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, 1999
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 October 31, 1999, there were outstanding 31,533,781 shares of Common Stock,
par value $0.01 per share, of the registrant (includes 1,393,977 shares of
Common Stock owned by a trust on behalf of the Company 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, 1999 and
December 31, 1998 3
Consolidated Statements of Income - Three and nine months
ended September 30, 1999 and 1998 4
Consolidated Statement of Changes in Shareholders' Equity
- Nine months ended September 30, 1999 5
Consolidated Statements of Cash Flows
- Nine months ended September 30, 1999 and 1998 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 6. Exhibits and Reports on Form 8-K 15
SIGNATURES 16
2
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
September 30, December 31,
ASSETS 1999 1998
------------- ------------
Bonds at market value (amortized cost of $1,810,470 and $1,655,042) $ 1,775,903 $ 1,708,040
Equity investments at market value (cost of $60,435 and $64,292) 52,764 68,243
Short-term investments 138,354 98,554
------------- ------------
Total investments 1,967,021 1,874,837
Cash 4,765 3,490
Deferred acquisition costs 195,310 199,559
Prepaid reinsurance premiums 259,859 217,096
Reinsurance recoverable on unpaid losses 6,468 3,907
Receivable for securities sold 30,889 1,655
Other assets 174,750 143,662
------------- ------------
TOTAL ASSETS $ 2,639,062 $ 2,444,206
============= ============
LIABILITIES AND MINORITY INTEREST, REDEEMABLE PREFERRED
STOCK AND SHAREHOLDERS' EQUITY
Deferred premium revenue $ 810,024 $ 721,699
Losses and loss adjustment expenses 71,803 63,947
Deferred federal income taxes 55,907 87,254
Ceded reinsurance balances payable 28,241 31,502
Payable for securities purchased 210,231 105,859
Notes payable 230,000 230,000
Minority interest 22,002 20,388
Accrued expenses and other liabilities 120,590 117,421
------------- ------------
TOTAL LIABILITIES AND MINORITY INTEREST 1,548,798 1,378,070
------------- ------------
REDEEMABLE PREFERRED STOCK
Redeemable preferred stock (20,000,000 and 3,000,000 shares authorized;
2,000,000 issued and outstanding; par value of $.01 per share) 20 20
Additional paid-in capital - preferred 680 680
------------- ------------
700 700
------------- ------------
Common stock (200,000,000 and 50,000,000 shares authorized;
32,276,301 issued; par value of $.01 per share) 323 323
Additional paid-in capital - common 740,863 733,442
Accumulated other comprehensive income (loss) (net of deferred
income tax provision (benefit) of $(14,783) and $20,288) (27,455) 37,678
Accumulated earnings 400,050 325,150
Deferred equity compensation 45,963 43,946
Less treasury stock at cost (2,144,125 and 2,372,839 shares held) (70,180) (75,103)
------------- ------------
TOTAL SHAREHOLDERS' EQUITY 1,089,564 1,065,436
------------- ------------
TOTAL LIABILITIES AND MINORITY INTEREST, REDEEMABLE PREFERRED STOCK
AND SHAREHOLDERS' EQUITY $ 2,639,062 $ 2,444,206
============= ============
See notes to condensed consolidated financial statements. 1998 numbers
have been revised. See Note 3 "Restatements and Reclassifications."
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,
------------- -------------
1999 1998 1999 1998
--------- --------- --------- ---------
Revenues:
Net premiums written (net of premiums ceded
of $41,106, $22,562, $89,620 and $66,074) $ 70,853 $ 54,462 $ 172,598 $ 154,530
Increase in deferred premium revenue (28,152) (21,844) (45,829) (57,539)
--------- --------- --------- ---------
Premiums earned (net of premiums ceded of
$16,431, $11,796, $46,652 and $37,497) 42,701 32,618 126,769 96,991
Net investment income 24,432 19,710 69,192 57,648
Net realized gains (losses) (6,022) 8,907 (15,652) 15,579
Other income 928 44 1,080 400
--------- --------- --------- ---------
TOTAL REVENUES 62,039 61,279 181,389 170,618
--------- --------- --------- ---------
Expenses:
Losses and loss adjustment expenses (net of
reinsurance recoveries of $5,027, $88,
$2,796 and $(6,780)) 1,950 1,046 5,950 3,140
Interest expense 4,154 2,408 12,461 7,250
Policy acquisition costs 9,604 8,397 30,197 25,311
Other operating expenses 7,270 1,411 20,647 17,900
--------- --------- --------- ---------
TOTAL EXPENSES 22,978 13,262 69,255 53,601
--------- --------- --------- ---------
Minority interest and equity earnings (665) (1,593)
--------- ---------
INCOME BEFORE INCOME TAXES 38,396 48,017 110,541 117,017
Provision for income taxes 8,689 13,411 25,205 31,359
--------- --------- --------- ---------
NET INCOME 29,707 34,606 85,336 85,658
--------- --------- --------- ---------
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities:
Holding gains (losses) arising during period (27,742) 21,069 (76,082) 27,856
Less: reclassification adjustment for losses
(gains) included in net income 4,301 (5,789) 10,949 (10,126)
--------- --------- --------- ---------
Other comprehensive income (loss) (23,441) 15,280 (65,133) 17,730
--------- --------- --------- ---------
COMPREHENSIVE INCOME $ 6,266 $ 49,886 $ 20,203 $ 103,388
========= ========= ========= =========
As based upon net income:
Basic earnings per common share $ 0.97 $ 1.20 $ 2.79 $ 2.96
========= ========= ========= =========
Diluted earnings per common share $ 0.93 $ 1.15 $ 2.67 $ 2.83
========= ========= ========= =========
See notes to condensed consolidated financial statements. Net income for the
periods ended September 30, 1998 has been revised. See Note 3
"Restatements and Reclassifications."
4
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in thousands)
Additional Accumulated Deferred
Paid-In Other Comp- Equity
Common Capital - rehensive Accumulated Compen- Treasury
Stock Common Income (Loss) Earnings sation Stock Total
----- ------ ------------- -------- ------ ----- -----
BALANCE, December 31, 1998 $323 $733,442 $37,678 $325,150 $43,946 $(75,103) $1,065,436
Net income 85,336 85,336
Net unrealized loss on investments (65,133) (65,133)
Dividends paid on common stock
($0.345 per share) (10,436) (10,436)
Deferred equity compensation 13,104 13,104
Deferred equity payout 1,534 (11,087) 1,644 (7,909)
Purchase of 51,658 shares of
common stock (2,504) (2,504)
Sale of 221,100 shares of treasury
stock 5,887 5,783 11,670
---- -------- -------- -------- ------- -------- ----------
BALANCE, September 30, 1999 $323 $740,863 $(27,455) $400,050 $45,963 $(70,180) $1,089,564
==== ======== ======== ======== ======= ========= ==========
See notes to condensed consolidated financial statements. 1998 numbers have
been revised. See Note 3 "Restatements and Reclassifications."
5
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Nine Months Ended September 30,
-------------------------------
1999 1998
----------- -----------
Cash flows from operating activities:
Premiums received, net $ 171,519 $ 173,581
Policy acquisition and other operating expenses
paid, net (52,337) (46,928)
Loss and LAE recovered (paid), net (641) 10,928
Net investment income received 61,622 56,368
Recoverable advances received (paid) (10,889) 1,884
Federal income taxes paid (30,872) (41,804)
Interest paid (12,172) (7,217)
Other, net (2,271) (1,235)
----------- -----------
Net cash provided by operating activities 123,959 145,577
----------- -----------
Cash flows from investing activities:
Proceeds from sales of bonds 1,607,865 1,401,419
Purchases of bonds (1,695,494) (1,562,778)
Purchases of property and equipment (686) (898)
Net decrease (increase) in short-term securities (37,188) 51,708
Other investments, net 911 (14,208)
----------- -----------
Net cash used for investing activities (124,592) (124,757)
----------- -----------
Cash flows from financing activities:
Dividends paid (10,436) (9,387)
Treasury stock, net 12,393 (18,252)
Other (49) 329
----------- -----------
Net cash provided by (used for) financing
activities 1,908 (27,310)
----------- -----------
Net increase (decrease) in cash 1,275 (6,490)
Cash at beginning of period 3,490 12,475
----------- -----------
Cash at end of period $ 4,765 $ 5,985
=========== ===========
See notes to condensed consolidated financial statements. 1998 numbers have
been revised. See Note 3 "Restatements and Reclassifications."
6
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Nine Months Ended September 30, 1999 and 1998
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, 1999, the Company was owned 5.7% by MediaOne
Capital Corporation (MediaOne), 20.0% by White Mountains Insurance Group, Inc.
(White Mountains), formerly Fund American Enterprises Holdings, Inc., 6.4% by
The Tokio Marine and Fire Insurance Co., Ltd. (Tokio Marine), 5.4% by XL Capital
Ltd (XL) and 62.5% 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 1998 Annual
Report to Shareholders filed on Form 10-K, as amended. 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, 1999 and for all periods presented have been made.
The December 31, 1998 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, 1999 and 1998 are not necessarily indicative of the operating
results for the full year.
3. RESTATEMENTS AND RECLASSIFICATIONS
During a review of the Company's shelf registration statement in April
1999, the Securities and Exchange Commission (SEC) staff advised the Company
that, in its opinion, the accounting the Company had used for the forward
purchase agreements for the benefit of employees and directors should be changed
(see Note 2 section entitled "Restatement and Reclassifications" of the
Company's consolidated financial statements filed on Form 10-K, as amended).
The effect of this change in accounting for the forward purchase
agreements as previously reported and as adjusted are shown below (in thousands,
except per share data):
Information as reported:
1998
------------------------
First Nine Third
Months Quarter
------ -------
Income before taxes $116,747 $42,450
Net income 85,483 30,988
Basic earnings per common share 2.95 1.08
Diluted earnings per common share 2.83 1.03
7
Information as adjusted:
1998
------------------------
First Nine Third
Months Quarter
------ -------
Income before taxes $117,017 $48,017
Net income 85,658 34,606
Basic earnings per common share 2.96 1.20
Diluted earnings per common share 2.83 1.15
The effect on shareholders' equity was a decrease of $7,300,000 at
December 31, 1998.
In addition, the Company reclassified the redeemable preferred stock
outside of shareholders' equity, which decreased shareholders' equity as of
December 31, 1998 by $700,000.
4. SUBSEQUENT EVENT
The Company announced in October 1999 a plan to sell approximately
$140,000,000 of common shares. The Company plans to sell common shares to its
major shareholders, White Mountains, Tokio Marine and XL at a price of $54.20
per share, subject to certain closing conditions. This price represents 97.5% of
the average of the high and low sale price of the Company's common shares on the
New York Stock Exchange on October 29, 1999. Shares will also be sold on the
same terms to one or more financial institutions, which will hold such shares in
connection with forward share purchase arrangements with the Company. The
Company has a mirror arrangement under certain benefit plans pursuant to which
employees and directors bear the risks and rewards of the forward arrangements.
Closings of the sales are expected by year-end.
8
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations
1999 and 1998 Third Quarter Results
The Company's 1999 third quarter net income was $29.7 million, compared with
$34.6 million for the same period in 1998, a decrease of 14.2%. Core net income
(operating net income less the after-tax effect of refundings and prepayments)
was $35.9 million, compared with $27.3 million for the same period in 1998, an
increase of 31.4%. Total core revenues in the third quarter of 1999 increased
$14.9 million, from $51.4 million in 1998 to $66.2 million in 1999, while total
core expenses increased only $3.9 million. Operating net income (net income less
the after-tax effect of net realized capital gains or losses and the cost of the
equity based compensation programs and other non-operating items) was $36.7
million for the third quarter of 1999 versus $27.8 million for the comparable
period in 1998, an increase of $8.9 million or 32.0%.
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. 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. The discount rate
used to calculate the gross PV premiums written is 5.9% for 1999 and was 6.3%
for 1998. The discount rates represent the average pre-tax yield on the
Company's investment portfolio for the previous three years. 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 45.4%, to $112.0 million for the third quarter
of 1999 from $77.0 million for the third quarter of 1998. Gross PV premiums
written increased 67.7%, to $150.8 million in the third quarter of 1999 from
$89.9 million in the third quarter of 1998. The increase in gross premiums
written and gross PV premiums written was due primarily to the increase in U.S.
asset-backed and international transactions. In the third quarter of 1999, U.S.
asset-backed gross PV premiums written were $52.5 million, as compared with
$30.3 million in 1998, an increase of 73.3%, while international gross PV
premiums were $39.0 million as compared with $10.9 million in 1998, an increase
of 257.8%. The increase in asset-backed transactions was strong across all
sectors while in the international sector the Company insured several large
transactions during the quarter. For the U.S. municipal business, gross PV
premiums written in the third quarter increased to $59.3 million in 1999 from
$48.7 million in 1998, an increase of 21.8%.
In the third quarter of 1999, the Company insured par value of bonds totaling
$14.7 billion compared with $13.4 billion in 1998, an increase of 9.0%. FSA's
third quarter U.S. asset-backed component rose 42.4% to $5.9 billion, while its
U.S. municipal sector decreased 6.6% to $7.9 billion and the international
sector remained flat at $0.9 billion. Net premiums written were $70.9 million
for the third quarter of 1999, an increase of 30.1% when compared with 1998. Net
premiums earned for the third quarter of 1999 were $42.7 million, compared with
$32.6 million in the third quarter of 1998, an increase of 30.9%. Premiums
earned from refundings and prepayments were $1.8 million for the third quarter
of 1999 and $1.0 million for the same period of 1998, contributing $0.8 million
and $0.5 million, respectively, to after-tax earnings. Net premiums earned for
the quarter grew 29.4% relative to the same period in 1998 when the effects of
refundings and prepayments are eliminated.
9
Net investment income was $24.4 million for the third quarter of 1999 and $19.7
million for the comparable period in 1998, an increase of 24.0%. The Company's
effective tax rate on investment income was 17.2% for the third quarter of 1998
compared with 15.2% for the same period in 1999. In the third quarter of 1999,
the Company realized $6.0 million in net capital losses as compared with net
capital gains of $8.9 million for the same period in 1998. Capital gains and
losses are a by-product of the normal investment management process and will
vary substantially from period to period.
The provision for losses and loss adjustment expenses during the third quarter
of 1999 was $1.9 million compared with $1.0 million in 1998, 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. Net transfers from the general reserve to case reserves
totaled $2.7 million during the third quarter of 1999. At September 30, 1999,
the unallocated balance in the Company's general loss reserve was $49.6 million.
Total policy acquisition and other operating expenses (excluding the cost of the
equity based compensation programs of $4.0 million for the third quarter of 1999
compared with a reversal of expense of $1.6 million for the same period of 1998)
were $12.9 million for the third quarter of 1999 compared with $11.4 million for
the same period in 1998, an increase of 13.5%. Excluding the effects of
refundings, total policy acquisition and other operating expenses were $12.3
million for the third quarter of 1999 compared with $11.1 million for the same
period in 1998, an increase of 11.3%. The increase was the result of higher DAC
amortization due to a higher level of premiums earned and personnel costs.
Income before income taxes for the third quarter of 1999 was $38.4 million, down
from $48.0 million, or 20.0%, for the same period in 1998.
The Company's effective tax rate for the third quarter of 1999 was 22.6%
compared with 27.9% for the same period in 1998. This decrease is the result of
the Company recognizing capital losses in the third quarter of 1999 versus
capital gains for the same period in 1998 and higher tax-exempt investment
income.
The weighted average number of diluted shares of common stock outstanding
increased from 30,012,000 for the quarter ended September 30, 1998, to
31,917,000 during the third quarter of 1999. This increase was primarily due to
1.6 million shares the Company issued to XL Capital Ltd in November 1998.
Diluted earnings per share decreased from $1.15 for the third quarter of 1998 to
$0.93 for the same period in 1999.
1999 and 1998 First Nine Months Results
The Company's 1999 first nine months of net income was $85.3 million, compared
with $85.7 million for the same period in 1998, a decrease of 0.4%. Core net
income was $100.2 million, compared with $78.3 million for the same period in
1998, an increase of 28.0%. Total core revenues in the first nine months of 1999
increased $41.6 million, from $145.9 million in 1998 to $187.5 million in 1999,
while total core expenses increased only $14.0 million. Operating net income was
$104.7 million for the first nine months of 1999 versus $82.6 million for the
comparable period in 1998, an increase of $22.1 million or 26.8%.
Gross premiums written increased 18.9%, to $262.2 million for the first nine
months of 1999 from $220.6 million for the first nine months of 1998. Also,
gross PV premiums written increased 57.3%, to $389.9 million in 1999 from $247.9
million in the first nine months of 1998. In the first nine months of 1999, U.S.
asset-backed gross PV premiums written were $156.8 million, as compared with
$78.1 million in the first nine months of 1998, an increase of 100.8%. For the
international sector, gross PV premiums written in the first nine months
increased to $102.1 million in 1999 from $21.7 million in 1998, an increase of
370.5%. For the U.S. municipal business, gross PV premiums written in the first
nine months decreased from $148.1 million in 1998 to $131.0 million in 1999, a
decrease of 11.5%.
In the first nine months of 1999, the Company insured par value of bonds
totaling $44.7 billion, a 12.7% increase over the same period in 1998. In the
first nine months of 1999, FSA's U.S. asset-backed and international sectors
rose 42.3% to $18.8 billion and 212.2% to $5.6 billion, respectively, while its
U.S. municipal sector fell 17.7% to $20.3 billion.
10
Net premiums written were $172.6 million for the first nine months of 1999, an
increase of $18.1 million, or 11.7%, when compared with 1998. Net premiums
earned for the first nine months of 1999 were $126.8 million, compared with
$97.0 million in the first nine months of 1998, an increase of 30.7%. Premiums
earned from refundings and prepayments were $9.5 million for the first nine
months of 1999 and $9.2 million for the same period of 1998, contributing $4.5
million and $4.3 million, respectively, to after-tax earnings. Net premiums
earned for the first nine months of 1999 grew 33.5% relative to the same period
in 1998 when the effects of refundings and prepayments are eliminated.
Net investment income was $69.2 million for the first nine months of 1999 and
$57.6 million for the comparable period in 1998, an increase of 20.0%. The
Company's effective tax rate on investment income was 17.8% for the first nine
months of 1998 compared with 15.0% for the first nine months of 1999. In the
first nine months of 1999, the Company realized $15.7 million in net capital
losses as compared with $15.6 million of net capital gains for the same period
in 1998. Capital gains and losses are a by-product of the normal investment
management process and will vary substantially from period to period.
The provision for losses and loss adjustment expenses during the first nine
months of 1999 was $5.9 million compared with $3.1 million for the same period
in 1998, representing additions to the Company's general loss reserve.
Total policy acquisition and other operating expenses (excluding the cost of the
equity based compensation programs of $12.4 million for the first nine months of
1999 compared with $10.8 million for the same period of 1998) were $38.4 million
for the first nine months of 1999 compared with $32.4 million for the same
period in 1998, an increase of 18.7%. Excluding the effects of refundings, total
policy acquisition and other operating expenses were $35.8 million for the first
nine months of 1999 compared with $29.8 million for the same period in 1998, an
increase of 20.3%.
Income before income taxes for the first nine months of 1999 was $110.5 million,
down from $117.0 million, or 5.5%, for the same period in 1998.
The Company's effective tax rate for the first nine months of 1999 was 22.8%
compared with 26.8% for the same period in 1998. This decrease is primarily the
result of the Company recognizing capital losses in the first nine months of
1999 versus capital gains for the same period in 1998 and higher tax-exempt
investment income.
The weighted average number of diluted shares of common stock outstanding
increased to 31,941,000 during the first nine months of 1999 from 30,252,000,
for the nine months ended September 30, 1998. Diluted earnings per share
decreased from $2.83 for the first nine months of 1998 to $2.67 for the same
period in 1999.
Liquidity and Capital Resources
The Company's consolidated invested assets and cash equivalents at September 30,
1999, net of unsettled security transactions, was $1,787.7 million, compared
with the December 31, 1998 balance of $1,770.6 million. These balances include
the change in the market value of the investment portfolio, which had an
unrealized loss position of $42.2 million at September 30, 1999 and $56.9
million in unrealized gains at December 31, 1998.
At September 30, 1999, the Company had, at the holding company level, an
investment portfolio of $38.8 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 or surplus note payments from 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 1998 and has paid no dividends to date in 1999. Based upon FSA's
statutory
11
statements for the quarter ended September 30, 1999, 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 $67.5 million. In addition, the Company holds $120 million of
surplus notes of FSA. Payments of principal and interest on such notes may be
made with the approval of the New York Insurance Department. FSA paid $6.7
million of accrued interest on such notes during the first nine months of 1999
and, as of September 30, 1999, has accrued interest payable of $1.5 million.
Dividends paid by the Company to its shareholders increased to $10.4 million in
the first nine months of 1999 from $8.9 million in 1998 and to $0.3450 per
common share in 1999 from $0.3275 in 1998. In addition to paying dividends, the
Company uses funds to make debt service payments and to repurchase shares of the
Company's common stock to fund employee benefit plans.
The Company has outstanding $100.0 million of 6.950% Senior Quarterly Income
Debt Securities due November 1, 2098 and callable on or after November 1, 2003,
and $130.0 million of 7.375% Senior Quarterly Income Debt Securities due
September 30, 2097 and callable on or after September 18, 2002.
In May 1996, the Company entered into forward agreements with two financial
institutions (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. At September 30, 1999, 562,200 Forward Shares remained in the
program. Of these, 33,078 shares were held for the benefit of the Company as a
result of the repurchase of Forward Shares from employees and directors, and
529,122 shares continued to be held for the benefit of employees and directors.
For each dollar change in the Company's share price, net income will be affected
by approximately $0.3 million, or $0.01 per share.
In September 1999, the Company announced that it had entered into a new forward
agreement with a financial institution. The financial institution will purchase
shares of the Company's common stock at a limit price and will hold the shares
subject to the forward arrangement. Under the forward arrangement, the Company
will either purchase such shares within a five-year period or direct their sale,
in which case the Company would pay or receive the difference between the market
value and the sum of the original purchase price plus carrying costs but less
dividends. The Company will have a mirror arrangement under certain of its
benefit plans, under which employees and directors bear the economic risk and
reward of the forward shares. The participants' account balances under such
plans will secure their obligations under the forward share arrangement. At
September 30, 1999, 203,500 shares had been purchased and are being held subject
to such forward agreement.
FSA's primary uses of funds are to pay operating expenses and to pay dividends
or make surplus note payments to its parent. FSA's funds are also required to
satisfy 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
payment 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 by matching insured payments with available cash flow or
other payment sources. 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.
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.
12
FSA has a credit arrangement, aggregating $150.0 million, provided by commercial
banks and intended for general application to transactions insured by FSA and
its insurance company subsidiaries. At September 30, 1999, there were no
borrowings under this arrangement, which expires on April 28, 2000, 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 is $186.9 million, of which $99.3 million was unutilized at September
30, 1999.
FSA has a standby line of credit commitment in the amount of $240.0 million with
a group of international Aaa/AAA-rated banks to provide loans to FSA after it
has incurred, during the term of the facility, cumulative municipal losses (net
of any recoveries) in excess of the greater of $230.0 million or 5.75% of
average annual debt service of the covered portfolio. The obligation to repay
loans made under this agreement is a limited recourse obligation payable solely
from, and collateralized by, a pledge of recoveries realized on defaulted
insured obligations in the covered portfolio, including certain installment
premiums and other collateral. This commitment has a term beginning on April 30,
1999 and expiring on April 30, 2006 and contains an annual renewal provision
subject to approval by the banks. No amounts have been utilized under this
commitment as of September 30, 1999.
The Company has no plans for material capital expenditures within the next
twelve months.
Year 2000 Readiness Disclosure
The Company established its Year 2000 (Y2K) committee in 1997. The committee has
investigated potential effects on FSA of the Y2K problem arising from the
inability of some computers to properly recognize dates in the year 2000 and
later. The Company has examined its hardware, software, network, and customer
and vendor interdependencies in FSA's information systems and has found no
material problems with any mission-critical FSA systems. It has conducted
appropriate tests on its larger hardware and networking components, personal
computers and material systems software, and all such systems are considered to
be Y2K compliant. As of September 30, 1999, the Company has completed
verification of Y2K compliance with outside vendors from which the Company
purchases software. The cost of the Company's Y2K compliance has been
immaterial.
FSA's financial guaranty policies do not contain an exclusion for Y2K problems.
Each guaranty policy is customized for its individual transaction, so the actual
policy and other transaction documents should be consulted regarding questions
about the effect of Y2K problems of specific parties on specific policies. For
example, if an issuer failed to make an insured payment due to a Y2K problem,
FSA's insurance policy generally would cover such failure. On the other hand, if
the issuer made the payment and the trustee failed to distribute it to
bondholders due to a Y2K problem, FSA's insurance policy generally would not
cover such failure. To investigate whether certain entities connected with
transactions it insures have Y2K problems that could affect insured payments,
FSA has surveyed the servicers and trustees for FSA-insured asset-backed
transactions and has also surveyed certain companies that operate in a trustee,
paying agent or securities depository capacity for a large component of FSA's
public finance book of business. Responses to date have generally indicated
active Y2K testing and remediation programs.
While none of the parties that the Company has surveyed have informed the
Company of any material issues regarding Y2K readiness, there can be no
assurance that each party will be Y2K compliant. Failure by an issuer or
servicer in an FSA-insured transaction to be Y2K compliant may result in
unanticipated claims upon FSA. While FSA generally would be entitled to
reimbursement for any such claims paid, the liquidity and credit exposure to FSA
from such claims could be material. As a result, management plans to increase
its available liquidity in its investment portfolio at year end 1999 in order to
meet presently unanticipated demand for claims payments. FSA provides additional
information about its Y2K compliance program on its website at www.fsa.com/y2k.
Subsequent Event
The Company announced in October 1999 a plan to sell approximately $140.0
million of common shares. The Company plans to sell common shares to its major
shareholders White Mountains, Tokio Marine and XL at a price of $54.20 per
share, subject to certain closing conditions. This price represents 97.5% of the
average of the high and low sale price on the New York Stock Exchange on October
29, 1999. Shares will also be sold on the same terms to
13
one or more financial institutions, which will hold such shares in connection
with forward share purchase arrangements with the Company. Management and a
special board committee considered both a private sale and a public offering and
determined that the proposed private sale offered higher net proceeds. No
brokerage or underwriting fees will be paid by the Company in connection with
the sale of shares. Closings of the sales are expected by year-end.
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, as amended, for the year ended December 31, 1998. 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.
14
PART II
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27 Financial Data Schedules.
99 Financial statements of Financial Security Assurance Inc. for
the quarterly period ended September 30, 1999.
(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 12, 1999 Jeffrey S. Joseph
Managing Director & Controller (Chief
Accounting Officer)
16
Exhibit Index
Exhibit No. Exhibit
- ----------- -------
27 Financial Data Schedules.
99 Financial statements of Financial Security Assurance Inc. for the
quarterly period ended September 30, 1999.