SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) 0F THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the period from ___________ to
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Commission file number 1-10967
ENHANCE FINANCIAL SERVICES GROUP INC.
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(Exact name of registrant as specified in its charter)
New York 13-3333448
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
335 Madison Avenue, New York, New York 10017
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(Address of principal executive offices) (Zip Code)
(212) 983-3100
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(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if
changed since last report)
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 proceeding 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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 37,999,169 shares of common
stock, par value $.10 per share, as of May 12, 1999.
ENHANCE FINANCIAL SERVICES GROUP INC.
INDEX
Page
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - March 31, 1999 and December 31, 1998 ........ 3
Consolidated Statements of Income - Three months ended March 31,
1999 and 1998 ............................................................. 4
Consolidated Statement of Shareholders' Equity - Three months ended March
31, 1999 .................................................................. 5
Consolidated Statements of Cash Flows - Three months ended March 31, 1999
and 1998 .................................................................. 6
Notes to Consolidated Financial Statements ................................ 7-8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ......................................... 9-13
PART II OTHER INFORMATION
Item 6. Exhibits ........................................................... 13
Signature .................................................................. 14
Exhibit 27 Financial data schedules
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands except share amounts)
March 31, 1999 December 31, 1998
-------------- -----------------
(unaudited)
Assets
Investments:
Fixed maturities, held to maturity, at amortized cost $ 189,755 $ 196,768
(market value $197,759 and $205,792)
Fixed maturities, available for sale, at market 736,421 694,374
(amortized cost $705,938 and $657,644)
Common stock, at market (cost $498) 839 839
Investment in affiliates 99,833 96,867
Short-term investments 14,805 50,794
Cash and cash equivalents 12,843 5,542
----------- -----------
Total Investments 1,054,496 1,045,184
Premiums and other receivables 31,173 35,950
Accrued interest and dividends receivable 13,709 15,241
Deferred policy acquisition costs 107,017 103,794
Federal income taxes recoverable 12,467 9,717
Prepaid reinsurance premiums 5,585 7,000
Reinsurance recoverable on unpaid losses 2,237 2,500
Receivable from affiliates 12,833 16,710
Receivable for securities 34,630 9,590
Other assets 78,794 90,731
----------- -----------
TOTAL ASSETS $ 1,352,941 $ 1,336,417
=========== ===========
Liabilities and Shareholders' Equity
LIABILITIES
Losses and loss adjustment expenses $ 36,693 $ 36,239
Reinsurance payable on paid losses and loss adjustment 6,966 5,994
expenses
Deferred premium revenue 318,996 315,215
Accrued profit commissions 2,068 2,511
Deferred income taxes 75,245 79,569
Long-term debt 75,000 75,000
Short-term debt 75,777 54,290
Payable for securities 38,988 11,557
Accrued expenses and other liabilities 47,704 49,843
Payable to affiliates -- 43,553
----------- -----------
TOTAL LIABILITIES 677,437 673,771
----------- -----------
SHAREHOLDERS' EQUITY
Common stock-$.10 par value, Authorized-100,000,000 shares,
issued-39,900,932 and 39,812,937 shares 3,990 3,981
Additional paid-in capital 251,248 249,851
Retained earnings 434,090 418,214
Accumulated other comprehensive income 18,762 23,186
Treasury stock (32,586) (32,586)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY 675,504 662,646
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,352,941 $ 1,336,417
=========== ===========
See notes to unaudited consolidated financial statements.
3
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands except per share amounts)
(unaudited)
Three Months Ended March 31,
1999 1998
---- ----
Revenues
Net premiums written $ 29,486 $ 33,664
Increase in deferred premium revenue (5,195) (10,009)
----------- -----------
Premiums earned 24,291 23,655
Net investment income 13,554 12,928
Net realized losses (3,890) (324)
Assignment sales 8,302 10,424
Other income 2,186 1,624
----------- -----------
Total revenues 44,443 48,307
----------- -----------
Expenses
Losses and loss adjustment expenses 2,757 2,255
Policy acquisition costs 8,875 8,115
Profit commissions 114 439
Other operating expenses - insurance 3,908 3,426
- non-insurance 11,416 7,728
----------- -----------
Total expenses 27,070 21,963
----------- -----------
Income from operations 17,373 26,344
Equity in net income of affiliates 4,683 2,601
Foreign currency gains 13 --
Interest expense (2,444) (1,851)
----------- -----------
Income before income taxes 19,625 27,094
Income tax expense 1,472 7,876
----------- -----------
Net income $ 18,153 $ 19,218
=========== ===========
Basic earnings per share $ 0.48 $ 0.51
=========== ===========
Diluted earnings per share $ 0.46 $ 0.49
=========== ===========
Basic weighted average shares outstanding 37,919 37,476
=========== ===========
Diluted weighted average shares outstanding 39,192 39,251
=========== ===========
See notes to unaudited consolidated financial statements.
4
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
ENHANCE FINANCIAL SERVICES GROUP INC.
UNAUDITED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 1999
(in thousands except share and per share amounts)
Outstanding Common Stock Treasury Stock
------------------------ ------------------
Shares Amount Shares Amount
------ ------ ------ ------
Balance, December 31, 1998 $ 39,812,937 $ 3,981 1,950,794 ($32,586)
Comprehensive income:
Net income for the period -- -- -- --
Unrealized foreign currency translation adjustment (net of tax of $614) -- -- -- --
Unrealized gains during the period (net of tax of $1,768) -- -- -- --
Total comprehensive income: -- -- -- --
Dividends paid ($0.06 per share) -- -- -- --
Exercise of stock options 89,495 9 -- --
Issuance of common stock (1,500) -- -- --
---------- ------- --------- --------
Balance, March 31, 1999 39,900,932 $ 3,990 1,950,794 $(32,586)
========== ======= ========= ========
Accumulated
Other Comprehensive Income
--------------------------
Foreign
Currency
Additional Unearned Transactions
Paid-in Capital Compensation Adjustments
--------------- ------------ -----------
Balance, December 31, 1998 $ 249,851 ($ 493) $ 714
Comprehensive income:
Net income for the period -- -- --
Unrealized foreign currency translation adjustment (net of tax of $614) -- -- (1,140)
Unrealized gains during the period (net of tax of $1,768) -- -- --
Total comprehensive income: -- -- --
Dividends paid ($0.06 per share) -- -- --
Exercise of stock options 1,397 -- --
Issuance of common stock -- -- --
--------- ------ ------
Balance, March 31, 1999 $ 251,248 $ (493) $ (426)
========= ====== ======
Accumulated
Other Comprehensive Income
--------------------------
Unrealized
Holding Gains Retained
(Losses) Earnings Total
-------- -------- -----
Balance, December 31, 1998 $ 22,965 $ 418,214 $662,646
Comprehensive income:
Net income for the period -- 18,153 --
Unrealized foreign currency translation adjustment (net of tax of $614) -- -- --
Unrealized gains during the period (net of tax of $1,768) (3,284) -- --
Total comprehensive income: -- -- 13,729
Dividends paid ($0.06 per share) -- (2,277) (2,277)
Exercise of stock options -- -- 1,406
Issuance of common stock -- -- --
-------- ------------ --------
Balance, March 31, 1999 $ 19,681 $ 434,090 $675,504
======== ============ ========
See notes to unaudited consolidated financial statements.
-5-
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(unaudited)
Three Months Ended March 31,
-------------------------------
1999 1998
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 18,153 $ 19,218
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation of fixed assets 226 228
Amortization of investments, net (2,597) (1,566)
Loss on investments, net 3,890 324
Equity in net income of affiliates (4,683) (2,601)
Compensation, restricted stock award program 1,405 6,529
Change in assets and liabilities:
Premiums and other receivables 4,777 (1,918)
Accrued interest and dividends receivable 1,532 338
Accrued expenses and other liabilities (6,236) (3,675)
Deferred policy acquisition costs (3,223) (447)
Deferred premium revenue, net 5,195 10,009
Accrued profit commissions (443) 439
Losses and loss adjustment expenses, net 1,688 2,522
Payable to (receivable from) affiliates (39,676) (30,515)
Payable (receivable) for securities 2,390 (4,616)
Other assets 12,000 25,193
Income taxes, net (3,429) 4,509
----------- -----------
Net cash provided by (used in) operating activities (9,031) 23,971
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (287) (561)
Proceeds from sales and maturities of investments 92,043 30,089
Purchase of investments (134,617) (58,881)
Sales of short-term investments, net 37,575 (392)
(Purchase) sales of other invested assets, net (1,586) 4,179
Investment in affiliates 1,717 (88)
----------- -----------
Net cash used in investing activities (5,155) (25,654)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital stock -- 6,529
Short-term debt 21,487 --
Dividends paid -- (2,064)
Purchase of treasury stock -- (5,963)
----------- -----------
Net cash provided by (used in) financing activities 21,487 (1,498)
----------- -----------
Net change in cash and cash equivalents 7,301 (3,181)
Cash and cash equivalents, beginning of period 5,542 21,405
----------- -----------
Cash and cash equivalents, end of period $ 12,843 $ 18,224
=========== ===========
See notes to unaudited consolidated financial statements.
6
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
PERIODS ENDED MARCH 31, 1999 AND 1998
1. 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 for the year ended December 31, 1998 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 Subsidiaries (collectively the "Company"). The results of
operations for the three months ended March 31, 1999 may not be indicative of
the results that may be expected for the year ending December 31, 1999.
2. DIVIDENDS DECLARED
In March 1999, Enhance Financial declared a cash dividend of $.06 per
share totaling approximately $2,277,000.
3. COMMON STOCK
On June 26, 1998, Enhance Financial effected a two-for-one split of its
common stock. An amount equal to the par value of common shares issued to effect
the split was transferred from additional paid-in capital to the common stock
account. This transfer has been reflected in the consolidated statement of
shareholders' equity at January 1, 1998. On June 3, 1998, the Company's
shareholders approved an increase in the number of shares of common stock
authorized for issuance to 100 million. All references to number of common
shares and to per-share information in the consolidated financial statements and
related notes have been adjusted to reflect the stock split on a retroactive
basis.
During the first quarter of 1999, no common stock repurchases were made by
Enhance Financial.
4. COMPREHENSIVE INCOME
Effective in 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." This pronouncement established new rules for the
reporting and display of comprehensive income and its components in a full set
of general purpose financial statements. The adoption of this statement had no
impact on the Company's financial position or results of operations. SFAS No.
130 requires the Company's unrealized gains and losses and changes in foreign
currency translation adjustment to be included in other comprehensive income.
Total comprehensive income for the three months ended March 31, 1999 and
1998 was 13.7 million and 19.1 million, respectively. Presently, other
comprehensive income represents net income plus changes in unrealized gains and
losses on available for sale securities, and foreign currency translation
adjustments.
7
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
PERIODS ENDED MARCH 31, 1999AND 1998
5. NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standard Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," which
becomes effective for the Company January 1, 2000. 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. Derivatives can be
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or a firm commitment, (b) a hedge of the exposure
to variable cash flow of a forecast transaction, or (c) a hedge of foreign
currency exposure of a net investment in foreign operations, an unrecognized
firm commitment, an available-for-sale security, or a foreign currency
denominated forecasted transaction. The Company is currently reviewing the
impact of the implementation of SFAS No. 133 on its financial statements.
In March 1998, the National Association of Insurance Commissioners adopted
the Codification of Statutory Accounting Principle ( the "Codification"). The
Codification is intended to standardize regulatory accounting and reporting for
the insurance industry and is proposed to be effective January 1, 2001. However,
statutory accounting principles will continue to be established by individual
state laws and permitted practices, and it is uncertain when or if, the State of
New York will require adoption of the Codification for the preparation of
statutory financial statements. The Company has not finalized the quantification
of the effects of Codification on its statutory statements.
6. 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.
In April 1999, the Company completed a $13.7 million purchase of a
portfolio of approximately 500 residential mortgage-backed securities. The
transaction was structured by Credit-Based Asset Servicing and Securitization
LLC ("C-BASS"), a New York City-based joint venture, which will also manage and
service the portfolio for the Company. The transaction is expected to produce
significant pre-tax economic profits over the life of the acquired portfolio.
Additionally, the transaction will provide ancillary benefits that will result
in a lowering of the Company's effective tax rate in 1999 and beyond. The
Company's effective tax rate for the first quarter of 1999 was 7.5% compared to
29.1% for the comparable period of 1998.
7. RECLASSIFICATIONS
Certain of the 1998 amounts have been reclassified to conform to the
current year presentation.
8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
The Company divides its business operations into two reportable operating
segments: insurance businesses and asset-based businesses.
The insurance businesses of the Company, which are engaged through its
indirectly held subsidiaries, Enhance Reinsurance Company and Asset Guaranty
Insurance Company (collectively the "Insurance Subsidiaries"), include
principally the reinsurance of financial guaranties of municipal and
asset-backed debt obligations issued by monoline financial guaranty insurers. In
addition, the Company is engaged in other insurance, reinsurance and
non-insurance businesses that utilize the Company's expertise in performing
sophisticated analyses of complex, credit-based risks. The Company's other
insurance businesses involve the issuance of direct financial guaranties of
smaller municipal debt obligations, trade credit reinsurance, financial
institutions credit insurance (which includes excess-SIPC/excess-ICS and related
type bonds) and financial responsibility bonds. Some of these other insurance
businesses are conducted by Van-American Insurance Company ("Van-Am"), a
Kentucky domiciled insurer which writes reclamation bonds for the coal mining
industry, and surety bonds covering the closure and post-closure obligations of
landfill operators. The Company has decided to end this line of business. The
Company also provides surety and other credit-based insurance products through
its 25% ownership of Seguradora Brasileira de Fiancas S.A.
The Company operates its asset-based businesses primarily through its
consolidated subsidiary, Singer Asset Finance Company, L.L.C. ("Singer") and a
partially owned affiliate, Credit-Based Asset Servicing and Securitization
LLC ("C-BASS"). The Company's asset-based businesses include the origination,
purchase, servicing and/or securitization of special assets, including lottery
awards, structured settlement payments and sub-performing/non- performing and
seller-financed residential mortgages, real estate and subordinated residential
mortgage-backed securities.
The Company's revenues consist primarily of (a) premiums earned on
insurance and reinsurance contracts, (b) investment income and (c) the sale of
securitized lottery prizes and structured settlement payment streams.
Results of Operations
Three Months Ended March 31, 1999 vs. Three Months Ended March 31, 1998
Gross premiums written in the first quarter of 1999 were $29.6 million
compared with $33.4 million in the same period in 1998, representing a decrease
of 11.4%.
Net premiums written decreased 12.5% to $29.5 million in the first quarter
of 1999 from $33.7 million in the same period in 1998, which benefited from a
large facultative reinsurance transaction. Of the Company's net premiums written
in the first quarter of 1999, 37.3%, 22.7% and 40.0% were derived from the
reinsurance of municipal bonds, the reinsurance of non-municipal obligations and
the Company's other insurance lines, respectively, compared to 48.3%, 16.5% and
35.2% during the same period in 1998.
In the first quarter of 1999, municipal new-issue volume was $57.9
billion, a decline of 19.3% from the same period in 1998. The insured portion of
such new issues was 50.9% and 48.8% during the first quarters of 1999 and 1998,
respectively. Total municipal bond refundings in the first quarter of 1999
represented approximately 22.9% of new-issue volume, down from 33.5% for the
first quarter of 1998.
Earned premiums grew 2.5% to $24.3 million in the first quarter of 1999
from $23.7 million in the first quarter of 1998. Earned premiums from refundings
contributed $2.0 million (or 8.2%) of earned premiums in the first quarter of
1999 compared to $4.4 million (or 18.6%) in the same period in 1998. Deferred
premium revenue, net of prepaid reinsurance premiums, grew to $313.4 million at
March 31, 1999 from $308.2 million at December 31, 1998.
9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Net investment income increased 5.4% to $13.6 million in the first quarter
of 1999 from $12.9 million in the same period in 1998. This increase resulted
primarily from the growth in the Company's fixed maturities portfolio and
short-term investments from $892.9 million at March 31, 1998 to $941.0 million
at March 31, 1999. The average yields on the Company's investment portfolio were
5.9% and 6.1% for the first quarters of 1999 and 1998, respectively. In
addition, the Company realized $3.9 million of capital losses in the first
quarter of 1999 compared with $0.3 million of capital losses in the first
quarter of 1998. The 1999 capital loss includes the recognition of a $4.7
million pre-tax write down of two holdings in Commercial Financial Services,
Inc. ("CFS"). CFS is currently protected under Chapter 11 of the bankruptcy code
as an outgrowth of allegations of improper activities. Though CFS continues to
service the debt on a current basis, the Company does not expect to recover its
entire investment. The ultimate realizable amount depends on the outcome of the
bankruptcy of CFS, and is therefore subject to further adjustments.
The Company recognized revenues from disposition of assignments, through
securitization and other sales, of $8.3 million in the first quarter of 1999
compared to $10.4 million in the first quarter of 1998. Incurred losses and LAE
were $2.8 million in the first quarter of 1999 compared to $2.3 million for the
same period of 1998.
The Company's insurance expense ratio was 53.1% in the first quarter of
1999 compared to 50.6% in the first quarter of 1998. Non-insurance expenses
increased to $11.4 million in the first quarter of 1999 from $7.7 million during
the same period in 1998 reflecting the cost of reorganizing Singer's operations
including large start-up expenses in its new viatical settlements product.
Policy acquisition costs ("PAC") were $8.9 million and $8.1 million for the
first quarters of 1999 and 1998, respectively, representing 36.5% and 34.3% of
earned premiums in those respective periods.
The Company realized income of $4.7 million from its investments in
affiliates in the first quarter of 1999 compared to $2.6 million in the first
quarter of 1998.
Interest expense totaled $2.4 million and $1.9 million in the first
quarters of 1999 and 1998, respectively, reflecting the increase in the
Company's short-term debt outstanding.
The Company's effective tax rate for the first quarter of 1999 was 7.5%
compared to 29.1% for the 1998 first quarter as a result of the April 1999
purchase of a portfolio of residential mortgage-backed securities. As described
in the notes to the unaudited financial statements, the transaction will provide
auxillary benefits that will result in a lowering of the Company's effective tax
rate in 1999 and beyond.
The Company's 1999 first quarter net income decreased 5.5% to $18.2
million from $19.2 million in the first quarter of 1998. First quarter 1999
basic and diluted earnings per share decreased 5.9% and 6.1%, respectively, to
$.48 and $.46 from $.51 and $.49 in the first-quarter of 1998. The decline
resulted from capital losses in the first-quarter 1999 of $3.9 million, compared
to capital losses of $0.3 million in the 1998 quarter.
The diluted weighted average shares outstanding during the first quarter
of 1999 was 39.2 million compared to 39.3 million during the first quarter of
1998.
All references to number of common shares and per-share information
reflect the two-for-one stock split, which was effective on June 26, 1998.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
As a holding company, Enhance Financial funds the payment of its operating
expenses, principal and interest on its debt obligations, dividends to its
shareholders and the repurchase of common stock primarily from dividends from
its wholly-owned subsidiary, Enhance Investment Corporation ("Enhance
Investment"), whose ability to provide such dividends to Enhance Financial
depends upon dividends and other payments from the Insurance Subsidiaries;
manages cash flows associated with the Company's diversification activities and
draws on its line of credit provided under the credit agreement described below.
Payments of dividends to Enhance Investment by the Insurance Subsidiaries are
subject to restrictions relating to statutory capital and surplus and net
investment income. During the first quarter of 1999, the Insurance Subsidiaries
paid $6.5 million of dividends to Enhance Investment, which paid a dividend of
$6.5 million to Enhance Financial. As of March 31, 1999, the maximum amount of
dividends remaining available from the Insurance Subsidiaries without prior
approval of the insurance regulatory authorities was $13.7 million.
The Company's cash flow used for operations for the first quarter of 1999
was $9.0 million compared to cash flow provided from operations of $24.0 million
for the same period in 1998. The carrying value of the Company's investment
portfolio (total investments less investment in affiliates) increased to $955
million at March 31, 1999 from $948 million at December 31, 1998 principally as
a result of the cash flows from operations.
The Company maintains a credit facility providing for borrowings to be
used for general corporate purposes. During the second quarter of 1998, the
Company entered into a new unsecured credit agreement with four major commercial
banks for up to $100 million of borrowings, an increase of $25 million over the
previous agreement (which was terminated). As of March 31, 1999, the Company had
$75.8 million outstanding under the credit agreement.
In July 1996, the Company formed C-BASS, a joint venture in which each of
Enhance Financial and Mortgage Guaranty Insurance Company owns a 48% interest.
The Company had contributed $55.5 million to C-BASS through March 31, 1999
(including its 100% interest in Litton Loan Servicing Inc.) and expects that it
will provide additional funding. In January 1998 the Company guarantied
repayment of up to $25 million of the amount outstanding under a $50 million
LIBOR-based unsecured revolving credit facility that C-BASS obtained from a
major commercial bank. The full amount of $50 million was drawn down by C-BASS
during 1998. The outstanding principal under the facility is currently due no
later than July 31, 1999.
In the first quarter of 1999, Enhance Financial declared cash dividends of
$.06 per share, aggregating $2,277,062.
YEAR 2000
As the Year 2000 approaches, management is assessing the Company's
potential exposure to the so called "millenium bug" and the effects the century
date change may have on its electronic systems and those of its significant
business partners. Since certain computer programs were written using two digits
rather than four to define the applicable year, computing devices and systems
may recognize a date using the two digits "00" as 1900 rather than the year
2000. Those that do not recognize a date correctly could generate erroneous data
and/or cause systems to fail.
As part of its firm-wide Year 2000 Project, the Company has established a
Year 2000 Task Force consisting of senior management of the Company, led by the
Chief Information Officer and the General Counsel. It has also retained an
independent information technology consulting firm and outside legal counsel to
provide assistance with Year 2000 readiness and has adequate staff to administer
the Project. The progress of the Company's Year 2000 Project is being monitored
by the Audit Committee of the board of directors.
The Year 2000 Project covers both computer systems and infrastructure ("IT
systems") as well as other systems and equipment which utilize embedded
microchips ("non-IT systems"). It also considers the readiness of significant
third parties on which the Company depends, such as clients, vendors and service
providers. The Year 2000 Project has six phases: Project Development and
Resource Mobilization, Assessment, Remediation,
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Testing, Contingency Planning and Implementation. The status of each phase is as
follows. Project Development and Resource Mobilization is substantially
complete. Assessment of internal IT systems and non-IT systems has proceeded
through inventory and analysis of all systems deemed critical by management.
Assessment of exposure to third party risks, by means of evaluation of
questionnaires mailed to significant third parties is in progress. As part of
its third-party due diligence, the Company is assessing the Year 2000 readiness
of all major products and services purchased from vendors and service providers
of IT and non-IT components and systems. Remediation and Testing of IT systems
and non-IT systems are in progress, and a separate IT test environment has been
established for selected applications deemed critical by management. Contingency
Planning, including disaster recovery planning is in progress and will continue
throughout 1999. Implementation of contingency plans will be made as and when
needed. Based on the assessment of its major IT systems and non-IT systems, the
Company expects that all necessary remediation and testing will be completed to
insure Year 2000 readiness in all material respects.
Since 1997, Enhance has invested in a major initiative to replace and
upgrade its technology. This ongoing project addresses, among other matters,
many of the Year 2000 issues of the Company's internal IT systems. The Company
has expended approximately $2 million on this project, which, accordingly,
includes a portion of the cost of Year 2000 readiness. Additional expenditures
for Year 2000 readiness, which will be funded through operating cash flow, are
expected to total approximately $1.5 million. These cost estimates are based
upon currently available information and may change as the Year 2000 Project
proceeds. However, the cost of Year 2000 readiness is not expected to affect
materially the financial condition of the Company.
The failure of IT systems and non-IT systems associated with cash
management, servicing, communications and building facilities would in varying
degrees have a material adverse effect on the Company. Such failures could
disrupt the Company's ability to conduct normal business operations, including
financial transactions such as payment of claims or debts, collecting or funding
of receivables and selling of commercial paper. The consequences of such
failures could include business interruption, lost revenue and illiquidity. The
magnitude of the financial impact of such potential failures is not known at
this time. The Company is continuing to consider its reasonably likely worst
case Year 2000 scenarios and their potential financial impact. The Year 2000
Project includes a provision for contingency planning for systems and facilities
that will generally involve processing that does not rely upon computer systems
and will utilize additional staff as needed.
The Company has communicated with third parties with which it has material
dealings to determine the status of their Year 2000 readiness and it is in the
process of assessing its exposure to potential third party Year 2000 failures.
Management has determined that the following consequences to the Company could
result from the failure of such third parties to successfully address their Year
2000 issues: Obligors of Insured Issues (see also next paragraph) - increased
credit risk, claims, loss of premiums and renewals; Primaries and Reinsurers -
increased credit risk, uncollected claims, premium loss, impaired liquidity;
Counterparties and Issuers of Obligations - investment portfolio downgrade, loss
of income and/or principal; Financial Institutions and Lenders - impaired
liquidity, loss of income and/or principal; Vendors and Service Providers -
interrupted power, building access, telecommunications, flow of goods, security
and professional and technical services.
The policies of insurance and reinsurance issued by the Company, its
primary insurers and its reinsurers do not contain specific exclusions for Year
2000-related defaults. Accordingly, these policies would generally cover a
default by an obligor of this type. Although the insurers would expect
eventually to recover the amounts paid in claims for Year 2000-related defaults
by obligors, the coincidence of several such unanticipated claims could result
in short-term liquidity risk for the insurers. Management has concluded, based
on its investigation to date, that the risk of losses due to Y2K readiness
issues confronting the obligors insured issues which it insures and the primary
insurers which it reinsures is low. Failure of a trustee or paying agent for a
given insured obligation to make payment on that obligation as a result of a
Year 2000-related event (or otherwise) would generally not be covered by the
insurance or reinsurance policy, and no such claims are expected. Nevertheless,
the Company is investigating whether its insured obligors as well as their
trustees, paying agents and other related parties will be Year 2000 ready, and
it will establish appropriate contingency plans based upon the results of this
inquiry.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
In addition to other risks in connection with the Year 2000, general
uncertainty among market participants could cause a decline in business activity
and revenue in 1999 and 2000, as companies address their Year 2000 issues. The
Company cannot predict the magnitude of this possible decline or the impact that
it may have on its financial results for those years. However, the Company has
undertaken a thorough review of third-party risks inherent in Year 2000 issues,
and it is working with the industry group allied with its core business to
identify and address credit and other business issues related to Year 2000. The
Company is also assessing potential effects of unexpected failures in local,
national or international systems, including power, communication and
transportation systems, on which the normal conduct of business depends, and it
will establish contingency plans to deal with such failures, although there can
be no assurance that such plans can be effective in such circumstances,
especially in the case of widespread economic disruption.
Management believes, based upon its investigation to date, that the
Company will be substantially Year 2000 ready on or before December 31, 1999.
However, there can be no assurance, due to the uncertain nature of potential
Year 2000 problems and the Company's lack of control over some of them,
especially the readiness of third parties, that all Year 2000 issues will be
foreseen and corrected in a timely fashion. Failure of the efforts by the
Company or certain third parties to be Year 2000 ready could result in the
disruption of the Company's normal business activities or in unanticipated
claims upon the Company, either of which could have a material adverse effect.
Management is assessing the need to increase its liquidity, from various
sources, in order to meet unanticipated demand for the claims payment.
Part II: Other Information
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 6. Exhibits and reports on Form 8-K
(a) Exhibits
Exhibit 27. Financial data schedules.
(b) Reports on Form 8-K
None.
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by tbe
undersigned thereunto duly authorized.
Date: May 17, 1999 ENHANCE FINANCIAL SERVICES GROUP INC.
By: /s/ Arthur Dubroff
-----------------------------------------
Arthur Dubroff
Executive Vice President (duly
authorized officer) and Principal
Financial Officer
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