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| TGIC > SEC Filings for TGIC > Form 10-Q on 14-Nov-2012 | All Recent SEC Filings |
14-Nov-2012
Quarterly Report
Management's Discussion and Analysis of Financial Condition and Results of Operations analyzes our consolidated financial condition, changes in financial position, and results of operations for the three months and nine month periods ended September 30, 2012 and 2011. This discussion supplements Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2011, and should be read in conjunction with the interim financial statements and notes contained herein.
Certain of the statements contained in this Quarterly Report on Form 10-Q are "forward-looking statements" and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements include estimates and assumptions related to economic, competitive, regulatory, operational and legislative developments and typically are identified by use of terms such as "may," "will," "should," "could," "expect," "plan," "anticipate," "believe," "estimate," "predict," "potential," "continue" and similar words, although some forward-looking statements are expressed differently. These forward-looking statements are subject to change, uncertainty and circumstances that are, in many instances, beyond our control and they have been made based upon our current expectations and beliefs concerning future developments and their potential effect on us. Actual developments and their results could differ materially from those expected by us, depending on the outcome of a number of factors, including: the possibility that the Illinois Department of Insurance may take various actions regarding Triad if we do not operate our business in accordance with the revised financial and operating plan and the Corrective Orders, or for other reasons, including seeking receivership proceedings; our ability to operate our business in run-off and maintain a solvent run-off; our ability to continue as a going concern; the possibility of general economic and business conditions that are different than anticipated; legislative, regulatory, and other similar developments; changes in interest rates, employment rates, the housing market, the mortgage industry and the stock market; legal and other proceedings regarding modifications and refinancing of mortgages and/or foreclosure proceedings; the possibility that there will not be adequate interest in our common stock to ensure efficient pricing; and the relevant factors described in Item 1A, "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2011 and in the Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 section below, as well as in other reports and statements that we file with the Securities and Exchange Commission (the "SEC"). Forward-looking statements are based upon our current expectations and beliefs concerning future events and we undertake no obligation to update or revise any forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statements are made, except as required by the federal securities laws. Any forward-looking statements that are made are current only as of the date on which we filed this report.
Overview
Triad Guaranty Inc. ("TGI") is a holding company which, through its wholly-owned subsidiary, Triad Guaranty Insurance Corporation ("TGIC"), is a nationwide mortgage guaranty insurer pursuing a run-off of its existing in-force book of business. The term "run-off" means continuing to service existing mortgage guaranty insurance policies but not writing any new policies. Unless the context requires otherwise, references to "Triad" in this Quarterly Report on Form 10-Q refer to the operations of TGIC and its wholly-owned subsidiary, Triad Guaranty Assurance Corporation ("TGAC"). References to "we," "us," "our," and the "Company" refer collectively to the operations of TGI and Triad.
· billing and collecting premiums on policies that remain in force;
· working with borrowers in default to remedy or cure the default and/or mitigate our loss;
· reviewing policies for the existence of misrepresentation, fraud, or non-compliance with stated programs; and
· settling all legitimate filed claims per the provisions of the policies and the two Corrective Orders issued by the Department.
The term "settled," as used in this report in the context of the payment of a claim, refers to the satisfaction of Triad's obligations following the submission of valid claims by our policyholders. As required by the second Corrective Order, effective on and after June 1, 2009, valid claims are settled by a combination of 60% in cash and 40% in the form of a deferred payment obligation ("DPO"). The Corrective Orders, among other things, allow management to continue to operate Triad under the close supervision of the Department, include restrictions on the distribution of dividends or interest on surplus notes payable to TGI by Triad, and include restrictions on the payment of claims.
Recent Developments and Risks
Pending Regulatory Matters
The second Corrective Order requires Triad to set aside invested assets in an escrow account in an amount equal to the combined DPO and accrued interest thereon. The second Corrective Order also requires Triad to accrue interest on the DPO at a rate equal to Triad's investment portfolio yield as defined in the second Corrective Order. At September 30, 2012, the recorded DPO, including accrued interest of $45.7 million, amounted to $765.0 million, which exceeded the cash and invested assets of Triad at that date. We previously reported to the Department that as of August 31, 2012, the aggregate amount of the DPO liability exceeded the cash and invested assets of Triad that were available for segregation in a separate account. Accordingly, Triad was not in compliance with this provision of the second Corrective Order as of August 31, 2012. We have asked the Department to amend, modify or otherwise waive compliance with this provision of the second Corrective Order. In addition, we have requested that the calculation of the interest on the DPO prescribed in the second Corrective Order be amended to limit the amount to a maximum equal to the actual aggregate net investment income that Triad earns rather than an amount based on the effective rate earned by Triad on its investments.
In response to Triad's requests for these modifications to the second Corrective Order, the Department held a public hearing on September 10, 2012, and invited Triad and its policyholders to provide testimony regarding these proposed amendments. In addition, the Department invited Triad and its policyholders to provide testimony as to whether Triad should be permitted to continue to run off its existing book of insurance business or whether the Department should implement a different regulatory approach, including receivership proceedings for the conservation, rehabilitation or liquidation of Triad. The Department extended the period for comments and written testimony on these matters until November 30, 2012.
Impact of Expense Reimbursements on TGI's Liquidity
TGI is the public company whose stock is traded on the OTC Markets Group's OTCQB tier ("Pink Sheets") under the symbol "TGIC". TGI owns Triad, which is its only operating subsidiary. Aside from its ownership of Triad, TGI's assets at September 30, 2012 total approximately $1.0 million, which consisted primarily of cash holdings, compared to $1.3 million at June 30, 2012 and $1.5 million at December 31, 2011. The remainder of the $820.6 million of assets reported on the September 30, 2012 consolidated balance sheet presented in this Form 10-Q are the assets of Triad. TGI currently has no outstanding debt or other known material liabilities other than potential liabilities and costs of defense associated with the pending securities law class action litigation described under "Legal Proceedings" elsewhere in this Form 10-Q.
As previously reported, TGI has explored strategies to acquire complementary
profitable businesses and utilize the net operating loss carryforwards ("NOLs")
that were generated on a consolidated basis with Triad in order to increase its
future value for the benefit of its stockholders as well as provide a limited
benefit for Triad policyholders. Tax laws related to the use of NOLs
effectively preclude TGI from raising material amounts of equity capital because
such a transaction would likely materially impair the value of the NOLs. To
date, TGI has been unsuccessful in identifying a viable acquisition candidate.
Given the limited amount of cash remaining at TGI and its inability to raise
additional funds, no assurance can be given that TGI will ever be successful in
implementing such a strategy.
Given its current financial condition, we do not believe TGI would be able to
successfully access the capital markets to obtain long-term or short-term debt
or equity financing. TGI's primary source of revenue is the reimbursement of
expenses from Triad. Investment income from TGI's cash holdings is immaterial.
Triad is prohibited from paying dividends or distributing assets to TGI without
the approval of the Department. We believe that, absent significant positive
changes in the economy and the residential real estate market, Triad's existing
assets combined with its future premiums will not be sufficient to meet Triad's
current and future policyholder obligations. Therefore, none of Triad's assets
would be available to TGI and its stockholders other than to reimburse certain
TGI expenses incurred on behalf of Triad, but only if approved by the
Department. Accordingly, the ultimate value of TGI could be considered its cash
holdings, which will decline over time to the extent its future expenses are not
reimbursed by Triad. Since September 30, 2012, TGI's cash holdings have
declined further from $1.0 million to approximately $750,000 as of the date of
this Form 10-Q.
This will ultimately cause TGI to commence winding up its business and liquidating through a Chapter 11 bankruptcy proceeding or through other liquidation proceedings. A final decision by the Department to cease allowing Triad to reimburse TGI's expenses will likely leave TGI with no alternative other than to commence such a proceeding. See Item 1A, "Risk Factors" in the Company's Annual Report on Form 10-K for the year ended December 31, 2011 for more information.
Legal Matters
On September 4, 2009, Triad filed a complaint against American Home Mortgage ("AHM") in the United States Bankruptcy Court for the District of Delaware seeking rescission of multiple master mortgage guaranty insurance policies ("master policies") and declaratory relief. The complaint sought relief from AHM as well as all owners of loans insured under the master policies by way of a defendant class action. Triad continued to accept premiums and process claims under the master policies, with the earned premiums and settled losses reflected in the Consolidated Statements of Comprehensive Loss. However, as a result of the litigation, Triad ceased remitting claim payments to companies servicing loans originated by AHM and the liability for losses settled but not paid is included in "Accrued expenses and other liabilities" on the Consolidated Balance Sheets. On August 27, 2012, Triad's complaint was dismissed on jurisdictional grounds. Triad continues to accept premiums and process claims under the master policies and accrue the claim payments. If Triad does not institute new proceedings in state or federal court to rescind coverage under the master policies, Triad will be required to pay the accrued claim payments, which total approximately $83 million, in the fourth quarter of 2012 or the first quarter of 2013. Triad currently has adequate liquidity to fund this payment.
We have been in mediation with Countrywide in an effort to settle its lawsuit filed against us alleging breach of contract. We have agreed to a proposed settlement, which is subject to regulatory approval by the Department. In connection with the proposed settlement, we have voluntarily suspended rescissions of coverage related to loans originated by Countrywide and that would be included in the settlement. We cannot predict whether the Department will approve this settlement or the impact on Triad if the Department fails to approve the settlement and the litigation is restarted. See "Legal Proceedings" elsewhere in this Form 10-Q.
We have historically provided Primary and Modified Pool mortgage guaranty
insurance coverage on U.S. residential mortgage loans. We classify a policy as
Primary insurance when the policy is not part of a structured bulk transaction
that includes an aggregate stop-loss limit applied to the entire group of loans.
We classify all other insurance as Modified Pool insurance. Policies insured as
part of a Modified Pool transaction have individual coverage but there is an
aggregate stop-loss limit applied to the entire group of insured loans.
Our insurance remains effective until one of the following events occurs: the policy is cancelled at the insured's request; we terminate the policy for non-payment of premium; the policy defaults and we satisfy our obligations under the insurance contract; or we rescind or deny coverage under the policy for violations of provisions of a master policy. Additionally, coverage may be cancelled on certain Modified Pool transactions if pre-determined aggregate stop loss limits are met, or if coverage is reduced to a de minimus amount of the initial amount insured or, for some contracts, ten years from the date of the contract.
Persistency, which measures the percentage of insurance in force remaining from one-year prior, is an important metric in understanding our future premium revenue. The longer a policy remains on our books, or "persists", the greater the amount of total premium revenue we will earn from the policy.
In run-off, our revenues principally consist of earned renewal premiums, which are reported net of reinsurance premiums ceded to captive reinsurers and premium refunds paid or accrued related primarily to rescissions, and investment income. We also realize investment gains and investment losses on the sale and impairment of securities, with the net gain or loss reported as a component of revenue.
In run-off, our expenses consist primarily of: settled claims (including loss adjustment expenses) net of any losses ceded to captive reinsurers; changes in reserves for estimated future claim payments on loans that are currently in default (including new defaults that are reported during the period) net of any reserves ceded to captive reinsurers; general and administrative costs of servicing existing policies; other general business expenses; and interest expense on the DPO.
As we are operating in run-off and are issuing no new insurance commitments, our future results of operations largely depend on the amount of future premium that we earn less the amount of losses that we incur each period on the new defaults reported to us. In addition, our results may be significantly impacted by the favorable or adverse development of our loss reserves. Our results from operations will benefit if we are able to settle our loss reserves at a lesser amount than that reported on our balance sheet through loss mitigation, litigation and settlements with servicers. Conversely, our results from operations will be negatively impacted if the settled losses are greater than the loss reserves provided. Our results of operations also depend on a number of other factors, many of which are not under our control. These factors include:
· the conditions of the housing, mortgage and capital markets that have a direct impact on default rates, loss mitigation efforts, cure rates, and ultimately, the amount of claims settled;
· the overall general state of the economy and job market;
· persistency levels on our remaining insurance in force; and
· operating efficiencies.
Our results of operations in run-off could also be impacted by Federal government and private initiatives to limit foreclosures through loan modifications, refinancing mortgages at lower interest rates, or debt forgiveness. See the discussion below for further details on these initiatives. Lastly, our results of operations in run-off could be materially affected by our ability to recognize benefits from our NOL carryforwards.
To better comprehend our financial position and results of operations, it is important to understand the difference between accounting principles generally accepted in the United States of America ("GAAP") and statutory accounting principles ("SAP") applicable to insurance companies and how we use these accounting principles.
As an insurance company, Triad is required to file financial statements prepared
in accordance with SAP with the Department as well as the insurance departments
of the states in which it conducts business. The financial statements for Triad
that are provided to the Department and that form the basis for our corrective
plan required by the Corrective Orders are prepared in accordance with SAP as
set forth in the Illinois Insurance Code or prescribed by the Department.
However, the Company prepares its financial statements presented in this
Quarterly Report on Form 10-Q and in our other SEC filings in conformity with
GAAP. The primary difference between GAAP and SAP for Triad at September 30,
2012 was the reporting requirements relating to the establishment of the DPO
stipulated in the second Corrective Order, which is described below.
A deficit in assets occurs when recorded liabilities exceed recorded assets in financial statements prepared under GAAP. A deficiency in policyholders' surplus occurs when recorded liabilities exceed recorded assets in financial statements prepared under SAP. A deficit in assets at any particular point in time under GAAP is not necessarily a measure of insolvency. However, we believe that if Triad were to report a deficiency in policyholders' surplus under SAP for an extended period of time, Illinois law may require the Department to seek receivership of Triad, which could compel TGI to institute a proceeding seeking relief from creditors under U.S. bankruptcy laws, or otherwise consider dissolution of the Company. The second Corrective Order was designed in part to help Triad maintain its policyholders' surplus.
Corrective Orders
Triad has entered into two Corrective Orders with the Department as detailed below and in the Company's Annual Report on Form 10-K for the year ended December 31, 2011. Among other things, the Corrective Orders:
· Require oversight by the Department on substantially all operating matters;
· Prohibit stockholder dividends from Triad to TGI without the prior approval of the Department;
· Prohibit the accrual of interest and the payment of interest and principal on Triad's surplus note to TGI without the prior approval of the Department;
· Restrict Triad from making any payments or entering into any transaction that involves the transfer of assets to, or liabilities from, any affiliated parties without the prior approval of the Department;
· Require Triad to obtain prior written approval from the Department before entering into certain transactions with unaffiliated parties;
· Require that all valid claims under Triad's mortgage guaranty insurance policies are settled 60% in cash and 40% by recording a DPO;
· Require the accrual of simple interest on the DPO at the same average net rate earned by Triad's investment portfolio; and
· Require that loss reserves in financial statements prepared in accordance with SAP be established to reflect the cash portion of the estimated claim settlement but not the DPO.
The recording of a DPO does not impact reported settled losses as we continue to report the entire amount of a claim in our statements of comprehensive loss under both bases of accounting. The accounting treatment for the recording of DPOs on our balance sheet on a SAP basis is similar to a surplus note that is reported as a component of statutory surplus, which serves to increase reported statutory surplus. However, in our financial statements prepared in accordance with GAAP included in this report, the DPOs and related accrued interest are reported as a liability. At September 30, 2012, the cumulative effect of the DPO requirement on statutory policyholders' surplus, including the impact of establishing loss reserves at anticipated cash payment rather than the estimated full claim amount, was to increase statutory policyholders' surplus by $1.1 billion over the amount that would have been reported absent the second Corrective Order. The cumulative increase to statutory policyholders' surplus of the DPO requirement was $967.5 million at December 31, 2011. There was no such impact to loss reserves or stockholders' deficit calculated on a GAAP basis which is the primary reason for the reported deficit in assets. Any repayment of the DPO or the associated accrued interest is dependent on the financial condition and future prospects of Triad and is subject to the approval of the Department.
The second Corrective Order provides financial thresholds, specifically regarding the statutory risk-to-capital ratio and the level of statutory policyholders' surplus that, if met, may indicate that the Department should reduce the DPO percentage and/or require distributions to DPO holders. In January 2012, the Department notified Triad that as of December 31, 2011, based upon Triad's surplus position, risk-to-capital ratio and the continued economic uncertainty, the Department determined that no change to the DPO percentage was in order nor would it be appropriate for Triad to make a distribution to the DPO holders.
Failure to comply with the provisions of the Corrective Orders or any other violation of the Illinois Insurance Code may result in the imposition of fines or penalties or subject Triad to further legal proceedings, including the institution by the Department of receivership proceedings for the conservation, rehabilitation, or liquidation of Triad. Any such actions would likely lead TGI to institute a proceeding seeking relief from creditors under U.S. bankruptcy laws, or otherwise consider dissolution of the Company. See Item 1A, "Risk . . .
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