SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File No. 1-12644
Financial Security Assurance Holdings Ltd.
(Exact name of registrant as specified in its charter)
New York 13-3261323
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
350 Park Avenue
New York, New York 10022
(Address of principal executive offices)
(212) 826-0100
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
At November 6, 1998, there were outstanding 31,533,781 shares of Common Stock,
par value $0.01 per share, of the registrant (includes 1,626,678 shares of
Common Stock owned by a trust on behalf of the registrant and excludes 742,520
shares of Common Stock actually held in treasury).
INDEX
PAGE
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Financial Security Assurance Holdings Ltd. and Subsidiaries
Consolidated Balance Sheets - September 30, 1998 and
December 31, 1997 3
Consolidated Statements of Income - Three and nine months
ended September 30, 1998 and 1997 4
Consolidated Statement of Changes in Shareholders' Equity
- Nine months ended September 30, 1998 5
Consolidated Statements of Cash Flows
- Nine months ended September 30, 1998 and 1997 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
PART II OTHER INFORMATION, AS APPLICABLE
Item 5. Other Information 14
Item 6. Exhibits and Reports on Form 8-K 14
SIGNATURES 15
2
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
September 30, December 31,
ASSETS 1998 1997
---- ----
Bonds at market value (amortized cost of $1,415,814 and
$1,230,479) $ 1,481,100 $ 1,268,158
Equity investments at market value (cost of $35,969 and
$29,430) 36,886 30,539
Short-term investments 85,413 132,931
----------- -----------
Total investments 1,603,399 1,431,628
Cash 5,985 12,475
Deferred acquisition costs 186,700 171,098
Prepaid reinsurance premiums 202,139 173,123
Reinsurance recoverable on unpaid losses 1,872 30,618
Receivable for securities sold 17,390 20,623
Other assets 75,265 61,079
----------- -----------
TOTAL ASSETS $ 2,092,750 $ 1,900,644
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deferred premium revenue $ 682,228 $ 595,196
Losses and loss adjustment expenses 61,323 75,417
Deferred federal income taxes 59,571 56,872
Ceded reinsurance balances payable 24,370 11,199
Payable for securities purchased 84,441 72,979
Notes payable 130,000 130,000
Accrued expenses and other liabilities 85,376 76,621
----------- -----------
TOTAL LIABILITIES 1,127,309 1,018,284
----------- -----------
Preferred stock (3,000,000 shares authorized; 2,000,000
issued and outstanding; par value of $.01 per share) 20 20
Common stock (50,000,000 shares authorized; 32,276,301
issued; par value of $.01 per share) 323 323
Additional paid-in capital - preferred 680 680
Additional paid-in capital - common 693,845 693,851
Accumulated other comprehensive income (net of deferred
income tax provision of $23,123 and $13,575) 42,942 25,212
Accumulated earnings 307,220 231,124
Deferred equity compensation 33,358 26,181
Less treasury stock at cost (3,868,202 and 3,521,847 shares
held) (112,947) (95,031)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY 965,441 882,360
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,092,750 $ 1,900,644
=========== ===========
See notes to condensed consolidated financial statements.
3
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
1998 1997 1998 1997
---- ---- ---- ----
Revenues:
Net premiums written (net of premiums ceded
of $22,562, $13,559, $66,074 and $50,986) $ 54,462 $ 28,911 $ 154,530 $ 123,590
Increase in deferred premium revenue (21,844) (1,707) (57,539) (44,051)
--------- --------- --------- ---------
Premiums earned (net of premiums ceded of
$11,796, $9,525, $37,497 and $28,791) 32,618 27,204 96,991 79,539
Net investment income 19,710 17,920 57,648 51,402
Net realized gains 8,907 5,315 15,579 6,648
Other income 44 5,765 400 9,022
--------- --------- --------- ---------
TOTAL REVENUES 61,279 56,204 170,618 146,611
--------- --------- --------- ---------
Expenses:
Losses and loss adjustment expenses (net of
reinsurance recoveries of $88, $443, $(6,780)
and $2,881) 1,046 2,426 3,140 6,867
Interest expense 2,408 1,834 7,250 2,917
Policy acquisition costs 8,397 7,365 25,311 20,714
Other operating expenses 6,978 6,683 18,170 15,893
--------- --------- --------- ---------
TOTAL EXPENSES 18,829 18,308 53,871 46,391
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES 42,450 37,896 116,747 100,220
Provision for income taxes 11,462 10,671 31,264 27,512
--------- --------- --------- ---------
NET INCOME 30,988 27,225 85,483 72,708
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gains arising during period 21,069 12,791 27,856 17,275
Less: reclassification adjustment for gains
included in net income (5,789) (3,455) (10,126) (4,321)
--------- --------- --------- ---------
Other comprehensive income 15,280 9,336 17,730 12,954
--------- --------- --------- ---------
COMPREHENSIVE INCOME $ 46,268 $ 36,561 $ 103,213 $ 85,662
========= ========= ========= =========
As based upon net income:
Basic earnings per common share $ 1.08 $ 0.91 $ 2.95 $ 2.42
========= ========= ========= =========
Diluted earnings per common share $ 1.03 $ 0.88 $ 2.83 $ 2.36
========= ========= ========= =========
See notes to condensed consolidated financial statements.
4
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in thousands)
Additional Additional Accumulated Deferred
Paid-In Paid-In Other Comp- Equity
Preferred Common Capital - Capital - rehensive Accumulated Compen- Treasury
Stock Stock Preferred Common Income Earnings sation Stock Total
----- ----- --------- ------ ------ -------- ------ ----- -----
BALANCE, December 31, 1997 $20 $323 $680 $693,851 $25,212 $231,124 $26,181 $(95,031) $882,360
Net income 85,483 85,483
Net unrealized gain on
investments 17,730 17,730
Dividends paid on common stock
($0.3275 per share) (9,387) (9,387)
Deferred equity compensation 11,101 11,101
Deferred equity payout 492 (3,857) 204 (3,161)
Purchase of 359,650 shares of
common stock (18,455) (18,455)
Issuance of 13,295 shares of
treasury stock for options
exercised (16) (67) 335 252
Forward share transactions-
settlements with employees
and directors (482) (482)
--- ---- ---- -------- ------- -------- ------- --------- --------
BALANCE, September 30, 1998 $20 $323 $680 $693,845 $42,942 $307,220 $33,358 $(112,947) $965,441
=== ==== ==== ======== ======= ======== ======= ========= ========
See notes to condensed consolidated financial statements.
5
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Nine Months Ended September 30,
-------------------------------
1998 1997
---- ----
Cash flows from operating activities:
Premiums received, net $ 173,581 $ 119,152
Policy acquisition and other operating expenses
paid, net (46,928) (33,278)
Loss and LAE recovered (paid), net 10,928 (7,131)
Net investment income received 56,368 49,136
Recoverable advances received (paid) 1,884 (6,242)
Federal income taxes paid (41,804) (13,479)
Interest paid (7,217) (2,442)
Other, net (1,235) 653
------------ ------------
Net cash provided by operating activities 145,577 106,369
------------ ------------
Cash flows from investing activities:
Proceeds from sales of bonds 1,401,419 789,671
Purchases of bonds (1,562,778) (853,566)
Other, net (14,208) 7,986
Purchases of property and equipment (898) (2,547)
Net decrease (increase) in short-term securities 51,708 (131,920)
------------ ------------
Net cash used for investing activities (124,757) (190,376)
------------ ------------
Cash flows from financing activities:
Issuance of long-term debt, net 125,905
Repayment of debt (30,000)
Dividends paid (9,387) (8,879)
Treasury stock (18,252) (2,215)
Other 329 (540)
------------ ------------
Net cash provided by (used for) financing
activities (27,310) 84,271
------------ ------------
Net increase (decrease) in cash (6,490) 264
Cash at beginning of period 12,475 8,146
------------ ------------
Cash at end of period $ 5,985 $ 8,410
============ ============
See notes to condensed consolidated financial statements.
6
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Nine Months Ended September 30, 1998 and 1997
1. ORGANIZATION AND OWNERSHIP
Financial Security Assurance Holdings Ltd. (the Company) is an insurance
holding company domiciled in the State of New York. The Company is primarily
engaged (through its insurance subsidiaries, collectively known as FSA) in the
business of providing financial guaranty insurance on asset-backed and municipal
obligations. At September 30, 1998, the Company was owned 42.6% by MediaOne
Capital Corporation (MediaOne), formerly U S WEST Capital Corporation, 12.2% by
Fund American Enterprises Holdings, Inc. (Fund American) and its subsidiaries,
6.8% by The Tokio Marine and Fire Insurance Co., Ltd. (Tokio Marine) and 38.4%
by the public and employees. These percentages are calculated based upon
outstanding shares, which are reduced by treasury shares as presented in these
financial statements.
2. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared in
accordance with instructions to Form 10-Q and, accordingly, 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 Company's 1997 Annual
Report to Shareholders. The accompanying financial statements have not been
audited by independent accountants in accordance with generally accepted
auditing standards but, in the opinion of management, all adjustments, which
include only normal recurring adjustments, necessary to present fairly the
financial position, results of operations and cash flows at September 30, 1998
and for all periods presented have been made. The December 31, 1997 condensed
balance sheet data was derived from audited financial statements, but does not
include all disclosures required by generally accepted accounting principles.
The results of operations for the periods ended September 30, 1998 and 1997 are
not necessarily indicative of the operating results for the full year.
3. COMPREHENSIVE INCOME
The Company adopted Statement of Financial Accounting Standards (SFAS) No.
130, Reporting Comprehensive Income, which requires that all components of other
comprehensive income be classified by their nature in a financial statement and
accumulated balances of other comprehensive income be displayed separately from
retained earnings and additional paid-in capital in the equity section of a
balance sheet. The Company is disclosing this information in its statements of
income. Comprehensive income is defined as the change in shareholders' equity
during a period from transactions and other events and circumstances from
non-owner sources and includes net income and all changes in shareholders'
equity except those from investments by owners and distributions to owners. This
statement did not change the current accounting treatment for components of
comprehensive income such as changes in unrealized gains or losses on securities
available for sale.
4. RECENTLY ISSUED ACCOUNTING STANDARD
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities (FAS No. 133). FAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. FAS
No. 133 is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999. The impact of FAS No. 133 on the Company has not yet been
determined.
7
5. SUBSEQUENT EVENTS
On November 3, 1998, the Company and EXEL Limited closed a transaction to
create two new Bermuda-based financial guaranty insurance companies. Each of the
new companies has been initially capitalized with approximately $100,000,000.
One company, Financial Security Assurance International Ltd., is an indirect
subsidiary of FSA and the other company, X.L. Financial Assurance Ltd., is a
subsidiary of EXEL Limited. The Company has a minority interest in the EXEL
company, and EXEL has a minority interest in the FSA company. In conjunction
with forming the new companies, the Company and EXEL Limited swapped $80,000,000
of their respective common shares, with the Company delivering to EXEL Limited
1,632,653 common shares out of treasury. The Company then sold $60,000,000 of
the EXEL shares to an unrelated third party in order to fund, in part, its
investment in Financial Security Assurance International Ltd.
On November 6, 1998, the Company entered into an agreement to sell,
subject to customary closing conditions, $100,000,000 of 6.95% Senior Quarterly
Income Debt Securities due 2098 and callable without premium or penalty
commencing November, 2003 or at any time following certain tax events. The
proceeds from the sale of the securities will be used to augment the capital of
the Company's insurance company subsidiaries and for general corporate purposes.
8
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations
1998 and 1997 Third Quarter Results
The Company's 1998 third quarter net income was $31.0 million, compared with
$27.2 million for the same period in 1997, an increase of 13.8%. Core net income
(operating net income less the after-tax effect of refundings and prepayments)
was $27.3 million, compared with $22.5 million for the same period in 1997, an
increase of 21.5%. Total core revenues in the third quarter of 1998 increased
$8.1 million, from $43.3 million in 1997 to $51.4 million in 1998, while total
core expenses increased $1.9 million. Operating net income (net income less the
after-tax effect of net realized capital gains or losses and the cost of the
performance share program and other non-operating items) was $27.8 million for
the third quarter of 1998 versus $23.5 million for the comparable period in
1997, an increase of $4.3 million or 18.5%.
There are two measures of gross premiums originated for a given period. Gross
premiums written captures premiums collected in the period, whether collected
up-front for business originated in the period, or in installments for business
originated in prior periods. An alternative measure, the gross present value of
premiums written (gross PV premiums written) reflects future installment
premiums discounted to a present value, as well as up-front premiums, but only
for business originated in the period. At the beginning of 1998, the Company
revised the discount rate used to estimate gross PV premiums written in order to
more accurately reflect current interest rates. The new discount rate of 6.3%
represents the average pre-tax yield on the Company's investment portfolio for
the previous three years. The Company intends to revise the discount rate in
future years according to the same formula. For business written prior to 1998,
the discount rate remains 9.5% in all years. The change to the new discount rate
has no effect on current or future earned premiums. The Company considers gross
PV premiums written to be the better indicator of a given period's origination
activity because a substantial part of the Company's premiums are collected in
installments, a practice typical of the asset-backed business. Regardless of the
measure used, quarter to quarter comparisons are of limited significance because
originations fluctuate from quarter to quarter but historically have not
exhibited a seasonal pattern.
Gross premiums written increased 81.4%, to $77.0 million for the third quarter
of 1998 from $42.5 million for the third quarter of 1997. Gross PV premiums
written increased 102.5%, to $89.9 million in 1998 from $44.4 million in the
third quarter of 1997. The increase in gross PV premiums written was the result
of higher volume in both the municipal sector and the asset-backed sector. In
the third quarter of 1998, asset-backed gross PV premiums written were $40.0
million, as compared with $18.1 million in 1997, an increase of 121.2%. For the
municipal business, gross PV premiums written in the third quarter increased
from $26.3 million in 1997 to $49.9 million in 1998, an increase of 89.7%.
In the third quarter of 1998, the Company insured par value of bonds totaling
$13.4 billion, an 85.6% increase over the same period in 1997. FSA's third
quarter asset-backed component rose 28.7% to $4.9 billion while its municipal
sector rose 148.7% to $8.5 billion.
Net premiums written were $54.5 million for the third quarter of 1998, an
increase of 88.4% when compared with 1997. Net premiums earned for the third
quarter of 1998 were $32.6 million, compared with $27.2 million in the third
quarter of 1997, an increase of 19.9%. Premiums earned from refundings and
prepayments were $1.0 million for the third quarter of 1998 and $2.2 million for
the same period of 1997, contributing $0.5 million and $1.0 million,
respectively, to after-tax earnings. Net premiums earned for the quarter grew
26.4% relative to the same period in 1997 when the effects of refundings and
prepayments are eliminated.
9
Net investment income was $19.7 million for the third quarter of 1998 and $17.9
million for the comparable period in 1997, an increase of 10.0%. The Company's
effective tax rate on investment income was 20.1% for the third quarter of 1997
compared with 17.2% for the same period in 1998. In the third quarter of 1998,
the Company realized $8.9 million in net capital gains as compared with net
capital gains of $5.3 million for the same period in 1997. Capital gains and
losses are a by-product of the normal investment management process and will
vary substantially from period to period.
During the third quarter of 1997, the Company realized a $5.4 million net gain
from the sale of a subsidiary. The subsidiary was sold because its insurance
licenses were no longer required.
The provision for losses and loss adjustment expenses during the third quarter
of 1998 was $1.0 million compared with $2.4 million in 1997, representing
additions to the Company's general loss reserve. The additions to the general
loss reserve represent management's estimate of the amount required to
adequately cover the net cost of claims. The Company will, on an ongoing basis,
monitor these reserves and may periodically adjust such reserves based on the
Company's actual loss experience, its future mix of business, and future
economic conditions. At September 30, 1998, the unallocated balance in the
Company's general loss reserve was $55.3 million.
Total policy acquisition and other operating expenses (excluding the cost of the
performance share program of $4.0 million for the third quarter of 1998 compared
with $3.9 million for the same period of 1997) were $11.4 million for the third
quarter of 1998 compared with $10.1 million for the same period in 1997, an
increase of 12.5%. Excluding the effects of refundings, total policy acquisition
and other operating expenses were $11.1 million for the third quarter of 1998
compared with $9.4 million for the same period in 1997, an increase of 18.0%.
The increase was the result of higher DAC amortization due to a higher level of
premiums earned, personnel costs and bank facility fees.
Income before income taxes for the third quarter of 1998 was $42.5 million, up
from $37.9 million, or 12.0%, for the same period in 1997.
The Company's effective tax rate for the third quarter of 1998 was 27.0%
compared with 28.2% for the same period in 1997.
The weighted average number of diluted shares of common stock outstanding
decreased to 30,012,000 for the quarter ended September 30, 1998, from
31,069,000 during the third quarter of 1997. This decrease was due to shares the
Company repurchased to fund obligations under employee benefit plans and to
close out a portion of its forward share purchase arrangement, as discussed in
previous filings, partially offset by an increase in the dilutive effect of its
convertible preferred stock and shares issuable under its performance share
program. Diluted earnings per share increased to $1.03 for the third quarter of
1998 from $0.88 for the same period in 1997.
The Company has assessed its internal operating systems and software for Year
2000 compliance. Management does not expect that the arrival of the Year 2000
will require any material upgrade to its internal systems or software. The
Company is conducting a survey of Year 2000 readiness of trustees, servicers,
issuers and other parties in FSA-insured transactions. While such other parties
have not informed the Company of any material issues regarding Year 2000
readiness, there can be no assurance that each such party will be Year 2000
compliant. Failure by an issuer or servicer in an FSA-insured transaction to be
Year 2000 compliant may result in unanticipated claims upon FSA. While FSA
generally would be entitled to reimbursement for any such claims paid, the
liquidity exposure to FSA from such claims could be material. Failure by a
trustee in an FSA-insured transaction to make payments to insured
securityholders due to failure by the trustee to be Year 2000 compliant
generally would not entitle the trustee to make claims upon FSA.
1998 and 1997 First Nine Months Results
The Company's 1998 first nine months net income was $85.5 million, compared with
$72.7 million for the same period in 1997, an increase of 17.6%. Core net income
was $78.3 million, compared with $65.1 million for the same period in 1997, an
increase of 20.3%. Total core revenues in the first nine months of 1998
increased $21.7 million, from $124.2 million in 1997 to $145.9 million in 1998,
while total core expenses increased $4.5 million. Operating net income was $82.6
million for the first nine months of 1998 versus $68.6 million for the
comparable period in 1997, an increase of $14.0 million or 20.3%.
10
Gross premiums written increased 26.4%, to $220.6 million for the first nine
months of 1998 from $174.6 million for the same period in 1997. Also, gross PV
premiums written increased 42.4%, to $247.9 million in 1998 from $174.1 million
for the comparable period in 1997. In the first nine months of 1998,
asset-backed gross PV premiums written were $91.9 million, as compared with
$78.3 million in the same period during 1997, an increase of 17.4% due to higher
levels of consumer and structured finance transactions partially offset by lower
international business. For the municipal business, gross PV premiums written in
the first nine months increased to $156.0 million in 1998 from $95.8 million in
1997, an increase of 62.8%.
In the first nine months of 1998, the Company insured par value of bonds
totaling $39.6 billion, a 68.5% increase over the same period in 1997. For the
first nine months, FSA's asset-backed sector rose 14.1% to $14.4 billion while
its municipal sector rose 132.1% to $25.2 billion.
Net premiums written were $154.5 million for the first nine months of 1998, an
increase of $30.9 million, or 25.0%, when compared with the same period during
1997. Net premiums earned for the first nine months of 1998 were $97.0 million,
compared with $79.5 million in the same period of 1997, an increase of 21.9%.
Premiums earned from refundings and prepayments were $9.2 million for the first
nine months of 1998 and $7.8 million for the same period of 1997, contributing
$4.3 million and $3.6 million, respectively, to after-tax earnings. Net premiums
earned for the first nine months grew 22.3% relative to the same period in 1997
when the effects of refundings and prepayments are eliminated.
Net investment income was $57.6 million for the first nine months of 1998 and
$51.4 million for the comparable period in 1997, an increase of 12.1%. The
Company's effective tax rate on investment income was 19.7% for the first nine
months of 1997 compared with 17.8% for the same period in 1998. In the first
nine months of 1998, the Company realized $15.6 million in net capital gains as
compared with $6.6 million for the same period in 1997. Capital gains and losses
are a by-product of the normal investment management process and will vary
substantially from period to period. The Company also realized in the first nine
months of 1997 a net gain of $7.0 million on the sale of non-essential
subsidiaries.
The provision for losses and loss adjustment expenses during the first nine
months of 1998 was $3.1 million compared with $6.9 million for the same period
in 1997, representing additions to the Company's general loss reserve.
Total policy acquisition and other operating expenses (excluding the cost of the
performance share program of $11.1 million for the first nine months of 1998
compared with $7.4 million for the same period of 1997) were $32.4 million for
the first nine months of 1998 compared with $29.2 million for the same period in
1997, an increase of 10.9%. Excluding the effects of refundings, total policy
acquisition and other operating expenses were $29.8 million for the first nine
months of 1998 compared with $26.9 million for the same period in 1997, an
increase of 10.7%.
Income before income taxes for the first nine months of 1998 was $116.7 million,
up from $100.2 million, or 16.5%, for the same period in 1997.
The Company's effective tax rate for the first nine months of 1998 was 26.8%
compared with 27.5% for the same period in 1997.
The weighted average number of diluted shares of common stock outstanding
decreased from 30,910,000 during the first nine months of 1997 to 30,252,000,
for the nine months ended September 30, 1998. Diluted earnings per share
increased to $2.83 for the first nine months of 1998 from $2.36 for the same
period in 1997.
Liquidity and Capital Resources
The Company's consolidated invested assets and cash equivalents at September 30,
1998, net of unsettled security transactions, was $1,536.3 million, compared
with the December 31, 1997 balance of $1,379.3 million. These balances include
the change in the market value of the investment portfolio, which had an
unrealized gain position of $66.2 million at September 30, 1998 and $38.8
million at December 31, 1997.
11
At September 30, 1998, the Company had, at the holding company level, an
investment portfolio of $56.2 million available to fund the liquidity needs of
its activities outside of its insurance operations. Because the majority of the
Company's operations are conducted through FSA, the long-term ability of the
Company to service its debt and to declare and pay dividends will largely depend
upon the receipt of dividends from and payments on surplus notes by FSA and upon
external financings.
FSA's ability to pay dividends is dependent upon FSA's financial condition,
results of operations, cash requirements, rating agency approval and other
related factors and is also subject to restrictions contained in the insurance
laws and related regulations of New York and other states. Under New York State
insurance law, FSA may pay dividends out of earned surplus, provided that,
together with all dividends declared or distributed by FSA during the preceding
12 months, the dividends do not exceed the lesser of (i) 10% of policyholders'
surplus as of its last statement filed with the New York Superintendent of
Insurance or (ii) adjusted net investment income during this period. FSA paid no
dividends in 1997. Based upon FSA's statutory statements for the quarter ended
September 30, 1998, and considering dividends that can be paid by its
subsidiary, the maximum amount available for payment of dividends by FSA without
regulatory approval over the following 12 months is approximately $50.4 million.
In addition, the Company holds a $50 million surplus note of FSA. Payments of
principal or interest on such note may be made with the approval of the New York
Insurance Department. The New York Superintendent has approved the repurchase by
FSA of up to $75.0 million of its shares from its parent, all of which have been
repurchased by June 30, 1998.
Dividends paid by the Company to its shareholders increased to $9.4 million in
the first nine months of 1998 from $8.9 million in the comparable period of 1997
and to $0.3275 per common share in the first nine months of 1998 from $0.2975 in
the first nine months of 1997. In addition to paying dividends, the Company uses
funds to make debt service payments and to fund employee benefit plans.
The Company has outstanding $130.0 million of 7-3/8% Senior Quarterly Income
Debt Securities due September 30, 2097 and callable without premium or penalty
on or after September 18, 2002.
In May 1996, the Company repurchased 1,000,000 shares of its common stock from
MediaOne for a purchase price of $26.50 per share. At the same time, the Company
also entered into forward agreements with two banks (the Counterparties) in
respect of 1,750,000 shares (the Forward Shares) of the Company's common stock.
Under the forward agreements, the Company has the obligation either (i) to
purchase the Forward Shares from the Counterparties for a price equal to $26.50
per share plus carrying costs or (ii) to direct the Counterparties to sell the
Forward Shares, with the Company receiving any excess or making up any shortfall
between the sale proceeds and $26.50 per share plus carrying costs in cash or
additional shares, at its option. The Company made the economic benefit and risk
of 750,000 of these shares available for subscription by certain of the
Company's employees and directors. When an individual participant exercises
Forward Shares under the subscription program, the Company settles with the
participant but does not necessarily close out the corresponding Forward Share
position with the Counterparties. The cost of these settlements during 1997 was
$2.1 million and was charged to additional paid-in capital. By the fourth
quarter of 1997, such exercises by participants had increased the number of
shares allocated to the Company from 1,000,000 shares to 1,187,800 shares.
During the fourth quarter of 1997, the Company exercised rights under the
forward agreements, purchasing 1,187,800 Forward Shares for a total cost of
$33.9 million. At September 30, 1998, as a result of the Company's exercise, the
repurchased shares were held as treasury stock, and 562,200 shares remained in
the program. As a result of the repurchase of Forward Shares from employees and
directors, 31,078 shares are held for the benefit of the Company and 531,122
shares continue to be held for the benefit of the employees and directors.
FSA's primary uses of funds are to pay operating expenses, to pay dividends to
its parent and to repurchase stock from its parent. FSA's funds are also
required to satisfy future claims, if any, under insurance policies in the event
of default by an issuer of an insured obligation and the unavailability or
exhaustion of other liquidity sources in the transaction, such as the cash flow
or collateral underlying the obligations. FSA seeks to structure asset-backed
transactions to address liquidity risks through inclusion of such other
liquidity sources in transactions. The insurance policies issued by FSA provide,
in general, that payments of principal, interest and other amounts insured by
FSA may not be accelerated by the holder of the obligation but are paid by FSA
in accordance with the obligation's original payment schedule or, at FSA's
option, on an accelerated basis. These policy provisions prohibiting
acceleration of certain claims are mandatory under Article 69 of the New York
Insurance Law and serve to reduce FSA's liquidity requirements.
12
The Company believes that FSA's expected operating liquidity needs, both on a
short- and long-term basis, can be funded from its operating cash flow. In
addition, FSA has a number of sources of liquidity that are available to pay
claims on a short- and long-term basis: cash flow from written premiums, FSA's
investment portfolio and earnings thereon, reinsurance arrangements with
third-party reinsurers, liquidity lines of credit with banks, and capital market
transactions.
A group of international Aaa/AAA-rated banks make available to FSA a standby
irrevocable limited recourse line of credit, which was increased from $125.0
million to $240.0 million during 1997. This credit facility provides liquidity
and credit support to FSA in the event losses from municipal obligations in
FSA's insured portfolio exceed specified limits. Repayment of amounts drawn
under the line will be limited primarily to recoveries of losses related to such
municipal obligations. The facility expires on April 30, 2005 unless extended.
FSA has a credit arrangement aggregating $150.0 million at September 30, 1998,
which is provided by commercial banks and intended for general corporate
purposes, including application to transactions insured by FSA. At September 30,
1998, there were no borrowings under this arrangement. The banks' commitments to
lend under the arrangement expire August 30, 1999, unless extended. In addition,
there are credit arrangements assigned to specific insured transactions. In
August 1994, FSA entered into a facility agreement with Canadian Global Funding
Corporation. Under the agreement, FSA can arrange financing for transactions
subject to certain conditions. The amount of this facility was $186.9 million,
of which $45.3 million was unutilized at September 30, 1998.
The Company has no plans for material capital expenditures within the next
twelve months.
Subsequent Events
On November 3, 1998, the Company and EXEL Limited closed a transaction to create
two new Bermuda-based financial guaranty insurance companies. Each of the new
companies has been initially capitalized with approximately $100,000,000. One
company, Financial Security Assurance International Ltd., is an indirect
subsidiary of FSA and the other company, X.L. Financial Assurance Ltd., is a
subsidiary of EXEL Limited. The Company has a minority interest in the EXEL
company, and EXEL has a minority interest in the FSA company. In conjunction
with forming the new companies, the Company and EXEL Limited swapped $80,000,000
of their respective common shares, with the Company delivering to EXEL Limited
1,632,653 common shares out of treasury. The Company then sold $60,000,000 of
the EXEL shares to an unrelated third party in order to fund, in part, its
investment in Financial Security Assurance International Ltd.
On November 6, 1998, the Company entered into an agreement to sell, subject to
customary closing conditions, $100,000,000 of 6.95% Senior Quarterly Income Debt
Securities due 2098 and callable without premium or penalty commencing November,
2003 or at any time following certain tax events. The proceeds from the sale of
the securities will be used to augment the capital of the Company's insurance
company subsidiaries and for general corporate purposes.
Forward-Looking Statements
This quarterly report contains forward-looking statements regarding, among other
things, the Company's plans and prospects. Important factors, including general
market conditions and the competitive environment, could cause actual results to
differ materially from those described in such forward-looking statements.
Certain of these factors are described in more detail under the heading
"Forward-Looking Statements" in Item 1 of the Company's Annual Report on Form
10-K for the year ended December 31, 1997. Forward-looking statements in this
report are expressly qualified by all such factors. The Company undertakes no
obligation to revise or update any forward-looking statements to reflect changes
in events or expectations or otherwise.
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PART II
OTHER INFORMATION
Item 5. Other Information
On November 3, 1998, the Company and EXEL Limited closed a transaction to
create two new Bermuda-based financial guaranty insurance companies. Each
of the new companies has been initially capitalized with approximately
$100,000,000. One company, Financial Security Assurance International
Ltd., is an indirect subsidiary of FSA and the other company, X.L.
Financial Assurance Ltd., is a subsidiary of EXEL Limited. The Company has
a minority interest in the EXEL Limited company, and EXEL Limited has a
minority interest in the FSA company. In conjunction with forming the new
companies, the Company and EXEL Limited swapped $80,000,000 of their
respective common shares, based upon the closing price for such shares on
the New York Stock Exchange on October 29, 1998, with the Company
delivering to EXEL Limited 1,632,653 unregistered shares of common stock,
$0.01 par value, out of treasury and with EXEL Limited delivering to the
Company 1,066,667 class A ordinary shares. The Company issued its common
shares to EXEL Limited in reliance upon an exemption from registration
under the Securities Act of 1933 (the "Act") pursuant to Section 4(2) of
the Act. EXEL Limited represented that it took such shares as an
investment and without a view to distribute such shares. In connection
with such transaction, the Company entered into a registration rights
agreement with EXEL Limited pursuant to which EXEL Limited is entitled to
cause the Company to register such shares under the Act upon the terms set
forth in such agreement. The Company then sold 800,000 of the EXEL Limited
shares to an unrelated third party for $60,000,000 in cash in order to
fund, in part, its investment in Financial Security Assurance
International Ltd.
On November 6, 1998, the Company entered into an agreement to sell,
subject to customary closing conditions, $100,000,000 of 6.95% Senior
Quarterly Income Debt Securities due 2098 and callable without premium or
penalty commencing November 2003 or at any time following certain tax
events. The proceeds from the sale of the securities will be used to
augment the capital of the Company's insurance company subsidiaries and
for general corporate purposes.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(10) Credit Agreement dated as of August 31, 1998 among Financial
Security Assurance Inc., each of its insurance company
affiliates listed on Schedule I attached thereto, the Banks
party thereto from time to time and Deutsche Bank AG, New York
Branch, as Agent
(27) Financial data schedules
(99) Financial statements of Financial Security Assurance Inc. for
the quarterly period ended September 30, 1998
(b) Reports on Form 8-K
None
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
By /s/ Jeffrey S. Joseph
-------------------------------------------------------
November 10, 1998 Jeffrey S. Joseph
Managing Director & Controller (Chief Accounting Officer)
15
Exhibit Index
Exhibit No. Exhibit
- ----------- -------
(10) Credit Agreement dated as of August 31, 1998 among Financial
Security Assurance Inc., each of its insurance company
affiliates listed on Schedule I attached thereto, the Banks
party thereto from time to time and Deutsche Bank AG, New York
Branch, as Agent
(27) Financial data schedules
(99) Financial statements of Financial Security Assurance Inc. for the
quarterly period ended September 30, 1998