines, secured by assets held by non-consolidated entities. The
financings mature on December 29 and 30, 2000. Should the respective lenders
elect not to renew the facilities, it will be necessary for the Company to
refinance or sell the assets. In the event of default, the Company is exposed to
the potential loss of its equity of approximately $21.9 million and the reversal
of gains previously recognized of approximately $13.0 million. Additionally, if
the Company reacquires these assets, they would be subject to current
mark-to-market adjustments. Also, Singer has arranged for approximately $590.0
million of off-balance sheet collateralized permanent financing, secured by
assets held by the non-consolidated entities.
At September 30, 2000, Singer is obligated to purchase approximately
$21.0 million of lottery assets and $4.2 of structured settlements, at prices
that approximate their market value and are substantially protected by hedge
agreements.
On August 10, 2000, the Company entered into a letter of intent with
certain members of Singer's management for the sale of certain of Singer's
off-balance sheet assets, including its pipeline of lottery and structured
settlement transactions and certain intangibles. Although the letter has
expired, the Company continues to negotiate the terms of such sale.
8. INVESTMENT IN NEW SUBSIDIARY
In April 2000 Enhance Financial acquired a convertible preferred stock
representing a majority equity interest in Credit2B.com Inc. ("Credit2B"), a
newly formed corporation, in return for cash and future capital commitments
aggregating $14.0 million. Through September 30, 2000, Enhance Financial has
funded $3.4 million of the $14.0 million commitment. Additionally, in October
2000 Enhance Financial funded an additional $2.7 million.
The goal of Credit2B is to facilitate business trade credit on the
Internet. It seeks to integrate data, analytics, scoring, and financial
alternatives for business-to-business exchanges and web sellers to approve
transactions and to offload risk in real time. Credit2B and Enhance Financial
have entered into employment agreements with several of Credit2B's officers
(including its President and Chief Executive Officer and its Chief Operating
Officer), which provide base and incentive compensation of approximately $3.3
million per annum ($1.7 million of which is attributable to the aforementioned
two officers). Each such agreement is cancelable upon 30 days notice by either
party.
12
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
PERIODS ENDED SEPTEMBER 30, 2000 AND 1999
(UNAUDITED)
Enhance Financial currently intends to divest itself of its ownership
of its stock in Credit2B prior to the end of 2000 and obtain value for Enhance
Financial's shareholders. Accordingly, the Company at September 30, 2000 has
accounted for its investment in Credit2B on the equity method of accounting
notwithstanding that Enhance Financial's designees compose a majority of the
Credit2B board of directors resulting in Enhance Financial having effective
voting control of Credit2B. Enhance Financial's ability to complete its
divestiture of Credit2B is subject to the current market-related uncertainties
affecting the Internet businesses in general.
Credit2B incurred a net loss for the period April 17, 2000 (date of
inception) to September 30, 2000 of $2.9 million, of which Enhance Financial's
share is $2.5 million ($2.1 million for the three-month period ended September
30, 2000).
9. RESTRUCTURING AND SHUTDOWN EXPENSES
In September 2000, the Company determined to place Singer into
wind-down and incurred $7.5 million for severance and related shutdown costs.
See Note 7 for additional information regarding the October 2000 sale of certain
assets of ELB.
In May 2000, the Company ceased operations of its New Products and
Ventures Group and incurred $2.9 million for severance and related shutdown
costs.
In May 2000, the Company transferred its entire equity interests in AGS
Financial Group LLC , the entity that conducted a significant portion of the
Company's South American operations, to the Company's partners (who constituted
senior management of the enterprise) for nominal consideration. In connection
with such transaction, the Company recognized a loss of $1.3 million.
10. LOSS RESERVE - CREDITRUST EXPOSURE
The Company insured three securitization transactions in 1998 for
special purpose subsidiaries of Creditrust Corporation ("Creditrust"), which has
since filed for protection under the bankruptcy laws. In each case the Company
insured notes issued by the special purpose vehicle and secured by pledges of
receivables from pools of charged-off credit card obligations. The Company has
concluded that the proceeds of the pledged receivables will likely be
insufficient to satisfy the timely payment of the insured notes in two of those
transactions and has, accordingly, established the indicated case-basis reserves
aggregating $4.0 million of which $1.0 million has been charged to current
earnings. In addition, the Company has received information alleging that
certain of the data that Creditrust conveyed to the Company upon which the
Company relied to gauge collection performance in the insured transactions for
which reserves have been established had been altered and was therefore
unreliable. Primarily as a result of these allegations, the Company filed a
motion in Creditrust's bankruptcy proceeding seeking the appointment of a
trustee to manage Creditrust's affairs.
The Company believes the reserve amounts to be reasonable based on the
information it currently has concerning the performance of the respective pools.
The Company will continue to monitor these transactions closely for fluctuations
in pool performance. See Note 13 for additional information regarding the
litigation with Creditrust.
13
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
PERIODS ENDED SEPTEMBER 30, 2000 AND 1999
(UNAUDITED)
11. SEGMENT REPORTING
The Company has two reportable segments: insurance and asset-based
businesses. The insurance segment provides credit-related insurance coverage to
meet the needs of customers in a wide variety of domestic and international
markets. The Company's largest insurance business is the provision of
reinsurance to the monoline primary financial guaranty insurers for both
municipal bonds and non-municipal obligations. The Company also provides trade
credit reinsurance, financial responsibility bonds, excess-SIPC insurance and
direct financial guaranty insurance. The asset-based businesses segment deals
primarily with credit-based servicing and securitization of assets in
underserved markets, in particular, the origination, purchase, servicing and
securitization of special assets, including lottery awards, structured
settlement payments, sub-performing/non-performing and seller financed
residential mortgages and delinquent consumer assets. The Company's reportable
segments are strategic business units, which are managed separately as each
business requires different marketing and sales expertise.
The Company evaluates performance based on net income. Summarized
financial information concerning the Company's operating segments is presented
in the following tables:
In thousands
September 30, 2000
------------------
Insurance Asset-based Total
--------- ----------- -----
Revenues from external customers $82,607 $ 10,455 $93,062
Net investment income 46,995 282 47,277
Net income (loss) 37,235 (27,391) 9,844
Segment assets 1,098,470 455,162 1,553,632
September 30, 1999
------------------
In thousands
Insurance Asset-based Total
--------- ----------- -----
Revenues from external customers $75,601 $ 33,154 $ 108,755
Net investment income 42,762 -- 42,762
Net income 51,020 13,023 64,043
Segment assets 1,213,998 220,865 1,434,863
The following are reconciliations of reportable segment revenues and
profit to Enhance Financial's consolidated totals:
In Thousands September 30,
-------------
2000 1999
---- ----
REVENUES
Total revenues from external customers for reportable segments $ 93,062 $ 108,755
Net investment income for reportable segments 47,277 42,762
Realized losses (1,357) (4,480)
--------- ---------
Total consolidated revenues $ 138,982 $ 147,037
========= =========
14
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
PERIODS ENDED SEPTEMBER 30, 2000 AND 1999
(UNAUDITED)
12. LITIGATION
Creditrust and its president filed a complaint against Enhance
Financial and its wholly owned subsidiary, Asset Guaranty Insurance Company
("Asset Guaranty") on April 4, 2000 in the United States District Court for the
District of Maryland alleging that a senior employee of Enhance Financial had
posted messages on an internet message board containing derogatory, false,
misleading, and/or confidential information regarding Creditrust, in violation
of various state and federal common law and statutory duties. This alleged
misconduct would have been unauthorized and contrary to Company policy. The
employee identified in the lawsuit is no longer employed by the Company.
Nonetheless, the complaint alleges that the message board activity was
undertaken on behalf of the Company to further its competitive interests. On May
9, 2000, Enhance Financial and Asset Guaranty filed a motion to dismiss the
complaint, which has not yet been argued or decided.
On October 19, 2000, Enhance Financial and Asset Guaranty entered into
a settlement agreement with Creditrust and its president, which provides for
dismissal with prejudice of the complaint against Enhance Financial and Asset
Guaranty with no payment of money by Enhance Financial or Asset Guaranty (the
"Settlement Agreement"). The Settlement Agreement was reached as part of a
global resolution of claims between and among parties including Enhance
Financial and Asset Guaranty and Creditrust and its president, which included
the claims brought by Asset Guaranty against Creditrust in Creditrust's
bankruptcy proceeding. The Settlement Agreement is subject to approval by the
Bankruptcy Court, and it will not become effective, and the complaint against
Enhance Financial and Asset Guaranty will not be dismissed (although it is
currently stayed) unless and until the Bankruptcy Court approves a plan of
reorganization filed by Creditrust, which incorporates the terms of the
Settlement Agreement. The settlement is also subject to certain other
contingencies, which may or may not be satisfied.
In November 2000, the Official Committee of Unsecured Creditors of
Creditrust filed objections to the Settlement Agreement and a plan of
organization in connection with the Creditrust bankruptcy that does not
contemplate implementation of the Settlement Agreement, and Wells Fargo Bank
Minnesota, N.A., as trustee, filed certain objections to the plan of
reorganization filed by Creditrust.
Even if the Settlement Agreement does not become effective and the
motion to dismiss is not granted, in whole or in part, the Company believes that
Creditrust's claims against the Enhance Financial and Asset Guaranty are not
well founded and that the outcome of this litigation will not be material to the
Company's business.
15
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
To the Board of Directors and Shareholders of
Enhance Financial Services Group Inc.
New York, NY 10017
We have reviewed the accompanying consolidated balance sheet of Enhance
Financial Services Group Inc. and subsidiaries (the "Company") as of September
30, 2000, and the related consolidated statements of income for the three-month
and nine-month periods ended September 30, 2000 and 1999 and the consolidated
statements of shareholders' equity and cash flows for the nine-month periods
ended September 30, 2000 and 1999. These financial statements are the
responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and of making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States of
America, the objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to such consolidated financial statements for them to be in conformity
with accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of the
Company as of December 31, 1999, and the related consolidated statements of
income, shareholders' equity and cash flows for the year then ended (not
presented herein); and in our report dated March 27, 2000, we expressed an
unqualified opinion on those consolidated financial statements. In our opinion,
the information set forth in the accompanying consolidated balance sheet as of
December 31, 1999 is fairly stated, in all material respects, in relation to the
consolidated balance sheet from which it has been derived.
/s/ DELOITTE & TOUCHE LLP
New York, New York
November 17, 2000