Triad Guaranty Inc.
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
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 March 31, 2006
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 is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated
filer in Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer þ Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Act) Yes o No þ
Number of shares of Common Stock, par value $0.01 per share, outstanding as of May 5, 2006,
was 14,836,135.
TRIAD GUARANTY INC.
INDEX
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Page |
Part I. Financial Information |
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Item 1.
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Financial Statements |
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Consolidated Balance Sheets as of March 31, 2006
(Unaudited) and December 31, 2005
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1 |
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Consolidated Statements of Income for the Three Months
Ended March 31, 2006 and 2005 (Unaudited)
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2 |
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Consolidated Statements of Cash Flows for the Three Months
Ended March 31, 2006 and 2005 (Unaudited)
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3 |
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Notes to Consolidated Financial Statements
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4 |
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Item 2.
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Managements Discussion and Analysis of Financial
Condition and Results of Operations
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10 |
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Item 3.
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Quantitative and Qualitative Disclosures about Market Risk
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34 |
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Item 4.
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Controls and Procedures
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34 |
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Part II. Other Information |
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Item 1.
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Legal Proceedings
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35 |
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Item 1A.
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Risk Factors
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35 |
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Item 2.
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Unregistered Sales of Equity Securities and Use of Proceeds
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35 |
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Item 3.
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Defaults Upon Senior Securities
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35 |
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Item 4.
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Submission of Matters to a Vote of Security Holders
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35 |
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Item 5.
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Other Information
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35 |
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Item 6.
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Exhibits
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35 |
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Signature |
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36 |
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
TRIAD GUARANTY INC.
CONSOLIDATED BALANCE SHEETS
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(Unaudited) |
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March 31 |
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December 31 |
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2006 |
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2005 |
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(In thousands, except share data) |
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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: $530,658 and $518,137) |
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$ |
541,393 |
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$ |
534,064 |
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Equity securities (cost: $9,628 and $7,001) |
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9,987 |
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8,159 |
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Short-term investments |
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5,053 |
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4,796 |
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556,433 |
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547,019 |
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Cash and cash equivalents |
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13,743 |
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8,934 |
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Real estate acquired in claim settlement |
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10,198 |
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5,721 |
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Accrued investment income |
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7,012 |
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7,237 |
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Deferred policy acquisition costs |
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33,904 |
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33,684 |
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Prepaid federal income taxes |
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139,465 |
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139,465 |
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Property and equipment |
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7,613 |
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7,827 |
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Income taxes recoverable |
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181 |
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Reinsurance recoverable |
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1 |
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948 |
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Other assets |
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17,609 |
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16,487 |
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Total assets |
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$ |
785,978 |
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$ |
767,503 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Liabilities: |
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Losses and loss adjustment expenses |
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$ |
52,614 |
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$ |
51,074 |
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Unearned premiums |
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13,944 |
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13,494 |
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Amounts payable to reinsurers |
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4,279 |
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4,810 |
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Deferred income taxes |
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159,180 |
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155,189 |
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Long-term debt |
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34,503 |
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34,501 |
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Accrued interest on debt |
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584 |
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1,275 |
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Current taxes payable |
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563 |
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Accrued expenses and other liabilities |
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5,104 |
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7,969 |
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Total liabilities |
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270,771 |
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268,312 |
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Commitments and contingencies Note 4
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Stockholders equity: |
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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 14,831,560 shares
at March 31, 2006 and 14,774,153 shares at December 31, 2005 |
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148 |
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148 |
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Additional paid-in capital |
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101,853 |
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103,657 |
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Accumulated other comprehensive income, net of income tax
liability of $3,883 at March 31, 2006 and $5,980 at
December 31, 2005 |
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7,211 |
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11,106 |
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Deferred compensation |
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(3,161 |
) |
Retained earnings |
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405,995 |
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387,441 |
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Total stockholders equity |
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515,207 |
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499,191 |
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Total liabilities and stockholders equity |
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$ |
785,978 |
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$ |
767,503 |
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See accompanying notes.
1
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
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Three Months Ended |
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March 31 |
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2006 |
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2005 |
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(In thousands, except share data) |
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Revenue: |
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Premiums written: |
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Direct |
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$ |
59,312 |
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$ |
48,327 |
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Ceded |
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(10,970 |
) |
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(9,616 |
) |
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Net premiums written |
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48,342 |
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38,711 |
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Change in unearned premiums |
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(452 |
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66 |
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Earned premiums |
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47,890 |
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38,777 |
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Net investment income |
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6,222 |
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5,415 |
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Net realized investment gains |
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900 |
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7 |
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Other income |
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(2 |
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9 |
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55,010 |
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44,208 |
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Losses and expenses: |
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Net losses and loss adjustment expenses |
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16,351 |
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10,630 |
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Interest expense on debt |
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693 |
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693 |
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Amortization of deferred policy acquisition costs |
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3,862 |
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3,657 |
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Other operating expenses (net of acquisition costs deferred) |
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8,513 |
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7,217 |
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29,419 |
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22,197 |
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Income before income taxes |
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25,591 |
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22,011 |
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Income taxes: |
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Current |
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972 |
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694 |
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Deferred |
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6,066 |
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5,557 |
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7,038 |
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6,251 |
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Net income |
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$ |
18,553 |
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$ |
15,760 |
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Earnings per common and common equivalent share: |
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Basic |
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$ |
1.26 |
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$ |
1.08 |
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Diluted |
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$ |
1.25 |
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$ |
1.07 |
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Shares used in computing earnings per common and common
equivalent share: |
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Basic |
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14,758,349 |
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14,618,183 |
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Diluted |
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14,862,471 |
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14,777,681 |
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See accompanying notes.
2
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
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Three Months Ended |
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March 31 |
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2006 |
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2005 |
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(In thousands) |
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Operating activities |
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Net income |
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$ |
18,553 |
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$ |
15,760 |
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Adjustments to reconcile net income to net cash provided by
operating activities: |
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Losses, loss adjustment expenses and unearned premium reserves |
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1,990 |
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684 |
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Accrued expenses and other liabilities |
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(2,865 |
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(2,807 |
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Current taxes payable |
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563 |
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Income taxes recoverable |
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181 |
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310 |
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Amounts due to/from reinsurer |
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416 |
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191 |
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Accrued investment income |
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225 |
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226 |
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Policy acquisition costs deferred |
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(4,082 |
) |
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(4,226 |
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Amortization of deferred policy acquisition costs |
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3,862 |
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3,657 |
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Net realized investment gains |
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(900 |
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(7 |
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Provision for depreciation |
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615 |
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826 |
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Accretion of discount on investments |
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(35 |
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(30 |
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Deferred income taxes |
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6,066 |
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5,557 |
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Prepaid federal income taxes |
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355 |
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Real estate acquired in claim settlement, net of write-downs |
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(4,477 |
) |
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78 |
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Accrued interest on debt |
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(691 |
) |
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(691 |
) |
Other assets |
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(1,122 |
) |
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160 |
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Other operating activities |
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709 |
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748 |
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Net cash provided by operating activities |
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19,008 |
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20,791 |
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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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(22,616 |
) |
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(27,594 |
) |
Sales fixed maturities |
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8,000 |
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503 |
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Maturities
fixed maturities |
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2,160 |
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3,327 |
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Purchases
equities |
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(4,622 |
) |
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Sales equities |
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2,946 |
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Net change in short-term investments |
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(257 |
) |
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7,346 |
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Purchases of property and equipment |
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(401 |
) |
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(772 |
) |
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Net cash used in investing activities |
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(14,790 |
) |
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(17,190 |
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Financing activities |
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Excess tax benefits from share-based compensation |
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270 |
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Proceeds from exercise of stock options |
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321 |
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262 |
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Net cash provided by financing activities |
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591 |
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262 |
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Net change in cash and cash equivalents |
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4,809 |
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|
3,863 |
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Cash and cash equivalents at beginning of period |
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8,934 |
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10,440 |
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Cash and cash equivalents at end of period |
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$ |
13,743 |
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$ |
14,303 |
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Supplemental schedule of cash flow information |
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Cash paid during the period for: |
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Income taxes and United States Mortgage Guaranty Tax and Loss
Bonds |
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$ |
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$ |
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Interest |
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1,383 |
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1,383 |
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See accompanying notes.
3
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Unaudited)
1. The Company
Triad Guaranty Inc. is a holding company, which through its wholly-owned subsidiary, Triad
Guaranty Insurance Corporation (Triad), provides mortgage insurance coverage in the United
States. This 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. Triad Guaranty Inc. and its subsidiaries are collectively referred to as the Company.
2. Accounting Policies And Basis Of Presentation
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in conformity
with accounting principles generally accepted in the United States of America for interim financial
information and with the instructions to Form 10-Q and Article 10 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 (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for the three months ended March 31, 2006
are not necessarily indicative of the results that may be expected for the year ending December 31,
2006. For further information, refer to the consolidated financial statements and footnotes
thereto included in the Triad Guaranty Inc. annual report on Form 10-K for the year ended December
31, 2005.
Share-Based Compensation
Prior to January 1, 2006, the Company accounted for stock option grants and grants of
restricted stock under its 1993 Long-Term Stock Incentive Plan (the Plan), which is more fully
described in Note 8, using the intrinsic value method prescribed in Accounting Principles Board
Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25), as permitted by Statement of
Financial Accounting Standards No. 123 (SFAS 123). In accordance with APB 25, compensation
expense was recognized for grants of restricted stock, but not for grants of stock options. In
December 2004, the Financial Accounting Standards Board issued SFAS No. 123 (revised 2004),
Share-Based Payment (SFAS 123(R)). SFAS 123(R) requires the compensation expense relating to
share-based payment transactions to be recognized in financial statements. The Company adopted
SFAS 123(R) effective January 1, 2006, utilizing the modified prospective application as defined in
that statement. Under that transition method, compensation expense recognized in the first quarter
of 2006 includes: a) compensation expense for all share-based payments granted prior to, but not
yet vested as of January 1, 2006 based on the grant-date fair value estimated in accordance with
the original provisions of SFAS 123, and b) compensation expense for all share-based payments
granted subsequent to January 1, 2006,
4
based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R).
Results for prior periods have not been restated.
The following table shows the effect of adopting SFAS 123(R) in the Companys financial
statements (in thousands, except per share information):
|
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|
|
|
|
Three Months Ended |
|
|
March 31, 2006 |
Income before income taxes |
|
$ |
(280 |
) |
Net income |
|
$ |
(182 |
) |
Earnings per share basic |
|
$ |
(0.01 |
) |
Earnings per
share diluted |
|
$ |
(0.01 |
) |
Prior to the adoption of SFAS 123(R), the Company presented all tax benefits of deductions
resulting from share-based compensation as operating cash flows in the Statement of Cash Flows.
SFAS 123(R) requires the cash flows resulting from the tax benefits of tax deductions in excess of
the compensation expense recognized for those share-based payments to be classified as financing
cash flows. The $270,000 excess tax benefit classified as a financing cash inflow would have been
classified as an operating cash inflow if the Company had not adopted SFAS 123(R).
The following table illustrates the effect on net income and earnings per share if the Company
had applied the fair value recognition provisions of SFAS 123 to options granted in all periods
presented. For purposes of this pro forma disclosure, the value of the options is estimated using
a Black-Scholes option pricing model and amortized to expense over the options vesting periods (in
thousands, except for earnings per share information):
|
|
|
|
|
|
|
Three Months Ended |
|
|
March 31, 2005 |
Net income as reported |
|
$ |
15,760 |
|
Net income pro forma |
|
$ |
15,614 |
|
|
|
|
|
|
Earnings per share as reported: |
|
|
|
|
Basic |
|
$ |
1.08 |
|
Diluted |
|
$ |
1.07 |
|
|
|
|
|
|
Earnings per share pro forma: |
|
|
|
|
Basic |
|
$ |
1.07 |
|
Diluted |
|
$ |
1.06 |
|
3. 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.
5
4. 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. Triad evaluates the financial
condition of its reinsurers and monitors credit risk arising from similar geographic regions,
activities, or economic characteristics of its reinsurers to minimize its exposure to significant
losses from reinsurer insolvency.
Insurance In Force, Dividend Restrictions, and Statutory Results
Insurance regulations generally limit the writing of mortgage guaranty insurance to an
aggregate amount of insured risk no greater than 25 times the total of statutory capital and
surplus and the statutory contingency reserve. The amount of net risk for insurance in force at
March 31, 2006 and December 31, 2005, 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. Triads ratio is as
follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, 2006 |
|
|
December 31, 2005 |
|
Net risk |
|
$ |
7,446,926 |
|
|
$ |
7,312,697 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Statutory capital and surplus |
|
$ |
135,375 |
|
|
$ |
131,582 |
|
Statutory contingency reserve |
|
|
469,398 |
|
|
|
447,826 |
|
|
|
|
|
|
|
|
Total |
|
$ |
604,773 |
|
|
$ |
579,408 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Risk-to-capital ratio |
|
12.3 to 1 |
|
|
|
12.6 to 1 |
|
|
|
|
|
|
|
|
Triad and its wholly-owned subsidiaries are each required under their respective domiciliary
states insurance code to maintain a minimum level of statutory capital and surplus. Triad, an
Illinois domiciled insurer, is required under the Illinois Insurance Code (the Code) to maintain
minimum statutory capital and surplus of $5 million. The Code permits dividends to be paid only
out of earned surplus and also requires prior approval of extraordinary dividends. An
extraordinary dividend is any dividend or distribution of cash or other property, the fair value of
which, together with that of other dividends or distributions made within a period of twelve
consecutive months, exceeds the greater of (a) ten percent of statutory surplus as regards
policyholders, or (b) statutory net income for the calendar year preceding the date of the
dividend.
Net income as determined in accordance with statutory accounting practices was $25.6
million and $22.0 million for the three months ended March 31, 2006 and 2005, respectively, and
$77.1 million for the year ended December 31, 2005.
6
At March 31, 2006 and December 31, 2005, the amount of Triads equity that could be paid out
in dividends to stockholders was $51.6 million and $47.9 million, respectively, which was the
earned surplus of Triad on a statutory basis on those dates.
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. Amounts recoverable from the sale of properties acquired
in lieu of foreclosure are considered in the determination of the reserve estimates. 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 age, policy year, geography, chronic late
payment characteristics, the number of months the policy has been in default, as well as whether
the policies in default were underwritten through the flow channel or as part of a structured bulk
transaction. The estimates are continually reviewed, and as adjustments to these liabilities
become necessary, such adjustments are reflected in the financial statements in the periods in
which the adjustments are made.
Litigation
A lawsuit was filed against the Company in January 2004 in the ordinary course of the
Companys business alleging violations of the Fair Credit Reporting Act. The Company is vigorously
defending the lawsuit. In the opinion of management, the ultimate resolution of this pending
litigation will not have a material adverse effect on the financial position or results of
operations of the Company.
5. Earnings Per Share
Basic and diluted earnings per share are based on the weighted-average daily number of shares
outstanding. For diluted earnings per share, the denominator includes the dilutive effects of
stock options and unvested restricted stock on the weighted-average shares outstanding. There are
no other reconciling items between the denominators used in basic earnings per share and diluted
earnings per share. The numerator used in basic earnings per share and diluted earnings per share
is the same for all periods presented.
6. Comprehensive Income
Comprehensive income consists of net income and other comprehensive income. For the Company,
other comprehensive income is composed of unrealized gains or losses on available-for-sale
securities, net of income tax. For the three months ended March 31, 2006 and 2005, the Companys
comprehensive income was $14.7 million and $12.5 million, respectively.
7
7. Income Taxes
Income tax expense differs from the amounts computed by applying the Federal statutory income
tax rate to income before income taxes primarily due to tax-exempt interest that the Company earns
from its investments in municipal bonds.
8. Long-Term Stock Incentive Plan
Under the Companys 1993 Long-Term Stock Incentive Plan (the Plan), certain directors,
officers, and key employees are eligible to receive various share-based compensation awards. Stock
options and restricted stock may be awarded under the Plan for a fixed number of shares with a
requirement for stock options granted to have an exercise price equal to or greater than the fair
value of the shares at the date of grant. Generally, both the stock options and restricted stock
awards vest over three years, although certain shares will vest immediately in the event of a
change in control of the Company. Options granted under the Plan expire no later than ten years
following the date of grant. The number of options or restricted shares authorized to be granted
or issued under the Plan is 2,600,000 shares. As of March 31, 2006, 669,101 shares were reserved
and 94,624 shares were available for issuance under the Plan. Gross compensation expense of
approximately $800,000 along with the related tax benefit of approximately $280,000 was recognized
in the financial statements for the three months ended March 31, 2006. For the same period of
2005, compensation expense of approximately $397,000, along with the associated tax benefit of
approximately $139,000 was recognized, which related to restricted stock granted. For the three
months ended March 31, 2006, approximately $125,000 of share-based compensation was capitalized as
part of deferred acquisition costs. No share-based compensation was capitalized for the three
months ended March 31, 2005.
A summary of option activity under the Plan for the three months ended March 31, 2006 is
presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
|
Weighted- |
|
|
Aggregate |
|
|
Average |
|
|
|
Number |
|
|
Average |
|
|
Intrinsic |
|
|
Remaining |
|
|
|
of Shares |
|
|
Exercise Price |
|
|
Value |
|
|
Contractual Term |
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
Outstanding, January 1, 2006 |
|
|
588,780 |
|
|
$ |
37.21 |
|
|
|
|
|
|
|
|
|
Granted |
|
|
9,594 |
|
|
|
42.00 |
|
|
|
|
|
|
|
|
|
Exercised |
|
|
23,896 |
|
|
|
13.44 |
|
|
|
|
|
|
|
|
|
Cancelled |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, March 31, 2006 |
|
|
574,478 |
|
|
|
38.28 |
|
|
$ |
5,357 |
|
|
5.3 years |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable, March 31, 2006 |
|
|
429,672 |
|
|
|
36.68 |
|
|
$ |
4,643 |
|
|
3.9 years |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8
The fair value of stock options is estimated on the date of grant using a Black-Scholes
pricing model. The weighted-average assumptions used for options granted during the three months
ended March 31, 2006 and 2005 are noted in the following table. The expected volatilities are
based on volatility of the Companys stock over the most recent historical period corresponding to
the expected term of the options. The Company also uses historical data to estimate option
exercise and employee terminations within the model; separate groups of employees with similar
historical exercise and termination histories are considered separately for valuation purposes.
The risk-free rates for the periods corresponding to the expected terms of the options are based on
U.S. Treasury rates in effect on the dates of grant.
|
|
|
|
|
|
|
|
|
|
|
2006 |
|
2005 |
Expected volatility |
|
|
34.2 |
% |
|
|
40.1 |
% |
Expected dividend yield |
|
|
0.0 |
% |
|
|
0.0 |
% |
Expected term |
|
5.0 years |
|
|
5.0 years |
|
Risk-free rate |
|
|
4.5 |
% |
|
|
3.7 |
% |
The weighted-average grant-date fair value of options granted during the three months ended
March 31, 2006 and 2005 was $15.92 and $22.09, respectively. The total intrinsic value of options
exercised during the three months ended March 31, 2006 and 2005 was approximately $738,000 and
$998,000, respectively.
A summary of restricted stock activity under the Plan for the three months ended March 31,
2006 is presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
Average |
|
|
|
Number of |
|
|
Grant-Date |
|
|
Shares |
|
Fair Value |
Nonvested, January 1, 2006 |
|
|
101,415 |
|
|
$ |
46.93 |
|
Granted |
|
|
33,315 |
|
|
|
42.00 |
|
Vested |
|
|
29,631 |
|
|
|
46.06 |
|
Cancelled |
|
|
120 |
|
|
|
53.94 |
|
|
|
|
|
|
|
|
|
|
Nonvested, March 31, 2006 |
|
|
104,979 |
|
|
|
45.60 |
|
|
|
|
|
|
|
|
|
|
The fair value of restricted stock is determined based on the closing price of the Companys
shares on the grant date. The weighted-average grant-date fair value of restricted stock granted
during the three months ended March 31, 2006 and 2005 was $42.00 and $53.97, respectively.
As of March 31, 2006, there was $6.6 million of total unrecognized compensation expense
related to nonvested stock options and restricted stock granted under the Plan. That expense is
expected to be recognized over a weighted-average period of 2.3 years. The total fair value of
stock options and restricted stock vested during the three months ended March 31, 2006 and 2005 was
$1.4 million and $1.7 million, respectively.
The Company issues new shares upon exercise of stock options.
9
|
|
|
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
the consolidated financial condition, changes in financial position, and results of operations for
the three months ended March 31, 2006 and 2005, of the Company. This discussion supplements
Managements Discussion and Analysis in Form 10-K for the year ended December 31, 2005, and should
be read in conjunction with the interim financial statements and notes contained herein.
Certain of the statements contained herein, other than statements of historical fact, are
forward-looking statements. These statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995 and include estimates and assumptions related
to economic, competitive, and legislative developments. These forward-looking statements are
subject to change and uncertainty, which are, in many instances, beyond our control and have been
made based upon our 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 certain factors, including the possibility of general economic and
business conditions that are different than anticipated, legislative developments, changes in
interest rates or the stock markets, stronger than anticipated competitive activity, as well as the
risk factors described in Item 1A of our Form 10-K and the Safe Harbor Statement under the Private
Securities Litigation Reform Act of 1995 with respect to forward-looking statements contained
herein.
Update on Critical Accounting Policies and Estimates
Our Annual Report on Form 10-K describes the accounting estimates and assumptions that we
consider to be the most critical to an understanding of our financial statements because they
inherently involve significant judgments and uncertainties. These critical accounting policies
relate to the assumptions and judgments utilized in establishing the reserve for losses and loss
adjustment expenses, determining if declines in fair values of investments are other than
temporary, and establishing appropriate initial amortization schedules for deferred policy
acquisition costs (DAC) and subsequent adjustments to that amortization.
We believe that these continue to be the critical accounting policies applicable to the
Company and that these policies were applied in a consistent manner during the first three months
of 2006.
Overview
Through our subsidiaries, we provide Primary and Modified Pool mortgage guaranty insurance
coverage to residential mortgage lenders and investors as a credit-enhancement vehicle, typically
when individual borrowers have less than 20% equity in the property. Business originated by
lenders and submitted to us on a loan-by-loan basis is referred to as our flow channel business.
The majority of our Primary insurance is delivered through the flow channel. We also provide
mortgage insurance to lenders and investors who seek additional default protection, capital relief,
and credit-enhancement on groups of loans that are sold in the
10
secondary market. These transactions are referred to as our structured bulk channel business.
All of our Modified Pool insurance is delivered through the structured bulk channel.
Our revenues principally consist of a) initial and renewal earned premiums from flow business
(net of reinsurance premiums ceded as part of our risk management strategies), b) initial and
renewal earned premiums from structured bulk transactions, and c) investment income on invested
assets. We also realize investment gains, net of investment losses, periodically as a source of
revenue when the opportunity presents itself within the context of our overall investment strategy.
Our expenses consist of a) amounts ultimately paid on claims submitted, b) changes in reserves
for estimated future claim payments, c) general and administrative costs of acquiring new business
and servicing existing policies, d) other general business expenses, and e) income taxes.
Our profitability depends largely on a) the adequacy of our product pricing and underwriting
discipline relative to the risks insured, b) persistency levels, c) operating efficiencies, and d)
the level of investment yield, including realized gains and losses, on our investment portfolio.
We define persistency as the percentage of insurance in force remaining from twelve months prior.
Cancellations of policies originated during the past twelve months are not considered in our
calculation of persistency. This method of calculating persistency may vary from that of other
mortgage insurers. We believe that our calculation presents an accurate measure of the percentage
of insurance in force remaining from twelve months prior. Cancellations result primarily from the
borrower refinancing or selling insured mortgaged residential properties and, to a lesser degree,
from the borrower achieving prescribed equity levels at which the lender no longer requires
mortgage guaranty insurance.
For a more detailed description of our industry and operations, refer to the Business
section of our Form 10-K.
Consolidated Results of Operations
Following is selected financial information for the three months ended March 31, 2006 and
2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% |
|
|
|
|
|
|
|
|
|
|
Change |
|
|
|
|
|
|
|
|
|
|
2006 |
|
|
2006 |
|
2005 |
|
vs. 2005 |
|
|
(In thousands, except percentages and per share information) |
Earned premiums |
|
$ |
47,890 |
|
|
$ |
38,777 |
|
|
|
23.5 |
% |
Net losses and loss adjustment expenses |
|
|
16,351 |
|
|
|
10,630 |
|
|
|
53.8 |
|
Net income |
|
|
18,553 |
|
|
|
15,760 |
|
|
|
17.7 |
|
Diluted earnings per share |
|
$ |
1.25 |
|
|
$ |
1.07 |
|
|
|
16.8 |
|
Net income for the first three months of 2006 increased from the first quarter of 2005
primarily driven by growth in earned premiums that exceeded growth in net losses and loss
adjustment expenses. This increase in earned premiums was the result of growth of our
11
insurance in force due to increasing persistency rates and strong production of Modified Pool
insurance in the last twelve months. Based on information available from the industry association
and other public sources, our estimated market share of net new insurance written, using industry
definitions, was 10.1% for the first quarter of 2006 compared to 8.0% for the first quarter of
2005.
The growth of our insurance in force, seasoning of our portfolio and an increase in average
claim severity were the primary factors causing the significant increase in net losses and loss
adjustment expenses in the first three months of 2006 over that of 2005. The actual number of
claims paid increased in the first quarter of 2006 as a greater percentage of insurance in force
reached the peak claim paying period. Our average severity of paid claims was $25,100 for the
first quarter of 2006 compared to $23,700 for the first quarter of 2005.
The increase in diluted earnings per share for the first quarter of 2006 over that of 2005 was
consistent with the increase in net income. Realized investment gains, net of taxes, increased
diluted earnings per share in the first quarter of 2006 by $0.04 and had no impact in the first
quarter of 2005. Realized investment gains and losses per diluted share is a non-GAAP measure. We
believe this is relevant and useful information to investors because, except for write-downs on
other-than-temporarily impaired securities, it shows the effect that our discretionary sales of
investments had on earnings. See further discussion of impairment write-downs in the Realized
Losses and Impairments section below.
We describe our results in greater detail in the discussions that follow. The information is
presented in three categories: Production and In Force, Revenues, and Losses and Expenses.
Production and In Force
A summary of new production for the first quarter of 2006 and 2005 broken out between Primary
and Modified Pool follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% Change |
|
|
|
|
|
|
|
|
|
|
|
2006 vs. |
|
|
|
2006 |
|
|
2005 |
|
|
2005 |
|
|
|
(In millions, except percentages) |
|
Primary insurance written |
|
$ |
1,948 |
|
|
$ |
2,191 |
|
|
|
(11.1 |
)% |
Modified pool insurance written |
|
|
4,606 |
|
|
|
2,103 |
|
|
|
119.0 |
|
|
|
|
|
|
|
|
|
|
|
|
Total insurance written |
|
$ |
6,554 |
|
|
$ |
4,294 |
|
|
|
52.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
The overall mortgage loan origination market declined approximately 11% from the first quarter
of 2005, according to estimates published by Fannie Mae, causing a decline in net new Primary
insurance written for the entire industry. This decline along with a slight decrease in market
penetration in our flow channel led to the decline in our Primary insurance written. We anticipate
that the overall mortgage loan origination market will be smaller for all of 2006 than 2005, which
could further moderate our Primary new insurance written for the year. However,
12
we believe that piggyback loan arrangements, such as 80-10-10s, have become less attractive
to borrowers as short-term interest rates have risen. If interest rates remain at current levels
or continue to rise, the erosion of mortgage insurance written caused by these arrangements may
soften, which could partially mitigate the overall reduction of Primary insurance written.
We write Modified Pool insurance only through our structured bulk channel. Our Modified Pool
insurance written grew significantly in the first quarter of 2006 due to strong industry production
and our successful bidding to provide insurance on those transactions that meet our loan quality
and pricing objectives. Structured bulk transactions for the entire industry grew approximately
124% according to information available from the industry association and other publicly available
data. Modified Pool insurance written is likely to vary significantly from period to period due
to: a) the limited number of transactions (but with larger size) occurring in this market, b) the
level of competition from other mortgage insurers, c) the relative attractiveness in the
marketplace of mortgage insurance versus other forms of credit enhancement, and d) the changing
loan composition and underwriting criteria of the market. We believe there will continue to be
opportunities throughout the remainder of 2006 in the structured bulk transaction market that meet
our loan quality and pricing objectives.
The following table provides estimates of our national market share of net new insurance
written, using industry definitions, through our flow and structured bulk channels based on
information available from the industry association and other public sources for the three months
ended March 31, 2006 and 2005:
|
|
|
|
|
|
|
|
|
|
|
2006 |
|
2005 |
Flow channel |
|
|
5.3 |
% |
|
|
5.5 |
% |
Structured bulk channel |
|
|
16.7 |
% |
|
|
16.5 |
% |
Total |
|
|
10.1 |
% |
|
|
8.0 |
% |
Our total market share increased in the first quarter of 2006 due to strong production through
our structured bulk channel coupled with the fact that structured bulk business represented
approximately 42% of the total market for the industry for the first quarter of 2006 compared to
approximately 23% for the first quarter of 2005. As mentioned earlier, our structured bulk market
share will vary from period to period since this market can have significantly larger transactions
and our share of this market is dependent on the availability of transactions that meet our credit
quality and pricing benchmarks and on our ability to bid successfully to provide insurance on these
transactions.
13
We continue to increase our participation in the Alt-A marketplace. We have defined Alt-A as
individual loans having FICO scores greater than 619 and that have been underwritten with reduced
or no documentation. We have defined A Minus loans as those having FICO scores greater than 574,
but less than 620. We have defined Sub Prime loans as those with credit scores less than 575. The
following table summarizes the credit quality characteristics of our Primary new insurance written
during the first quarter of 2006 and 2005 and reflects the growth in our Alt-A production:
|
|
|
|
|
|
|
|
|
|
|
2006 |
|
2005 |
Prime |
|
|
74.9 |
% |
|
|
78.1 |
% |
Alt-A |
|
|
22.8 |
|
|
|
14.2 |
|
A Minus |
|
|
2.0 |
|
|
|
6.1 |
|
Sub Prime |
|
|
0.3 |
|
|
|
1.6 |
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
Other risk characteristics that we consider in our underwriting discipline include the
percentage of adjustable rate mortgages (ARMs) and the percentage of loans with LTVs greater than
95%. The following table summarizes the percentage of our Primary production in ARMs and higher
LTV loans for the first three months of 2006 and 2005:
|
|
|
|
|
|
|
|
|
|
|
2006 |
|
2005 |
ARMs |
|
|
32.4 |
% |
|
|
38.1 |
% |
LTV greater than 95% |
|
|
10.1 |
% |
|
|
13.1 |
% |
The majority of our Modified Pool production has been in the Alt-A marketplace over the last
two years. LTVs on policies originated in the structured bulk channel are generally lower than
those on policies we receive via the flow channel. Those policies may also have other Primary
coverage in front of our risk. The percentages of ARMs included in our Modified Pool production
approximate those included in our Primary production.
Periodically we enter into structured bulk transactions involving loans that have insurance
effective dates within the current reporting period but for which detailed loan information
regarding the insured loans is not provided by the issuer of the transaction until later. When this
situation occurs, we accrue premiums that are due but not yet paid based upon the estimated
commitment amount of the transaction in the reporting period with respect to each loans insurance
effective date. However, these policies are not reflected in our insurance in force, new insurance
written, or related industry data totals until we verify the loan level detail. At March 31, 2006,
we had approximately $1.5 billion of structured transactions with effective dates within the first
quarter for which loan level detail had not been received and, therefore, are not included in our
own data or industry totals. These amounts will be reported as new production and insurance in
force totals in the second quarter of 2006, when the issuer of the transactions provides accurate
loan level detail to us. We have included in premium written and premium earned the respective
estimated amounts due and earned during the first quarter of 2006 related to this insurance. At
March 31, 2005 we had $0.9 billion of structured transactions with effective dates within the first
quarter of 2005 for which loan level detail had not been received.
14
The following table provides detail on our direct insurance in force at March 31, 2006 and
2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% Change |
|
|
|
|
|
|
|
|
|
|
|
2006 vs. |
|
|
|
2006 |
|
|
2005 |
|
|
2005 |
|
|
|
(In millions, except percentages) |
|
Primary insurance |
|
$ |
29,891 |
|
|
$ |
29,001 |
|
|
|
3.1 |
% |
Modified Pool insurance |
|
|
18,309 |
|
|
|
9,217 |
|
|
|
98.6 |
|
|
|
|
|
|
|
|
|
|
|
|
Total insurance |
|
$ |
48,200 |
|
|
$ |
38,218 |
|
|
|
26.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
Our Primary insurance in force at March 31, 2006 grew from March 31, 2005 as a result of
continued production and improving persistency rates. Primary insurance persistency improved to
71.1% at March 31, 2006 compared to 69.0% at March 31, 2005. Due to the recent rise in interest
rates, we anticipate that persistency rates will continue near current levels or increase
moderately throughout the remainder of 2006. However, persistency may be adversely affected if
interest rates decline significantly from the levels experienced during the first quarter of 2006.
Our Modified Pool insurance in force at March 31, 2006 grew significantly from March 31, 2005
due primarily to our strong production in the structured bulk market that experienced large growth
from the first quarter of 2005. Approximately 36% of our insurance written attributable to our
structured bulk channel during the first three months of 2006 was structured with deductibles that
put us in the second loss position compared to 88% for the first three months of 2005. The decline
in Modified Pool insurance written with deductibles in the first quarter of 2006 from that of 2005
was the result of increased business with entities that do not utilize deductibles in their
structures, although the use of deductibles remains an effective part of our Modified Pool risk
management strategy.
Similar to the trend in new insurance written discussed above, Alt-A continues to grow as a
percentage of our Primary insurance in force. The following table shows the percentage of our
insurance in force that we have classified as Alt-A at March 31, 2006 and 2005:
|
|
|
|
|
|
|
|
|
|
|
2006 |
|
2005 |
Primary insurance in force |
|
|
10.4 |
% |
|
|
7.6 |
% |
Modified Pool insurance in force |
|
|
68.4 |
% |
|
|
61.3 |
% |
Total insurance in force |
|
|
32.0 |
% |
|
|
20.5 |
% |
15
The following tables highlight the percentages of the Primary risk in force by credit quality
and loan type at March 31, 2006 and 2005:
|
|
|
|
|
|
|
|
|
|
|
2006 |
|
2005 |
Credit quality: |
|
|
|
|
|
|
|
|
Prime |
|
|
83.9 |
% |
|
|
86.1 |
% |
Alt-A |
|
|
11.2 |
|
|
|
8.5 |
|
A Minus |
|
|
4.1 |
|
|
|
4.5 |
|
Sub Prime |
|
|
0.8 |
|
|
|
0.9 |
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan type: |
|
|
|
|
|
|
|
|
Fixed |
|
|
73.8 |
% |
|
|
75.6 |
% |
ARM |
|
|
26.2 |
|
|
|
24.4 |
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
We offer mortgage insurance structures designed to allow lenders to share in the risks of
mortgage insurance. One such structure is our captive reinsurance program under which 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 following table
shows the percentage of our Primary flow channel insurance in force as well as the percentage of
our total insurance in force that was subject to captive reinsurance arrangements at March 31, 2006
and 2005.
|
|
|
|
|
|
|
|
|
|
|
2006 |
|
2005 |
Primary flow insurance in force |
|
|
59.9 |
% |
|
|
56.7 |
% |
Total insurance in force |
|
|
36.7 |
% |
|
|
42.0 |
% |
The growth of the Primary flow insurance in force that was subject to captive reinsurance
arrangements at March 31, 2006 over March 31, 2005 was the result of increased production from
lenders that participate in those arrangements. The decline in the total direct insurance in force
subject to captive reinsurance at March 31, 2006 from March 31, 2005 reflects the fact that a
greater portion of our insurance in force consists of Modified Pool insurance in force, which is
written through the structured bulk channel and is not subject to captive reinsurance arrangements.
We believe captive reinsurance arrangements are an effective risk management tool as selected
lenders share in the risk under these arrangements. Additionally, captive reinsurance arrangements
are structured so that Triad receives credit against the capital required in certain risk-based
capital models utilized by rating agencies. We remain committed to structuring captive reinsurance
arrangements, including deep ceded arrangements where the net premium cede rate is greater than
25%, on a lender-by-lender basis as we deem it to be prudent. We will continue to be an active
participant with our lender partners in captive reinsurance arrangements.
16
Revenues
A summary of the significant individual components of our revenue for the first quarter of
2006 and 2005 follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% |
|
|
|
|
|
|
|
|
|
|
|
Change |
|
|
|
|
|
|
|
|
|
|
|
2006 vs. |
|
|
|
2006 |
|
|
2005 |
|
|
2005 |
|
|
|
(In thousands, except percentages) |
|
Direct premium written |
|
$ |
59,312 |
|
|
$ |
48,327 |
|
|
|
22.7 |
% |
Ceded premium written |
|
|
(10,970 |
) |
|
|
(9,616 |
) |
|
|
14.1 |
|
|
|
|
|
|
|
|
|
|
|
|
Net premium written |
|
|
48,342 |
|
|
|
38,711 |
|
|
|
24.9 |
|
Change in unearned premiums |
|
|
(452 |
) |
|
|
66 |
|
|
|
(784.8 |
) |
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
47,890 |
|
|
$ |
38,777 |
|
|
|
23.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income |
|
$ |
6,222 |
|
|
$ |
5,415 |
|
|
|
14.9 |
|
Total revenues |
|
$ |
55,010 |
|
|
$ |
44,208 |
|
|
|
24.4 |
% |
Our direct premium written for the first quarter of 2006 grew substantially over that of 2005
as a result of increased insurance in force and the strong growth in our Modified Pool insurance
written discussed above. Production of new insurance combined with favorable persistency levels
increased renewal premiums, which are included in direct premium written, for the first quarter of
2006 by $13.6 million or 31.3% over the first three months of 2005. Annual persistency was 70.2%
at March 31, 2006 compared to 67.8% at March 31, 2005.
Ceded premium written is comprised of premiums written under excess of loss reinsurance
treaties with captive as well as non-captive reinsurance companies. The growth in ceded premium
written in the first quarter of 2006 over the first quarter of 2005 was not as large as the growth
in direct premium written as a result of a larger percentage of direct premium written not subject
to captive reinsurance arrangements. The following table provides further data on ceded premiums
for the three months ended March 31, 2006 and 2005:
|
|
|
|
|
|
|
|
|
|
|
2006 |
|
2005 |
Premium cede rate (ceded premiums written as a percentage
of direct premiums written) |
|
|
18.5 |
% |
|
|
19.9 |
% |
Captive reinsurance premium cede rate (ceded premiums
written under captive reinsurance arrangements as a
percentage of direct premiums written) |
|
|
17.3 |
% |
|
|
18.3 |
% |
Average captive premium cede rate (ceded premiums written
under captive reinsurance arrangements as a percentage of
direct premiums written under captive reinsurance
arrangements) |
|
|
37.2 |
% |
|
|
36.6 |
% |
17
The table below provides data on insurance written that was subject to captive reinsurance
arrangements for the three months ended March 31, 2006 and 2005:
|
|
|
|
|
|
|
|
|
|
|
2006 |
|
2005 |
Primary insurance written |
|
|
55.1 |
% |
|
|
46.8 |
% |
Total insurance written |
|
|
16.4 |
% |
|
|
23.9 |
% |
The percentage of Primary insurance written subject to captive reinsurance arrangements for
the first quarter of 2006 increased over the first quarter of 2005 due to a decline in production
of certain lender-paid programs that are not subject to captive reinsurance arrangements from the
first quarter of 2005. Because a greater portion of our total production in the first quarter of
2006 came from Modified Pool insurance, the percentage of total insurance written subject to
captive reinsurance for the first quarter of 2006 declined from 2005. None of our Modified Pool
insurance written in 2006 and 2005 was subject to captive reinsurance arrangements.
The difference between net written premiums and earned premiums is the change in the unearned
premium reserve, which is established primarily on premiums received on annual products. Our
unearned premium liability increased $0.5 million from December 31, 2005 to March 31, 2006 compared
to a decline of $0.1 million from December 31, 2004 to March 31, 2005.
Assuming no significant decline in interest rates, we anticipate our persistency will remain
at current levels or improve slightly during the remainder of 2006. This should continue to have a
positive effect on renewal earned premiums and total earned premiums.
Net investment income for the first quarter of 2006 increased over that for the first quarter
of 2005 due to growth in average invested assets, partially offset by declines in portfolio yields.
Average invested assets at cost or amortized cost for the first quarter of 2006 grew by 15.7% over
the first quarter of 2005 as a result of the investment of cash flows from operations. Our
investment portfolio tax-equivalent yield was 6.74% at March 31, 2006 compared to 6.91% at March
31, 2005. We anticipate a continuing decline in the overall portfolio tax-equivalent yield as
current interest rates are still below our average portfolio rate. See further discussion of the
Investment Portfolio section of this document.
18
Losses and Expenses
A summary of the individual components of losses and expenses for the three months ended March
31, 2006 and 2005 follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% Change |
|
|
|
|
|
|
|
|
|
|
2006 vs. |
|
|
2006 |
|
2005 |
|
2005 |
|
|
(In thousands, except percentages) |
Net losses and loss adjustment expenses |
|
$ |
16,351 |
|
|
$ |
10,630 |
|
|
|
53.8 |
% |
Amortization of deferred policy acquisition costs |
|
|
3,862 |
|
|
|
3,657 |
|
|
|
5.6 |
|
Other operating expenses (net of acquisition
costs deferred) |
|
|
8,513 |
|
|
|
7,217 |
|
|
|
18.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss ratio |
|
|
34.1 |
% |
|
|
27.4 |
% |
|
|
|
|
Expense ratio |
|
|
25.6 |
% |
|
|
28.1 |
% |
|
|
|
|
Combined ratio |
|
|
59.7 |
% |
|
|
55.5 |
% |
|
|
|
|
Net losses and loss adjustment expenses (LAE) are comprised of both paid losses and LAE and
the change in loss and LAE reserves during the period. Net losses and LAE for the first quarter of
2006 increased significantly over the first quarter of 2005 primarily due to an increase in paid
claims and an increase in reserves. The growth in paid claims and reserves are a result of the
continued seasoning of our portfolio. Additionally, an increase in the severity on actual paid
claims as well as the severity utilized in the reserve models contributed to the increase in new
losses and LAE. We will focus separately on paid claims and the increase in reserves.
19
The following table provides detail on paid claims and the average severity for our Primary
and Modified Pool insurance for the three months ended March 31, 2006 and 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% Change |
|
|
|
|
|
|
|
|
|
|
|
2006 vs. |
|
|
|
2006 |
|
|
2005 |
|
|
2005 |
|
|
|
(In thousands, except percentages) |
|
Paid claims: |
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance |
|
$ |
13,284 |
|
|
$ |
8,681 |
|
|
|
53.0 |
% |
Modified Pool insurance |
|
|
1,100 |
|
|
|
970 |
|
|
|
13.4 |
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
14,384 |
|
|
$ |
9,651 |
|
|
|
49.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of claims paid: |
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance |
|
|
506 |
|
|
|
352 |
|
|
|
43.8 |
% |
Modified Pool insurance |
|
|
67 |
|
|
|
55 |
|
|
|
21.8 |
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
573 |
|
|
|
407 |
|
|
|
40.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average severity: |
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance |
|
$ |
26.3 |
|
|
$ |
24.7 |
|
|
|
|
|
Modified Pool insurance |
|
|
16.4 |
|
|
|
17.6 |
|
|
|
|
|
Total |
|
|
25.1 |
|
|
|
23.7 |
|
|
|
|
|
Paid claims for the first three months of 2006 increased over the first three months of 2005
primarily due to the seasoning of our portfolio as a larger percentage of our insurance in force
reaches its anticipated highest claim frequency period of years two to five from loan origination
combined with overall growth of the insurance portfolio. To assist in the understanding of the
seasoning process and the impact on paid claims, we have provided the following table that presents
Primary risk in force at March 31, 2006 and 2005 by policy year (which is defined as the year the
insurance became effective):
|
|
|
|
|
|
|
|
|
Policy Year |
|
2006 |
|
2005 |
2001 and prior |
|
|
6.4 |
% |
|
|
9.7 |
% |
2002 |
|
|
8.0 |
|
|
|
12.6 |
|
2003 |
|
|
24.6 |
|
|
|
37.3 |
|
2004 |
|
|
24.4 |
|
|
|
34.2 |
|
2005 |
|
|
31.3 |
|
|
|
6.2 |
|
2006 |
|
|
5.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
Approximately 63% of our insurance in force was in the peak claim paying period of the second
through fifth years at March 31, 2006 compared to 60% at March 31, 2005 and 39% at March 31, 2004.
While the percentage of insurance in force in the peak claim paying period continues to grow, the
rate of growth has dropped significantly from that experienced during 2005.
20
The increase in average severity shown above also contributed to the growth in paid losses.
The increase is reflective of the larger loan sizes and, as mentioned earlier, also reflects the
growth of Alt-A loans that generally have a larger average loan balance than the rest of our
portfolio. One of the loss mitigation techniques that we utilize in an attempt to lower claim
severity is the purchase and subsequent sale of properties in lieu of foreclosure. We greatly
expanded the use of this technique in the second half of 2005 and are continuing to utilize this
strategy in 2006. Through the use of updated claims administration software and the addition of
real estate personnel to our claims staff, we are experiencing some
success in limiting the growth
of claims severity. We expect the average severity will continue to trend upward as the newer
policy years develop and the average loan amounts rise with the increase in housing prices.
Net losses and loss adjustment expenses also include the change in reserves for losses and
loss adjustment expenses. The following table provides further information about our loss reserves
at March 31, 2006 and 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% Change |
|
|
|
|
|
|
|
|
|
|
|
2006 vs. |
|
|
|
2006 |
|
|
2005 |
|
|
2005 |
|
|
|
(In thousands, except percentages) |
|
|
Primary insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Reserves for reported defaults |
|
$ |
44,399 |
|
|
$ |
29,793 |
|
|
|
49.0 |
% |
Reserves for defaults incurred but not reported |
|
|
3,686 |
|
|
|
2,592 |
|
|
|
42.2 |
|
|
|
|
|
|
|
|
|
|
|
|
Total Primary insurance |
|
|
48,085 |
|
|
|
32,385 |
|
|
|
48.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Modified Pool insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Reserves for reported defaults |
|
|
3,960 |
|
|
|
1,885 |
|
|
|
110.1 |
|
Reserves for defaults incurred but not reported |
|
|
465 |
|
|
|
456 |
|
|
|
2.0 |
|
|
|
|
|
|
|
|
|
|
|
|
Total Modified Pool insurance |
|
|
4,425 |
|
|
|
2,341 |
|
|
|
89.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserve for loss adjustment expenses |
|
|
104 |
|
|
|
99 |
|
|
|
5.1 |
|
|
|
|
|
|
|
|
|
|
|
|
Total reserves for losses and loss adjustment
expenses |
|
$ |
52,614 |
|
|
$ |
34,825 |
|
|
|
51.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
The reserve for losses and loss adjustment expenses at March 31, 2006 increased significantly
from March 31, 2005 primarily due to an increase in defaults, changes in the frequency of defaults
resulting in claims and an increase in severity utilized in our reserving methodology. 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.
21
The following table shows default statistics as of March 31, 2006 and 2005:
|
|
|
|
|
|
|
|
|
|
|
2006 |
|
2005 |
Total business: |
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
317,670 |
|
|
|
272,839 |
|
Number of loans in default |
|
|
6,892 |
|
|
|
5,463 |
|
With deductibles |
|
|
1,127 |
|
|
|
538 |
|
Without deductibles |
|
|
5,765 |
|
|
|
4,925 |
|
Percentage of loans in default (default rate) |
|
|
2.17 |
% |
|
|
2.00 |
% |
Percentage of loans in default excluding
deductibles |
|
|
1.81 |
% |
|
|
1.81 |
% |
|
|
|
|
|
|
|
|
|
Primary insurance: |
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
215,736 |
|
|
|
217,657 |
|
Number of loans in default |
|
|
5,116 |
|
|
|
4,134 |
|
Percentage of loans in default |
|
|
2.37 |
% |
|
|
1.90 |
% |
|
|
|
|
|
|
|
|
|
Modified Pool insurance: |
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
101,934 |
|
|
|
55,182 |
|
Number of loans in default |
|
|
1,776 |
|
|
|
1,329 |
|
With deductibles |
|
|
1,127 |
|
|
|
538 |
|
Without deductibles |
|
|
649 |
|
|
|
791 |
|
Percentage of loans in default |
|
|
1.74 |
% |
|
|
2.41 |
% |
Percentage of loans in default excluding
deductibles |
|
|
0.64 |
% |
|
|
1.43 |
% |
|
|
|
|
|
|
|
|
|
Primary Alt-A business: |
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
16,838 |
|
|
|
13,134 |
|
Number of loans in default |
|
|
634 |
|
|
|
445 |
|
Percentage of loans in default |
|
|
3.77 |
% |
|
|
3.39 |
% |
The increase in the default rate for Primary insurance is attributable to the continued
seasoning of our business as a greater percentage of the insurance in force moves into the peak
claim paying period and the defaults from FEMA-designated areas as a result of hurricanes Katrina
and Rita that occurred in the second half of 2005.
As shown in the above table, the number of Modified Pool defaults subject to deductibles
continued to increase while the number of Modified Pool defaults without deductibles declined at
March 31, 2006 from March 31, 2005. At March 31, 2006, no individual structured bulk transaction
with deductibles as part of the structure had incurred total losses that were nearing these
individual deductible amounts. We do not provide reserves on Modified Pool defaults with
deductibles until the incurred losses for that specific structured bulk transaction reach a
pre-established threshold.
22
A significant portion of the increase in defaults occurred in FEMA-designated areas as a
result of hurricanes Katrina and Rita. Primary and Modified Pool insurance defaults from these
FEMA-designated areas totaled 791 at March 31, 2006. The following table shows the changes in the
defaults in these areas from December 31, 2005 to March 31, 2006:
|
|
|
|
|
Number of defaults in FEMA-designated areas at December 31, 2005 |
|
|
891 |
|
Number of defaults in FEMA-designated areas cured during the first
quarter of 2006 with no loss incurred |
|
|
(292 |
) |
Number of new defaults in FEMA-designated areas reported during the
first quarter of 2006 |
|
|
192 |
|
|
|
|
|
|
Number of defaults in FEMA-designated areas at March 31, 2006 |
|
|
791 |
|
|
|
|
|
|
Number of defaults in FEMA-designated areas at March 31, 2006
without deductibles |
|
|
608 |
|
|
|
|
|
|
The terms of our coverage exclude any cost or expense related to the repair or remedy of any
physical damage to the property collateralizing an insured mortgage loan. We have not obtained
detailed property assessments for the defaults in the FEMA-designated areas. Our exposure could be
limited if such assessments demonstrate that there is significant un-repaired physical damage to
properties securing loans for which we have provided mortgage insurance. Additionally, we believe
that many borrowers living in these areas did not make scheduled mortgage payments due to
forbearance granted by Fannie Mae, Freddie Mac and lenders, even though the individual borrowers
financial condition was not significantly impacted. Given the unique circumstances surrounding
that situation and absent any evidence that these would develop differently, we reserved for these
defaults at our normal level. At March 31, 2006, there were reserves of $5.1 million for defaults
in the FEMA-designated areas compared to $4.5 million at December 31, 2005, utilizing our normal
reserving methodology. We will continue to monitor this situation throughout the remainder of 2006
as the longer-term impacts develop.
We anticipate that our number of loans in default for both Primary and Modified Pool insurance
will continue to increase as a larger percentage of our insurance in force reaches its peak claim
paying period and as a result of overall growth of our insurance in force. We also expect default
rates to increase as the Alt-A business becomes a larger percentage of our insurance in force. We
expect reserves will increase as our business continues to grow and season.
We are cautious about housing market conditions in certain regions that have recently
experienced rapid house price appreciation. Changes in the economic environment could accelerate
paid and incurred loss development. Our reserving model incorporates managements judgments and
assumptions regarding these factors; however, due to the uncertainty of future premium levels,
losses, economic conditions, and other factors that affect earnings, it is difficult to predict the
impact of such higher claim frequencies on future earnings.
Amortization of DAC for the first quarter of 2006 increased moderately over that for the same
period in 2005, reflecting growth in the asset balance, partially offset by improved persistency.
A full discussion of the impact of persistency on DAC amortization is included in the Deferred
Policy Acquisition Costs section below.
23
Other operating expenses for the first three months of 2006 increased over the first three
months of 2005 due to growth in our insurance in force and due to expenses incurred in connection
with the organizational changes following the hiring of several new executives. Further, the
adoption of SFAS 123(R) requiring the expensing of stock options increased other operating expenses
by approximately $280,000 in the first quarter of 2006. Because the growth in net premiums written
was greater than the growth in expenses, the expense ratio (ratio of the amortization of deferred
policy acquisition costs and other operating expenses to net premiums written) for the first
quarter of 2006 was 25.6% compared to 28.1% for the first quarter of 2005. Given our expectations
for premium growth, we anticipate continued improvements in our expense ratio.
Our effective tax rate was 27.5% for the first three months of 2006 compared to 28.4% for the
first three months of 2005. The decline in the effective tax rate was due primarily to an increase
in tax-exempt interest resulting from growth of investments in tax-preferred municipal securities.
We expect our effective tax rate to remain near current levels or increase slightly as we expect
earned premium to grow faster than tax-preferred income.
Significant Customers
Our objective is controlled, profitable growth in both Primary and Modified Pool business
while adhering to our risk management strategies. Our strategy is to continue our focus on
national lenders while maintaining the productive relationships that we have built with regional
lenders. Competition within the mortgage insurance industry continues to increase as many large
mortgage lenders have limited the number of mortgage insurers with whom they do business. At the
same time, consolidation among national lenders has increased the share of the mortgage origination
market controlled by the largest lenders and that has led to further concentrations of business
with a relatively small number of lenders. Many of the national lenders allocate Primary business
to several different mortgage insurers. These allocations can vary over time. Our ten largest
customers were responsible for 78% of Primary insurance written during the first quarter of 2006
compared to 75% for the first quarter of 2005. Our two largest customers were responsible for 42%
of Primary insurance written during the first quarter of 2006 compared to 59% for the first quarter
of 2005. Through actively seeking business with other lenders that meet our criteria, we are
broadening our customer base in order to limit our concentration with these two largest lenders.
The loss of or considerable reduction in business from one or more of these significant customers
without a corresponding increase from other lenders would have an adverse effect on our business.
Financial Position
Total assets increased to $786 million at March 31, 2006, an annualized growth rate of 10%
over December 31, 2005, with most of the growth in invested assets. Total liabilities increased
moderately to $271 million at March 31, 2006 from $268 million at December 31, 2005, primarily
driven by an increase in deferred tax liabilities. This section identifies several items on our
balance sheet that are important in the overall understanding of our financial position. These
items include deferred policy acquisition costs, prepaid federal income tax and related deferred
income taxes. The majority of our assets are in our investment portfolio. A separate Investment
Portfolio section follows the Financial Position section and reviews our
24
investment portfolio, key portfolio management strategies, and methodologies by which we
manage credit risk.
Deferred Policy Acquisition Costs
Costs expended to acquire new business are capitalized as DAC and recognized as expense over
the anticipated premium paying life of the policy in a manner that approximates the estimated gross
profits. We employ a dynamic model that calculates amortization of DAC separately for each year of
policy origination. The model relies on assumptions that we make based upon historical industry
experience and our own unique experience regarding the annual persistency development of each year
of policy origination. Persistency is the most important assumption utilized in determining the
timing of reported amortization expense reflected in the income statement and the carrying value of
DAC on the balance sheet. A change in the assumed persistency can impact the current and future
amortization expense as well as the carrying value on the balance sheet. Our model accelerates DAC
amortization through a dynamic adjustment when actual persistency for a particular year of policy
origination is lower than the estimated persistency originally utilized in the model. This dynamic
adjustment is capped at the levels assumed in the models, and we do not decrease DAC amortization
below the levels assumed in the model when persistency increases above those levels. When actual
persistency is lower than that assumed in our models, the dynamic adjustment effectively adjusts
the estimated policy life utilized in the model to a policy life based upon the current actual
persistency.
Our DAC models separate the costs capitalized and the amortization streams between
transactions arising from structured bulk and flow delivery channels. Generally, structured bulk
transactions have significantly lower acquisition costs associated with the production of the
business and they also have a shorter original estimated policy life. We apply the dynamic
adjustment to the structured bulk DAC models utilizing the same methodology. At March 31, 2006,
net unamortized DAC relating to structured bulk transactions amounted to 7.0% of the total DAC on
the balance sheet compared to 6.8% at December 31, 2005.
The following table shows the DAC asset for the three months ended March 31, 2006 and 2005 and
the effect of persistency on amortization:
|
|
|
|
|
|
|
|
|
|
|
2006 |
|
|
2005 |
|
|
|
(In thousands, except percentages) |
|
Balance beginning of year |
|
$ |
33,684 |
|
|
$ |
32,453 |
|
Costs capitalized |
|
|
4,082 |
|
|
|
4,227 |
|
|
|
|
|
|
|
|
|
|
Amortization normal |
|
|
(3,849 |
) |
|
|
(3,315 |
) |
Amortization
dynamic adjustment |
|
|
(13 |
) |
|
|
(342 |
) |
|
|
|
|
|
|
|
Total amortization |
|
|
(3,862 |
) |
|
|
(3,657 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance end of year |
|
$ |
33,904 |
|
|
$ |
33,023 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annual Persistency |
|
|
70.2 |
% |
|
|
67.8 |
% |
|
|
|
|
|
|
|
25
The growth in the normal DAC amortization is due to the growth in the DAC asset. As the
annual persistency improved at March 31, 2006 from March 31, 2005, DAC amortization resulting from
the dynamic adjustment for the first quarter of 2006 declined from that of 2005.
Assuming no significant declines in interest rates, we expect persistency to improve
moderately throughout the remainder of 2006. Based on this assumption, we anticipate DAC
amortization to increase at a rate similar to growth in the DAC asset.
Prepaid Federal Income Taxes and Deferred Income Taxes
We purchase ten-year non-interest bearing United States Mortgage Guaranty Tax and Loss Bonds
(Tax and Loss Bonds) to take advantage of a special contingency reserve deduction specific to
mortgage guaranty companies. We record these 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
will become due in ten years when the contingency reserve is released, and the Tax and Loss Bonds
mature. The proceeds from the maturity of the Tax and Loss Bonds are used to fund the income tax
payments. Prepaid income taxes were $139.5 million at March 31, 2006 and December 31, 2005, as no
purchases of Tax and Loss Bonds were required in the first quarter of 2006.
Deferred income taxes are provided for the differences in reporting taxable income in the
financial statements and on the tax return. The largest cumulative difference is the special
contingency reserve deduction for mortgage insurers mentioned above. The remainder of the deferred
tax liability has primarily arisen from book and tax reporting differences related to DAC and
unrealized investment gains.
Investment Portfolio
Portfolio Description
Our strategy for managing our investment portfolio is to optimize investment returns while
preserving capital and liquidity and adhering to regulatory and rating agency requirements. We
invest for the long term, and most of our investments are held until they mature. Our investment
portfolio includes primarily fixed income securities, and the majority of these are tax-preferred
state and municipal bonds. We have established a formal investment policy that describes our
overall quality and diversification objectives and limits. Our investment policy and strategies
are subject to change depending upon regulatory, economic, and market conditions as well as our
existing financial condition and operating requirements, including our tax position. While we
invest for the long term and most of our investments are held until they mature, 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 strategies and operating requirements.
All investments are carried on our balance sheet at fair value.
26
The following table shows the growth and diversification of our investment portfolio:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2006 |
|
|
December 31, 2005 |
|
|
|
Amount |
|
|
Percent |
|
|
Amount |
|
|
Percent |
|
|
|
(In thousands, except percentages) |
|
Fixed maturity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U. S. government obligations |
|
$ |
11,936 |
|
|
|
2.2 |
% |
|
$ |
12,124 |
|
|
|
2.2 |
% |
State and municipal bonds |
|
|
507,614 |
|
|
|
91.2 |
|
|
|
500,027 |
|
|
|
91.4 |
|
Corporate bonds |
|
|
21,787 |
|
|
|
3.9 |
|
|
|
21,855 |
|
|
|
4.0 |
|
Mortgage-backed bonds |
|
|
56 |
|
|
|
0.0 |
|
|
|
58 |
|
|
|
0.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
|
541,393 |
|
|
|
97.3 |
|
|
|
534,064 |
|
|
|
97.6 |
|
Equity securities |
|
|
9,987 |
|
|
|
1.8 |
|
|
|
8,159 |
|
|
|
1.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available-for-sale
securities |
|
|
551,380 |
|
|
|
99.1 |
|
|
|
542,223 |
|
|
|
99.1 |
|
Short-term investments |
|
|
5,053 |
|
|
|
0.9 |
|
|
|
4,796 |
|
|
|
0.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
556,433 |
|
|
|
100.0 |
% |
|
$ |
547,019 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
We seek to provide liquidity in our investment portfolio through cash equivalent investments
and through diversification and investment in publicly traded securities. We attempt to maintain a
level of liquidity and duration in our investment portfolio consistent with our business outlook
and the expected timing, direction, and degree of changes in interest rates.
We also manage risk and liquidity by limiting our exposure on individual securities. The
following table shows the ten largest exposures to an individual creditor in our investment
portfolio as of March 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
Carrying |
|
% of Total |
Name of Creditor |
|
Value |
|
Invested Assets |
|
|
(In thousands, except percentages) |
Atlanta, Georgia Airport |
|
$ |
6,750 |
|
|
|
1.21 |
% |
State of Pennsylvania |
|
|
6,035 |
|
|
|
1.08 |
% |
Federal National Mortgage Association |
|
|
5,330 |
|
|
|
0.96 |
% |
State of Hawaii |
|
|
5,304 |
|
|
|
0.95 |
% |
AAM/ZAZOVE Institutional Income Fund |
|
|
5,250 |
|
|
|
0.94 |
% |
Port of Seattle, Washington |
|
|
4,563 |
|
|
|
0.82 |
% |
Cook County, Illinois |
|
|
4,202 |
|
|
|
0.76 |
% |
Denver, Colorado City and County Airport |
|
|
4,193 |
|
|
|
0.75 |
% |
Charlotte, North Carolina Airport |
|
|
4,125 |
|
|
|
0.74 |
% |
State of Nevada Water Pollution Control |
|
|
4,042 |
|
|
|
0.73 |
% |
As shown above, no investment in the securities of any single issuer exceeded 2% of our
investment portfolio at March 31, 2006.
27
The following table shows the results of our investment portfolio for the three months ended
March 31, 2006 and 2005:
|
|
|
|
|
|
|
|
|
|
|
2006 |
|
2005 |
|
|
(In thousands, except percentages) |
Average investments at cost
or amortized cost |
|
$ |
537,631 |
|
|
$ |
464,805 |
|
Pre-tax net investment income |
|
$ |
6,222 |
|
|
$ |
5,415 |
|
Pre-tax yield |
|
|
4.6 |
% |
|
|
4.7 |
% |
Tax-equivalent yield-to-maturity |
|
|
6.7 |
% |
|
|
6.8 |
% |
Pre-tax realized investment gains |
|
$ |
900 |
|
|
$ |
7 |
|
The small decline in the tax-equivalent yield-to-maturity shown above reflects the impact of
the maturity or call of higher yielding investments and the subsequent investment purchases at new
money rates available, which were lower than that of our overall portfolio. We anticipate this
trend to continue throughout the remainder of 2006.
Unrealized Gains and Losses
The following table summarizes by category our unrealized gains and losses in our securities
portfolio at March 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost or |
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Fair |
|
|
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Value |
|
|
|
|
|
|
|
(In thousands) |
|
|
|
|
|
Fixed maturity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U. S. government obligations |
|
$ |
12,353 |
|
|
$ |
7 |
|
|
$ |
(424 |
) |
|
$ |
11,936 |
|
State and municipal bonds |
|
|
498,525 |
|
|
|
11,395 |
|
|
|
(2,306 |
) |
|
|
507,614 |
|
Corporate bonds |
|
|
19,727 |
|
|
|
2,067 |
|
|
|
(7 |
) |
|
|
21,787 |
|
Mortgage-backed bonds |
|
|
53 |
|
|
|
3 |
|
|
|
|
|
|
|
56 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal, fixed maturities |
|
|
530,658 |
|
|
|
13,472 |
|
|
|
(2,737 |
) |
|
|
541,393 |
|
Equity securities |
|
|
9,628 |
|
|
|
476 |
|
|
|
(117 |
) |
|
|
9,987 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total securities |
|
$ |
540,286 |
|
|
$ |
13,948 |
|
|
$ |
(2,854 |
) |
|
$ |
551,380 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
These unrealized gains and losses do not necessarily represent future gains or losses 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. We monitor unrealized losses through further analysis according to maturity
date, credit quality, individual creditor exposure and the length of time the individual security
has continuously been in an unrealized loss position. Of the gross unrealized losses on fixed
maturity securities shown above, approximately $1.8 million related to bonds with a maturity date
in excess of ten years. The largest individual unrealized loss on any one security at March 31,
2006 was approximately $153,000 on a U.S. governmental agency bond with an amortized cost of $5.0
million. Gross unrealized gains and losses at March 31, 2005 were $16.7 million and $(1.5)
million, respectively.
28
Credit Risk
Credit risk is inherent in an investment portfolio. We manage this risk through a structured
approach to internal investment quality guidelines and diversification while assessing the effects
of the changing economic landscape. One way we attempt to limit the inherent credit risk in the
portfolio is to maintain investments with high ratings. The following table shows our investment
portfolio by credit ratings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2006 |
|
|
December 31, 2005 |
|
|
|
Amount |
|
|
Percent |
|
|
Amount |
|
|
Percent |
|
|
|
(In thousands, except percentages) |
|
Fixed Maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. treasury and agency bonds |
|
$ |
11,936 |
|
|
|
2.2 |
% |
|
$ |
12,124 |
|
|
|
2.3 |
% |
AAA |
|
|
425,539 |
|
|
|
78.6 |
|
|
|
420,489 |
|
|
|
78.7 |
|
AA |
|
|
55,142 |
|
|
|
10.2 |
|
|
|
52,812 |
|
|
|
9.9 |
|
A |
|
|
30,447 |
|
|
|
5.6 |
|
|
|
30,176 |
|
|
|
5.7 |
|
BBB |
|
|
9,534 |
|
|
|
1.8 |
|
|
|
9,780 |
|
|
|
1.8 |
|
BB |
|
|
811 |
|
|
|
0.1 |
|
|
|
781 |
|
|
|
0.1 |
|
Not rated |
|
|
7,984 |
|
|
|
1.5 |
|
|
|
7,902 |
|
|
|
1.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
$ |
541,393 |
|
|
|
100.0 |
% |
|
$ |
534,064 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred stocks: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AA |
|
$ |
1,695 |
|
|
|
17.0 |
% |
|
$ |
1,709 |
|
|
|
20.9 |
% |
A |
|
|
1,553 |
|
|
|
15.5 |
|
|
|
1,559 |
|
|
|
19.1 |
|
BBB |
|
|
1,139 |
|
|
|
11.4 |
|
|
|
1,125 |
|
|
|
13.8 |
|
Not rated |
|
|
498 |
|
|
|
5.0 |
|
|
|
490 |
|
|
|
6.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,885 |
|
|
|
48.9 |
|
|
|
4,883 |
|
|
|
59.8 |
|
Common stocks |
|
|
5,102 |
|
|
|
51.1 |
|
|
|
3,276 |
|
|
|
40.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equities |
|
$ |
9,987 |
|
|
|
100.0 |
% |
|
$ |
8,159 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
We regularly review our investment portfolio to identify securities that may have suffered
impairments in value that will not be recovered, termed potentially distressed securities. In
identifying potentially distressed securities, we screen all securities held with a particular
emphasis on those that have a fair value to cost or amortized cost ratio of less than 80%.
Additionally, as part of this identification process, we utilize the following information:
|
§ |
|
Length of time the fair value was below amortized cost |
|
|
§ |
|
Industry factors or conditions related to a geographic area negatively affecting
the security |
|
|
§ |
|
Downgrades by a rating agency |
|
|
§ |
|
Past due interest or principal payments or other violation of covenants |
|
|
§ |
|
Deterioration of the overall financial condition of the specific issuer |
In analyzing our potentially distressed securities list for other-than-temporary impairments,
we pay special attention to securities that have been on the list continually for a period greater
than six months. Our ability and intent to retain the investment for a sufficient
29
time to recover its value is also considered. We assume that, absent reliable contradictory
evidence, a security that is potentially distressed for a continuous period greater than nine
months has incurred an other-than-temporary impairment. Such reliable contradictory evidence might
include, among other factors, a liquidation analysis performed by our investment advisors or
outside consultants, improving financial performance of the issuer, or valuation of underlying
assets specifically pledged to support the credit.
When we conclude that a decline is other than temporary, the security is written down to fair
value through a charge to realized investment gains and losses. We adjust the amortized cost for
securities that have experienced other-than-temporary impairments to reflect fair value at the time
of the impairment. We consider factors that lead to an other-than-temporary impairment of a
particular security in order to determine whether these conditions have impacted other similar
securities.
Of the $2.9 million of gross unrealized losses at March 31, 2006, 34 securities had a fair
value to cost or amortized cost ratio of less than 90% and had a combined unrealized loss of
approximately $35,000.
Information about unrealized gains and losses is subject to changing conditions. Securities
with unrealized gains and losses will fluctuate, as will those securities that we identify as
potentially distressed. Our current evaluation of other-than-temporary impairments reflects our
intent to hold securities for a reasonable period of time sufficient for a forecasted recovery of
fair value. However, our intent to hold certain of these securities may change in future periods
as a result of facts and circumstances impacting a specific security. If our intent to hold a
security with an unrealized loss changes, and we do not expect the security to fully recover prior
to the expected time of disposition, we will write down the security to its fair value in the
period that our intent to hold the security changes.
Realized Losses and Impairments
Realized losses include both write-downs of securities with other-than-temporary impairments
and losses from the sales of securities. During the first quarter of 2006, we wrote down four
securities by a total of approximately $155,000. Further details on the two most significant
write-downs are as follows:
|
|
|
Approximately $65,000 was a write-down on preferred stock of a U.S.
governmental agency that was continuously in an unrealized loss position for
over twelve months. The market value of the security was at 97% of its book
value at the time of the write-down, but given the length of time the security
had been continuously in an unrealized loss position, we determined the
impairment was other-than-temporary. The circumstances surrounding this
impairment did not impact any other securities in our portfolio. |
|
|
|
|
Approximately $50,000 was a write-down on bonds of a financing company
related to a U.S. car manufacturer. The car manufacturer had posted weak
operating results throughout 2005, lowered earnings projections and had been
downgraded by rating agencies. Although the financing company was very |
30
|
|
|
liquid and had never missed a payment, we determined the impairment was
other-than-temporary due to the circumstances surrounding the related car
manufacturer. We later sold this security at a value approximately equal to its
book value after the write-down. No other securities were impacted by the
circumstances surrounding this impairment. |
We did not write-down any securities during the first quarter of 2005.
Liquidity and Capital Resources
Our sources of operating funds consist primarily of premiums written and investment income.
Operating cash flow is applied primarily to the payment of claims, interest, expenses, and prepaid
federal income taxes in the form of Tax and Loss Bonds.
We generated positive cash flow from operating activities of $19.0 million in the first
quarter of 2006 compared to $20.8 million for the first quarter of 2005. The slight decrease from
2005 in cash provided by operating activities reflects our strategic
shift towards increased use of
our option to purchase properties in settlement of claims. During the first quarter of 2006,
purchases of properties as part of our loss mitigation strategy, net of sales, resulted in a cash
outflow of $4.5 million compared to a cash inflow of approximately $78,000 in the first quarter of
2005. The amount of cash outflow from the purchase of properties during the first quarter of 2006
is reflective of the limited historical use of the program, as the purchases have outnumbered the
sales. We expect to reach some level of equilibrium regarding cash flow as this program matures
and sales approximate purchases. However, we project it will remain a net use of cash for the
remainder of 2006.
Positive cash flows are invested pending future payments of claims and expenses. Our business
does not routinely require significant capital expenditures other than for enhancements to our
computer systems and technological capabilities. Cash flow shortfalls, if any, could be funded
through sales of short-term investments and other investment portfolio securities. We have no
existing lines of credit due to the sufficiency of the operating funds from the sources described
above.
The insurance laws of the State of Illinois impose certain restrictions on dividends that an
insurance subsidiary can pay the parent company. These restrictions, based on statutory accounting
practices, include requirements that dividends may be paid only out of statutory earned surplus and
that limit the amount of dividends that may be paid without prior approval of the Illinois
Insurance Department. There have been no dividends paid by the insurance subsidiaries to the
parent company. Further, there are no restrictions or requirements for capital support
arrangements between the parent company and Triad or its subsidiaries.
We cede business to captive reinsurance affiliates of certain mortgage lenders (captives),
primarily under excess of loss reinsurance agreements. Generally, reinsurance recoverables on loss
reserves and unearned premiums ceded to these captives are backed by trust funds or letters of
credit.
Total stockholders equity increased to $515.2 million at March 31, 2006 compared to
31
$499.2 million at December 31, 2005. This increase resulted primarily from net income for the
first quarter of 2006 of $18.6 million and additional paid-in-capital of $1.3 million resulting
from share-based compensation to employees and the associated tax benefit, partially offset by a
decrease in net unrealized gains on investments of $3.9 million.
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 March 31, 2006 and December 31,
2005:
|
|
|
|
|
|
|
|
|
|
|
March 31, 2006 |
|
|
December 31, 2005 |
|
Statutory policyholders surplus |
|
$ |
135.4 |
|
|
$ |
131.6 |
|
Statutory contingency reserve |
|
|
469.4 |
|
|
|
447.8 |
|
|
|
|
|
|
|
|
Total |
|
$ |
604.8 |
|
|
$ |
579.4 |
|
|
|
|
|
|
|
|
The primary difference between statutory policyholders surplus and equity computed under
generally accepted accounting principles is the statutory contingency reserve. Mortgage insurance
companies are required to add to the contingency reserve an amount equal to 50% of calendar year
earned premiums and retain the reserve for 10 years, even if the insurance is no longer in force.
Therefore, a growing company such as Triad normally has an increase in its contingency reserve
rather than in statutory surplus.
Triads ability to write insurance depends on the maintenance of its financial strength
ratings and the adequacy of its capital in relation to risk in force. A significant reduction of
capital or a significant increase in risk may impair Triads ability to write additional insurance.
A number of states also generally limit Triads risk-to-capital ratio to 25-to-1. As of March 31,
2006, Triads risk-to-capital ratio was 12.3-to-1 as compared to 12.6-to-1 at December 31, 2005.
The risk-to-capital ratio is calculated using net risk in force as the numerator and statutory
capital as the denominator. Net risk in force accounts for risk ceded under reinsurance
arrangements, including captive risk-sharing arrangements as well as any applicable stop-loss
limits and deductible amounts.
Triad is rated AA by both Standard & Poors Ratings Services and Fitch Ratings and Aa3 by
Moodys Investors Service. S&P has not changed its Negative rating outlook for the U.S. private
mortgage insurance industry that was issued in July of 2003. In December 2004, Fitch maintained
its Negative rating outlook for the U.S. private mortgage insurance industry. Currently, Fitch,
S&P, and Moodys all report a Stable ratings outlook for Triad. A reduction in Triads rating or
outlook could adversely affect our operations.
Fannie Mae has revised its approval requirements for mortgage insurers. The new rules require
prior approval by Fannie Mae for many of Triads activities and new products, allow for other
approved types of mortgage insurers rated less than AA, and give Fannie Mae increased rights to
revise the eligibility standards of mortgage insurers. We do not see any material impact on our
current or future operations as a result of the new rules, although a material impact could still
occur if Fannie Mae were to begin to utilize mortgage insurers rated below AA or revise
eligibility standards of mortgage insurers in a way that would be adverse to Triad.
32
The Office of Federal Housing Enterprise Oversight (OFHEO) issued its risk-based capital rules
for Fannie Mae and Freddie Mac in the first quarter of 2002. The regulation provides capital
guidelines for Fannie Mae and Freddie Mac in connection with their use of various types of credit
protection counterparties including a more preferential capital credit for insurance from a AAA
rated private mortgage insurer than for insurance from a AA rated private mortgage insurer. The
phase-in period for OFHEOs risk-based capital rules is ten years. We do not believe the new
risk-based capital rules had an adverse impact on our financial condition or operations through the
first quarter of 2006 or that these rules will have a significant adverse impact on our financial
condition or operations in the future. However, if the risk-based capital rules result in future
changes to the preferences of Fannie Mae and Freddie Mac regarding their use of the various types
of credit enhancements or their choice of mortgage insurers based on their credit rating, our
operations and financial condition could be significantly impacted.
Off Balance Sheet Arrangements and Aggregate Contractual Obligations
We have no material off-balance sheet arrangements at March 31, 2006.
We lease office facilities, automobiles, and office equipment under operating leases with
minimum lease commitments that range from one to ten years. We have no capitalized leases or
material purchase commitments.
Our long-term debt has a single maturity date of 2028. There have been no material changes to
the aggregate contractual obligations shown in our Form 10-K.
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
Managements Discussion and Analysis and 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:
|
§ |
|
interest rates may increase or decrease from their current levels; |
|
|
§ |
|
housing prices may increase or decrease from their current levels; |
|
|
§ |
|
housing transactions requiring mortgage insurance may decrease for many reasons
including changes in interest rates or economic conditions or alternative credit
enhancement products; |
|
|
§ |
|
our market share may change as a result of changes in underwriting criteria or
competitive products or rates; |
|
|
§ |
|
the amount of insurance written could be adversely affected by changes in federal
housing legislation, including changes in the Federal Housing Administration loan
limits and coverage requirements of Freddie Mac and Fannie Mae (Government Sponsored
Enterprises); |
|
|
§ |
|
our financial condition and competitive position could be affected by legislation
or regulation impacting the mortgage guaranty industry or the Government Sponsored
Entities, specifically, and the financial services industry in general; |
|
|
§ |
|
rating agencies may revise methodologies for determining our financial strength
ratings and may revise or withdraw the assigned ratings at any time; |
33
|
§ |
|
decreases in persistency, which are affected by loan refinancings in periods of
low interest rates, may have an adverse effect on earnings; |
|
|
§ |
|
the amount of insurance written and the growth in insurance in force or risk in
force as well as our performance may be adversely impacted by the competitive
environment in the private mortgage insurance industry, including the type,
structure, mix and pricing of our products and services and our competitors; |
|
|
§ |
|
if we fail to properly underwrite mortgage loans under contract underwriting
service agreements, we may be required to assume the costs of repurchasing those
loans; |
|
|
§ |
|
with consolidation occurring among mortgage lenders and our concentration of
insurance in force generated through relationships with significant lender
customers, our margins may be compressed and the loss of a significant customer or a
change in their business practices affecting mortgage insurance may have an adverse
effect on our earnings; |
|
|
§ |
|
our performance may be impacted by changes in the performance of the financial
markets and general economic conditions; |
|
|
§ |
|
economic downturns in regions where our risk is more concentrated could have a
particularly adverse effect on our financial condition and loss development; |
|
|
§ |
|
revisions in risk-based capital rules by the Office of Federal Housing Enterprise
Oversight for Fannie Mae and Freddie Mac could severely limit our ability to compete
against various types of credit protection counterparties, including AAA rated
private mortgage insurers; |
|
|
§ |
|
changes in the eligibility guidelines of Fannie Mae or Freddie Mac could have an
adverse effect on the Company; |
|
|
§ |
|
proposed regulation by the Department of Housing and Urban Development to exclude
packages of real estate settlement services, which may include any required mortgage
insurance premium paid at closing, from the anti-referral provisions of the Real
Estate Settlement Procedures Act could adversely affect our earnings; |
|
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§ |
|
our financial and competitive position could be affected by regulatory activity
requiring changes to mortgage industry business practices, such as captive
reinsurance. |
Accordingly, actual results may differ from those set forth in the forward-looking statements.
Attention also is directed to other risk factors set forth in documents filed by the Company with
the Securities and Exchange Commission.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Companys market risk exposures at March 31, 2006 have not materially changed from those
identified in the Form 10-K for the year ended December 31, 2005.
Item 4. Controls and Procedures
|
a) |
|
We carried out an evaluation, under the supervision and with the participation of our
management, including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO),
of the effectiveness of our disclosure controls and procedures pursuant to |
34
|
|
|
Securities Exchange Act of 1934 (Act) Rule 13a-15. Based on that evaluation, our management,
including our CEO and CFO, concluded, as of the end of the period covered by this report,
that our disclosure controls and procedures were effective. Disclosure controls and
procedures include controls and procedures designed to ensure that management, including our
CEO and CFO, is alerted to material information required to be disclosed in our filings
under the Act so as to allow timely decisions regarding our disclosures. 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 have been no changes in internal controls over financial reporting during the
first quarter of 2006 that have materially affected, or are reasonably likely to materially
affect, our internal controls over financial reporting. |
PART II. OTHER INFORMATION
Item 1.
Legal Proceedings None
Item 1A. Risk Factors
There have been no material changes with respect to the risk factors disclosed in our Annual
Report on Form 10-K for the year ended December 31, 2005.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds None
Item 3.
Defaults Upon Senior Securities None
Item 4.
Submission of Matters to a Vote of Security Holders None
Item 5.
Other Information None
Item 6.
Exhibits See exhibit index on page 37.
35
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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Date: May 10, 2006 |
|
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/s/ Kenneth S. Dwyer |
|
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Kenneth S. Dwyer
|
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Vice President and Chief Accounting Officer |
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36
EXHIBIT INDEX
|
|
|
|
|
Exhibit Number |
|
Description |
|
|
|
|
|
|
31 |
(i) |
|
Certification of Chief Executive Officer pursuant to
Exchange Act Rule 13a-14(a), as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002. |
|
|
|
|
|
31(ii)
|
|
Certification of Chief Financial Officer pursuant to
Exchange Act Rule 13a-14(a), as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002. |
|
|
|
|
|
|
32 |
|
|
Certifications of Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002. |
37