FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2009
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 0-22342
Triad Guaranty Inc.
(Exact name of registrant as specified in its charter)
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Delaware
(State or other jurisdiction of
incorporation or organization)
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56-1838519
(I.R.S. Employer
Identification No.) |
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101 South Stratford Road
Winston-Salem, North Carolina
(Address of principal executive offices)
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27104
(Zip Code) |
(336) 723-1282
(Registrants 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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer o | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company þ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
Number of shares of common stock, par value $0.01 per share, outstanding as of July 31, 2009, was
15,215,378.
TRIAD GUARANTY INC.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
TRIAD GUARANTY INC.
CONSOLIDATED BALANCE SHEETS
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June 30, |
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December 31, |
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(dollars in thousands, except per share data) |
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2009 |
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2008 |
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(unaudited) |
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ASSETS |
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Invested assets: |
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Securities available-for-sale, at fair value: |
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Fixed maturities (amortized cost: $806,383 and $844,964) |
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$ |
847,809 |
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$ |
854,186 |
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Equity securities (cost: $17 and $566) |
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31 |
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583 |
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Short-term investments |
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3,800 |
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40,653 |
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Total invested assets |
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851,640 |
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895,422 |
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Cash and cash equivalents |
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31,600 |
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39,940 |
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Real estate acquired in claim settlement |
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713 |
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Accrued investment income |
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10,115 |
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10,515 |
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Property and equipment |
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6,515 |
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7,747 |
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Reinsurance recoverable, net |
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234,248 |
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150,848 |
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Other assets |
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41,020 |
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25,349 |
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Total assets |
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$ |
1,175,138 |
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$ |
1,130,534 |
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LIABILITIES AND STOCKHOLDERS (DEFICIT) EQUITY |
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Liabilities: |
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Losses and loss adjustment expenses |
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$ |
1,591,207 |
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$ |
1,187,840 |
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Unearned premiums |
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14,890 |
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15,863 |
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Amounts payable to reinsurers |
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115 |
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719 |
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Long-term debt |
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34,535 |
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34,529 |
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Deferred payment obligation |
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27,020 |
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Accrued interest |
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2,476 |
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1,275 |
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Accrued expenses and other liabilities |
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34,585 |
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26,974 |
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Total liabilities |
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1,704,828 |
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1,267,200 |
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Commitments and contingencies Note 5 |
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Stockholders deficit: |
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Preferred stock, par value $0.01 per share authorized 1,000,000
shares; no shares issued and outstanding |
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Common stock, par value $0.01 per share authorized 32,000,000
shares; issued and outstanding 15,215,378 shares at June 30, 2009
and 15,161,259 shares at December 31, 2008 |
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152 |
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151 |
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Additional paid-in capital |
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112,998 |
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112,629 |
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Accumulated other comprehensive income, net of income tax liability
of $14,680 at June 30, 2009 and $3,265 at December 31, 2008 |
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27,262 |
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6,063 |
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Accumulated deficit |
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(670,102 |
) |
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(255,509 |
) |
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Deficit in assets |
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(529,690 |
) |
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(136,666 |
) |
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Total liabilities and stockholders deficit |
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$ |
1,175,138 |
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$ |
1,130,534 |
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See accompanying notes.
1
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
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Three Months Ended |
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Six Months Ended |
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June 30, |
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June 30, |
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(dollars in thousands, except per share data) |
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2009 |
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2008 |
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2009 |
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2008 |
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Revenue: |
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Premiums written: |
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Direct |
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$ |
73,821 |
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$ |
84,561 |
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$ |
129,444 |
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$ |
173,946 |
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Ceded |
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(10,027 |
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(15,480 |
) |
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(21,157 |
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(31,475 |
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Net premiums written |
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63,794 |
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69,081 |
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108,287 |
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142,471 |
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Change in unearned premiums |
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1,039 |
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784 |
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904 |
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(542 |
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Earned premiums |
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64,833 |
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69,865 |
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109,191 |
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141,929 |
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Net investment income |
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10,859 |
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9,175 |
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22,051 |
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18,722 |
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Net realized investment gains (losses) |
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2,017 |
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(3,799 |
) |
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(2,548 |
) |
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(1,096 |
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Other income |
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2 |
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2 |
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4 |
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4 |
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77,711 |
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75,243 |
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128,698 |
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159,559 |
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Losses and expenses: |
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Net losses and loss adjustment expenses |
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431,368 |
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292,749 |
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532,945 |
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514,008 |
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Net change in premium deficiency reserve |
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(15,000 |
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Interest expense |
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1,895 |
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696 |
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2,589 |
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2,172 |
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Policy acquisition costs |
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39,416 |
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Other operating expenses (net of acquisition
costs deferred) |
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8,680 |
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27,238 |
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18,091 |
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41,344 |
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441,943 |
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305,683 |
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553,625 |
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596,940 |
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Loss before income tax benefit |
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(364,232 |
) |
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(230,440 |
) |
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(424,927 |
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(437,381 |
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Income tax benefit: |
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Current |
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1,081 |
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2 |
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1,081 |
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(2 |
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Deferred |
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(5,894 |
) |
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(31,631 |
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(11,415 |
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(88,554 |
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(4,813 |
) |
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(31,629 |
) |
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(10,334 |
) |
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(88,556 |
) |
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Net loss |
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$ |
(359,419 |
) |
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$ |
(198,811 |
) |
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$ |
(414,593 |
) |
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$ |
(348,825 |
) |
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Loss per common and common equivalent share: |
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Basic |
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$ |
(23.91 |
) |
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$ |
(13.36 |
) |
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$ |
(27.65 |
) |
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$ |
(23.45 |
) |
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Diluted |
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$ |
(23.91 |
) |
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$ |
(13.36 |
) |
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$ |
(27.65 |
) |
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$ |
(23.45 |
) |
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Shares used in computing loss per common and
common equivalent share: |
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Basic |
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15,031,394 |
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14,878,662 |
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14,994,535 |
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14,873,636 |
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Diluted |
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15,031,394 |
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14,878,662 |
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14,994,535 |
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14,873,636 |
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See accompanying notes.
2
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(unaudited)
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Six Months Ended |
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June 30, |
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(dollars in thousands) |
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2009 |
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2008 |
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Operating activities |
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Net loss |
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$ |
(414,593 |
) |
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$ |
(348,825 |
) |
Adjustments to reconcile net loss to net cash provided by
operating activities: |
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Losses, loss adjustment expenses and unearned premium reserves |
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402,394 |
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|
457,890 |
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Accrued expenses and other liabilities |
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7,611 |
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|
9,904 |
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Deferred payment obligation |
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27,020 |
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Income taxes recoverable |
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(6,576 |
) |
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Reinsurance, net |
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(84,004 |
) |
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|
(56,026 |
) |
Accrued investment (loss) income |
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400 |
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(586 |
) |
Policy acquisition costs deferred |
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(3,173 |
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Policy acquisition costs |
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|
39,416 |
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Net realized investment losses |
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|
2,548 |
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|
1,096 |
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Provision for depreciation |
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|
1,266 |
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|
2,338 |
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Accretion of discount on investments |
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|
704 |
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|
793 |
|
Deferred income taxes |
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(11,415 |
) |
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|
(88,554 |
) |
Prepaid federal income taxes |
|
|
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|
52,825 |
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Real estate acquired in claim settlement, net of write-downs |
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|
713 |
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|
4,658 |
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Accrued interest |
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|
1,201 |
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(80 |
) |
Other assets |
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|
577 |
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|
4,104 |
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Other operating activities |
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|
514 |
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2,433 |
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Net cash (used in) provided by operating activities |
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(71,640 |
) |
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|
78,213 |
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Investing activities |
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Securities available-for-sale: |
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Purchases fixed maturities |
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(128,623 |
) |
|
|
(584,572 |
) |
Sales fixed maturities |
|
|
120,024 |
|
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|
430,107 |
|
Maturities fixed maturities |
|
|
34,631 |
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|
20,333 |
|
Sales equities |
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|
533 |
|
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|
266 |
|
Net change in short-term investments |
|
|
36,769 |
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|
31,655 |
|
Property and equipment |
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(34 |
) |
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(1,080 |
) |
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Net cash provided by (used in) investing activities |
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|
63,300 |
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(103,291 |
) |
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Financing activities |
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Repayment of revolving credit facility |
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(80,000 |
) |
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Net cash used in financing activities |
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|
(80,000 |
) |
|
|
|
|
|
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|
Foreign currency translation adjustment on cash and cash equivalents |
|
|
|
|
|
|
(64 |
) |
|
|
|
|
|
|
|
Net change in cash and cash equivalents |
|
|
(8,340 |
) |
|
|
(105,142 |
) |
Cash and cash equivalents at beginning of period |
|
|
39,940 |
|
|
|
124,811 |
|
|
|
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Cash and cash equivalents at end of period |
|
$ |
31,600 |
|
|
$ |
19,669 |
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Supplemental schedule of cash flow information |
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Cash paid (received) during the period for: |
|
|
|
|
|
|
|
|
Income taxes and United States Mortgage Guaranty
Tax and Loss Bonds |
|
$ |
7,736 |
|
|
$ |
(410 |
) |
Interest |
|
$ |
1,383 |
|
|
$ |
2,248 |
|
See accompanying notes.
3
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)
1. The Company
Triad Guaranty Inc. (TGI) is a holding company which, through its wholly-owned subsidiary,
Triad Guaranty Insurance Corporation (TGIC), historically has provided mortgage insurance
coverage in the United States. Triad, as used in this report, includes the operations of TGIC
and its wholly-owned subsidiary, Triad Guaranty Assurance Corporation. Mortgage insurance allows
buyers to achieve homeownership with a reduced down payment, facilitates the sale of mortgage loans
in the secondary market and protects lenders from credit default-related expenses. TGIC is an
Illinois-domiciled insurance company and the Illinois Department of Insurance is our primary
regulator. The Illinois Insurance Code grants broad powers to the Department and its Director
(collectively, the Department) to enforce rules or exercise discretion over almost all
significant aspects of our insurance business. Triad ceased issuing new commitments for mortgage
guaranty insurance coverage on July 15, 2008 and is operating the business in run-off under two
Corrective Orders issued by the Department. The first Corrective Order was issued in August 2008.
The second Corrective Order was issued in March 2009 and subsequently amended in May 2009. The
term run-off, as used in this report, refers to Triad no longer writing new mortgage insurance
policies, but continuing to service its existing policies. Servicing existing policies includes:
receiving premiums on policies that remain in force; cancelling coverage at the insureds request;
terminating policies for non-payment of premium; working with borrowers in default to remedy the
default and/or mitigate Triads loss; and settling all legitimate filed claims per the provisions
of the Corrective Orders. The term settled, as used in this report in the context of the payment
of a claim, refers to the satisfaction of TGICs obligations following the submission of valid
claims by our policyholders. Prior to June 1, 2009, valid claims were settled by a cash payment.
Effective on and after June 1, 2009, valid claims are settled by a combination of 60% in cash and
40% in the form of a deferred payment obligation (DPO), as discussed further in Note 2, below.
The Corrective Orders, among other things, allow management to continue to operate Triad under
close supervision by the Department, include restrictions on the distribution of dividends or
interest on notes payable to its parent by Triad, and include restrictions on the payment of
claims. Failure to comply with the provisions of the Corrective Orders could result in the
imposition of fines or penalties or subject Triad to further legal proceedings, including
receivership proceedings for the conservation, rehabilitation or liquidation of Triad. Triad
Guaranty Inc. and its subsidiaries are collectively referred to herein as the Company.
2. Going Concern
The Company prepares its financial statements presented in this quarterly report on Form 10-Q
in conformity with accounting principles generally accepted in the United States of America
(GAAP). The financial statements for Triad that are provided to the Department and that form the
basis for our corrective plan were prepared in accordance with Statutory Accounting Principles
(SAP) as set forth in the Illinois Insurance Code. The primary differences between GAAP and SAP
for Triad at June 30, 2009 were the methodology utilized for the establishment of reserves and the
reporting requirements stipulated in the second Corrective Order. A deficit in assets occurs when
recorded liabilities exceed recorded assets in financial statements prepared under GAAP. A
deficiency in policyholders surplus occurs when recorded liabilities exceed recorded assets in
financial statements prepared under SAP. A deficit in assets is not necessarily a measure of
insolvency. However, the Company believes that if Triad were to report a deficiency in
policyholders surplus, Illinois law may require the Department to seek receivership in the courts,
which could compel the parent, TGI, to institute a proceeding seeking relief from creditors under
U.S. bankruptcy laws. The second Corrective Order attempts to mitigate the possibility of a
deficiency in policyholders surplus by providing for the settlement of claims 60% in cash and 40%
in the form of a DPO, which is accounted for as a component of policyholders surplus under SAP.
4
The Company has prepared its financial statements on a going concern basis under GAAP, which
contemplates the realization of assets and the satisfaction of liabilities and commitments in the
normal course of business. However, there is substantial doubt as to the Companys ability to
continue as a going concern. This uncertainty is based on, among other things, the possible
inability of Triad to comply with the provisions of the Corrective Orders, the Companys recurring
losses from operations and the Company reporting an increasing deficit in assets as of the end of
each of its last four calendar quarters. The Companys financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset amounts or amounts
of liabilities that might be necessary should the Company be unable to continue in existence.
The Company incurred significant operating losses for the year ended December 31, 2008 and
continued to incur operating losses during the first six months of 2009. At June 30, 2009, the
Company had a deficit in assets of $529.7 million, which reflects an increase of $348.3 million or
192% from the deficit reported at March 31, 2009. The Companys operating losses are the result of
increased defaults under the mortgages that the Company has insured and resulting foreclosures and
claims by policyholders for insurance coverage. Contributing to the defaults and claims are steep
declines in U.S home prices, particularly in certain distressed markets, tightened credit markets,
and the continuing economic recession in the United States. Additionally and as noted above, the
Company is limited in its ability to offset these operating losses with revenue from new business
because Triad is operating in run-off under two Corrective Orders issued by the Department and can
no longer issue commitments for new insurance.
Terms of the initial Corrective Order required Triad to submit a corrective plan, which
included a five-year projection of operations and financial condition. The plan was submitted by
Triad in October 2008 and indicated a solvent run-off. Since the approval of the initial
corrective plan, the Company has periodically revised the assumptions initially utilized as a
result of continued deteriorating economic conditions impacting its financial condition, results of
operations and future prospects. In early 2009, Triads projections indicated that Triad would
report a deficiency in policyholders surplus under SAP as early as March 31, 2009. As a result,
the Department issued the second Corrective Order requiring Triad to settle its claim liabilities
with 60% cash and 40% by recording a DPO. On March 31, 2009 Triad reduced the amount of reserves
recorded on its SAP balance sheet to the amounts that would be settled in cash, which provided an
increase in policyholders surplus. Triad began settling claim liabilities with 60% cash and 40%
DPO on June 1, 2009. The DPO is represented by a separate entry in Triads financial statements
and will accrue a carrying charge at Triads earned investment rate. Absent the accounting
treatment required by the recording of the DPO, Triad would have reported a deficiency in
policyholders surplus of $423.6 million at June 30, 2009. Payment of the carrying charges and the
DPO will be subject to Triads future financial performance and will require approval of the
Department.
If the Companys revised corrective plan is unsuccessful, Illinois law may require the
Department to seek receivership in the courts, which could compel the parent, TGI, to institute a
proceeding seeking relief from creditors under U.S. bankruptcy laws. The ability to successfully
implement the revised corrective plan by management is unknown at this time and is dependent upon
many factors, including improved macroeconomic conditions in the United States.
3. Accounting Policies and Basis of Presentation
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in conformity
with GAAP for interim financial information and with the instructions to Form 10-Q and Article 8 of
Regulation S-X. Accordingly, they do not include all of the information and footnotes required by
accounting principles generally accepted in the United States for complete financial statements.
In the opinion of management, all adjustments considered necessary for a fair presentation have
been included. Operating results for the three months and six months ended June 30, 2009 are not
necessarily indicative of the results that may be expected for the year ending
5
December 31, 2009 or subsequent quarterly periods. For further information, refer to the
consolidated financial statements and footnotes thereto included in the Companys Annual Report on
Form 10-K for the year ended December 31, 2008.
Recent Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) No. 168, The FASB Accounting Standards Codification and the
Hierarchy of Generally Accepted Accounting Principles (SFAS 168). SFAS 168 establishes the FASB
Accounting Standards Codification (the Codification), which was officially launched on July 1,
2009, and became the primary source of authoritative U.S. GAAP recognized by the FASB to be applied
by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange
Commission (the SEC) under the authority of Federal securities laws are also sources of
authoritative GAAP for SEC registrants. The subsequent issuances of new standards will be in the
form of Accounting Standards Updates that will be included in the Codification. SFAS 168 is
effective for financial statements issued for interim and annual periods ending after September 15,
2009. The Company plans to adopt SFAS 168 effective in the third quarter of 2009. As the
Codification is neither expected nor intended to change GAAP, the adoption of SFAS 168 is not
expected to have a material impact on the Companys financial position and results of operations.
In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (SFAS
167). SFAS 167, which amends FASB Interpretation (FIN) No. 46 (revised December 2003),
Consolidation of Variable Interest Entities, (FIN 46(R)), prescribes a qualitative model for
identifying whether a company has a controlling financial interest in a variable interest entity
(VIE) and eliminates the quantitative model prescribed by FIN 46(R). The new model identifies
two primary characteristics of a controlling financial interest: (1) provides a company with the
power to direct significant activities of the VIE, and (2) obligates a company to absorb losses of
and/or provides rights to receive benefits from the VIE. SFAS 167 requires a company to reassess
on an ongoing basis whether it holds a controlling financial interest in a VIE. A company that
holds a controlling financial interest is deemed to be the primary beneficiary of the VIE and is
required to consolidate the VIE. This statement is effective for fiscal years beginning after
November 15, 2009. The Company plans to adopt SFAS 167 effective January 1, 2010. The adoption of
SFAS 167 is not expected to have a material impact on the Companys financial position and results
of operations.
In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets
(SFAS 166). SFAS 166 removes the concept of a qualifying special-purpose entity from SFAS No.
140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities
(SFAS 140) and removes the exception from applying FIN 46(R). This statement also clarifies the
requirements for isolation and limitations on portions of financial assets that are eligible for
sale accounting. This statement is effective for fiscal years beginning after November 15, 2009.
The Company plans to adopt SFAS 166 effective January 1, 2010. The adoption of SFAS 166 is not
expected to have a material impact on the Companys financial position and results of operations.
Effective June 30, 2009, the Company adopted SFAS No. 165, Subsequent Events (SFAS 165).
This standard is based upon the same principles that exist within the auditing standards and thus
formally establishes accounting standards for disclosing those events occurring after the balance
sheet date but before the financial statements are issued or available to be issued. The statement
requires public entities to evaluate subsequent events through the date that the financial
statements are issued, while all other entities should evaluate subsequent events through the date
that the financial statements are available to be issued. SFAS 165 categorizes subsequent events
into recognized subsequent events (or historically Type I events) and nonrecognized subsequent
events (or historically Type II events). The statement also enhances disclosure requirements for
subsequent events. SFAS 165 was effective upon issuance. The adoption of SFAS 165 did not have a
material impact on the Companys financial position and results of operations.
6
Effective June 30, 2009, the Company adopted FSP SFAS 107-1 and Accounting Principles Board
(APB) Opinion No. 28-1, Interim Disclosures about Fair Value of Financial Instruments (FSP 107-1
and APB 28-1). FSP 107-1 amends FASB SFAS No. 107, Disclosures about Fair Values of Financial
Instruments, to require a company to disclose in the body or in the accompanying notes of its
summarized financial information for interim reporting periods the fair value of all financial
instruments for which it is practicable to estimate fair value, whether recognized or not
recognized in the balance sheet. APB 28-1 amends APB Opinion No. 28, Interim Financial Reporting,
to require entities to disclose the methods and significant assumptions used to estimate the fair
value of financial instruments and describe changes in methods and significant assumptions. The
Company has presented the necessary disclosures herein in Note 7, Fair Value Measurement.
Effective June 30, 2009, the Company adopted FSP SFAS 115-2 & SFAS 124-2, Recognition and
Presentation of Other-Than-Temporary Impairments (FSP SFAS 115-2 & SFAS 124-2). FSP SFAS 115-2 &
SFAS 124-2 amends the other-than-temporary impairment guidance for debt securities to make that
guidance more operational and to improve the presentation and disclosure of a companys
investments, including other-than-temporary impairments on debt and equity securities, in the
financial statements. The adoption of FSP SFAS 115-2 & SFAS 124-2 did not have a material impact
on the Companys financial position and results of operations.
Effective June 30, 2009, the Company adopted FSP SFAS 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and
Identifying Transactions That Are Not Orderly (FSP SFAS 157-4). This FSP provides guidance
related to: (1) estimating fair value when the volume and level of activity for an asset or
liability have significantly decreased in relation to normal market activity for the asset or
liability, and (2) circumstances that may indicate that a transaction is not orderly (i.e. forced
liquidation or distressed sale). This FSP was effective prospectively for interim and annual
reporting periods ending after June 15, 2009. The adoption of FSP SFAS 157-4 did not have a
material impact on the Companys financial position and results of operations.
On January 1, 2009, the Company adopted SFAS 141(R), Business Combinations (SFAS 141(R)).
SFAS 141(R) is intended to improve reporting by creating greater consistency in the accounting and
financial reporting of business combinations, resulting in more complete, comparable and relevant
information for investors and other users of financial statements. To achieve this goal, the new
standard requires the acquiring entity in a business combination to recognize all (and only) the
assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair
value as the measurement objective for all assets acquired and liabilities assumed; and expands the
disclosure requirements for material business combinations. The adoption of SFAS 141(R) did not
have a material impact on the Companys financial position and results of operations for the three
and six months ended June 30, 2009.
On January 1, 2009, the Company adopted SFAS 160, Noncontrolling Interests in Consolidated
Financial Statements (SFAS 160). SFAS 160 is intended to improve the relevance, comparability,
and transparency of financial information provided to investors by requiring all entities to report
noncontrolling (minority) interests in subsidiaries in the same way as equity in the consolidated
financial statements. Moreover, SFAS 160 eliminates the diversity that currently exists in
accounting for transactions between an entity and noncontrolling interests by requiring that they
be treated as equity transactions. The presentation and disclosure requirements of SFAS 160 were
applied retrospectively. The adoption of SFAS 160 did not have a material impact on the Companys
financial position and results of operations.
4. Consolidation
The consolidated financial statements include the accounts of Triad Guaranty Inc. and all of
its subsidiaries. All significant intercompany accounts and transactions have been eliminated.
7
5. Commitments and Contingencies
Reinsurance
Certain premiums and losses are ceded to other insurance companies under various reinsurance
agreements, the majority of which are captive reinsurance agreements with affiliates of certain
customers. Reinsurance contracts do not relieve Triad from its obligations to policyholders.
Failure of the reinsurer to honor its obligation could result in losses to Triad; consequently,
allowances are established for amounts deemed uncollectible.
Under captive reinsurance agreements, the counterparties are required to establish trust
accounts to support the reinsurers obligations under the reinsurance agreements. At June 30,
2009, we had approximately $272.1 million in captive reinsurance trust balances supporting the risk
transferred to the captive reinsurers. As of June 30, 2009, there were five captive reinsurance
arrangements where the total ceded reserves, combined with any unpaid ceded claims, had exceeded
the trust balance by $75.8 million and the recoverable recorded was therefore limited to the trust
balance.
Insurance In Force, Dividend Restrictions, and Statutory Results
Historically, insurance regulators and rating agencies utilized the risk-to-capital ratio as a
general guideline to limit the risk a mortgage insurer could write with a 25-to-1 risk-to-capital
ratio as the maximum allowed. Capital for purposes of this computation includes the statutory
capital and surplus as well as the statutory contingency reserve. The amount of net risk for
insurance in force at June 30, 2009, December 31, 2008, and June 30, 2008, as presented below, was
computed by applying the various percentage settlement options to the insurance in force amounts,
adjusted by risk ceded under reinsurance agreements, any applicable stop-loss limits and
deductibles. Several states have specifically allowed mortgage insurers to reduce the risk
outstanding by the amount of risk in default, for which reserves have been provided, in their
calculation of risk-to-capital. In the calculation presented below, the Company has not reduced
the risk outstanding for the risk in default. Triads ratio is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
June 30, |
|
(dollars in thousands) |
|
2009 |
|
|
2008 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net risk |
|
$ |
10,049,236 |
|
|
$ |
11,019,036 |
|
|
$ |
11,721,202 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Statutory capital and surplus |
|
$ |
178,580 |
|
|
$ |
88,027 |
|
|
$ |
192,096 |
|
Statutory contingency reserve |
|
|
|
|
|
|
|
|
|
|
82,615 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
178,580 |
|
|
$ |
88,027 |
|
|
$ |
274,711 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Risk-to-capital ratio |
|
56.3 to 1 |
|
|
125.2 to 1 |
|
|
42.7 to 1 |
|
|
|
|
|
|
|
|
|
|
|
The increase in statutory policyholders surplus and the decline in the risk-to-capital ratio
at June 30, 2009 from the levels at December 31, 2008 is primarily the result of the impact on
statutory loss reserves of the additional Corrective Order that requires all valid claims be
settled 60% in cash and 40% by recording a DPO. As a result of this requirement, loss reserves
under SAP at June 30, 2009 have been reduced by $575.2 million. This accounting change under SAP
was adopted on a prospective basis as of March 31, 2009, and amounted to $485.5 million on that
date. The entire amount was recorded as a cumulative effect to surplus. At June 30, 2009, the
cumulative effect of this requirement on statutory policyholders surplus has been an increase of
$602.2 million. There was no such impact to loss reserves or stockholders equity calculated on a
GAAP basis.
In run-off, Triad will not be issuing any new commitments for insurance. Any new insurance
written will come only from commitments issued up to July 15, 2008 and this amount is expected to
be immaterial. Even if
Triads risk-to-capital ratio were to be reduced to 25-to-1 or lower as a result of the second
Corrective Order, we would continue to be prohibited from issuing new commitments for insurance.
8
As determined in accordance with SAP, Triad experienced a net loss of $210.7 million and
$381.7 million, respectively, for the three months and six months ended June 30, 2009; a net loss
of $573.9 million for the year-ended December 31, 2008; and a net loss of $165.0 million and $320.0
million, respectively, for the three months and six months ended June 30, 2008. Effective
September 30, 2008, Triad changed its method of calculating the reserve for losses under SAP for
its statutory financial statements as permitted by the Illinois insurance code, which requires that
reserves are to be provided on loans that were in default four months or greater or loans in
foreclosure. Previously, Triad had provided reserves on loans that were two months or greater in
default or loans in foreclosure, which was another acceptable method of statutory accounting. This
change had no impact on the Companys methodology for calculating reserves under GAAP.
Under the Corrective Orders issued by the Department, Triad is currently prohibited, and
expects to be prohibited for the foreseeable future, from paying any dividends to the Company.
Triad also has a $25 million outstanding surplus note held by the Company. Under the terms of the
Corrective Orders, Triad is also prohibited from paying interest on the surplus note.
Loss Reserves
The Company establishes loss reserves to provide for the estimated costs of settling claims on
loans reported in default and estimates of loans in default that are in the process of being
reported to the Company as of the date of the financial statements. Consistent with industry
accounting practices, the Company does not establish loss reserves for future claims on insured
loans that are not currently in default. Loss reserves are established by management using
historical experience and by making various assumptions and judgments about claim rates (frequency)
and claim amounts (severity) to estimate ultimate losses to be paid on loans in default. The
Companys reserving methodology gives effect to current economic conditions and profiles
delinquencies by such factors as default status, policy year, specific lenders, and the number of
months the policy has been in default, as well as the combined original loan-to-value (LTV)
ratio. Also, the Company believes policies originated by certain lenders may have involved
misrepresentations, fraud or other underwriting violations that provide Triad with the right to
deny or rescind coverage and, accordingly, the reserving methodology also accounts for expected
rescissions. The assumptions utilized in the calculation of the loss reserve estimate are
continually reviewed, and as adjustments to the reserve become necessary, such adjustments are
reflected in the financial statements in the periods in which the adjustments are made.
Litigation
The Company is involved in litigation and other legal proceedings in the ordinary course of
business as well as the case named below. No pending litigation or other legal proceedings are
expected to have a material adverse effect on the financial position of the Company.
On February 6, 2009, James L. Phillips served a complaint against Triad Guaranty Inc., Mark K.
Tonnesen and Kenneth W. Jones in the United States District Court, Middle District of North
Carolina. The plaintiff purports to represent a class of persons who purchased or otherwise
acquired the common stock of the Company between October 26, 2006 and April 1, 2008 and the
complaint alleges violations of federal securities laws by the Company and two of its present or
former officers. The court has appointed lead counsel for the plaintiff and an amended complaint
was filed June 22, 2009. Our response to the amended complaint is due August 21, 2009. We intend
to contest the lawsuit vigorously.
Triad maintained a $95 million Excess-of-Loss reinsurance treaty that was to provide a benefit
when Triads risk-to-capital ratio exceeded 25-to-1 and the combined ratio exceeded 100% (the
attachment point).
Once the attachment point was reached, following a one-time deductible of $25 million, the
carrier would be responsible for the reimbursement of all paid losses in each quarter that the
attachment point was breached up to the
9
one-time $95 million policy limit. The reinsurance treaty
attached at the end of the first quarter of 2008; however, in April 2008 the reinsurance carrier
provided a notice of termination of the agreement. The dispute was submitted to an arbitration
panel and the arbitration hearing took place in December 2008 and January 2009. On June 4, 2009,
Triad was notified that the arbitration panel had determined that the reinsurance carrier was
required to reimburse Triad for claims paid from April 1, 2009 through May 19, 2009 following the
one-time deductible of $25 million. As a result, the amount recoverable was substantially less than
the $95 million policy limit. Subsequently, Triad and the reinsurance carrier entered into an
agreement to settle the matter in full in exchange for a payment from the reinsurance carrier to
Triad of $10 million, which resolves all disputes between the parties and concludes all remaining
rights and obligations of the parties under the reinsurance treaty. In addition to the payment
from the reinsurance carrier, Triad has also recovered $2.0 million in premium that had previously
been expensed. Net of expenses associated with concluding the arbitration, the settlement
decreased the net loss for the second quarter of 2009 by approximately $11.7 million.
6. Investments
Available-for-sale Securities
Pursuant to SFAS No. 157, Fair Value Measurements (SFAS 157), we have categorized
available-for-sale securities into a three-level hierarchy, based on the priority of the inputs to
the respective valuation technique. The fair value hierarchy gives the highest priority to
unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the
lowest priority to unobservable inputs (Level 3), as described herein in Note 7, Fair Value
Measurement, which also includes additional disclosures regarding our fair value measurements
required by SFAS 157.
The amortized cost, gross unrealized gains and losses and fair value of available-for-sale
securities as of June 30, 2009 and December 31, 2008 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2009 |
|
|
|
Cost or |
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Fair |
|
(dollars in thousands) |
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Value |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U. S. government obligations |
|
$ |
5,415 |
|
|
$ |
308 |
|
|
$ |
|
|
|
$ |
5,723 |
|
State, municipal, and other
government bonds |
|
|
132,917 |
|
|
|
6,450 |
|
|
|
|
|
|
|
139,367 |
|
Corporate bonds |
|
|
504,575 |
|
|
|
27,573 |
|
|
|
|
|
|
|
532,148 |
|
Asset-backed bonds |
|
|
49,345 |
|
|
|
2,703 |
|
|
|
|
|
|
|
52,048 |
|
Residential mortgage-backed bonds |
|
|
114,131 |
|
|
|
4,392 |
|
|
|
|
|
|
|
118,523 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal, fixed maturities |
|
|
806,383 |
|
|
|
41,426 |
|
|
|
|
|
|
|
847,809 |
|
Equity securities |
|
|
17 |
|
|
|
14 |
|
|
|
|
|
|
|
31 |
|
Short term investments |
|
|
3,796 |
|
|
|
4 |
|
|
|
|
|
|
|
3,800 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total securities |
|
$ |
810,196 |
|
|
$ |
41,444 |
|
|
$ |
|
|
|
$ |
851,640 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2008 |
|
|
|
Cost or |
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Fair |
|
(dollars in thousands) |
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Value |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U. S. government obligations |
|
$ |
7,646 |
|
|
$ |
350 |
|
|
$ |
|
|
|
$ |
7,996 |
|
State, municipal, and other
government bonds |
|
|
168,694 |
|
|
|
2,872 |
|
|
|
|
|
|
|
171,566 |
|
Corporate bonds |
|
|
479,563 |
|
|
|
2,633 |
|
|
|
|
|
|
|
482,196 |
|
Asset-backed bonds |
|
|
65,667 |
|
|
|
82 |
|
|
|
|
|
|
|
65,749 |
|
Residential mortgage-backed bonds |
|
|
123,394 |
|
|
|
3,285 |
|
|
|
|
|
|
|
126,679 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal, fixed maturities |
|
|
844,964 |
|
|
|
9,222 |
|
|
|
|
|
|
|
854,186 |
|
Equity securities |
|
|
566 |
|
|
|
17 |
|
|
|
|
|
|
|
583 |
|
Short term investments |
|
|
40,565 |
|
|
|
88 |
|
|
|
|
|
|
|
40,653 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total securities |
|
$ |
886,095 |
|
|
$ |
9,327 |
|
|
$ |
|
|
|
$ |
895,422 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The amortized cost and estimated fair value of fixed maturity available-for-sale securities,
at June 30, 2009, are summarized by stated maturity as follows:
|
|
|
|
|
|
|
|
|
|
|
Available-for-Sale |
|
|
|
Amortized |
|
|
Fair |
|
(dollars in thousands) |
|
Cost |
|
|
Value |
|
|
|
|
|
|
|
|
|
|
Maturity: |
|
|
|
|
|
|
|
|
One year or less |
|
$ |
86,254 |
|
|
$ |
89,539 |
|
After one year through five years |
|
|
452,465 |
|
|
|
475,568 |
|
After five years through ten years |
|
|
79,686 |
|
|
|
84,862 |
|
After ten years |
|
|
187,978 |
|
|
|
197,840 |
|
|
|
|
|
|
|
|
Total |
|
$ |
806,383 |
|
|
$ |
847,809 |
|
|
|
|
|
|
|
|
Actual maturities may differ from contractual maturities because issuers may have the right to
call or pre-pay obligations.
Realized Gains (Losses) Related to Investments
The details of net realized investment gains (losses) are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
(dollars in thousands) |
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities available-for-sale: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross realized gains |
|
$ |
1,844 |
|
|
$ |
5,103 |
|
|
$ |
2,682 |
|
|
$ |
5,879 |
|
Gross realized losses |
|
|
(47 |
) |
|
|
(8,886 |
) |
|
|
(5,352 |
) |
|
|
(9,820 |
) |
Equity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross realized gains |
|
|
58 |
|
|
|
|
|
|
|
62 |
|
|
|
22 |
|
Gross realized losses |
|
|
|
|
|
|
(6 |
) |
|
|
(83 |
) |
|
|
(6 |
) |
Foreign currency gross realized gains |
|
|
116 |
|
|
|
(10 |
) |
|
|
95 |
|
|
|
2,827 |
|
Other investment gains |
|
|
46 |
|
|
|
|
|
|
|
48 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized losses |
|
$ |
2,017 |
|
|
$ |
(3,799 |
) |
|
$ |
(2,548 |
) |
|
$ |
(1,096 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Given our recurring losses from operations and the significant doubt regarding our ability to
continue as a going concern, we may no longer have the ability to hold impaired assets for a
sufficient time to recover their value.
11
As a result, we made the decision to recognize an impairment loss on all securities whose
amortized cost is greater than the reported fair value and thus have no unrealized losses at June
30, 2009.
While market conditions have improved recently, the unrealized gains are partly due to
previous impairment of our fixed income securities. These unrealized gains do not necessarily
represent future gains that we will realize. Changing conditions related to specific securities,
overall market interest rates, or credit spreads, as well as our decisions concerning the timing of
a sale, may impact values we ultimately realize. Taxable securities typically exhibit greater
volatility in value than tax-preferred securities and thus we expect greater volatility in
unrealized gains and realized losses going forward. Volatility may increase in periods of
uncertain market or economic conditions.
7. Fair Value Measurement
Fair Value of Financial Instruments
The carrying values and fair values of financial instruments as of June 30, 2009 and December
31, 2008 are summarized below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2009 |
|
December 31, 2008 |
|
|
|
|
|
|
Fair |
|
|
|
|
|
Fair |
(dollars in thousands) |
|
Carrying Value |
|
Value |
|
Carrying Value |
|
Value |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturity securities
available-for-sale |
|
$ |
847,809 |
|
|
$ |
847,809 |
|
|
$ |
854,186 |
|
|
$ |
854,186 |
|
Equity securities available-for-sale |
|
|
31 |
|
|
|
31 |
|
|
|
583 |
|
|
|
583 |
|
Financial Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt |
|
|
34,535 |
|
|
|
16,256 |
|
|
|
34,529 |
|
|
|
10,124 |
|
Valuation Methodologies and Associated Inputs
Investments
We measure our investments that are required to be carried at fair value based on assumptions
used by market participants in pricing the security. The most appropriate valuation methodology is
selected based on the specific characteristics of the fixed maturity or equity security, and we
consistently apply the valuation methodology to measure the securitys fair value. Our fair value
measurement is based on a market approach, which utilizes prices and other relevant information
generated by market transactions involving identical or comparable securities. Sources of inputs
to the market approach include third-party pricing services, independent broker quotations or
pricing matrices. We use observable and unobservable inputs to our valuation methodologies.
Observable inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads,
two-sided markets, benchmark securities, bids, offers and reference data. In addition, market
indicators, industry and economic events are monitored and further market data is acquired if
certain triggers are met. For certain security types, additional inputs may be used, or some of
the inputs described above may not be applicable. For broker-quoted only securities, quotes from
market makers or broker-dealers are obtained from sources recognized to be market participants. In
order to validate the pricing information and broker-dealer quotes, we employ, where possible,
procedures that include comparisons with similar observable positions, comparisons with subsequent
sales, discussions with senior business leaders and brokers and observations of general market
movements for those security classes. For those securities trading in less liquid or illiquid
markets with limited or no pricing information, we use unobservable inputs in order to measure the
fair value of these securities. In cases where this information is not available, such as for
privately placed securities, fair value is estimated using an internal pricing
matrix. This matrix relies on managements judgment concerning the discount rate used in
calculating expected future cash flows, credit quality, industry sector performance and expected
maturity.
12
We do not adjust prices received from third parties; however, we do analyze the third-party
pricing services valuation methodologies and related inputs and perform additional evaluations to
determine the appropriate level within the fair value hierarchy.
The observable and unobservable inputs to our valuation methodologies are based on a set of
standard inputs that we generally use to evaluate all of our available-for-sale securities. The
standard inputs used in order of priority are benchmark yields, reported trades, broker/dealer
quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data.
Depending on the type of security or the daily market activity, standard inputs may be prioritized
differently or may not be available for all available-for-sale securities on any given day.
Cash and Cash Equivalents
Cash and cash equivalents are carried at amortized cost, which approximates fair value. This
category includes highly liquid debt instruments purchased with a maturity of three months or less.
Due to the nature of these assets, we believe these assets should be classified as Level 2.
Long-Term Debt
The fair value of the Companys long-term debt is estimated using discounted cash flow
analysis based on the Companys current incremental borrowing rates for similar types of borrowing
arrangements.
Fair Value of Investments
The Company utilizes the provisions of SFAS 157 in its estimation and disclosures about fair
value. SFAS 157 defines fair value, establishes a framework for measuring fair value under GAAP,
and expands disclosures about fair value measurements. SFAS 157 applies to other accounting
pronouncements that require or permit fair value measurements. The Company adopted SFAS 157
effective for its fiscal year beginning January 1, 2008.
SFAS 157 establishes a fair value hierarchy that prioritizes the inputs to valuation methods
used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices
in active markets for identical assets or liabilities (Level 1 measurements) and the lowest
priority to unobservable inputs (Level 3 measurements). The three levels of the fair value
hierarchy under SFAS 157 are as follows:
|
Level 1: |
|
Unadjusted quoted prices in active markets that are accessible at the
measurement date for identical, unrestricted assets or liabilities. |
|
|
Level 2: |
|
Quoted prices in markets that are not active, or inputs that are
observable either directly or indirectly, for substantially the full term of the
asset or liability. |
|
|
Level 3: |
|
Prices or valuation techniques that require inputs that are both
significant to the fair value measurement and unobservable (i.e., supported with
little or no market activity). |
An assets or a liabilitys level within the fair value hierarchy is based on the lowest level
of input that is significant to the fair value measurement. The Company did not have any material
assets or liabilities measured at fair value on a non-recurring basis as of June 30, 2009. The
following table summarizes the assets measured at fair value on a recurring basis and the source of
the inputs in the determination of fair value as of June 30, 2009 and December 31, 2008:
13
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements at Reporting Date Using |
|
|
|
|
|
|
|
Quoted Prices in |
|
|
|
|
|
|
|
|
|
|
|
|
|
Active Markets for |
|
|
Significant Other |
|
|
Significant |
|
|
|
|
|
|
|
Identical Assets |
|
|
Observable Inputs |
|
|
Unobservable Inputs |
|
(dollars in thousands) |
|
June 30, 2009 |
|
|
(Level 1) |
|
|
(Level 2) |
|
|
(Level 3) |
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities
available-for-sale |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities |
|
$ |
847,809 |
|
|
$ |
|
|
|
$ |
845,972 |
|
|
$ |
1,837 |
|
Equity securities |
|
|
31 |
|
|
|
31 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
847,840 |
|
|
$ |
31 |
|
|
$ |
845,972 |
|
|
$ |
1,837 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements at Reporting Date Using |
|
|
|
|
|
|
|
Quoted Prices in |
|
|
|
|
|
|
|
|
|
|
|
|
|
Active Markets for |
|
|
Significant Other |
|
|
Significant |
|
|
|
|
|
|
|
Identical Assets |
|
|
Observable Inputs |
|
|
Unobservable Inputs |
|
(dollars in thousands) |
|
December 31, 2008 |
|
|
(Level 1) |
|
|
(Level 2) |
|
|
(Level 3) |
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities
available-for-sale |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities |
|
$ |
854,186 |
|
|
$ |
|
|
|
$ |
851,651 |
|
|
$ |
2,535 |
|
Equity securities |
|
|
583 |
|
|
|
583 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
854,769 |
|
|
$ |
583 |
|
|
$ |
851,651 |
|
|
$ |
2,535 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Significant unobservable inputs (Level 3) were used in determining the fair value on certain
bonds in the fixed maturities portfolio during this period. The following table provides a
reconciliation of the beginning and ending balances of these Level 3 bonds and the related gains
and losses related to these assets during the second quarter and the first six months of 2009 and
2008, respectively.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurement Using Significant |
|
|
|
Unobservable Inputs (Level 3) |
|
|
|
Certain Bonds in Fixed Maturities AFS Portfolio |
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
(dollars in thousands) |
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning balance |
|
$ |
1,757 |
|
|
$ |
3,345 |
|
|
$ |
2,535 |
|
|
$ |
7,402 |
|
Total gains and losses (realized and unrealized): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Included in operations |
|
|
(43 |
) |
|
|
1 |
|
|
|
(331 |
) |
|
|
(130 |
) |
Included in other comprehensive income |
|
|
133 |
|
|
|
(300 |
) |
|
|
50 |
|
|
|
(343 |
) |
Purchases, issuances and settlements |
|
|
(10 |
) |
|
|
29,265 |
|
|
|
(417 |
) |
|
|
25,382 |
|
Transfers in and/or out of Level 3 |
|
|
|
|
|
|
897 |
|
|
|
|
|
|
|
897 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending balance |
|
$ |
1,837 |
|
|
$ |
33,208 |
|
|
$ |
1,837 |
|
|
$ |
33,208 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The amount of total gains and losses for the period included in
operations attributable to the change in unrealized gains
or losses relating to assets still held at the reporting date |
|
$ |
90 |
|
|
$ |
(284 |
) |
|
$ |
(281 |
) |
|
$ |
(347 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
14
8. Earnings (Loss) Per Share (EPS)
Basic and diluted EPS are based on the weighted-average daily number of shares outstanding.
For the three months and six months ended June 30, 2009 and 2008, the basic and diluted EPS
denominators are the same weighted-average daily number of shares outstanding. In computing
diluted EPS, only potential common shares that are dilutive those that reduce EPS or increase
loss per share are included. Exercise of options and unvested restricted stock are not assumed
if the result would be antidilutive, such as when a loss from operations is reported. The
numerator used in basic EPS and diluted EPS is the same for all periods presented. For the three
months and six months ended June 30, 2009, options to purchase approximately 48,934 and 79,534
shares, respectively, of the Companys common stock were excluded from the calculation of EPS
because they were antidilutive.
9. Comprehensive Income (Loss)
Comprehensive income (loss) consists of net income (loss) and other comprehensive income
(loss). For the Company, other comprehensive income (loss) is composed of unrealized gains or
losses on available-for-sale securities and foreign currency exchange, net of income taxes.
Effective with the issuance of the first Corrective Order, the Company no longer has the ability to
hold unrealized losses until such time that the securities recover in value or mature due to the
possibility that Illinois law may require the Department to seek receivership if the corrective
plan were deemed ineffective. Thus, any security with a fair value less than the book value at the
balance sheet date is considered to be other-than-temporarily impaired and the loss is recognized
as a realized loss in the Statements of Operations. For the three months and six months ended June
30, 2009, the Companys other comprehensive income was $10.9 million and $21.2 million,
respectively, and the Companys comprehensive loss was $348.5 million and $393.4 million,
respectively. For the three months ended June 30, 2008, the Companys other comprehensive income
was $0.3 million while the Company reported an other comprehensive loss for the six months ended
June 30, 2008 of $10.8 million. For the three months and six months ended June 30, 2008, the
Companys comprehensive loss was $198.6 million and $359.6 million, respectively.
10. Income Taxes
The income tax benefit for the three months and six months ended June 30, 2009 differs
substantially from that which is computed by applying the Federal statutory income tax rate of 35%
to the loss before income taxes. This difference is primarily due to the Companys inability to
recognize a benefit for expected tax loss carry forwards. The benefit recorded in 2009 reflects the
tax impact of unrealized gains recorded on available-for-sale securities.
11. Exit Costs
In June 2008, the Company recorded an accrual for certain exit costs in connection with the
transition of its business into run-off. As part of the transition to run-off, Triad implemented a
reduction in workforce by terminating approximately 100 employees based primarily in the sales,
marketing, technology and underwriting functions. The remaining workforce of approximately 150
full-time employees is focused on the payment of legitimate claims and servicing the insurance
portfolio during the run-off period.
As a result of the transition into run-off, the Company recorded an estimated pre-tax charge
of approximately $8.3 million in other operating costs on the Statements of Operations for the
period ended June 30, 2008. These charges included approximately $7.1 million in severance and
related personnel costs, approximately $1.0 million related primarily to the abandonment of a
portion of Triads main office lease that is expected to continue through 2012, and approximately
$0.2 million related to the termination of certain other leases, including those related to underwriting offices, equipment and automobiles. At June 30, 2009, there
remained approximately $0.6 million of accrued severance and related personnel costs and $0.6
million of lease abandonment costs. There have been no significant changes to the original
estimates since the initial establishment of the exit cost accruals.
15
12. Subsequent Events
Management has evaluated subsequent events to determine if events or transactions occurring
through the filing date of this Form 10-Q require potential
adjustment or disclosure in the financial statements. We are not
aware of any significant events that occurred subsequent to the
balance sheet date but prior to the filing of this report that would
have a material impact on our Consolidated Financial Statements.
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Managements Discussion and Analysis of Financial Condition and Results of Operations analyzes
our consolidated financial condition, changes in financial position, and results of operations for
the three months and six months ended June 30, 2009 and 2008. This discussion supplements
Managements Discussion and Analysis of Financial Condition and Results of Operations in our Annual
Report on Form 10-K for the year ended December 31, 2008, and should be read in conjunction with
the interim financial statements and notes contained herein.
Certain of the statements contained in this release are forward-looking statements and are
made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. These statements include estimates and assumptions related to economic, competitive,
regulatory, operational and legislative developments. These forward-looking statements are subject
to change, uncertainty and circumstances that are, in many instances, beyond our control and they
have been made based upon our current expectations and beliefs concerning future developments and
their potential effect on us. Actual developments and their results could differ materially from
those expected by us, depending on the outcome of a number of factors, including our ability to
operate our business in run-off, the possibility of general economic and business conditions that
are different than anticipated, legislative, regulatory, and other similar developments, changes in
interest rates, employment rates, the housing market, the mortgage industry and the stock market,
as well as the relevant factors described in this report under the headings Risk Factors and
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 in our Annual
Report on Form 10-K for the year ended December 31, 2008, as well as in other reports and
statements that we file with the Securities and Exchange Commission. Forward-looking statements
are based upon our current expectations and beliefs concerning future events and we undertake no
obligation to update or revise any forward-looking statements to reflect the impact of
circumstances or events that arise after the date the forward-looking statements are made.
Overview
Triad Guaranty Inc. (TGI) is a holding company that historically provided private mortgage
insurance coverage in the United States through its wholly-owned subsidiary, Triad Guaranty
Insurance Corporation (TGIC). Triad, as used in this report, includes the operations of TGIC
and its wholly-owned subsidiary, Triad Guaranty Assurance Corporation. TGIC is an
Illinois-domiciled insurance company and the Illinois Department of Insurance is our primary
regulator. The Illinois Insurance Code grants broad powers to the Department and its Director
(collectively, the Department) to enforce rules or exercise discretion over almost all
significant aspects of our insurance business. Triad ceased issuing new commitments for mortgage
guaranty insurance coverage on July 15, 2008 and we are operating our business in run-off. As used
in this report, the term run-off means writing no new mortgage insurance policies, but continuing
to service existing policies. Servicing existing policies includes: receiving premiums on policies
that remain in force; cancelling coverage at the insureds request; terminating policies for
non-payment of premium; working with borrowers in default to remedy the default and/or mitigate our
loss; and settling all legitimate filed claims per the provisions of the two Corrective Orders
issued by the Department. The first Corrective Order was issued in August 2008. The second
Corrective Order was issued in March 2009 and subsequently amended in May 2009. These Corrective
Orders, among other things, include restrictions on the distribution of dividends or interest on notes payable to its parent by
Triad, allow management to continue to operate Triad under close supervision, and include
restrictions on the payment of claims. Failure to comply with the provisions of the Corrective
Orders may result in the imposition of fines or penalties or subject
16
Triad to further legal proceedings, including receivership proceedings for the conservation, rehabilitation or liquidation
of Triad. TGI and its subsidiaries are collectively referred to herein as the Company.
We have historically provided Primary and Modified Pool mortgage guaranty insurance coverage
on U.S. residential mortgage loans. We classify insurance as Primary when we are in the first loss
position and the loan-to-value amount, or LTV, is 80% or greater when the loan is originated. We
classify all other insurance as Modified Pool. The majority of our Primary insurance has been
delivered through the flow channel, which is defined as loans originated by lenders and submitted
to us on a loan-by-loan basis. We have also historically provided mortgage insurance to lenders
and investors who seek additional default protection (typically secondary coverage or on loans for
which the individual borrower has greater than 20% equity), capital relief, and credit-enhancement
on groups of loans that are sold in the secondary market. These transactions are referred to as
our structured bulk channel business. Those individual loans in the structured bulk channel in
which we are in the first loss position and the LTV ratio is greater than 80% are classified as
Primary. All of our Modified Pool insurance has been delivered through the structured bulk
channel. Our insurance remains effective until one of the following events occurs: the policy is
cancelled at the insureds request; we terminate the policy for non-payment of premium; the policy
defaults and we satisfy our obligations under the insurance contract; or we rescind the policy for
violations of provisions of a master policy.
In run-off, our revenues principally consist of:
|
|
|
earned renewal premiums from the remaining insurance in force, net of: |
|
|
|
reinsurance premiums ceded, primarily for captive reinsurance, and |
|
|
|
|
refunds paid or accrued resulting from the
cancellation of insurance in force or for coverage anticipated to be
rescinded due to violations of certain provisions of a master policy;
and |
We may also realize investment gains and investment losses on the sale and impairment of
securities, with the net gain or loss reported as a component of revenue.
In run-off, our expenses consist primarily of:
|
|
|
settled claims; |
|
|
|
|
changes in reserves for estimated future claim payments on loans that are
currently in default; |
|
|
|
|
general and administrative costs of servicing existing policies; |
|
|
|
|
other general business expenses; |
|
|
|
|
interest expense on deferred payment obligations (each, a DPO); and |
|
|
|
|
interest expense on long-term debt. |
Our results of operations in run-off depend largely on:
|
|
|
the conditions of the housing, mortgage and capital markets that have a
direct impact on default rates, mitigation efforts, cure rates and ultimately
the amount of claims settled; |
|
|
|
|
the overall general state of the economy and job market; |
|
|
|
|
persistency levels on our remaining insurance in force; |
|
|
|
|
operating efficiencies; and |
|
|
|
|
the level of investment yield, including realized gains and losses, on our
investment portfolio. |
Persistency is an important metric in understanding our premium revenue, especially in run-off
as no new business is being written, so our overall premium base will decline over time.
Generally, the longer a policy remains on our books, or persists, the greater the amount of renewal premium revenue we will
earn from the policy. Cancellations result primarily from the borrower refinancing or selling
insured mortgaged residential properties; from policies being rescinded due to fraud,
misrepresentation or other underwriting violations; from a
17
servicer choosing to cancel the insurance; from the payment of a claim; and, to a lesser degree, from the borrower achieving
prescribed equity levels, at which point the lender no longer requires mortgage guaranty insurance.
Recent Events Affecting our Business
Triad has entered into two Corrective Orders with the Department. The first Corrective Order
was entered into on August 5, 2008 and remains in effect. This Corrective Order was implemented as
a result of our decision to cease writing new mortgage guaranty insurance and to commence a run-off
of our existing insurance in force as of July 15, 2008. Among other things, this Corrective Order:
|
|
|
Required Triad to submit a corrective plan to the Department; |
|
|
|
|
Prohibits all stockholder dividends from Triad to its parent company without
the prior approval of the Department; |
|
|
|
|
Prohibits interest and principal payments on Triads surplus note to its
parent company without the prior approval of the Department; |
|
|
|
|
Restricts Triad from making any payments or entering into any transaction
that involves the transfer of assets to, or liabilities from, any affiliated
parties without the prior approval of the Department; |
|
|
|
|
Requires Triad to obtain prior written approval from the Department before
entering into certain transactions with unaffiliated parties; |
|
|
|
|
Requires Triad to meet with the Department in person or via teleconference
as necessary; and |
|
|
|
|
Requires Triad to furnish to the Department certain reports, agreements,
actuarial opinions and information on an ongoing basis at specified times. |
We submitted a corrective plan to the Department as required under the Corrective Order. The
corrective plan we submitted included, among other items, a five-year statutory financial
projection for Triad and a detailed description of our planned course of action to address our
current financial condition. The financial statements that form the basis of our corrective plan
were prepared in accordance with Statutory Accounting Principles (SAP) set forth in the Illinois
Insurance Code. SAP differs from generally accepted accounting principles (GAAP), which are
followed to prepare the financial statements presented in this report. We received approval of the
corrective plan from the Department in October 2008.
Since the approval of our initial corrective plan, we have revised the assumptions we
initially utilized in our run-off financial forecast model as a result of a number of factors,
including continued deteriorating economic conditions impacting our financial condition, results of
operations and future prospects. The assumptions produced a range of potential ultimate outcomes
for our run-off, but included projections showing that absent additional action by the Department
or favorable changes in our business, we would report a deficiency in policyholders surplus as
calculated in accordance with SAP as early as March 31, 2009. This statutory insolvency would
likely lead to the Department seeking receivership of Triad in the courts and the institution of
bankruptcy proceedings by the Company.
As a result, the Department issued the second Corrective Order effective on March 31, 2009, as
amended on May 26, 2009. This second Corrective Order stipulates or prescribes:
|
|
|
Effective June 1, 2009, all valid claims under Triads mortgage guaranty insurance
policies will be settled 60% in cash and 40% by recording a DPO; |
|
|
|
|
At March 31, 2009, Triad was required to adjust surplus and reserves reflecting the
impact of the Corrective Order on future settled claims; |
|
|
|
|
The DPO will accrue a carrying charge based on the investment yield earned by Triads
investment portfolio; |
18
|
|
|
Triad will establish an escrow account at least equal to the DPO balance and any
associated carrying charges; |
|
|
|
|
Triad will require that any risk or obligation of any captive reinsurer shall be paid in
full, and will deposit any excess reinsurance recovery above the 60% cash payment into an
escrow account; |
|
|
|
|
Payment of the carrying charge and the DPO will be subject to Triads future financial
performance and will require the approval of the Department; |
|
|
|
|
Procedures to account for the impact of the Corrective Order in the financial statements
prepared in accordance with SAP; |
|
|
|
|
Upon payment of a claim under these provisions, Triad shall be deemed to have fully
satisfied its obligations under the respective insurance policy; |
|
|
|
|
Other restrictions and requirements affecting the payment and transferability of the
DPOs and associated carrying charge; and |
|
|
|
|
Certain reporting requirements. |
The DPO recording requirements of the second Corrective Order became effective on June 1,
2009. At June 30, 2009, the recorded DPOs amounted to $27.0 million, reflecting the DPO
transactions for the month of June. The recording of a DPO will not impact reported settled losses
as we will continue to report the entire amount. The accounting for the DPO on a SAP basis is
similar to a surplus note which is reported as a component of statutory surplus, and, as such, is
dependent on the approval by the Department for any repayment of the DPO or the associated carrying
charge. However, in our financial statements prepared in accordance with GAAP, the DPO is reported
as a liability. In accordance with the second Corrective Order, the carrying charge associated
with the DPO is one month in arrears. Therefore, there was no accrual for carrying charges at June
30, 2009.
Failure to comply with the provisions of the Corrective Orders or any other violation of the
Illinois Insurance Code may result in the imposition of fines or penalties or subject Triad to
further legal proceedings, including receivership proceedings for the conservation, rehabilitation
or liquidation of Triad. See Item 1A, Risk Factors in our Annual Report on Form 10-K for the
year ended December 31, 2008 for more information.
Prior to the second Corrective Order, our recurring losses from operations and resulting
decline in policyholders surplus as calculated in accordance with SAP increased the likelihood
that Triad would be placed into receivership and raised substantial doubt about our ability to
continue as a going concern. The positive impact on surplus resulting from the second Corrective
Order has resulted in Triad reporting a policyholders surplus in its financial statements reported
under SAP of $178.6 million at June 30, 2009, as opposed to a deficiency in policyholders surplus
of $423.6 million on the same date had the second Corrective Order not been implemented. While
implementation of the second Corrective Order has deferred the institution of an involuntary
receivership proceeding, no assurance can be given that the Department will not seek receivership
of Triad in the future. The Department may seek receivership of Triad based on its determination
that Triad will ultimately become insolvent or for other reasons. If the Department were to seek
receivership of Triad, the holding company could be compelled to institute a proceeding seeking
relief from creditors under U.S. bankruptcy laws. Our consolidated financial statements that are
presented in this report do not include any adjustments that reflect the financial risks of Triad
entering receivership proceedings and assume that we will continue as a going concern. We expect
losses from operations to continue and our ability to continue as a going concern is dependent on
the successful implementation of the revised corrective plan. See Item 1A, Risk Factors in our
Annual Report on Form 10-K for the year ended December 31, 2008 for more information about our
financial solvency and going concern risks and uncertainties..
At June 30, 2009, as calculated under GAAP, the Company reported a deficit in assets of $529.7
million compared to a deficit in assets of $136.7 million at December 31, 2008 and stockholders
equity of $140.9 million at June 30, 2008. A deficit in assets occurs when recorded liabilities
exceed recorded assets and is not necessarily a measure of insolvency. The deficit in assets is primarily the result of the substantial
increase in loss reserves and settled claims over the last six quarters. The Company will have to
earn in excess of $529.7 million on a GAAP
19
basis during the remaining run-off period to be financially solvent and continue as a going
concern. We expect to continue to report a deficit in assets for the foreseeable future. See Part
II, Item 1A, Risk Factors in this Quarterly Report on Form 10-Q for more information about our
financial solvency and going concern risks and uncertainties.
We have identified a substantial number of underwriting or program violations and
misrepresentations in defaults reported to us and we have subsequently rescinded or cancelled
coverage on these policies at a rate substantially greater than we have historically experienced.
In the fourth quarter of 2008, we expanded the criteria used to determine whether a default would
be investigated for underwriting violations in accordance with our master policy provisions. While
we expect to continue to settle all legitimate claims, we expect an increase in rescission activity
for the remainder of 2009 based on the number of policies under review and the number of
occurrences of underwriting violations identified during 2008 and the first half of 2009. The
impact of rescissions on reserves provided and accruals for anticipated premium refunds has been
significant. See Update on Critical Accounting Policies and Estimates in this report for
additional discussion on rescissions. Any impediment to our ability to rescind coverage for
underwriting violations would be detrimental to our success in run-off.
Triad maintained a $95 million Excess-of-Loss reinsurance treaty that was subject to
arbitration as the insurer had cancelled the policy. On June 4, 2009, Triad was notified that the
arbitration panel had determined that the reinsurance carrier was required to reimburse Triad for
claims paid from April 1, 2009 through May 19, 2009 following the one-time deductible of $25
million. As a result, the amount recoverable was substantially less than the $95 million policy
limit. Following the panels decision, Triad and the reinsurance carrier reached an agreement and
have settled the matter in full in exchange for a payment from the reinsurance carrier to Triad of
$10 million, which resolves all disputes between the parties and concludes all remaining rights and
obligations of the parties under the reinsurance treaty. In addition to the payment from the
reinsurance carrier, Triad also recovered approximately $2.0 million in premium that had previously
been expensed. Net of expenses associated with concluding the arbitration, the settlement
decreased the net loss for the second quarter of 2009 by approximately $11.7 million.
Since the latter part of 2008, several government programs have been initiated that, in
general, are designed to provide relief to homeowners and the financial markets. Some of these
programs involve modifying the terms of mortgages in an effort to reduce foreclosure rates. Many of
these programs have been expanded since originally developed and may continue to change. We are
active participants in certain of these programs. We are unable to predict the impact that these
recent government initiatives will have on our future results of operations and prospects.
Consolidated Results of Operations
Following is selected financial information for the three months and six month ended June 30,
2009 and 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
(dollars in thousands, except |
|
|
|
|
|
|
|
|
|
% |
|
|
|
|
|
|
|
|
|
% |
per share data) |
|
2009 |
|
2008 |
|
Change |
|
2009 |
|
2008 |
|
Change |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
64,833 |
|
|
$ |
69,865 |
|
|
|
(7 |
) |
|
$ |
109,191 |
|
|
$ |
141,929 |
|
|
|
(23 |
) |
Net losses and loss
adjustment expenses |
|
|
431,368 |
|
|
|
292,749 |
|
|
|
47 |
|
|
|
532,945 |
|
|
|
514,008 |
|
|
|
4 |
|
Net loss |
|
|
(359,419 |
) |
|
|
(198,811 |
) |
|
|
81 |
|
|
|
(414,593 |
) |
|
|
(348,825 |
) |
|
|
19 |
|
Diluted loss per share |
|
|
(23.91 |
) |
|
|
(13.36 |
) |
|
|
79 |
|
|
|
(27.65 |
) |
|
|
(23.45 |
) |
|
|
18 |
|
The primary driver of the net loss for the three month and six month periods ending June 30,
2009 continues to be the deteriorated state of the housing and mortgage markets and the resulting
impact on net losses
20
and loss adjustment expenses (LAE). Net losses and LAE increased by $138.6
million and $18.9 million during the second quarter and first six months of 2009, respectively,
compared to the respective periods of 2008.
The reserve for losses and LAE increased by 25% during the second quarter of 2009, primarily
the result of increases in the frequency and severity factors utilized in our reserve calculation.
The number of loans in default at June 30, 2009 rose 9%, which was also a contributing factor in
the reserve increase during the second quarter of 2009. Certain segments of our portfolio continue
to perform more adversely as compared to the rest of the portfolio. These segments include:
|
|
|
Loans on properties in California, Florida, Arizona, and Nevada (which we refer
to collectively as distressed markets) At June 30, 2009, the default rate for
the distressed markets was 32.2% compared to 11.1% for the remaining portfolio and
defaults in the distressed markets comprised 58.5% of the gross risk in default
while only comprising 34.2 % of total risk in force. |
|
|
|
|
Policies originated in 2006 and 2007 At June 30, 2009, the default rate for
these policy years was 22.3% compared to 11.1% for the other policy years and
defaults in these policy years comprised 72.9% of the gross risk in default while
only comprising 57.1% of total risk in force. |
The increase in reserve for losses and LAE was mitigated somewhat by the impact of
risk-sharing structures, both from lender-captives and modified pool contracts. At June 30, 2009,
total benefits received from risk-sharing structures amounted to 32.7% of gross calculated reserves
compared to 20.7% at December 31, 2008 and 15.9% at June 30, 2008. The frequency factors utilized
in the estimation of our loss reserves has been mitigated by our estimate of anticipated
rescissions. While the adjustments made to our frequency factors remained relatively constant with
those employed in the first quarter of 2009, the overall impact has grown as the level of loss
reserves has increased.
Net settled losses and LAE totaled $153.8 million in the second quarter of 2009, an increase
of 119.8% from the second quarter of 2008. The number of claims settled increased by 103.0% in the
second quarter of 2009 compared to the second quarter of 2008 reflecting, among other factors, the
aging of the default inventory and the expiration of a number of government and lender foreclosure
moratoriums. Average severity on settled claims increased to $63,000 during the second quarter of
2009 compared $53,300 in the second quarter of 2008. We expect the number, severity, and amount of
settled claims to continue to increase for the remainder of 2009.
Earned premium for the second quarter of 2009 decreased by 7.2% compared to the second quarter
of 2008, primarily due to the decline in insurance in force. Insurance in force at June 30, 2009
declined by 13% from one-year prior as a result of low levels of new insurance written during the
preceding twelve months. The difference between these rates of decline is attributable to changes
in product mix as a result of cancellations as well as the return of previously expensed ceded
premium.
We describe our results of operations in greater detail in the discussion that follows. The
information is presented in four categories: Production; Insurance and Risk in Force; Revenues;
and Losses and Expenses.
Production
On July 15, 2008, we ceased issuing commitments for mortgage insurance. Going forward, our
production will consist of certificates issued from commitments for mortgage insurance that were
entered into prior to July 15, 2008. We wrote approximately $11 million and $35 million of new
insurance for the three months and six months ended June 30, 2009, respectively, all of which was
from our Primary flow channel and represented commitments on construction loans issued prior to
going into run-off. For the three months and six months ended June 30, 2008, we wrote
approximately $1.1 billion and $3.1 billion, respectively, of new insurance. We do not expect a
material amount of production going forward.
21
Insurance and Risk in Force
The following table provides detail on our direct insurance in force at June 30, 2009 and
2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
|
|
(dollars in millions) |
|
2009 |
|
|
2008 |
|
|
% Change |
|
Primary insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Primary flow insurance |
|
$ |
35,969 |
|
|
$ |
41,646 |
|
|
|
(14 |
) |
Structured bulk insurance |
|
|
3,579 |
|
|
|
4,248 |
|
|
|
(16 |
) |
|
|
|
|
|
|
|
|
|
|
|
Total Primary insurance |
|
|
39,548 |
|
|
|
45,894 |
|
|
|
(14 |
) |
|
|
|
|
|
|
|
|
|
|
|
Modified Pool insurance |
|
|
17,965 |
|
|
|
20,439 |
|
|
|
(12 |
) |
|
|
|
|
|
|
|
|
|
|
|
Total insurance |
|
$ |
57,513 |
|
|
$ |
66,333 |
|
|
|
(13 |
) |
|
|
|
|
|
|
|
|
|
|
|
Insurance in force at June 30, 2009 declined from June 30, 2008 as we have been in run-off
since July 15, 2008, and production since going into run-off consists solely of insurance
certificates issued on commitments outstanding at the time we entered run-off. This decline was
moderated by very strong persistency over the past year. Primary insurance persistency was 85.6%
at June 30, 2009 compared to 85.1% at June 30, 2008 while modified pool insurance persistency was
87.9% at June 30, 2009 compared to 86.4 % at June 30, 2008. We believe these levels of persistency
reflect the general inability of borrowers to refinance or sell their homes due to stricter
underwriting guidelines by lenders, as well as the nationwide decline in home prices. Mortgage
interest rates were at or near historically low levels during the period ended June 30, 2009 and
the majority of our insurance in force has associated interest rates greater than the current
rates. Recent government and private industry initiatives were developed, in part, to promote
liquidity in the mortgage markets through modifications to existing qualifying loans. Given the
interest rate environment and these initiatives, persistency could decline from current levels in
the remainder of 2009, which could have an adverse impact on our future earned premiums.
The following tables provide information on selected risk characteristics of our business
based on gross risk in force at June 30, 2009 and 2008. The following is a list of characteristics
we believe are important indicators of risk, among others, in our portfolios:
|
|
|
The percentage of business defined as non-prime credit quality; |
|
|
|
|
The percentage of Alt-A business; |
|
|
|
|
The percentage of business with a loan-to-value (LTV) greater than 95%; |
|
|
|
|
The percentage of interest only loans and adjustable rate mortgages
(ARMs), particularly ARMs with potential negative amortization; |
|
|
|
|
The percentage of condominium property types; |
|
|
|
|
The percentage of non-primary residence occupancy status; |
|
|
|
|
The percentage of loans in excess of $250,000; |
|
|
|
|
The concentration of risk in distressed market states; and |
|
|
|
|
The presence of multiple risk factors on a single insured loan. |
22
Risk in Force (1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary |
|
|
Modified Pool |
|
|
|
June 30, |
|
|
June 30, |
|
(dollars in millions) |
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Risk in Force |
|
$ |
10,316 |
|
|
$ |
11,943 |
|
|
$ |
5,254 |
|
|
$ |
5,965 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit Quality: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prime |
|
|
76.8 |
% |
|
|
75.6 |
% |
|
|
28.4 |
% |
|
|
27.8 |
% |
Alt-A |
|
|
19.7 |
|
|
|
20.9 |
|
|
|
70.8 |
|
|
|
71.4 |
|
A-Minus |
|
|
3.1 |
|
|
|
3.1 |
|
|
|
0.7 |
|
|
|
0.7 |
|
Sub Prime |
|
|
0.4 |
|
|
|
0.4 |
|
|
|
0.1 |
|
|
|
0.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LTV: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Greater than 95% |
|
|
25.1 |
% |
|
|
25.1 |
% |
|
|
|
% |
|
|
|
% |
90.01% to 95.00% |
|
|
32.8 |
|
|
|
32.5 |
|
|
|
0.2 |
|
|
|
0.2 |
|
90.00% and below |
|
|
42.1 |
|
|
|
42.4 |
|
|
|
99.8 |
|
|
|
99.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan Type: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed |
|
|
67.5 |
% |
|
|
66.2 |
% |
|
|
26.8 |
% |
|
|
26.2 |
% |
Interest Only |
|
|
10.3 |
|
|
|
10.4 |
|
|
|
23.3 |
|
|
|
23.3 |
|
ARM (amortizing) fixed period 5 years or
greater |
|
|
8.4 |
|
|
|
8.8 |
|
|
|
31.1 |
|
|
|
31.3 |
|
ARM (amortizing) fixed period less than 5
years |
|
|
2.1 |
|
|
|
2.2 |
|
|
|
5.6 |
|
|
|
5.7 |
|
ARM (potential negative amortization) |
|
|
11.7 |
|
|
|
12.4 |
|
|
|
13.2 |
|
|
|
13.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property Type: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Condominium |
|
|
11.0 |
% |
|
|
10.6 |
% |
|
|
9.8 |
% |
|
|
9.5 |
% |
Other (principally single-family detached) |
|
|
89.0 |
|
|
|
89.4 |
|
|
|
90.2 |
|
|
|
90.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Occupancy Status: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary residence |
|
|
87.6 |
% |
|
|
87.7 |
% |
|
|
73.1 |
% |
|
|
73.5 |
% |
Secondary home |
|
|
8.0 |
|
|
|
7.9 |
|
|
|
6.1 |
|
|
|
6.1 |
|
Non-owner occupied |
|
|
4.4 |
|
|
|
4.4 |
|
|
|
20.8 |
|
|
|
20.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage Amount: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$0 - $50,000 |
|
|
0.9 |
% |
|
|
0.8 |
% |
|
|
0.5 |
% |
|
|
0.5 |
% |
$51,000 - $100,000 |
|
|
9.5 |
|
|
|
9.3 |
|
|
|
5.4 |
|
|
|
5.3 |
|
$100,001 - $250,000 |
|
|
52.0 |
|
|
|
51.8 |
|
|
|
45.8 |
|
|
|
45.4 |
|
$250,001 - $500,000 |
|
|
32.1 |
|
|
|
32.2 |
|
|
|
42.0 |
|
|
|
42.2 |
|
Over $500,000 |
|
|
5.5 |
|
|
|
5.9 |
|
|
|
6.3 |
|
|
|
6.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Market Status: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distressed market states (AZ, CA, FL, NV) |
|
|
26.8 |
% |
|
|
27.2 |
% |
|
|
48.6 |
% |
|
|
48.8 |
% |
Non-distressed market states |
|
|
73.2 |
|
|
|
72.8 |
|
|
|
51.4 |
|
|
|
51.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
(1) |
|
Percentages represent distribution of gross risk in force on a per policy basis and do not account for
risk ceded to captive reinsurers or applicable stop-loss amounts and deductibles on Modified Pool
structured bulk transactions. |
The composition of our risk in force at June 30, 2009, based on certain of the risk factors
that we measure, including credit quality, LTV, loan type, property type, occupancy status, and
mortgage amount, remained relatively consistent with that of a year ago given the lack of
production over the previous twelve months and the
23
high level of persistency. Additionally, while
our exposure to the distressed markets expressed as a percentage of the total has remained
consistent over the past twelve months, the contribution to losses from the distressed markets has
been adversely disproportional to the percentage of the portfolio. Our portfolio contains
significant exposure to Alt-A loans and pay option ARM loans, as well as interest only loans. An
inherent risk in both a pay option ARM loan and an interest only loan is the scheduled milestone at
which the borrower must begin making amortizing payments. These payments can be substantially
greater than the minimum payments required before the milestone is met. An additional risk to a
pay option ARM loan is that the payment being made may be less than the amount of interest
accruing, creating negative amortization on the outstanding principal of the loan. These features
add uncertainty and potential risk. Due in part to recent market conditions, the Alt-A loans, pay
option ARM loans, and interest only loans have, as a group, performed significantly worse than the
remaining prime fixed rate loans through June 30, 2009.
We believe that a policy with a high LTV, all else being equal, will have a greater risk of
default than a policy with a low LTV, especially in periods such as we are in currently with
declining home prices. In the table
above, the percentage of risk in force by LTV is based on the LTV at the time the loan was
originated. We have not been provided with the mark-to-market LTV, or the LTV using current loan
amount and current market value, of our insured portfolio. To the extent that an insured loan in
our portfolio has experienced a decline in the underlying value, and we believe this to be the case
for a large percentage of our insured portfolio, the mark-to-market LTV of the policy may be
substantially higher than that at origination.
The premium rates we charge vary depending on the perceived risk of a loan at origination and
generally cannot be changed after issuance of coverage. The premium rates charged for business
originated in 2005, 2006 and 2007, and specifically for higher risk products including pay option
ARMs and Alt-A loans, may not generate ongoing premium revenue sufficient to cover future losses
associated with those products.
The following table shows gross risk in force as of June 30, 2009 by year of loan origination.
Business originated in 2006 and 2007 continues to comprise the majority of our risk in force. This
is due to the significant amounts of production during these two years as well as the large number
of policies that have been cancelled from prior origination years. In general, policies originated
during 2006 and 2007 have significantly higher amounts of average risk per policy than policies
originated prior to 2006. Furthermore, policies originated during these vintage years have
exhibited higher default rates than preceding vintage years. For additional information regarding
these vintage years, see Losses and Expenses, below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2009 |
|
|
|
Primary |
|
|
Modified Pool |
|
|
|
Gross Risk |
|
|
|
|
|
|
Gross Risk |
|
|
|
|
(dollars in millions) |
|
in Force * |
|
|
Percent |
|
|
in Force * |
|
|
Percent |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vintage Year |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004 and before |
|
$ |
2,205.7 |
|
|
|
21.4 |
|
|
$ |
758.3 |
|
|
|
14.4 |
|
2005 |
|
|
1,303.2 |
|
|
|
12.6 |
|
|
|
1,795.2 |
|
|
|
34.2 |
|
2006 |
|
|
2,135.6 |
|
|
|
20.7 |
|
|
|
1,942.5 |
|
|
|
37.0 |
|
2007 |
|
|
4,050.5 |
|
|
|
39.3 |
|
|
|
757.4 |
|
|
|
14.4 |
|
2008 |
|
|
621.4 |
|
|
|
6.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
10,316.4 |
|
|
|
100.0 |
|
|
$ |
5,253.4 |
|
|
|
100.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
Gross risk in force is on a per policy basis and does not account for risk ceded to captive reinsurers or
applicable stop-loss amounts and deductibles on Modified Pool structured bulk transactions. |
The percentage of our primary flow insurance in force subject to captive reinsurance
arrangements at June 30, 2009 was 56.0%, a slight decrease from 57.9% at the end of the second
quarter of 2008. Under captive reinsurance programs, reinsurance companies that are affiliates of
the lenders assume a portion of the risk associated with the lenders insured book of business in
exchange for a percentage of the premium. The risk
24
reinsured by the captive is supported by assets held in trust with Triad as the beneficiary. At
June 30, 2009, we had approximately $272.1 million in captive reinsurance trust balances with
$237.7 million of reserves ceded to those captives, which serves to limit our future loss exposure
to a small degree. Several of the captive reinsurers have trust balances below the reserves ceded
under the contracts. In those cases, the reserve credit that we recognize in the financial
statements is limited to the trust balances.
During the first quarter of 2009, one of our captive reinsurance agreements and the supporting
trust agreement was terminated at the request of the reinsurer. As a result of the termination, all
coverage ceased, the trust balance of $8.1 million supporting the reinsurance agreement was
returned to Triad.
Revenues
A summary of the significant individual components of our revenue for the second quarter and
first six months of 2009 and 2008 follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
(dollars in thousands) |
|
2009 |
|
|
2008 |
|
|
% Change |
|
|
2009 |
|
|
2008 |
|
|
% Change |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct premium written before
the impact of
refunds |
|
$ |
75,631 |
|
|
$ |
87,129 |
|
|
|
(13 |
) |
|
$ |
156,405 |
|
|
$ |
178,288 |
|
|
|
(12 |
) |
Less: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash refunds primarily
related to
rescissions |
|
|
(10,701 |
) |
|
|
(2,738 |
) |
|
|
291 |
|
|
|
(16,800 |
) |
|
|
(4,167 |
) |
|
|
303 |
|
Change in refund
accruals primarily
related to rescissions |
|
|
8,891 |
|
|
|
170 |
|
|
|
5,130 |
|
|
|
(10,161 |
) |
|
|
(175 |
) |
|
|
5,706 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct premium written |
|
|
73,821 |
|
|
|
84,561 |
|
|
|
(13 |
) |
|
|
129,444 |
|
|
|
173,946 |
|
|
|
|
|
Ceded premium written |
|
|
(10,027 |
) |
|
|
(15,480 |
) |
|
|
(35 |
) |
|
|
(21,157 |
) |
|
|
(31,475 |
) |
|
|
(33 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premium written |
|
|
63,794 |
|
|
|
69,081 |
|
|
|
(8 |
) |
|
|
108,287 |
|
|
|
142,471 |
|
|
|
(24 |
) |
Change in unearned premiums |
|
|
1,039 |
|
|
|
784 |
|
|
|
33 |
|
|
|
904 |
|
|
|
(542 |
) |
|
|
(267 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
64,833 |
|
|
$ |
69,865 |
|
|
|
(7 |
) |
|
$ |
109,191 |
|
|
$ |
141,929 |
|
|
|
(23 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income |
|
$ |
10,859 |
|
|
$ |
9,175 |
|
|
|
18 |
|
|
$ |
22,051 |
|
|
$ |
18,722 |
|
|
|
18 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized investment
(losses) gains |
|
$ |
2,017 |
|
|
$ |
(3,799 |
) |
|
|
(153 |
) |
|
$ |
(2,548 |
) |
|
$ |
(1,096 |
) |
|
|
132 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues |
|
$ |
77,711 |
|
|
$ |
75,243 |
|
|
|
3 |
|
|
$ |
128,698 |
|
|
$ |
159,559 |
|
|
|
(19 |
) |
The decline in direct premium written for the three months and six months ended June 30, 2009
compared to the respective periods of 2008 is primarily the result of a 13.3% decline in insurance
in force over the one-year period prior as well as the impact of premium refunds from rescissions.
Rescission activity has increased
dramatically since the beginning of 2008. When we rescind coverage on an insured policy, the
entire previously paid premium is refunded. For the second quarter and first six months of 2009,
cash premium refunded, primarily due to rescission activity, was 14.1% and 10.7%, respectively, of
direct premium written before the impact of refunds compared to 3.1% and 2.3% for the respective
periods of 2008. We also establish an accrual for expected premium refunds on policies that are
currently under investigation for rescission.
Ceded premium written is comprised primarily of premiums written under excess of loss
reinsurance treaties with captives. Ceded premium during the three months and six months ended
June 30, 2009 decreased over the respective periods of 2008 due to: (1) a decrease in insurance in
force subject to captive reinsurance as a result of policy cancellations and the termination of one
captive reinsurance arrangement; (2) the establishment of an accrual in the first quarter of 2009
to account for the rescission of coverage on policies subject to captive reinsurance and the
expected refunds of premiums previously ceded; and (3) the conclusion of the arbitration of the
Excess-of-Loss reinsurance treaty and the subsequent recovery of $2.0 million of ceded premium
previously expensed. The premium cede rate for the three months and six months ended June 30, 2009
decreased to 13.6% and
25
16.3%, respectively, from 18.3% and 18.1%, respectively, in the periods
one-year prior primarily due to the recovery of premium previously expensed.
The increase in net investment income was primarily due to the growth in average invested
assets and an increase in the yield of the portfolio. Average invested assets at cost or amortized
cost grew by 5.0% and 3.7% during the second quarter and first six months of 2009 compared to the
same periods of 2008. The growth in average invested assets is due to the investment of positive
operating cash flows during the six months ended December 31, 2008. The book yield on our
investment portfolio increased to 5.17% at June 30, 2009 compared to 4.65% at June 30, 2008. For a
further discussion, see Investment Portfolio.
Losses and Expenses
A summary of the individual components of losses and expenses for the three months and six
months ended June 30, 2009 and 2008 follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
(dollars in thousands) |
|
2009 |
|
|
2008 |
|
|
% Change |
|
|
2009 |
|
|
2008 |
|
|
% Change |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net losses and loss
adjustment expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net settled claims |
|
$ |
149,863 |
|
|
$ |
68,263 |
|
|
|
120 |
|
|
$ |
203,783 |
|
|
$ |
108,350 |
|
|
|
88 |
|
Net change in loss
reserves |
|
|
278,956 |
|
|
|
218,568 |
|
|
|
28 |
|
|
|
318,584 |
|
|
|
393,512 |
|
|
|
(19 |
) |
Loss adjustment
expenses |
|
|
2,549 |
|
|
|
5,918 |
|
|
|
(57 |
) |
|
|
10,578 |
|
|
|
12,146 |
|
|
|
(13 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
431,368 |
|
|
|
292,749 |
|
|
|
47 |
|
|
|
532,945 |
|
|
|
514,008 |
|
|
|
4 |
|
Net change in premium
deficiency |
|
|
|
|
|
|
(15,000 |
) |
|
|
(100 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Policy acquisition costs |
|
|
|
|
|
|
|
|
|
|
n/a |
|
|
|
|
|
|
|
39,416 |
|
|
|
(100 |
) |
Other operating expenses
(net of acquisition
costs deferred) |
|
|
8,680 |
|
|
|
27,238 |
|
|
|
(68 |
) |
|
|
18,091 |
|
|
|
41,344 |
|
|
|
(56 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss ratio |
|
|
665.4 |
% |
|
|
419.0 |
% |
|
|
59 |
|
|
|
488.1 |
% |
|
|
362.2 |
% |
|
|
35 |
|
Expense ratio |
|
|
13.6 |
% |
|
|
39.4 |
% |
|
|
(65 |
) |
|
|
16.7 |
% |
|
|
32.2 |
% |
|
|
(48 |
) |
Combined ratio |
|
|
679.0 |
% |
|
|
458.4 |
% |
|
|
48 |
|
|
|
504.8 |
% |
|
|
394.4 |
% |
|
|
28 |
|
Net losses and LAE are comprised of settled claims and LAE as well as the increase in the loss
and LAE reserve during the period.
The following table provides detail on direct settled claims and number of settled claims for
our Primary and Modified Pool insurance prior to the effect of ceded settled claims for the three
months and six months ended June 30, 2009 and 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
(dollars in thousands) |
|
2009 |
|
|
2008 |
|
|
% Change |
|
|
2009 |
|
|
2008 |
|
|
% Change |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct settled claims: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance |
|
$ |
114,947 |
|
|
$ |
48,187 |
|
|
|
139 |
|
|
$ |
171,224 |
|
|
$ |
77,423 |
|
|
|
121 |
|
Modified Pool
insurance |
|
|
48,826 |
|
|
|
20,192 |
|
|
|
142 |
|
|
|
56,561 |
|
|
|
31,044 |
|
|
|
82 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
163,773 |
|
|
$ |
68,379 |
|
|
|
140 |
|
|
$ |
227,785 |
|
|
$ |
108,467 |
|
|
|
110 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of claims settled: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance |
|
|
1,775 |
|
|
|
919 |
|
|
|
93 |
|
|
|
2,819 |
|
|
|
1,605 |
|
|
|
76 |
|
Modified Pool
insurance |
|
|
827 |
|
|
|
363 |
|
|
|
128 |
|
|
|
958 |
|
|
|
530 |
|
|
|
81 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
2,602 |
|
|
|
1,282 |
|
|
|
103 |
|
|
|
3,777 |
|
|
|
2,135 |
|
|
|
77 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct claims settled during the second quarter of 2009 increased by approximately 103% over
the second quarter of 2008 reflecting:
26
|
|
|
the aging of the default inventory, |
|
|
|
|
the end of certain lender and government-sponsored entity (GSE) foreclosure
moratoriums that had previously delayed the completion of the foreclosure process, which is
generally necessary before a claim can be filed, and |
|
|
|
|
the completion of a large number of investigations relating to early payment defaults in
a claim filed status. |
The average settled loss increased significantly during the second quarter of 2009 to $62,900
compared to $54,500 for the first quarter of 2009 and $53,300 during the second quarter of 2008.
The increase in the average settled loss is primarily the result of a higher percentage of claims
from the more recent vintage years, specifically the 2006 vintage year, and from the distressed
markets, both of which reflect larger loan balances (see tables below for more detail).
Furthermore, the results of our efforts to mitigate losses through pre-sales continued to
deteriorate during the second quarter reflecting the adverse conditions of the housing market and
state of the economy.
The following table shows the average loan size and average risk per policy by vintage year.
Policies originated during 2006 and 2007 comprised approximately 75% of our second quarter 2009
settled claims compared to 47% in the first quarter of 2009 and 38% in the second quarter of 2008.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary |
|
Modified Pool |
|
|
Average |
|
Average |
|
Average |
|
Average |
|
|
Loan Size |
|
Insured Risk |
|
Loan Size |
|
Insured Risk |
Vintage Year |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004 and Prior |
|
$ |
116,241 |
|
|
$ |
29,785 |
|
|
$ |
139,174 |
|
|
$ |
41,451 |
|
2005 |
|
|
154,968 |
|
|
|
40,854 |
|
|
|
175,815 |
|
|
|
57,201 |
|
2006 |
|
|
204,003 |
|
|
|
52,830 |
|
|
|
258,502 |
|
|
|
68,805 |
|
2007 |
|
|
205,662 |
|
|
|
55,352 |
|
|
|
270,858 |
|
|
|
78,816 |
|
2008 |
|
|
202,766 |
|
|
|
46,604 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Overall Average |
|
$ |
169,860 |
|
|
$ |
44,309 |
|
|
$ |
205,264 |
|
|
$ |
60,025 |
|
Policies from the distressed markets comprised 61.8% of our second quarter 2009 settled claims
compared to 31.9% in the second quarter of 2008. The following table shows the average loan size
and average risk per policy for the distressed markets compared to the remainder of the portfolio.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary |
|
|
Modified Pool |
|
|
|
Average |
|
|
Average |
|
|
Average |
|
|
Average |
|
|
|
Loan Size |
|
|
Insured Risk |
|
|
Loan Size |
|
|
Insured Risk |
|
Distressed States: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
California |
|
$ |
331,595 |
|
|
$ |
82,829 |
|
|
$ |
327,509 |
|
|
$ |
88,301 |
|
Florida |
|
|
199,770 |
|
|
|
53,001 |
|
|
|
207,468 |
|
|
|
57,430 |
|
Arizona |
|
|
196,089 |
|
|
|
51,516 |
|
|
|
201,148 |
|
|
|
62,667 |
|
Nevada |
|
|
238,104 |
|
|
|
64,061 |
|
|
|
224,232 |
|
|
|
71,314 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average distressed states |
|
$ |
237,250 |
|
|
$ |
61,548 |
|
|
$ |
255,649 |
|
|
$ |
71,818 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average non-distressed states |
|
$ |
153,740 |
|
|
$ |
40,186 |
|
|
$ |
170,757 |
|
|
$ |
51,949 |
|
The increase in the average settled claim amount was also influenced by our reduced ability to
mitigate claims. Continuing declines in home prices across almost all markets, with significant
declines in the distressed markets, combined with tighter mortgage credit availability have
continued to negatively impact our ability to mitigate losses through the sale of properties. The
greater concentration of settled claims from the distressed markets and the resulting negative
impact on our ability to mitigate losses contributed to the increase in average
paid loss during the second quarter of 2009. We expect our ability to mitigate losses will
continue to be adversely
27
affected by the continued pressure on home prices combined with the
limited availability of credit in the U.S. financial markets. A greater concentration of settled
claims in distressed markets will exacerbate this effect.
The table below provides the gross cumulative incurred loss incidence rate by book year
(calculated as cumulative gross losses settled plus loss reserves, excluding the impact of modified
pool and captive structures, divided by policy risk originated, in each case for a particular book
year) that have developed through June 30, 2009 and 2008.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended |
|
|
June 30, |
|
March 31, |
|
December 31, |
|
September 30, |
|
June 30, |
Book Year |
|
2009 |
|
2009 |
|
2008 |
|
2008 |
|
2008 |
2000 & Prior |
|
|
1.00 |
% |
|
|
0.99 |
% |
|
|
0.99 |
% |
|
|
0.98 |
% |
|
|
0.97 |
% |
2001 |
|
|
1.44 |
% |
|
|
1.42 |
% |
|
|
1.42 |
% |
|
|
1.38 |
% |
|
|
1.34 |
% |
2002 |
|
|
2.01 |
% |
|
|
1.94 |
% |
|
|
1.92 |
% |
|
|
1.87 |
% |
|
|
1.81 |
% |
2003 |
|
|
1.86 |
% |
|
|
1.70 |
% |
|
|
1.66 |
% |
|
|
1.59 |
% |
|
|
1.46 |
% |
2004 |
|
|
3.50 |
% |
|
|
2.86 |
% |
|
|
2.52 |
% |
|
|
2.21 |
% |
|
|
1.88 |
% |
2005 |
|
|
8.85 |
% |
|
|
6.71 |
% |
|
|
5.30 |
% |
|
|
4.45 |
% |
|
|
3.71 |
% |
2006 |
|
|
15.19 |
% |
|
|
10.46 |
% |
|
|
9.39 |
% |
|
|
7.83 |
% |
|
|
6.16 |
% |
2007 |
|
|
12.05 |
% |
|
|
7.72 |
% |
|
|
6.46 |
% |
|
|
5.66 |
% |
|
|
4.33 |
% |
2008 |
|
|
2.83 |
% |
|
|
1.83 |
% |
|
|
1.30 |
% |
|
|
0.60 |
% |
|
|
0.05 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
6.39 |
% |
|
|
4.63 |
% |
|
|
4.03 |
% |
|
|
3.49 |
% |
|
|
2.87 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prior to 2007, the policies that we insured historically defaulted for a variety of reasons
but primarily due to loss of employment, divorce, or illness of a mortgage holder. The probability
of these events occurring and impacting a borrower propensity to default increases over time.
Historically, we expected the gross cumulative incurred loss incidence rate for a specific book
year to also increase over time as the incidence of default is relatively low in the first few
years of development, typically reaches its peak in the second through the fifth year after loan
origination, and will moderately increase over time as a small number of policies continue to
default.
However, in addition to the above factors, the incidence of default in the current environment
has been and continues to be adversely impacted by the significant decline in home prices
throughout the United States. The more recent book years have particularly been impacted and, as
the above table indicates, these book years, specifically the 2006 and 2007 book years, are
exhibiting significantly adverse performance compared to the more developed earlier book years. We
do not expect this adverse performance to subside and expect the gross cumulative incurred loss
incidence rate of these book years to ultimately be significantly higher than our previous books of
business.
Net losses and loss adjustment expenses also include the change in reserves for losses and
loss adjustment expenses. The following table shows the change in reserves for losses and LAE for
the three months and six months ended June 30, 2009 and June 30, 2008:
28
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
(dollars in thousands) |
|
2009 |
|
|
2008 |
|
|
% Change |
|
|
2009 |
|
|
2008 |
|
|
% Change |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase in reserve for
losses and LAE on a
gross basis before the
benefit of captives
and Modified Pool
structures |
|
$ |
562,956 |
|
|
$ |
275,170 |
|
|
|
105 |
|
|
$ |
705,132 |
|
|
$ |
474,061 |
|
|
|
49 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ceded reserves to
captive reinsurers |
|
|
50,874 |
|
|
|
46,715 |
|
|
|
9 |
|
|
|
80,890 |
|
|
|
55,349 |
|
|
|
46 |
|
Impact of Modified
Pool structures |
|
|
234,495 |
|
|
|
5,674 |
|
|
|
4,033 |
|
|
|
301,764 |
|
|
|
16,737 |
|
|
|
1,703 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase in reserve
for losses
and loss adjustment
expenses |
|
$ |
277,587 |
|
|
$ |
222,781 |
|
|
|
25 |
|
|
$ |
322,478 |
|
|
$ |
401,975 |
|
|
|
(20 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The significant increase in the reserve for losses and LAE on a gross basis during the second
quarter and first six months of 2009 was greater than that for the respective periods of 2008
primarily due to increases in the severity and frequency components of our reserve estimation that
we implemented in the second quarter of 2009 coupled with an increase in the actual number of loans
in default. These increases were necessitated by continued deterioration in our ability to mitigate
our loss and a continued decline in our cure rate. We do not expect these conditions to improve for
the foreseeable future.
The net increase in reserve for losses and loss adjustment expenses for the second quarter and
first six months of 2009 was moderated substantially by the benefit received from structures,
primarily due to reaching stop loss levels in modified pool transactions. The benefit received from
structures accounted for 50.6% and 54.6% of the change in gross reserves in the second quarter and
first six months of 2009, respectively, compared to 19.3% and 15.6% in the respective quarters of
2008. We expect to continue to receive a benefit from structures, primarily the result of gross
losses exceeding the stop loss exit point in individual contracts.
The following table provides further information about our loss reserves carried on our
balance sheet at June 30, 2009, December 31, 2008 and June 30, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
June 30, |
|
(dollars in thousands) |
|
2009 |
|
|
2008 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Reserves for reported defaults |
|
$ |
1,045,348 |
|
|
$ |
728,981 |
|
|
$ |
530,734 |
|
Reserves for defaults incurred but not
reported |
|
|
48,575 |
|
|
|
65,671 |
|
|
|
53,593 |
|
|
|
|
|
|
|
|
|
|
|
Total Primary insurance |
|
|
1,093,923 |
|
|
|
794,652 |
|
|
|
584,327 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Modified Pool insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Reserves for reported defaults |
|
|
433,278 |
|
|
|
344,112 |
|
|
|
193,505 |
|
Reserves for defaults incurred but not
reported |
|
|
42,576 |
|
|
|
31,539 |
|
|
|
26,250 |
|
|
|
|
|
|
|
|
|
|
|
Total Modified Pool insurance |
|
|
475,854 |
|
|
|
375,651 |
|
|
|
219,755 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserve for loss adjustment expenses |
|
|
21,430 |
|
|
|
17,537 |
|
|
|
13,180 |
|
|
|
|
|
|
|
|
|
|
|
Total reserves for losses and loss adjustment
expenses |
|
$ |
1,591,207 |
|
|
$ |
1,187,840 |
|
|
$ |
817,262 |
|
|
|
|
|
|
|
|
|
|
|
The above table does not account for reserves ceded to lender-sponsored captive reinsurers.
The amount recoverable under captive reinsurance contracts, net of amounts due the respective
reinsurers, is shown as an asset on the balance sheet and amounted to approximately $234.2 million
and $55.3 million at June 30, 2009 and 2008, respectively.
29
The following table indicates the growth in both the gross risk in default and reserves in the
four distressed market states at June 30, 2009, December 31, 2008 and June 30, 2008.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
June 30, |
|
(dollars in thousands) |
|
2009 |
|
|
2008 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% of Gross Risk In Force: |
|
|
|
|
|
|
|
|
|
|
|
|
California |
|
|
14.4 |
% |
|
|
14.6 |
% |
|
|
15.3 |
% |
Florida |
|
|
11.7 |
% |
|
|
11.6 |
% |
|
|
12.1 |
% |
Arizona |
|
|
5.2 |
% |
|
|
5.2 |
% |
|
|
5.5 |
% |
Nevada |
|
|
3.0 |
% |
|
|
3.0 |
% |
|
|
3.1 |
% |
|
|
|
|
|
|
|
|
|
|
Total Distressed Market States |
|
|
34.3 |
% |
|
|
34.4 |
% |
|
|
36.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
% of Gross Risk in Default: |
|
|
|
|
|
|
|
|
|
|
|
|
California |
|
|
24.3 |
% |
|
|
25.1 |
% |
|
|
24.2 |
% |
Florida |
|
|
21.5 |
% |
|
|
23.1 |
% |
|
|
24.0 |
% |
Arizona |
|
|
7.4 |
% |
|
|
7.2 |
% |
|
|
6.3 |
% |
Nevada |
|
|
5.3 |
% |
|
|
5.0 |
% |
|
|
4.3 |
% |
|
|
|
|
|
|
|
|
|
|
Total Distressed Market States |
|
|
58.5 |
% |
|
|
60.4 |
% |
|
|
58.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
% of Gross Reserves: |
|
|
|
|
|
|
|
|
|
|
|
|
California |
|
|
24.6 |
% |
|
|
24.4 |
% |
|
|
23.4 |
% |
Florida |
|
|
22.5 |
% |
|
|
23.5 |
% |
|
|
24.6 |
% |
Arizona |
|
|
8.2 |
% |
|
|
7.4 |
% |
|
|
6.2 |
% |
Nevada |
|
|
5.6 |
% |
|
|
5.0 |
% |
|
|
4.2 |
% |
|
|
|
|
|
|
|
|
|
|
Total Distressed Market States |
|
|
60.9 |
% |
|
|
60.3 |
% |
|
|
58.4 |
% |
Certificates originated during 2006 and 2007 comprise 64.3% of our loans in default, but 72.9
% of the risk in default at June 30, 2009. Both measures are down slightly from the first quarter
levels due primarily to a large amount of claim activity attributable to the 2006 vintage book.
The difference in percentages of loans in default and risk in default primarily reflects the higher
loan amounts associated with these policy years.
To illustrate the impact of the changes in the frequency and severity factors utilized in the
reserve model, the following table details the amount of risk in default and the reserve balance as
a percentage of risk in default at June 30, 2009, December 31, 2008 and June 30, 2008. The table
also provides the impact of the rescission factor, which is a component of the frequency factor
utilized in the reserve model, on gross case reserves at the respective periods.
30
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
June 30, |
|
(dollars in millions) |
|
2009 |
|
|
2008 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross risk on loans in default |
|
$ |
3,532 |
|
|
$ |
2,729 |
|
|
$ |
1,780 |
|
Risk expected to be rescinded on loans in default |
|
|
(1,094 |
) |
|
|
(888 |
) |
|
|
(312 |
) |
|
|
|
|
|
|
|
|
|
|
Risk in default net of expected rescissions |
|
$ |
2,438 |
|
|
$ |
1,841 |
|
|
$ |
1,468 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross case reserve (1) |
|
$ |
1,889 |
|
|
$ |
1,146 |
|
|
$ |
801 |
|
Gross case reserves on loans expected to be rescinded |
|
|
(353 |
) |
|
|
(239 |
) |
|
|
(87 |
) |
|
|
|
|
|
|
|
|
|
|
Gross case reserves net of expected rescissions |
|
$ |
1,536 |
|
|
$ |
907 |
|
|
$ |
714 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross case reserves as a percentage of gross risk in default |
|
|
53.5 |
% |
|
|
42.0 |
% |
|
|
45.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross case reserves net of expected rescissions as a percentage
of gross risk in default, net of expected rescissions |
|
|
63.0 |
% |
|
|
49.3 |
% |
|
|
48.7 |
% |
Percentage decrease in gross case reserves from rescission factor |
|
|
18.7 |
% |
|
|
20.8 |
% |
|
|
10.8 |
% |
|
|
|
(1) |
|
Reflects gross case reserves, which excludes IBNR, ceded reserves and the benefit from Modified Pool structures, as a percentage
of risk in default for total delinquent loans. |
The following table shows default statistics as of June 30, 2009, December 31, 2008 and June
30, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
December 31, |
|
June 30, |
(dollars in thousands) |
|
2009 |
|
2008 |
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total business: |
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
320,350 |
|
|
|
345,055 |
|
|
|
365,649 |
|
Number of loans in default |
|
|
52,608 |
|
|
|
40,286 |
|
|
|
26,601 |
|
Percentage of loans in default (default rate) |
|
|
16.42 |
% |
|
|
11.68 |
% |
|
|
7.28 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
232,828 |
|
|
|
252,368 |
|
|
|
267,689 |
|
Number of loans in default |
|
|
31,338 |
|
|
|
24,241 |
|
|
|
16,075 |
|
Percentage of loans in default |
|
|
13.46 |
% |
|
|
9.61 |
% |
|
|
6.01 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Modified Pool insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
87,522 |
|
|
|
92,687 |
|
|
|
97,960 |
|
Number of loans in default |
|
|
21,270 |
|
|
|
16,045 |
|
|
|
10,526 |
|
Percentage of loans in default |
|
|
24.30 |
% |
|
|
17.31 |
% |
|
|
10.75 |
% |
The number of loans in default increased by 98% over the twelve months ended June 30, 2009.
The number of loans in default includes all reported delinquencies that are in excess of two
payments in arrears at the reporting date and all reported delinquencies that were previously in
excess of two payments in arrears and have not been brought current. The percentage of loans in
default, or default rate, has increased by 126% over this same period. The default rate is affected
by the number of policies in default as well as the number of policies in force. As we are in
run-off and are no longer issuing commitments for mortgage insurance, we expect the number of
policies in force to continue to decline which will have an adverse effect on the default rate. We
currently expect the overall default rate as well as the number of loans in default to increase
during the remainder of 2009.
We do not provide reserves on Modified Pool defaults with deductibles until the cumulative
incurred losses for that transaction reach the deductible threshold. For the transactions that
have exceeded this threshold, we have recognized cumulative losses of $456.8 million at June 30,
2009 compared to cumulative losses of $259.3 million at March 31, 2009 and $80.8 million at June
30, 2008. We have realized the majority of the benefit from the deductibles and do not expect any
material benefit going forward.
31
We also do not provide reserves on Modified Pool defaults where the cumulative incurred losses
to date for the related structure have exceeded the stop loss amount. At June 30, 2009, our loss
reserves were limited by $364.6 million as a result of incurred losses for certain structured
transactions exceeding the respective stop loss exit point. This amount was $119.5 million at
March 31, 2009, $37.5 million at December 31, 2008 and $0 at June 30, 2008. We believe that based
on the recent adverse development of our Modified Pool business, we will continue
to provide additional reserves on a gross basis on structured bulk transactions and we will
continue to limit the addition of reserves due to Modified Pool contracts reaching stop loss
limits.
As part of our overall risk management strategy, we have entered into excess of loss captive
reinsurance agreements with several of our lender customers. As detailed in Item 1,
BusinessReinsurance in our Annual Report on Form 10-K for the year ended December 31, 2008, we
retain the first loss position on the first aggregate layer of risk and reinsure a second finite
layer with the captive reinsurer. Certain captives have exceeded the first loss layer in incurred
losses, which resulted in the ceding of reserves and settled losses related to specific book years.
At June 30, 2009, we had ceded $237.7 million of reserves
and $14.0 million of cumulative settled
losses to captive reinsurers, of which $8.1 million resulted from the termination of one captive
reinsurance contract in the first quarter of 2009 and the return of the trust balance. At June 30,
2008, we had ceded $62.7 million of reserves to captive reinsurers. If the current default and
settled claim trends continue, we expect to cede additional reserves and settled losses to the
captive reinsurers in the remainder of 2009. However, we will continue to limit the ceded reserves
to the specific trust balances in the captives.
Expenses and Taxes
Other operating expenses during the second quarter and first six months of 2009 decreased by
68% and 56%, respectively, compared to the periods of 2008. The decreases are primarily the result
of the accrual for exit costs in the second quarter of 2008 relating to our decision to transition
to run-off as well as expenses incurred during the first six months of 2008 associated with the
attempted capital raising effort and the transition of our business to run-off.
During the first quarter of 2008, we wrote off the remaining deferred policy acquisition costs
(DAC) asset balance of $34.8 million as the estimated gross loss in the remaining portfolio no
longer supported the asset value. Subsequently, we have not capitalized any cost to acquire new
business.
At the end of the first quarter of 2008, we established a premium deficiency reserve because
the present value of our estimated future settled losses and expenses, net of the present value of
our estimated future renewal premiums, exceeded our existing net reserves. Subsequent to the first
quarter of 2008, the quarterly review of our outstanding book of business has not resulted in the
need to establish any further premium deficiency. This is primarily due to the large increases in
our recorded loss reserves.
The income tax benefit recognized in the three months and six months ended June 30, 2009 of
$4.8 million and $10.3 million represents the reduction of the allowance applied to the deferred
tax assets as a result of the growth in unrealized gains. Going forward, we may continue to incur
operating losses for tax purposes and generate net operating loss carry forwards for federal income
tax reporting purposes for which we will be unable to receive any immediate benefit in our
Statements of Operations.
Our effective tax rate was 1.3% and 2.4%, respectively, for the three months and six months
ended June 30, 2009 compared to 13.7% and 20.3% for the same periods of 2008. The effective tax
rate for 2009 reflects our inability to recognize any tax benefits, other than those obtained
through the growth in unrealized gains from expected net operating tax loss carryforwards.
32
Financial Position
Total assets at June 30, 2009 increased slightly to $1.2 billion compared to $1.1 billion at
December 31, 2008 primarily due to an increase in loss reserves ceded to captive reinsurers, which
is reported as an asset on the balance sheet. While total assets increased at June 30, 2009, total
cash and invested assets decreased from year-end levels by $52.1 million due to liquidity needs at
Triad. Total liabilities increased to $1.7 billion at June 30, 2009 from $1.3 billion at December
31, 2008. This increase was primarily due to the growth in loss and LAE reserves. The deficit in
assets has increased to $529.7 million at June 30, 2009 from $136.7 million at December 31, 2008.
This section identifies several items on our balance sheet that are important in the overall
understanding of our financial position. These items include DAC as well as prepaid federal income
tax and related deferred income taxes. The majority of our assets are included in our investment
portfolio. A separate Investment Portfolio section follows the Financial Position section and
reviews our investment portfolio, key portfolio management strategies, and methodologies by which
we manage credit risk within the investment portfolio.
Deferred Policy Acquisition Costs
Prior to the write-off of the DAC asset at March 31, 2008, we capitalized costs to acquire new
business as DAC and recognized these as expenses against future gross profits. At March 31, 2008,
we determined that the net present value of the estimated future cash flows on the remaining book
of business exceeded the recorded reserves (net of the unamortized DAC) which required the
establishment of a premium deficiency reserve. The actual mechanics of recording the premium
deficiency reserve require that we first reduce the DAC balance to zero before recording any
additional premium deficiency reserve. Therefore, we wrote down the DAC asset by $34.8 million in
the first quarter of 2008. We have not capitalized any costs to acquire new business subsequent to
the first quarter of 2008.
Investment Portfolio
Portfolio Description
Our goal for managing our investment portfolio is to optimize investment returns and provide
liquidity as necessary for the payment of claims while preserving capital and adhering to
regulatory requirements. We have established a formal investment policy that describes our overall
quality and diversification objectives and limits. Historically, the majority of our investment
portfolio was comprised of tax-preferred state and municipal fixed income securities. Given the
operating losses reported since the third quarter of 2007, we currently do not anticipate the
realization of tax benefits normally associated with state and municipal securities. As a result,
we made the decision in the second quarter of 2008 to restructure the investment portfolio into
taxable publicly-traded securities, primarily corporate debt obligations, asset-backed securities,
and mortgage-backed securities. In connection with the restructuring of our investment portfolio,
we shortened the portfolio duration to better match the maturities with our anticipated cash needs.
At June 30, 2009, we had $139.4 million of state, municipal, and other government bonds remaining
in our portfolio, of which $128.5 million were tax-preferred municipal securities. In the current
market, there are significant risks involved in attempting to liquidate the remaining tax-preferred
portfolio. These risks include execution risk in the selling of securities, additional credit risk
moving from primarily insured, highly rated municipal bonds to lower rated corporate bonds, and
potential deterioration in the market value of our municipal holdings due to economic conditions or
other reasons.
Our investment policy and strategies are subject to further change depending upon regulatory,
economic and market conditions as well as our existing financial condition and operating
requirements, including our tax position. We classify our entire investment portfolio as
available-for-sale. This classification allows us the flexibility to dispose of securities in
order to meet our investment objectives and operating requirements. All investments are carried on
our balance sheet at fair value.
33
The following table shows the composition of our investment portfolio at June 30, 2009 and
December 31, 2008.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2009 |
|
|
December 31, 2008 |
|
(dollars in thousands) |
|
Amount |
|
|
Percent |
|
|
Amount |
|
|
Percent |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U. S. government obligations |
|
$ |
5,723 |
|
|
|
0.7 |
% |
|
$ |
7,996 |
|
|
|
0.9 |
% |
State, municipal, and other government
bonds |
|
|
139,367 |
|
|
|
16.4 |
% |
|
|
171,566 |
|
|
|
19.2 |
% |
Corporate bonds |
|
|
532,148 |
|
|
|
62.5 |
% |
|
|
482,196 |
|
|
|
53.9 |
% |
Asset-backed bonds |
|
|
52,048 |
|
|
|
6.1 |
% |
|
|
65,749 |
|
|
|
7.3 |
% |
Residential mortgage-backed bonds |
|
|
118,523 |
|
|
|
13.9 |
% |
|
|
126,679 |
|
|
|
14.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
|
847,809 |
|
|
|
99.6 |
% |
|
|
854,186 |
|
|
|
95.4 |
% |
Equity securities |
|
|
31 |
|
|
|
0.0 |
% |
|
|
583 |
|
|
|
0.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available-for-sale securities |
|
|
847,840 |
|
|
|
99.6 |
% |
|
|
854,769 |
|
|
|
95.5 |
% |
Short-term investments |
|
|
3,800 |
|
|
|
0.4 |
% |
|
|
40,653 |
|
|
|
4.5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
851,640 |
|
|
|
100.0 |
% |
|
$ |
895,422 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
The decline in the value of the investment portfolio is primarily due to the use of the
proceeds from maturities and the sale of securities to fund the negative cash flow from operations
in the first half of 2009. We expect to continue to have negative cash flow from operations for
the foreseeable future, which will further reduce the value of our investment portfolio.
The following table shows the results of our investment portfolio for the three months ended
June 30, 2009 and 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
(dollars in thousands) |
|
2009 |
|
2008 |
|
2009 |
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average investments at cost or amortized cost |
|
$ |
852,044 |
|
|
$ |
811,592 |
|
|
$ |
848,145 |
|
|
$ |
818,051 |
|
Pre-tax net investment income |
|
$ |
10,859 |
|
|
$ |
9,175 |
|
|
$ |
22,051 |
|
|
$ |
18,722 |
|
Book yield |
|
|
5.2 |
% |
|
|
4.7 |
% |
|
|
5.2 |
% |
|
|
4.7 |
% |
Pre-tax realized investment (losses) gains |
|
$ |
2,017 |
|
|
$ |
(3,799 |
) |
|
$ |
(2,548 |
) |
|
$ |
(1,096 |
) |
The increase in the book yield is partly attributable to write downs in the previous twelve
months due primarily to other-than-temporary impairments. The taxable securities we have purchased
since the second quarter of 2008 generally have a lower duration but a similar book yield as the
longer duration municipal securities that comprised the majority of the portfolio at June 30, 2008.
The pre-tax realized investment gains in the second quarter of 2009 are primarily attributable to
the sale of securities and reflect improved market conditions during the second quarter of 2009.
The largest portion of the pre-tax realized investment losses in the six months ended June 30, 2009
are from write downs due to other-than-temporary impairments as described in Realized Gains
(Losses) and Impairments below.
34
Unrealized Gains and Losses
The following table summarizes by category our unrealized gains and losses in our securities
portfolio at June 30, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2009 |
|
|
|
Cost or |
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Fair |
|
(dollars in thousands) |
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Value |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U. S. government obligations |
|
$ |
5,415 |
|
|
$ |
308 |
|
|
$ |
|
|
|
$ |
5,723 |
|
State, municipal, and other government bonds |
|
|
132,917 |
|
|
|
6,450 |
|
|
|
|
|
|
|
139,367 |
|
Corporate bonds |
|
|
504,575 |
|
|
|
27,573 |
|
|
|
|
|
|
|
532,148 |
|
Asset-backed bonds |
|
|
49,345 |
|
|
|
2,703 |
|
|
|
|
|
|
|
52,048 |
|
Residential mortgage-backed bonds |
|
|
114,131 |
|
|
|
4,392 |
|
|
|
|
|
|
|
118,523 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal, fixed maturities |
|
|
806,383 |
|
|
|
41,426 |
|
|
|
|
|
|
|
847,809 |
|
Equity securities |
|
|
17 |
|
|
|
14 |
|
|
|
|
|
|
|
31 |
|
Short term investments |
|
|
3,796 |
|
|
|
4 |
|
|
|
|
|
|
|
3,800 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total securities |
|
$ |
810,196 |
|
|
$ |
41,444 |
|
|
$ |
|
|
|
$ |
851,640 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Given our recurring losses from operations and the significant doubt regarding our ability to
continue as a going concern, we may no longer have the ability to hold impaired assets for a
sufficient time to recover their value. As a result, we made the decision to recognize an
impairment loss on all securities whose amortized cost is greater than the reported fair value and
thus have no unrealized losses at June 30, 2009.
While market conditions have improved recently, the unrealized gains are partly due to
previous impairment of our fixed income securities. These unrealized gains do not necessarily
represent future gains that we will realize. Changing conditions related to specific securities,
overall market interest rates, or credit spreads, as well as our decisions concerning the timing of
a sale, may impact values we ultimately realize. Taxable securities typically exhibit greater
volatility in value than tax-preferred securities and thus we expect greater volatility in
unrealized gains and realized losses going forward. Volatility may increase in periods of uncertain
market or economic conditions.
35
Credit Risk
Credit risk is inherent in an investment portfolio. One way we attempt to limit the inherent
credit risk in our portfolio is to maintain investments with high ratings. The following table
shows our investment portfolio by credit ratings.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2009 |
|
|
December 31, 2008 |
|
(dollars in thousands) |
|
Amount |
|
|
Percent |
|
|
Amount |
|
|
Percent |
|
|
Fixed Maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. treasury and agency bonds |
|
$ |
5,723 |
|
|
|
0.7 |
|
|
$ |
7,996 |
|
|
|
0.9 |
|
AAA |
|
|
208,573 |
|
|
|
24.6 |
|
|
|
236,975 |
|
|
|
27.7 |
|
AA |
|
|
151,727 |
|
|
|
17.9 |
|
|
|
196,088 |
|
|
|
23.0 |
|
A |
|
|
432,217 |
|
|
|
51.0 |
|
|
|
381,936 |
|
|
|
44.7 |
|
BBB |
|
|
29,896 |
|
|
|
3.5 |
|
|
|
25,203 |
|
|
|
3.0 |
|
BB |
|
|
15,076 |
|
|
|
1.8 |
|
|
|
1,239 |
|
|
|
0.1 |
|
B |
|
|
1,019 |
|
|
|
0.1 |
|
|
|
619 |
|
|
|
0.1 |
|
CCC |
|
|
1,923 |
|
|
|
0.2 |
|
|
|
1,523 |
|
|
|
0.2 |
|
CC and lower |
|
|
341 |
|
|
|
0.0 |
|
|
|
48 |
|
|
|
0.0 |
|
Not rated |
|
|
1,314 |
|
|
|
0.2 |
|
|
|
2,559 |
|
|
|
0.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
$ |
847,809 |
|
|
|
100.0 |
|
|
$ |
854,186 |
|
|
|
100.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred stocks: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
A |
|
|
1 |
|
|
|
1.6 |
|
|
|
429 |
|
|
|
73.6 |
|
BBB |
|
|
|
|
|
|
|
|
|
|
133 |
|
|
|
22.8 |
|
C |
|
|
30 |
|
|
|
98.4 |
|
|
|
21 |
|
|
|
3.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equity securities |
|
$ |
31 |
|
|
|
100.0 |
|
|
$ |
583 |
|
|
|
100.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We evaluate the credit risk of a security by analyzing the underlying credit qualities of the
security. We also find value in any enhancement provided by the financial guaranty insurers to our
municipal and state tax-preferred securities. Such credit enhancements may benefit the credit
rating of the municipal or state tax-preferred security. Taxable securities generally do not have
such credit enhancements and the credit rating reflects the securities underlying credit
qualities.
The following table indicates the credit quality of our fixed maturity portfolio without the
benefit of the credit enhancements as provided by financial guaranty insurers at June 30, 2009:
|
|
|
|
|
|
|
|
|
|
|
Credit Quality Without Benefit |
|
|
|
of Credit Enhancements |
|
(dollars in thousands) |
|
Amount |
|
|
Percent |
|
|
|
|
|
|
|
|
|
|
U.S. treasury and agency bonds |
|
$ |
5,723 |
|
|
|
0.7 |
|
AAA |
|
|
178,488 |
|
|
|
21.1 |
|
AA |
|
|
100,936 |
|
|
|
11.9 |
|
A |
|
|
495,778 |
|
|
|
58.4 |
|
BBB |
|
|
28,636 |
|
|
|
3.4 |
|
BB |
|
|
14,632 |
|
|
|
1.7 |
|
B |
|
|
854 |
|
|
|
0.1 |
|
CCC |
|
|
|
|
|
|
|
|
CC and below |
|
|
1,786 |
|
|
|
0.2 |
|
Not rated |
|
|
20,976 |
|
|
|
2.5 |
|
|
|
|
|
|
|
|
Total Fixed Maturities |
|
$ |
847,809 |
|
|
|
100.0 |
|
|
|
|
|
|
|
|
36
As of June 30, 2009, we did not invest directly in any financial guaranty insurers, but we
were indirectly exposed to the risk of financial guaranty insurer default through the credit
enhancements provided on the majority of our state and municipal fixed maturity bond portfolio.
At June 30, 2009, the carrying value of our state and municipal bond portfolio amounted to
$134.2 million, with approximately $115.0 million containing credit enhancements from financial
guaranty insurers. The following table indicates the approximate exposure to and percentage of our
credit enhanced state and municipal bond portfolio by financial guaranty insurer at June 30, 2009:
Financial Guarantors
|
|
|
|
|
|
|
|
|
|
|
Credit Enhanced State and |
|
|
|
Municipal Portfolio |
|
(dollars in thousands) |
|
Amount |
|
|
Percent |
|
|
|
|
|
|
|
|
|
|
MBIA |
|
$ |
30,699 |
|
|
|
26.6 |
|
FSA |
|
|
26,900 |
|
|
|
23.4 |
|
FGIC |
|
|
24,816 |
|
|
|
21.6 |
|
AMBAC |
|
|
16,894 |
|
|
|
14.7 |
|
Others (four companies) |
|
|
15,703 |
|
|
|
13.7 |
|
|
|
|
|
|
|
|
Total |
|
$ |
115,012 |
|
|
|
100.0 |
|
|
|
|
|
|
|
|
Realized Gains (Losses) and Impairments
Net realized investment gains were $2.0 million in the second quarter of 2009 compared to a
net realized investment loss of $3.8 million in the corresponding period in 2008. The realized
investment gains for the second quarter of 2009 were partly attributable to the sale of previously
impaired securities. The realized investment losses in the second quarter of 2008 were primarily
due to other-than-temporary impairment losses.
Liquidity and Capital Resources
The accompanying consolidated financial statements have been prepared in accordance with GAAP
and assume that we will continue as a going concern, which contemplates the realization of assets
and the satisfaction of liabilities and commitments in the normal course of business. However, our
ability to continue as a going concern will be dependent on our ability to comply with terms of the
Corrective Orders, which includes an ultimate solvent run-off. If we are unable to comply with the
terms of the Corrective Orders, Illinois law may require the Department to seek receivership in the
courts. If Triad were placed into receivership, all of the assets and future cash flows of Triad
would be allocated to Triads policyholders to pay insurance claims and the administrative expenses
of the receivership, and none of such assets or cash flows would be available to the parent company
and its stockholders. As Triad is the Companys primary source of cash flow, if Triad were placed
in receivership proceedings by the Department, the parent, TGI, could be forced to institute a
proceeding seeking relief from creditors under U.S. bankruptcy laws and little or no funds would
ever be available for distribution to our stockholders. The report of our independent registered
public accounting firm with respect to our December 31, 2008 financial statements indicates that
there is substantial doubt about our ability to continue as a going concern.
Beginning on June 1, 2009 pursuant to the second Corrective Order, all valid claims under
Triads mortgage guaranty insurance policies are settled 60% in cash and 40% by the recording of a
DPO. Effective July 1, 2009, the DPO accrues a carrying charge based on the investment yield
earned by Triads investment portfolio and payment of both the DPO and the carrying charge is
subject to Triads future financial performance and requires the approval of the Department.
During the month of June 2009, Triad settled claims of $67.6 million through the payment of $40.6
million in cash and the recording of a DPO of $27.0 million. The specific terms of the Corrective
Order requiring the recording of a DPO will positively impact our operating cash flows in the near
term. However, because we remain obligated to pay the DPOs and will accrue a carrying charge on the
DPOs based on the
37
investment yield earned by Triads investment portfolio, we do not expect any
ultimate financial benefit to us from recording a DPO.
Generally, our sources of operating funds consist of premiums written and investment income.
Operating cash flow has historically been applied to the payment of claims, interest, expenses and
prepaid federal income taxes in the form of ten-year non-interest bearing United States Mortgage
Guaranty Tax and Loss Bonds (Tax and Loss Bond) purchases. During the period that we were
reporting positive results of operations and prior to our decision to enter into voluntary run-off,
we purchased Tax and Loss Bonds to take advantage of a special contingency reserve deduction that
mortgage guaranty companies are allowed for tax purposes. We recorded the Tax and Loss Bonds on
our balance sheet as prepaid federal income taxes. Purchases of Tax and Loss Bonds are essentially
a prepayment of federal income taxes that are scheduled to become payable in ten years, when the
contingency reserve is scheduled to be released, and the respective Tax and Loss Bonds are
scheduled to mature. The scheduled proceeds from the maturity of the Tax and Loss Bonds were
anticipated to be utilized to fund the income tax payments. However, beginning in 2007 and
continuing into 2008, we made the decision to redeem our Tax and Loss Bonds earlier than scheduled
due to our operating losses generated in those years, which has provided a source of funds. During
the first six months of 2008, we redeemed $52.8 million of Tax and Loss Bonds and substantially all
of the remaining Tax and Loss Bonds were redeemed in the last six months of 2008. Our holdings of
Tax and Loss Bonds at December 31, 2008 were negligible. During the first six months of 2009, we
did not redeem any Tax and Loss Bonds.
During the first six months of 2009, we had $71.6 million of negative cash flow from operating
activities compared to a positive cash flow of $78.2 million in the first six months of 2008. The
decline in operating cash flow in 2009 compared to the first six months of 2008 reflects the lack
of any redemption of Tax and Loss Bonds, a substantial increase in settled claims, and a decline in
premiums received.
Net
cash received from premiums amounted to $117.2 million during the first six months of 2009
compared to $144.4 million in the corresponding period in 2008. This decrease is due to the
overall decline in insurance in force as well as a significant amount of premium refunds related to
rescission activity. Premium refunds were $16.8 million in the first six months of 2009 compared to
$4.2 million in the corresponding period in 2008. We anticipate more refunds of premiums related
to rescission activity in the remainder of 2009 and have established a $25.5 million liability at
June 30, 2009 to account for this anticipated rescission activity.
Net cash paid for claims and LAE, after accounting for the impact of the DPO, increased to
$185.4 million during the six months ended June 30, 2009
from $110.0 million during the first six
months of 2008. Net settled claims in the first half of 2009 reflect
$21.9 million of reimbursed
paid claims from reinsurers, of which $10.0 million resulted from the settlement of the EOL
arbitration. Net cash paid for claims and LAE in the second quarter
of 2009 increased to $127.7
million compared to $57.7 million in the first quarter of 2009. The significant increase in settled
losses during the second quarter of 2009 was primarily due to the lifting of various foreclosure
moratoriums and the progression of a higher number of defaults from the 2006 and 2007 vintages
through the foreclosure process. DPOs of $27.0 million were recorded in June, the first month of
this requirement. While the DPO requirement will mitigate the actual cash paid on claims in any
period, we continue to expect that the amount of settled claims will continue to increase in
subsequent quarters and the increase may be substantial.
As described under Investment Portfolio, we continue to execute the repositioning of our
investment portfolio from a primarily tax-preferred portfolio to a taxable portfolio and to shorten
the maturities. The operating cash flow shortfall for the first six months of 2009 was funded
through sales of short-term investments and other investment securities. See Investment
Portfolio for more information.
At June 30, 2009, the Company reported a deficit in assets of $529.7 million compared to a
deficit in assets of $136.7 million at December 31, 2008 and stockholders equity of $140.9 million
at June 30, 2008. A deficit in assets occurs when recorded liabilities exceed recorded assets.
The primary factor contributing to the change since
38
the second quarter of 2008 is the net loss from
operations. We expect to continue to report a deficit in assets for the foreseeable future. The
deficit in assets, as well as other factors, could adversely impact our continued listing on The
NASDAQ Stock Market.
The insurance laws of the State of Illinois impose certain restrictions on dividends that an
insurance subsidiary can pay its parent company. As discussed previously, the Corrective Orders
prohibit the payment of dividends by our insurance subsidiary to the parent corporation without
prior approval from the Department, which is highly unlikely for the foreseeable future.
Included in policyholders surplus of the primary insurance subsidiary, Triad, is a surplus
note of $25 million payable to the registrant, its parent. The accrual of and payment of the
interest on the surplus note must be approved by the Department, which has broad discretion to
approve or disapprove any such payment. We do not expect that Triad will be able to pay any
principal or interest on this note for the foreseeable future.
The parent company has limited sources of cash flow. The $35 million outstanding long-term
debt, due in 2028, is the obligation of the parent company and not of Triad. Debt service amounts
to $2.8 million per year and is paid by the parent company. The primary source of funds for the
parent company debt service has historically been the interest paid on the $25 million surplus note
by Triad, which has provided $2.2 million on an annual basis. We do not expect this source of cash
to be available for the foreseeable future. At June 30, 2009, the parent company had cash and
invested assets of approximately $9.7 million. On July 15, 2009, the parent company remitted the
second of the semi-annual debt service payments on the outstanding long-term debt. The next debt
service payment is due in January 2010. We cannot provide any assurance that any future debt
service payments will be made and the ultimate ability of the parent company to repay the entire
$35 million is subject to substantial risks and cannot be assured unless a source of funds is
secured. The ability of the parent company to pay the debt service with funds obtained from Triad,
whether in the form of dividends, payments on the surplus note or otherwise, will require the
approval of the Department, and it is unlikely that such approval will be sought or obtained in the
foreseeable future.
Triad has historically reimbursed the parent company for the majority of its operating cash
expenses under a management agreement. Pursuant to the Corrective Orders, we are required to
submit to the Department a request for reimbursement of these expenses, excluding interest expense
on the long-term debt, on a quarterly basis. These parent company cash expenses range from
approximately $250,000 to $600,000 per quarter depending on certain activities and include legal,
director fees, accounting, and consulting fees. There can be no assurance these quarterly
expenditures will not increase in the future. If the Department prohibits or limits the
reimbursement by Triad of the parent companys operating expenses, the cash resources of the parent
company will be adversely affected.
Triads ability to incur any material operating and capital expenditures, as well as its
ability to enter into any new contracts with unaffiliated parties, also requires the Departments
approval (except for certain operating expenditures that have been preapproved by the Department).
Triad cedes business to captive reinsurance affiliates of certain mortgage lenders, primarily
under excess of loss reinsurance agreements. Generally, reinsurance recoverables on loss reserves
and unearned premiums ceded to these captives are backed by trust accounts where Triad is the sole
beneficiary. At June 30, 2009, total trust balances were approximately $272.1 million compared to
$239.1 million at June 30, 2008.
Triad ceased accepting commitments to write new mortgage insurance on July 15, 2008 and is
operating in run-off. The risk-to-capital ratio, which is utilized as a measure by many states and
regulators of an insurers capital adequacy and ability to underwrite new business, is no longer
relevant for Triad because we are operating in run-off.
39
Statutory capital, for the purpose of computing the net risk in force to statutory capital
ratio, includes both policyholders surplus and the contingency reserve. The following table
provides information regarding our statutory capital position at June 30, 2009, December 31, 2008
and June 30, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
June 30, |
|
(dollars in millions) |
|
2009 |
|
|
2008 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Statutory policyholders surplus |
|
$ |
178.6 |
|
|
$ |
88.0 |
|
|
$ |
192.1 |
|
Statutory contingency reserve |
|
|
|
|
|
|
|
|
|
|
82.6 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
178.6 |
|
|
$ |
88.0 |
|
|
$ |
274.7 |
|
|
|
|
|
|
|
|
|
|
|
Risk-to-capital ratio |
|
56.3 to 1 |
|
|
125.2 to 1 |
|
|
42.7 to 1 |
|
|
|
|
|
|
|
|
|
|
|
The increase in statutory policyholders surplus at June 30, 2009 compared to December 31,
2008 is primarily the result of the impact on statutory loss reserves of the Corrective Order that
requires all valid claims be settled 60% in cash and 40% by recording a DPO. Since the
implementation of the DPO requirement on March 31, statutory loss reserves under SAP have been
reduced by $575.2 million from the level absent this requirement. The total impact on
policyholders surplus has been an increase of $602.2 million which includes $27.0 million from the
establishment of DPOs on claims settled in June. There was no such impact to loss reserves or
stockholders equity as calculated on a GAAP basis. Even if Triads risk-to-capital ratio were to be
reduced to 25-to-1 or lower, we would continue to be prohibited from writing new business.
Update on Critical Accounting Policies and Estimates
Reserve for Losses and LAE
In our Annual Report on Form 10-K for the year ended December 31, 2008, we disclosed that the
amount of loss reserves as well as our reported premium income have both been reduced by the
estimate of future rescissions in the existing default portfolio. In general, a rescission occurs
when we determine that fraud, misrepresentation or other specified violations occurred in the
origination of a loan. When these violations are identified, insurance coverage from the date of
issuance is cancelled and the entire previously paid premium is refunded.
During 2008 and continuing into the first half of 2009, we experienced a much higher level of
rescission activity than in previous years. This activity has been concentrated in policies
originated in 2006 and 2007. We have also identified concentrations with specific lenders and by
delivery channel. We incorporate a factor in our computation of loss reserves to account for
expected rescissions, based upon the status of our investigation of early payment defaults. The
effect of the factor is to reduce the loss reserve by reflecting the probability that we may
rescind coverage on a certificate. The impact of this factor in our calculation of loss
reserves has increased over the last six quarters, although the growth slowed considerably in the
second quarter of 2009.
We also account for the impact of expected rescissions on our future premium revenue by
establishing an accrual for expected premium refunds. In establishing this accrual, we consider
the probability that a policy will be rescinded, which is consistent with the factor used in the
calculation of loss reserves. During the second quarter of 2009, the impact on premium earned was
minimal due to the large payment of premium refunds and corresponding release of the accrual. In
estimating the accrual for expected premium refunds, we rely on recent historical experience but
also use a substantial amount of judgment. While rescission activity has been significantly
elevated from our historical experience, our recent level of rescission activity is not necessarily
indicative of future trends. Furthermore, our ability to rescind a policy may be adversely impacted
by the insured disputing our rights and prevailing in court or arbitration. Any increase or
decrease in rescission factors would impact our reserves in the period in which the rescission
factor is adjusted.
40
Off Balance Sheet Arrangements and Aggregate Contractual Obligations
We had no material off-balance sheet arrangements at June 30, 2009.
We lease office facilities and office equipment under operating leases with minimum lease
commitments that range from one to five years. We had no capitalized leases or material purchase
commitments at June 30, 2009.
Our long-term debt has a single maturity date in 2028. There were no material changes during
the six months ended June 30, 2009 to the aggregate contractual obligations shown in our Annual
Report on Form 10-K for the year ended December 31, 2008.
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
Managements Discussion and Analysis of Financial Condition and Results of Operations and
other portions of this report contain forward-looking statements relating to future plans,
expectations and performance, which involve various risks and uncertainties, including, but not
limited to, the following:
|
|
|
a deeper or more prolonged recession in the United States coupled with the
tightening of the mortgage credit markets could increase defaults and limit
opportunities for borrowers to cure defaults or for Triad to mitigate losses, which
could have an adverse material impact on our business or results of operations; |
|
|
|
|
the possibility that the Department may take various actions regarding Triad if it
does not operate its business in accordance with its revised financial and operating
plan and the Corrective Orders, including seeking receivership proceedings, which
would effectively eliminate all remaining stockholder value; |
|
|
|
|
our ability to continue as a going concern; |
|
|
|
|
the ability of the parent company to pay the debt service with funds obtained from
Triad, whether in the form of dividends, payments on the surplus note or otherwise,
will require the approval of the Department, and it is unlikely that such approval
will be sought or, if sought, will be obtained in the foreseeable future; |
|
|
|
|
our loss reserves estimates are subject to uncertainties and are based on
assumptions that are currently volatile in the housing and mortgage industries and
therefore settled claims may be substantially different from our loss reserves; |
|
|
|
|
we may not continue to realize benefits from rescissions at the levels that we
have recently experienced; |
|
|
|
|
if house prices continue to fall, additional borrowers may default and claims
could be higher than anticipated; |
|
|
|
|
if unemployment rates continue to rise, especially in those areas that have
already experienced significant declines in house prices, defaults and claims could
be higher than anticipated; |
|
|
|
|
further economic downturns in regions where we have larger concentrations of risk
and in markets already distressed could have a particularly adverse effect on our
financial condition and loss development; |
|
|
|
|
the appointment of the Federal Housing Finance Agency (FHFA) as the conservator
of both Fannie Mae and Freddie Mac has resulted in changes in the business practices
of the GSEs; |
|
|
|
|
the impact of recently adopted programs and legislation affecting modifications
and refinancings of mortgages could materially impact our financial performance in
run-off; |
41
|
|
|
our financial condition and performance in run-off could be affected by
legislation adopted in the future, if any, impacting the mortgage industry, the GSEs
specifically, or the financial services industry in general; |
|
|
|
|
if the GSEs or our lender customers choose to cancel the insurance on policies
that we insure, our financial performance in run-off could be adversely affected; |
|
|
|
|
a significant decline in interest rates coupled with an increase in available
credit could increase refinancings and decrease the persistency of renewal premiums
and the quality of our insurance in force; |
|
|
|
|
if we have failed to properly underwrite mortgage loans under contract
underwriting service agreements, we may be required to assume the costs of
repurchasing those loans or face other remedies; |
|
|
|
|
any impediment to our ability to rescind coverage on insurance policies, which
would be detrimental to our success in run-off; |
|
|
|
|
our ability to lower operating expenses to the most efficient level while still
providing the ability to mitigate losses effectively during run-off, which will
directly impact our financial performance in run-off; and |
|
|
|
|
if we are unable to satisfy its continued listing requirements, we may be delisted
from The NASDAQ Stock Market. |
Accordingly, actual results may differ from those set forth in these forward-looking
statements. Attention also is directed to other risks and uncertainties set forth in documents
that we file from time to time with the SEC.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The information required by this Item 3 is not required to be provided by issuers, such as
us, that satisfy the definition of smaller reporting company under SEC rules.
Item 4T. Controls and Procedures
|
a) |
|
We carried out an evaluation, under the supervision and with the participation of our
management, including our Principal Executive Officer (PEO) and Principal Financial
Officer (PFO), of the effectiveness of our disclosure controls and procedures pursuant to
Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the Exchange Act).
Based on that evaluation, our management, including our PEO and PFO, concluded, as of the
end of the period covered by this report, that our disclosure controls and procedures were
effective to ensure that information required to be disclosed by us in the reports that we
file or submit under the Exchange Act is (a) accumulated and communicated to our
management, including our PEO and PFO, as appropriate to allow timely decisions regarding
required disclosure, and (b) recorded, processed, summarized and reported within the time
periods specified in the SECs rules and forms. In designing and evaluating disclosure
controls and procedures, we recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the desired
control objectives, as ours are designed to do. |
|
|
b) |
|
There were no changes to our internal control over financial reporting during the
period ended June 30, 2009 that materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting. |
42
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is involved in litigation and other legal proceedings in the ordinary course of
business as well as the matters identified below. No pending litigation or other legal proceedings
are expected to have a material adverse effect on the financial position of the Company.
On February 6, 2009, James L. Phillips served a complaint against Triad Guaranty Inc., Mark K.
Tonnesen and Kenneth W. Jones in the United States District Court, Middle District of North
Carolina. The plaintiff purports to represent a class of persons who purchased or otherwise
acquired the common stock of the Company between October 26, 2006 and April 1, 2008 and the
complaint alleges violations of federal securities laws by the Company and two of its present or
former officers. The court has appointed lead counsel for the plaintiff and an amended complaint
was filed on June 22, 2009. Our response to the amended complaint is due August 21, 2009. We
intend to contest the lawsuit vigorously.
Triad maintained a $95 million Excess-of-Loss reinsurance treaty that was to provide a benefit
when Triads risk-to-capital ratio exceeded 25-to-1 and the combined ratio exceeded 100% (the
attachment point). Once the attachment point was reached, following a one-time deductible of $25
million, the carrier would be responsible for the reimbursement of all paid losses in each quarter
that the attachment point was breached up to the one-time $95 million policy limit. The coverage
period was to be for 10 years. Additionally, terms of the treaty required Triad to continue the
payment of premiums to the reinsurer amounting to approximately $2 million per year for the entire
ten year period. The reinsurance treaty attached at the end of the first quarter of 2008; however,
in April 2008 the reinsurance carrier provided a notice of termination of the agreement. The
dispute was submitted to an arbitration panel and the arbitration hearing took place in December
2008 and January 2009. On June 4, 2009, Triad was notified that the arbitration panel had
determined that the reinsurance carrier was required to reimburse Triad for claims paid from April
1, 2009 through May 19, 2009 following the one-time deductible of $25 million. As a result, the
amount recoverable was substantially less than the $95 million policy limit. Subsequently, Triad
and the reinsurance carrier entered into an agreement to settle the matter in full in exchange for
a payment from the reinsurance carrier to Triad of $10 million, which resolves all disputes between
the parties and concludes all remaining rights and obligations of the parties under the reinsurance
treaty. In addition to the payment from the reinsurance carrier, Triad has also recovered $2.0
million in premium that had previously been expensed. Net of expenses associated with concluding
the arbitration, the settlement decreased the net loss for the second quarter of 2009 by
approximately $11.7 million.
Item 1A. Risk Factors
We reported a deficit in assets at June 30, 2009 of $529.7 million. In order to overcome this
deficit in assets, our future net income on the remaining insurance in force must exceed $529.7
million during the run-off period. There is substantial risk that the future net income during the
run-off will not exceed this amount, which could result in the institution of receivership
proceedings for Triad and subsequently could compel us to institute a proceeding seeking relief
from creditors under U.S. bankruptcy laws.
During the second quarter of 2009, our deficit in assets under GAAP increased $348 million to
$529.7 million due primarily to the net loss from operations. In order to overcome this deficit in
assets, future revenue must exceed future losses and expenses by at least $529.7 million. Our total
operating revenue, excluding realized investment gains and losses, decreased to $131 million for
the six months ended June 30, 2009 from $161 million for the six months ended June 30, 2008. We
project our revenue will continue to decline as our insurance in force declines.
43
The most significant component of loss from operations has been the increase in the reserve
for losses. We calculate our best estimate of the reserve for losses to provide for the estimated
ultimate costs of settling claims on loans reported in default, and loans in default that are in
the process of being reported to us, as of the date of our financial statements. Our reserving
process incorporates various components in a model that gives effect to current economic conditions
and segment defaults by a variety of criteria. Frequency and severity are the two most significant
assumptions in the establishment of our loss reserves. During the second quarter of 2009, we
increased both the frequency and severity factors based upon actual settled loss development over
the past year, and our expectation for future development. Economic conditions in the housing and
mortgage industries continue to be depressed and we do not anticipate a meaningful recovery in the
near-term. As a result of the current economic conditions, our loss mitigation opportunities
remain limited.
The actual amount of the claim payments may be substantially different from our loss reserve
estimates, even with updated factors at June 30, 2009. Our estimates could be adversely affected
by a variety of factors, including, but not limited to, a significant drop in house prices within
certain geographic regions in which the values have dropped only marginally through June 30, 2009,
continuing increases in the unemployment rate, and a decrease in the actual rescission rates
compared to those utilized in our reserve methodology. Changes to our estimates of reserves could
result in a significant impact to our results of operations, even in a stable economic environment,
and there can be no assurance that actual settled claims will not be substantially different than
our loss reserves. We expect that any increase in loss reserves will adversely affect our deficit
in assets.
The U.S. economic environment, particularly with respect to the level of unemployment and home
prices, continues to have a significant negative impact on the U.S. housing and mortgage markets.
Although we regularly review and consider our methodology for recording our loss reserve estimates,
these estimates are subject to uncertainties and are based on assumptions that we are required to
make during a time of unprecedented economic volatility. As a result, settled claims may
ultimately be substantially different than our loss reserves that we have recorded and may have a
material adverse impact on our financial condition and results of operations.
Cure rates over the last six months have decreased dramatically from previous historically low
levels. Additionally, through the first two quarters of 2009, default rates have increased and
home price declines have accelerated outside of our distressed markets. In response to these
developing economic trends, during the second quarter we raised the frequency and severity
assumptions utilized in our methodology for recording loss reserve estimates, which had a material
adverse impact on our operating results. Although our recorded loss reserves for the period ended
June 30, 2009 reflect our best estimates as of such date, settled claims could be substantially
different from the loss reserves that have been recorded and could materially and adversely affect
our financial condition and results of operations.
Item 6. Exhibits
The exhibits filed with this quarterly report on Form 10-Q are set forth in the Exhibit Index
on page 46 and are incorporated herein by reference.
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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 the undersigned thereunto duly authorized.
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Triad Guaranty Inc.
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/s/ Kenneth W. Jones
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August 7, 2009 |
Kenneth W. Jones |
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President and Chief Executive Officer (Duly Authorized
Officer, Principal Executive Officer and Principal
Financial Officer) |
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45
EXHIBIT INDEX
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Exhibit Number |
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Description |
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31.1
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Certification of Principal Executive Officer and Principal
Financial Officer pursuant to Exchange Act Rule 13a-14(a),
as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002. |
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32.1
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Certification of Principal Executive Officer and Principal
Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002. |
46