##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-Q [X]
    
    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934For the quarterly period ended September 30, 2004
 or [  ]
    
    Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934For the transition period from    to
 Commission File Number 0-22342   Triad Guaranty Inc.  Delaware
    
    56-1838519(State of Incorporation)
    
    (I.R.S. Employer Identification Number)
 101 South Stratford Road
Winston-Salem, North Carolina 27104
(Address of principal executive offices) (336) 723-1282
(Registrants telephone number, including area code)   Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past
90 days.    Yes [X] No [  ] Indicate by check mark whether the registrant is an accelerated filer (as
described in Exchange Act Rule 12b-2)    Yes
[X] No [  ] Number of shares of Common Stock, $.01 par value, outstanding as of October 15,
2004:
14,548,522 shares.




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##### Table of Contents



TRIAD GUARANTY INC. INDEX PageNumberPart I. Financial Information:Item 1.Financial Statements:Consolidated Balance Sheets as of September 30, 2004 (Unaudited)
and December 31, 2003
    
    
    1Consolidated Statements of Income for the Three and Nine Months
Ended September 30, 2004 and 2003 (Unaudited)
    
    
    2Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2004 and 2003 (Unaudited)
    
    
    3Notes to Consolidated Financial Statements
    
    
    4Item 2.Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    8Item 3.Quantitative and Qualitative Disclosures about Market Risk
    
    
    28Item 4.Controls and Procedures
    
    
    28Part II. Other Information:Item 1.Legal Proceedings
    
    
    30Item 2.Changes in Securities and Use of Proceeds
    
    
    30Item 3.Defaults Upon Senior Securities
    
    
    30Item 4.Submission of Matters to a Vote of Security Holders
    
    
    30Item 5.Other Information
    
    
    30Item 6.Exhibits and Reports on Form 8-K
    
    
    30Signature
    
    
    30Ex-31(i)Ex-31(ii)Ex-32




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PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements TRIAD GUARANTY INC. 
 CONSOLIDATED BALANCE SHEETS
 September 30
    
    December 312004
    
    2003(Dollars in thousands except share information)
    
    (Unaudited)AssetsInvested assets:Fixed maturities, available-for-sale, at fair value
    
    $
    439,529
    
    
    $
    375,097Equity securities, available-for-sale, at fair value
    
    
    11,844
    
    
    
    12,771Short-term investments
    
    
    13,581
    
    
    
    25,659464,954
    
    
    
    413,527Cash
    
    
    6,579
    
    
    
    973Real estate
    
    
    
    
    
    
    146Accrued investment income
    
    
    5,728
    
    
    
    4,575Deferred policy acquisition costs
    
    
    32,177
    
    
    
    29,363Prepaid federal income taxes
    
    
    112,405
    
    
    
    98,124Property and equipment
    
    
    9,453
    
    
    
    9,369Reinsurance recoverable
    
    
    1,311
    
    
    
    881Other assets
    
    
    14,358
    
    
    
    18,621Total assets
    
    $
    646,965
    
    
    $
    575,579Liabilities and stockholders equityLiabilities:Losses and loss adjustment expenses
    
    $
    32,547
    
    
    $
    27,186Unearned premiums
    
    
    14,724
    
    
    
    15,629Amounts payable to reinsurer
    
    
    4,287
    
    
    
    3,243Current taxes payable
    
    
    720
    
    
    
    6Deferred income taxes
    
    
    132,003
    
    
    
    115,459Unearned ceding commission
    
    
    316
    
    
    
    669Long-term debt
    
    
    34,491
    
    
    
    34,486Accrued interest on debt
    
    
    584
    
    
    
    1,275Accrued expenses and other liabilities
    
    
    9,059
    
    
    
    7,696Total liabilities
    
    
    228,731
    
    
    
    205,649Commitments and contingent liabilities  Note 4Stockholders equity:Preferred stock, par value $.01 per share  authorized
1,000,000 shares; no shares issued and outstanding
    
    
    
    
    
    
    Common stock, par value $.01 per share  authorized
32,000,000 shares; issued and outstanding 14,547,502 shares
at September 30, 2004 and 14,438,637 shares at December 31, 2003
    
    
    145
    
    
    
    144Additional paid-in capital
    
    
    91,841
    
    
    
    87,513Accumulated other comprehensive income, net of income tax
liability of $6,798 at September 30, 2004 and $6,025 at
December 31, 2003
    
    
    12,626
    
    
    
    11,190Deferred compensation
    
    
    (1,804
    )
    
    
    (1,128
    )Retained earnings
    
    
    315,426
    
    
    
    272,211Total stockholders equity
    
    
    418,234
    
    
    
    369,930Total liabilities and stockholders equity
    
    $
    646,965
    
    
    $
    575,579
 See accompanying notes. 1




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TRIAD GUARANTY INC. 
 CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
 Three Months Ended
    
    Nine Months EndedSeptember 30
    
    September 302004
    
    2003
    
    2004
    
    2003(Dollars in thousands except share information)Revenue:Premiums written:Direct
    
    $
    45,453
    
    
    $
    40,448
    
    
    $
    128,798
    
    
    $
    112,352Ceded
    
    
    (9,137
    )
    
    
    (7,329
    )
    
    
    (25,859
    )
    
    
    (19,713
    )Net premiums written
    
    
    36,316
    
    
    
    33,119
    
    
    
    102,939
    
    
    
    92,639Change in unearned premiums
    
    
    (497
    )
    
    
    (2,796
    )
    
    
    875
    
    
    
    (5,918
    )Earned premiums
    
    
    35,819
    
    
    
    30,323
    
    
    
    103,814
    
    
    
    86,721Net investment income
    
    
    5,255
    
    
    
    4,229
    
    
    
    14,439
    
    
    
    12,895Net realized investment gains (losses)
    
    
    (142
    )
    
    
    763
    
    
    
    416
    
    
    
    1,528Other income
    
    
    5
    
    
    
    4
    
    
    
    10
    
    
    
    2040,937
    
    
    
    35,319
    
    
    
    118,679
    
    
    
    101,164Losses and expenses:Net losses and loss adjustment expenses
    
    
    9,234
    
    
    
    6,053
    
    
    
    25,818
    
    
    
    16,698Interest expense on debt
    
    
    693
    
    
    
    693
    
    
    
    2,079
    
    
    
    2,079Amortization of deferred policy acquisition costs
    
    
    3,670
    
    
    
    5,315
    
    
    
    10,305
    
    
    
    12,757Other operating expenses (net of acquisition
costs deferred)
    
    
    6,699
    
    
    
    5,528
    
    
    
    19,768
    
    
    
    16,53720,296
    
    
    
    17,589
    
    
    
    57,970
    
    
    
    48,071Income before income taxes
    
    
    20,641
    
    
    
    17,730
    
    
    
    60,709
    
    
    
    53,093Income taxes:Current
    
    
    571
    
    
    
    181
    
    
    
    1,723
    
    
    
    534Deferred
    
    
    5,274
    
    
    
    5,002
    
    
    
    15,771
    
    
    
    15,0295,845
    
    
    
    5,183
    
    
    
    17,494
    
    
    
    15,563Net income
    
    $
    14,796
    
    
    $
    12,547
    
    
    $
    43,215
    
    
    $
    37,530Earnings per common and common equivalent share:Basic
    
    $
    1.02
    
    
    $
    .87
    
    
    $
    2.98
    
    
    $
    2.63Diluted
    
    $
    1.00
    
    
    $
    .86
    
    
    $
    2.94
    
    
    $
    2.59Shares used in computing earnings per common and
common equivalent share:Basic
    
    
    14,546,950
    
    
    
    14,352,980
    
    
    
    14,502,782
    
    
    
    14,284,781Diluted
    
    
    14,747,667
    
    
    
    14,558,548
    
    
    
    14,712,675
    
    
    
    14,470,056
 See accompanying notes. 2




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TRIAD GUARANTY INC. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 Nine Months EndedSeptember 30(Dollars in thousands)
    
    2004
    
    2003Operating activitiesNet income
    
    $
    43,215
    
    
    $
    37,530Adjustments to reconcile net income to net cash provided by
operating activities:Loss, loss adjustment expenses and unearned premium reserves
    
    
    4,456
    
    
    
    10,139Accrued expenses and other liabilities
    
    
    1,363
    
    
    
    (1,930
    )Current taxes payable
    
    
    714
    
    
    
    623Amounts due to/from reinsurer
    
    
    614
    
    
    
    (1,084
    )Accrued investment income
    
    
    (1,153
    )
    
    
    (894
    )Policy acquisition costs deferred
    
    
    (13,119
    )
    
    
    (13,624
    )Amortization of deferred policy acquisition costs
    
    
    10,305
    
    
    
    12,757Net realized investment gains
    
    
    (416
    )
    
    
    (1,528
    )Provision for depreciation
    
    
    2,417
    
    
    
    2,132Accretion of discount on investments
    
    
    (689
    )
    
    
    (2,852
    )Deferred income taxes
    
    
    15,771

    
    
    
    15,029Prepaid federal income taxes
    
    
    (14,281
    )
    
    
    (14,905
    )Unearned ceding commission
    
    
    (353
    )
    
    
    (537
    )Real estate acquired in claim settlement
    
    
    146
    
    
    
    1,350Accrued interest on debt
    
    
    (691
    )
    
    
    (691
    )Other assets
    
    
    4,263
    
    
    
    (2,517
    )Other operating activities
    
    
    (616
    )
    
    
    512Net cash provided by operating activities
    
    
    51,946
    
    
    
    39,510Investing activitiesSecurities available-for-sale:Purchases  fixed maturities
    
    
    (128,900
    )
    
    
    (82,157
    )Sales  fixed maturities
    
    
    70,703
    
    
    
    58,538Purchases  equities
    
    
    (370
    )
    
    
    (1,744
    )Sales  equities
    
    
    854
    
    
    
    914Net change in short-term investments
    
    
    12,078
    
    
    
    (13,034
    )Purchases of property and equipment
    
    
    (2,501
    )
    
    
    (1,842
    )Net cash used in investing activities
    
    
    (48,136
    )
    
    
    (39,325
    )Financing activitiesProceeds from exercise of stock options
    
    
    1,796
    
    
    
    3,853Net cash provided by financing activities
    
    
    1,796
    
    
    
    3,853Net change in cash
    
    
    5,606
    
    
    
    4,038Cash at beginning of period
    
    
    973
    
    
    
    233Cash at end of period
    
    $
    6,579
    
    
    $
    4,271Supplemental schedule of cash flow informationCash paid during the period for:Income taxes and United States Mortgage Guaranty Tax and Loss Bonds
    
    $
    15,488
    
    
    $
    15,723Interest
    
    
    2,765
    
    
    
    2,765
 See accompanying notes. 3




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TRIAD GUARANTY INC. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
 NOTE 1  THE COMPANY Triad Guaranty Inc. (the Company) is a holding company which, through
its wholly owned subsidiary, Triad Guaranty Insurance Corporation, provides
residential private mortgage insurance coverage in the United States to
mortgage lenders and investors to protect the lender or investor against loss
from defaults on low down payment residential mortgage loans and to facilitate
the sale of mortgage loans in the secondary market. NOTE 2  ACCOUNTING POLICIES AND BASIS OF PRESENTATION Basis of Presentation The accompanying unaudited consolidated financial
statements have been prepared in accordance with accounting principles
generally accepted in the United States 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 and nine months ended September
30, 2004 are not necessarily indicative of the results that may be expected for
the year ending December 31, 2004. 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, 2003. Stock Options Currently, the Company grants stock options to employees
for a fixed number of shares with an exercise price equal to or greater than
the fair value of the shares at the date of grant. The Company accounts for
stock option grants using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and
accordingly, recognizes no compensation expense for the stock option grants. 4




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For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options vesting period. Had
compensation expense for stock options been recognized using the fair value
method on the grant date, net income and earnings per share on a pro forma
basis would have been (in thousands, except for earnings per share
information): Three Months Ended
    
    Nine Months EndedSeptember 30
    
    September 302004
    
    2003
    
    2004
    
    2003Net income  as reported
    
    $
    14,796
    
    
    $
    12,547
    
    
    $
    43,215
    
    
    $
    37,530Net income  pro forma
    
    $
    14,675
    
    
    $
    12,408
    
    
    $
    42,832
    
    
    $
    37,046Earnings per share  as reported:Basic
    
    $
    1.02
    
    
    $
    0.87
    
    
    $
    2.98
    
    
    $
    2.63Diluted
    
    $
    1.00
    
    
    $
    0.86
    
    
    $
    2.94
    
    
    $
    2.59Earnings per share  pro forma:Basic
    
    $
    1.01
    
    
    $
    0.86
    
    
    $
    2.95
    
    
    $
    2.59Diluted
    
    $
    0.99
    
    
    $
    0.85
    
    
    $
    2.91
    
    
    $
    2.56
 NOTE 3  CONSOLIDATION The consolidated financial statements include Triad Guaranty Inc. and its
wholly owned subsidiary, Triad Guaranty Insurance Corporation (Triad), and
Triads wholly owned subsidiaries, Triad Guaranty Assurance Corporation and
Triad Re Insurance Corporation (collectively referred to as the Company). All
significant intercompany accounts and transactions have been eliminated. NOTE 4  COMMITMENTS AND CONTINGENT LIABILITIES Reinsurance Triad cedes certain premiums and losses to reinsurers under
various reinsurance agreements, the majority of which are captive reinsurance
agreements with 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 when and if deemed uncollectible. 5




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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 September 30, 2004 and
December 31, 2003, 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 and by applicable stop-loss limits,
based on the original insured amount of the loan. Triads ratio is as follows
(dollars in thousands): September 30
    
    December 312004
    
    2003Net risk
    
    $
    6,956,333
    
    
    $
    6,590,222Statutory capital and surplus
    
    $
    131,310
    
    
    $
    128,212Statutory contingency reserve
    
    
    351,972
    
    
    
    302,740Total
    
    $
    483,282
    
    
    $
    430,952Risk-to-capital ratio
    
    14.4-to-1
    
    15.3-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 $57.9 million and $51.0 million for the nine months ended September
30, 2004 and 2003, respectively, and $69.8 million for the year ended December
31, 2003. At September 30, 2004 and December 31, 2003, the amount of Triads equity
that could be paid out in dividends to stockholders was $47.6 million and $44.5
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 with respect to loans reported to be in
default and loans in default which have not been reported to the Company.
Reserves are established by management using estimated claim rates (frequency)
and claim amounts (severity) to estimate ultimate losses. The reserving process
gives effect to current economic conditions and profiles delinquencies by such
factors as policy year, geography, chronic late payment characteristics and
age. Due to the inherent uncertainty in estimating reserves for losses and loss
adjustment expenses, there can be no assurance that the reserves will prove to
be adequate to cover ultimate loss development. 6




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Litigation- A lawsuit has been filed against the Company in the ordinary
course of the Companys business alleging violations of the Fair Credit
Reporting Act. 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. A previous lawsuit filed against the Company alleging violations of the
Real Estate Settlement Procedures Act was settled on August 11, 2004 for an
immaterial amount. NOTE 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 effect of stock options 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. NOTE 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 September 30, 2004 and 2003, the Companys comprehensive
income was $23.6 million and $8.7 million, respectively. For the nine months
ended September 30, 2004 and 2003, comprehensive income totaled $44.7 million
and $39.3 million, respectively. NOTE 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. 7




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Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations Managements 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 month and nine month periods
ended September 30, 2004 and 2003, of Triad Guaranty Inc. and its consolidated
subsidiaries, collectively the Company. The discussion supplements
Managements Discussion and Analysis in Form 10-K for the year ended December
31, 2003 and should be read in conjunction with the interim financial
statements and notes contained therein. 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. There can be no
assurance that future developments will be in accordance with our expectations
or that the effect of future developments on the Company will be those
anticipated by us. Actual 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 or regulatory developments, changes in interest rates
or the stock markets, stronger than anticipated competitive activity, and the
factors described in the forward-looking statements. Update on Critical Accounting Estimates Our Form 10-K describes the accounting policies that are critical to the
understanding of our results of operations and our financial position. 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 nine months of 2004. Overview Through our subsidiaries, we provide mortgage guaranty insurance coverage
to residential mortgage lenders and investors in the United States as a
credit-enhancement vehicle, typically when individual borrowers have less than
20% equity in the property. 8




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Mortgage guaranty insurance also facilitates the sale of individual low
down payment loans in the secondary market and provides protection to lenders
who choose to keep the loans. Business originated by lenders and submitted to
us on a loan-by-loan basis is referred to as flow business. Premiums on flow
business can be either lender paid or borrower paid, although the majority is
borrower paid. 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 secondary market. This business is
referred to as structured bulk business. We derive our revenues principally from 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 essentially consist of a) amounts ultimately paid on claims
submitted, b) increases 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. For a more detailed description of our industry and operations, refer to
the Business section of our Form 10-K. 9




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Consolidated Results of Operations Following is a summary of our results for the three months and nine months
ended September 30, 2004 and 2003 (in thousands except per share information)
along with a column indicating the favorable or unfavorable change from 2003: Three Months Ended
    
    Nine Months EndedSeptember 30
    
    September 30Favorable/
    
    
    
    
    
    
    
    
    
    Favorable/2004
    
    2003
    
    (Unfavorable)
    
    2004
    
    2003
    
    (Unfavorable)Earned premiums
    
    $
    35,819
    
    
    $
    30,323
    
    
    
    18.1
    %
    
    $
    103,814
    
    
    $
    86,721
    
    
    
    19.7
    %Net investment income
    
    
    5,255
    
    
    
    4,229
    
    
    
    24.3
    
    
    
    14,439
    
    
    
    12,895
    
    
    
    12.0Net realized investment
(losses)/gains
    
    
    (142
    )
    
    
    763
    
    
    
    (118.6
    )
    
    
    416
    
    
    
    1,528
    
    
    
    (72.8
    )Other income
    
    
    5
    
    
    
    4
    
    
    
    25.0
    
    
    
    10
    
    
    
    20
    
    
    
    (50.0
    )Total revenues
    
    
    40,937
    
    
    
    35,319
    
    
    
    15.9
    
    
    
    118,679
    
    
    
    101,164
    
    
    
    17.3Net losses and loss
adjustment expenses
    
    
    9,234
    
    
    
    6,053
    
    
    
    (52.6
    )
    
    
    25,818
    
    
    
    16,698
    
    
    
    (54.6
    )Interest expense on debt
    
    
    693
    
    
    
    693
    
    
    
    
    
    
    
    2,079
    
    
    
    2,079
    
    
    
    Amortization of deferred
policy acquisition costs
    
    
    3,670
    
    
    
    5,315
    
    
    
    31.0
    
    
    
    10,305
    
    
    
    12,757
    
    
    
    19.2Other operating expenses
(net of acquisition costs
deferred)
    
    
    6,699
    
    
    
    5,528
    
    
    
    (21.2
    )
    
    
    19,768
    
    
    
    16,537
    
    
    
    (19.5
    )Income before income taxes
    
    
    20,641
    
    
    
    17,730
    
    
    
    16.4
    
    
    
    60,709
    
    
    
    53,093
    
    
    
    14.3Income taxes
    
    
    5,845
    
    
    
    5,183
    
    
    
    (12.8
    )
    
    
    17,494
    
    
    
    15,563
    
    
    
    (12.4
    )Net income
    
    $
    14,796
    
    
    $
    12,547
    
    
    
    17.9
    %
    
    $
    43,215
    
    
    $
    37,530
    
    
    
    15.1
    %Diluted earnings per share
    
    $
    1.00
    
    
    $
    0.86
    
    
    
    16.3
    %
    
    $
    2.94
    
    
    $
    2.59
    
    
    
    13.5
    %
 Our results for the three months and nine months ended September 30, 2004
were again positively impacted by improvements in persistency levels. The
quarterly persistency run rate, which we define as the annualized percentage of
insurance in force remaining from the end of the prior quarter excluding
business written in the current year, was 63.0% for the third quarter of 2004
compared to 19.3% for the third quarter of 2003. Increased persistency affects
our net income primarily in two ways: a) renewal earned premiums increase and
b) expenses decrease because of reduced amortization of DAC. Losses and loss adjustment expenses for the third quarter of 2004
increased 52.6% over the third quarter of 2003 and 54.6% for the nine months
ended September 30, 2004 over the same period of 2003, primarily due to the
significant growth and continued seasoning of our insurance in force. Low levels of
persistency during 2003 and 2002 have resulted in a book of business that is
relatively unseasoned. Experience has shown that the highest claims incidence
usually occurs three to six years after the policy is written. As our
book of business ages, we anticipate this increase in claims to
continue, and we expect an increase in the severity of losses as well. 10




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##### Table of Contents



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. Three Months Ended September 30, 2004 Compared to Three Months Ended September
30, 2003 Net income increased 17.9% for the third quarter of 2004 over the third
quarter of 2003 driven by an 18.1% increase in earned premiums combined with a
31.0% decrease in the amortization of DAC. Realized investment losses after
taxes reduced third quarter 2004 income by $0.01 per share on a diluted basis,
compared to a contribution from realized investment gains after taxes of $0.03
per share contribution on a diluted basis for the third quarter of 2003.
Diluted realized gains and losses per 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. Production and In Force Total insurance written in the third quarter of 2004 decreased 39.4% to
$4.0 billion from $6.6 billion for the same period of 2003. Total insurance
written includes insurance written from flow production and structured bulk
transactions. Flow insurance written for the third quarter of 2004 decreased 46.0% to
$2.7 billion from $5.0 billion in the third quarter of 2003. Refinancing
activity was very strong during the third quarter of 2003 as interest rates
remained near record lows. Refinances comprised 22.0% of our flow insurance
written in the third quarter of 2004 compared to 52.3% for the third quarter of
2003. Loan originations for the entire industry have declined in 2004 because
of a drop in refinancing activity. Further, the continued expansion of
alternative credit enhancements such as 80/10/10 structures (a combination of
an 80% first mortgage loan, a 10% second mortgage loan usually issued by the
same lender, and a 10% down payment) continues to erode the mortgage insurance
industrys overall penetration into the mortgage marketplace. Insurance written in the third quarter of 2004 attributable to structured
bulk transactions decreased to $1.3 billion from $1.6 billion in the same
period of 2003. Insurance written attributed to structured bulk transactions
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. 11




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##### Table of Contents



The following table provides estimates of our national market share of net
new primary insurance written based on preliminary information available from
the industry association and other public sources: Three Months EndedSeptember 302004
    
    2003Flow business
    
    
    4.9
    %
    
    
    5.1
    %Structured bulk transactions
    
    
    8.2
    %
    
    
    7.3
    %Total
    
    
    5.5
    %
    
    
    5.4
    %
 Our market share of flow business declined slightly in the third quarter
of 2004 from the third quarter of 2003 due to the decline in production of a
product driven primarily by the refinance segment. The increase in our
structured bulk transactions market share shown above was the result of the
greater availability of transactions that met our credit quality and pricing
benchmarks. 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 loans insurance effective date. However, the policies are not reflected
in our in force, insurance written, or related industry data totals until the
loan level detail is reported to us. At September 30, 2004, there were $67
million of structured bulk transactions with effective dates within the third
quarter for which loan level detail had not been received. These transactions
will be reflected as new production and included in related in force data in
the fourth quarter of 2004. As of September 30, 2003, there were $1.2 billion
of structured bulk transactions for which the loan level detail had not been
received. Premium written and premium earned for the third quarter of 2003
include the respective amounts due and earned related to this insurance, while
these amounts were reported as new production and insurance in force in the
fourth quarter of 2003. Total direct insurance in force reached $35.8 billion at September 30,
2004, compared to $31.7 billion at December 31, 2003, and $29.3 billion at
September 30, 2003, as a result of continued production and an improvement in
persistency. 12




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##### Table of Contents



The following table shows our persistency trends since September 30, 2003: Annual
    
    Quarterly PersistencyPersistency
    
    Run RateSeptember 30, 2004
    
    
    66.8
    %
    
    
    63.0
    %June 30, 2004
    
    
    59.9
    %
    
    
    56.9
    %March 31, 2004
    
    
    54.6
    %
    
    
    68.5
    %December 31, 2003
    
    
    50.7
    %
    
    
    46.3
    %September 30, 2003
    
    
    49.0
    %
    
    
    19.3
    %
 As mentioned earlier, the primary driver of our increasing persistency
rates has been the general rise in mortgage interest rates that has led to a
corresponding decline in refinancing activity. The credit quality of our existing insurance in force portfolio has
remained relatively consistent despite a 22.2% growth in direct insurance in
force from September 30, 2003 to September 30, 2004. As shown below, the
credit quality of our structured bulk business at September 30, 2004 has
improved over September 30, 2003 as we have focused our efforts on structured
transactions consisting of higher quality loans. Fair, Isaac and Co., Inc.
(FICO) credit scores are one of the major factors used in determining credit
risk in an existing book of business. The following table presents the FICO
credit score distribution of our risk in force for both flow and structured
bulk business at September 30, 2004 and 2003. Flow
    
    Structured Bulk2004
    
    2003
    
    2004
    
    2003Credit score less than 575
    
    
    0.7
    %
    
    
    0.8
    %
    
    
    1.8
    %
    
    
    4.4
    %Credit score between 575 and 619
    
    
    4.7
    %
    
    
    4.5
    %
    
    
    4.5
    %
    
    
    10.3
    %Credit score greater than 619
    
    
    94.6
    %
    
    
    94.7
    %
    
    
    93.7
    %
    
    
    85.3
    %
 As the table shows, we insure some loans that have FICO credit scores
below 575. We believe that these loans have a higher probability of loss than
loans with a FICO credit score of 575 or greater. We do not expect loans with
FICO scores less than 575 to become a significant portion of our insurance in
force. 13




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##### Table of Contents



A growing
percentage of our insurance in force is derived from loans that
are classified as Alt-A. In our flow business, we have defined Alt-A
as individual loans having high credit quality (FICO scores greater
than 620) and that have been underwritten with reduced or no
documentation. A small but increasing share of our flow business is
classified as Alt-A. However, the
majority of our structured bulk production in the last two years has been
classified as Alt-A. Our classification for structured bulk transactions is
based on the transaction as a whole as compared to individual loan-by-loan
characterization. Structured bulk transactions that we have defined as Alt-A
have high credit quality, but include loans that vary from guidelines typical
for Fannie Mae and Freddie Mac regarding one or more of the following
characteristics: loan amount, documentation level, loan purpose, employment
status or occupancy. The following table shows the percentage of our insurance
in force that we have classified as Alt-A at September 30, 2004 and December
31, 2003: September 30
    
    December 312004
    
    2003Flow
    
    
    5.7
    %
    
    
    4.5
    %Structured bulk
    
    
    95.0
    %
    
    
    87.3
    %Total
    
    
    25.4
    %
    
    
    17.1
    %
 Approximately 51% of our insurance written attributable to structured bulk
transactions during the third quarter of 2004 was structured with deductibles
that put us in the second loss position. Revenues Total direct premiums written increased 12.4% to $45.5 million for the
third quarter of 2004 from $40.4 million for the third quarter of 2003. This
increase was primarily due to an $8.5 million increase in renewal direct
premiums partially offset by a $3.5 million reduction in initial premiums. As
mentioned earlier, increased persistency is the main contributor to the
increase in renewal premiums while the decline in refinancings combined with
industry-wide lower mortgage originations caused the decline in initial
premiums. As further described in our Form 10-K, we cede a portion of premiums under
risk-sharing arrangements with our lender partners (referred to as captive
reinsurance arrangements) as well as under excess of loss reinsurance treaties.
The primary difference between direct premiums written and net premiums
written is ceded premium. Net premiums written increased 9.7% to $36.3 million
for the third quarter of 2004 from $33.1 million for the third quarter of 2003.
Ceded premiums written increased 24.7% to $9.1 million for the third quarter
of 2004 from $7.3 million for the third quarter of 2003 primarily due to an
increase in the amount of our premium subject to captive reinsurance
arrangements. Our premium cede rate (the ratio of ceded premiums written to
direct premiums written) was 20.1% for the third quarter of 2004 compared to
18.1% for the same period of 2003. During the third quarter of 2004, 51.3% of
flow insurance written and 34.0% of total insurance written was subject to
captive reinsurance arrangements compared to 44.1% of flow insurance written
and 33.3% of total insurance written in the same period of 2003. The increase
in the percentage of flow insurance written subject to 14




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##### Table of Contents



captive reinsurance arrangements from 2003 to 2004 is primarily a result
of decreased production in our lender-paid mortgage insurance program that is
generally not subject to captive reinsurance arrangements. Additionally, none
of our structured bulk transactions are subject to captive reinsurance
arrangements. The primary difference between net premiums written and earned premiums is
the change in the unearned premium reserve. Our unearned premium liability
increased $0.5 million from June 30, 2004 to September 30, 2004 compared to a
$2.8 million increase from June 30, 2003 to September 30, 2003. The growth in
the third quarter of 2003 was due to growth in sales of products with premiums
paid on an annual basis during that period. Net investment income for the third quarter of 2004 increased 24.3% over
the third quarter of 2003. This was the result of an increase in average
invested assets for the third quarter of 2004 over the same period of 2003, an
increase in investments with longer maturities during the third quarter of 2004
to take advantage of interest rate increases, and an increase in the market
value during the third quarter of 2004 of a certain security that requires
changes in market value to be reflected in investment income. Our investment
portfolio tax-equivalent yield declined to 7.02% at September 30, 2004 from
7.23% at September 30, 2003. Net realized investment gains/(losses), except for write-downs on
other-than-temporarily impaired securities, are the result of our discretionary
dispositions of investment securities in the context of our overall portfolio
management strategies and are likely to vary significantly from period to
period. Write-downs on other-than-temporarily impaired securities were
approximately $165,000 in both the third quarter of 2004 and 2003. See further
discussion of impairment write-downs in the Realized Gains, Losses and
Impairments section below. Losses and Expenses Losses and loss adjustment expenses increased 52.6% in the third quarter
of 2004 over the third quarter of 2003 due to growth in the number of paid
losses and delinquencies and is reflective of overall growth of our insurance
in force and the seasoning of our in force business. Net paid losses, excluding loss adjustment expenses, increased to $7.3
million during the third quarter of 2004 from $4.8 million during the third
quarter of 2003, an increase of 52.1%. Average severity (direct paid losses
divided by number of claims paid) for flow business decreased to approximately
$21,200 for the third quarter of 2004 compared to $25,000 for the same period
of 2003. 15




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##### Table of Contents



The following table provides detail on direct paid losses from flow
business and structured bulk business for the three months ended September 30,
2004 and 2003 (in thousands): 2004
    
    2003Flow business
    
    $
    6,224
    
    
    $
    3,983Structured bulk business
    
    
    1,056
    
    
    
    841Total
    
    $
    7,280
    
    
    $
    4,824
 Our loss ratio (the ratio of incurred losses to earned premiums) increased
to 25.8% for the third quarter of 2004 from 20.0% for the third quarter of
2003. The increase in the loss ratio is consistent with our expectations as a
greater amount of our insurance in force reaches its anticipated highest claim
frequency years. Changes in the economic environment could accelerate paid and
incurred loss development. Due to the inherent uncertainty of future premium
levels, losses, economic conditions, and other factors that affect earnings, it
is difficult to predict with any degree of certainty the impact of such higher
claim frequencies on future earnings. As previously mentioned, most of our
structured bulk production in 2003 and 2004 has been structured with
deductibles that put us in the second loss position, which we expect to
moderate the loss development in the bulk portfolio. The decrease in DAC amortization for the third quarter of 2004 over the
third quarter of 2003 is reflective of the increase in persistency for these
periods. A full discussion of the impact of persistency on DAC amortization is
included in the Deferred Policy Acquisition Costs section below. The increase in other operating expenses for the third quarter of 2004
over the third quarter of 2003 is relatively consistent with our growth in the
insurance in force. The expense ratio (ratio of the amortization of deferred
policy acquisition costs and other operating expenses to net premiums written)
for the third quarter of 2004 declined to 28.6% from 32.7% for the third
quarter of 2003 primarily due to the decrease in DAC amortization. Our effective tax rate decreased to 28.3% for the third quarter of 2004
from 29.2% for the third quarter of 2003 due primarily to a higher proportion
of interest income from tax-preferred municipal securities. We expect our
effective tax rate to range between 28% and 29% for the remainder of the year
depending on the relationship of tax-preferred investment income from our
municipal bond portfolio to total revenues. 16




---



##### Table of Contents



Nine Months Ended September 30, 2004 Compared to Nine Months Ended September
30, 2003 Net income increased 15.1% for the first nine months of 2004 over the
first nine months of 2003, driven by a 19.7% increase in earned premiums
combined with a 19.2% decrease in the amortization of DAC. Net realized
investment gains after taxes contributed $0.02 to earnings per share on a
diluted basis in the first nine months of 2004 compared to $0.07 for the first
nine months of 2003. Production and In Force Total insurance written in the first nine months of 2004 decreased 14.4%
to $13.1 billion from $15.3 billion for the same period of 2003. Total
insurance written includes insurance written from flow production and
structured bulk transactions. Flow insurance written for the first nine months of 2004 decreased 39.8%
to $8.0 billion from $13.3 billion in the first nine months of 2003.
Refinancing activity was very strong during the first nine months of 2003 as
interest rates generally declined during that period and generally increased
during the first nine months of 2004. Production for the entire industry has
declined in 2004 because of this change in interest rates. Refinancings
accounted for 29.8% of flow insurance written during the first nine months of
2004 compared to 54.6% in the first nine months of 2003. Insurance written in
the first nine months of 2004 includes $5.1 billion attributable to structured
bulk transactions compared to $2.0 billion in the first nine months of 2003. As mentioned earlier, total direct insurance in force reached $35.8
billion at September 30, 2004, compared to $31.7 billion at December 31, 2003,
and $29.3 billion at September 30, 2003, reflecting continued production and an
improvement in persistency. Revenues Total direct premiums written were $128.8 million for the nine months
ended September 30, 2004 compared to $112.4 million for the same period of
2003, an increase of 14.6% primarily due to a $23.2 million increase in renewal
direct premiums. As mentioned earlier, increased persistency is the main
contributor to this increase in renewal premiums. Net premiums written increased 11.1% to $102.9 million for the first nine
months of 2004 from $92.6 million for the first nine months of 2003. Ceded
premiums written increased 31.2% to $25.9 million for the nine months ended
September 30, 2004 as compared to $19.7 million for the nine months ended
September 30, 2003, primarily due to an increase in the amount of our premium
subject to captive reinsurance arrangements. Our premium cede rate was 20.1%
for the nine months ended September 30, 2004 compared to 17.5% for the same
period of 2003. During the first nine months of 2004, 56.7% of flow insurance
written and 34.6% of total insurance written was subject to 17




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##### Table of Contents



captive reinsurance arrangements, compared to 45.0% of flow insurance
written and 39.3% of total insurance written in the same period of 2003. The
increase in the percentage of flow insurance written subject to captive
reinsurance arrangements from 2003 to 2004 is primarily a result of continued
decreased production in our lender-paid mortgage insurance program that
generally is not subject to captive reinsurance arrangements as mentioned
earlier. Additionally, none of our structured bulk transactions are subject to
captive reinsurance arrangements. The primary difference between net premiums written and earned premiums is
the change in the unearned premium reserve. Our unearned premium liability
decreased $0.9 million from December 31, 2003 to September 30, 2004, as
compared to an increase of $6.0 million from December 31, 2002 to September 30,
2003. The increase during the first nine months of 2003 was due to growth in
sales during that period of products with premiums paid on an annual basis. Net investment income for the nine months ended September 30, 2004
increased 12.0% over the nine months ended September 30, 2003 despite a 20.3%
increase in average invested assets over the same periods due to a decline in
investment portfolio yields. Net realized investment gains for the nine months ended September 30, 2004
included write-downs on other-than-temporarily impaired securities of
approximately $304,000 compared to approximately $780,000 in the same period of
2003. See further discussion of impairment write-downs in the Realized Gains,
Losses and Impairments section below. Losses and Expenses Losses and loss adjustment expenses increased 54.6% for the first nine
months of 2004 over the first nine months of 2003 due to growth in the number
of paid losses and delinquencies and is reflective of overall growth of our
insurance in force and the seasoning of our in force business. Net paid losses, excluding loss adjustment expenses, increased to $20.0
million during the nine months ended September 30, 2004 from $12.2 million
during the nine months ended September 30, 2003, an increase of 63.9%. Average
severity for flow business was approximately $24,300 for the first nine months
of 2004 compared to $23,400 for the same period of 2003. 18




---



##### Table of Contents



The following table provides detail on direct paid losses from flow
business and structured bulk business for the nine months ended September 30,
2004 and 2003 (in thousands): 2004
    
    2003Flow business
    
    $
    17,362
    
    
    $
    10,984Structured bulk business
    
    
    2,643
    
    
    
    1,211Total
    
    $
    20,005
    
    
    $
    12,195
 Our loss ratio increased to 24.9% for the nine months ended September 30,
2004 from 19.3% for the same period of 2003. As explained earlier, the
increase in the loss ratio is consistent with our expectations given the
overall growth of insurance in force and as a greater amount of our insurance
in force reaches its anticipated highest claim frequency years. The decrease in DAC amortization for the first nine months of 2004
compared to the first nine months of 2003 again reflects the increase in
persistency for these periods. Other operating expenses for the nine months ended September 30, 2004
increased 19.5% over the nine months ended September 30, 2003 and is relatively
consistent with our growth in the insurance in force. The expense ratio for
the first nine months of 2004 declined to 29.2% compared to 31.6% for the first
nine months of 2003 primarily due to the decrease in the DAC amortization
mentioned above. Our effective tax rate decreased to 28.8% for the nine months ended
September 30, 2004 from 29.3% for the nine months ended September 30, 2003 due
primarily to a higher proportion of interest income from tax-preferred
municipal securities. Significant Customers Our objective is controlled, profitable growth in both the flow and
structured bulk arenas 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. Our ten
largest customers were responsible for 71.6% and 71.0% of flow insurance
written during the three month and nine month periods ending September 30,
2004, compared to 73.6% and 74.6% for the three and nine month periods ending
September 30, 2003, respectively. Our two largest customers were responsible
for 54.9% and 53.9% of flow insurance written during the three and nine month
periods ending September 30, 2004, compared to 57.4% and 58.1% for the three
and nine month periods ending September 30, 2003, respectively. The loss of
one or more of these significant customers could have an adverse effect on our
business. 19




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##### Table of Contents



Financial Position Total assets increased 12.4% to $647 million at September 30, 2004 from
$576 million at December 31, 2003. Total liabilities increased 11.2% to $229
million at September 30, 2004, from $206 million at December 31, 2003. Our
mortgage insurance operations and reserves are primarily supported by our
investment portfolio, which comprises most of our assets. This section
identifies several items on our balance sheet other than invested assets 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, and loss and loss adjustment expense reserves.
A separate Investment Portfolio discussion follows this section and reviews our
investment portfolio, key portfolio management strategies, and methodologies by
which we manage credit risk. Deferred Policy Acquisition Costs In accordance with generally accepted accounting principles, costs
expended to acquire new business are capitalized as DAC and recognized as
expense over the anticipated life of the policy. We employ models that
calculate amortization of DAC separately for each book year. The models rely
on assumptions that we make based upon historical industry experience and our
own unique experience regarding the annual persistency development of each book
year. 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. However, our models are dynamic and
adjust when actual book year persistency is lower than the assumptions employed
in the models. When this happens, the DAC amortization is accelerated through
a dynamic adjustment in order to match the amortization expense with the life
of the policies on which the acquisition costs were originally deferred. 20




---



##### Table of Contents



The following table shows the DAC asset for the three months and nine
months ended September 30, 2004 and 2003 and the effect of persistency on
amortization (in thousands): Three Months Ended
    
    Nine Months EndedSeptember 30
    
    September 302004
    
    2003
    
    2004
    
    2003Balance  beginning of period
    
    $
    31,553
    
    
    $
    30,239
    
    
    $
    29,363
    
    
    $
    28,997Costs capitalized
    
    
    4,294
    
    
    
    4,940
    
    
    
    13,119
    
    
    
    13,624Amortization  normal
    
    
    (3,040
    )
    
    
    (3,170
    )
    
    
    (9,166
    )
    
    
    (9,393
    )Amortization  dynamic
adjustment
    
    
    (630
    )
    
    
    (2,145
    )
    
    
    (1,139
    )
    
    
    (3,364
    )Total amortization
    
    
    (3,670
    )
    
    
    (5,315
    )
    
    
    (10,305
    )
    
    
    (12,757
    )Balance  end of period
    
    $
    32,177
    
    
    $
    29,864
    
    
    $
    32,177
    
    
    $
    29,864Quarterly persistency rate
    
    
    63.0
    %
    
    
    19.3
    %
 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) in lieu of paying current federal
income taxes to take advantage of a special contingency reserve deduction for
mortgage guaranty companies. We record these bonds as prepaid income taxes on
our balance sheet. During the nine months ended September 30, 2004, $1.1
million of Tax and Loss Bonds matured, and we purchased an additional $15.4
million of these bonds. 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 statutory contingency reserve. See our Form 10-K for a more complete description of income tax
transactions. Loss and Loss Adjustment Expense Reserve We establish reserves using estimated claim rates (frequency) and claim
amounts (severity) to estimate ultimate losses. Our reserving process
incorporates numerous factors in a formula that gives effect to current
economic conditions and profiles delinquencies by such factors as policy year,
geography, chronic late payment characteristics, and the number of months the
policy has been in default. Because the estimate for loss reserves is
sensitive to the estimates of claims frequency and severity, we perform
sensitivity analyses to test the reasonableness of the best estimate generated 21




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##### Table of Contents



by the loss reserve process. Changes to reserve estimates are reflected
in the financial statements in the periods in which the adjustments are
determined. Our loss and loss adjustment expense reserves increased to $32.5 million
at September 30, 2004, compared to $27.2 million at December 31, 2003 and $25.5
million at September 30, 2003. Loss and loss adjustment expense reserves are established on insured
mortgage loans when any notices of default are received, no matter what the age
of the default. Reserves also are established for estimated losses incurred on
notices of default not yet reported by the lender. Consistent with industry
practices, we do not establish loss reserves for future claims on insured loans
that are not currently in default. Approximately 76% of our insurance in force
was written within the last two years. The increase in reserves shown above is
indicative of the increase in the number of loans in default as more of our
insurance in force approaches the years with the highest incidence of claims
as well as an expected growth in the severity of claims. The following table shows default statistics as of September 30, 2004,
December 31, 2003, and September 30, 2003: September 30
    
    December 31
    
    September 302004
    
    2003
    
    2003Total business:Number of insured loans in force
    
    
    260,591
    
    
    
    236,234
    
    
    
    221,053Number of loans in default
    
    
    5,008
    
    
    
    4,242
    
    
    
    3,700Percentage of loans in default
(default rate)
    
    
    1.92
    %
    
    
    1.80
    %
    
    
    1.67
    %Flow business:Number of insured loans in force
    
    
    211,300
    
    
    
    205,033
    
    
    
    198,366Number of loans in default
    
    
    3,469
    
    
    
    3,053
    
    
    
    2,675Percentage of loans in default
    
    
    1.64
    %
    
    
    1.49
    %
    
    
    1.35
    %Structured bulk business:Number of insured loans in force
    
    
    49,291
    
    
    
    31,201
    
    
    
    22,687Number of loans in default
    
    
    1,539
    
    
    
    1,189
    
    
    
    1,025Percentage of loans in default
    
    
    3.12
    %
    
    
    3.81
    %
    
    
    4.52
    %
 The number of loans in default reported above includes all reported
delinquencies that are in excess of two payments in arrears at the reporting
date and all reported delinquencies that were previously in excess of two
payments in arrears and have not been brought current. The increase in the
default rate for the flow business is attributable primarily to the maturing of
the flow portfolio for reasons consistent with the increase in reserves
explained above. The default occurrences for both flow business and structured
bulk business are consistent with managements expectation. 22




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##### Table of Contents



Investment Portfolio Portfolio Description We manage our investment portfolio to meet or exceed 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
policies and strategies are subject to change depending upon regulatory,
economic, and market conditions, as well as our anticipated 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. The following schedule shows the
growth and diversification of our investment portfolio (in thousands). September 30, 2004
    
    December 31, 2003Amount
    
    Percent
    
    Amount
    
    PercentFixed maturity securities:U. S. government obligations
    
    $
    13,909
    
    
    
    3.0
    %
    
    $
    15,623
    
    
    
    3.8
    %Mortgage-backed bonds
    
    
    83
    
    
    
    0.0
    
    
    
    99
    
    
    
    0.0State and municipal bonds
    
    
    398,933
    
    
    
    85.8
    
    
    
    330,228
    
    
    
    79.9Corporate bonds
    
    
    26,604
    
    
    
    5.7
    
    
    
    29,147
    
    
    
    7.0Total fixed maturities
    
    
    439,529
    
    
    
    94.5
    
    
    
    375,097
    
    
    
    90.7Equity securities
    
    
    11,844
    
    
    
    2.6
    
    
    
    12,771
    
    
    
    3.1Total
available-for-sale
securities
    
    
    451,373
    
    
    
    97.1
    
    
    
    387,868
    
    
    
    93.8Short-term investments
    
    
    13,581
    
    
    
    2.9
    
    
    
    25,659
    
    
    
    6.2$
    464,954
    
    
    
    100.0
    %
    
    $
    413,527
    
    
    
    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. The duration to
maturity of the fixed maturity portfolio was 10.6 years at September 30, 2004
with an effective maturity of 8.5 years compared to a duration of 11.4 years
with an effective maturity of 6.4 years at December 31, 2003. Another way that
we manage risk and liquidity is to limit our exposure on individual securities.
As of September 30, 2004 and December 31, 2003, no investment in the
securities of any single issuer exceeded 2% of our investment portfolio. 23




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##### Table of Contents



Our effective pre-tax yield reflects the decrease in new money rates
available for investment coupled with our strategies to increase the overall
credit quality of the portfolio and increase our investment in state and
municipal bonds. 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
describes our fixed maturity holdings by credit ratings (in thousands): September 30, 2004
    
    December 31, 2003Amount
    
    Percent
    
    Amount
    
    PercentU.S. treasury and agency bonds
    
    $
    13,992
    
    
    
    3.2
    %
    
    $
    15,722
    
    
    
    4.2
    %AAA
    
    
    321,648
    
    
    
    73.2
    
    
    
    256,291
    
    
    
    68.3AA
    
    
    51,562
    
    
    
    11.7
    
    
    
    50,428
    
    
    
    13.4A
    
    
    35,684
    
    
    
    8.1
    
    
    
    35,937
    
    
    
    9.6BBB
    
    
    11,432
    
    
    
    2.6
    
    
    
    10,347
    
    
    
    2.8BB
    
    
    241
    
    
    
    0.1
    
    
    
    2,204
    
    
    
    0.7B
    
    
    205
    
    
    
    
    
    
    
    1,669
    
    
    
    0.4CCC and lower
    
    
    443
    
    
    
    0.1
    
    
    
    525
    
    
    
    0.1Not rated
    
    
    4,322
    
    
    
    1.0
    
    
    
    1,974
    
    
    
    0.5Total fixed maturities
    
    $
    439,529
    
    
    
    100.0
    %
    
    $
    375,097
    
    
    
    100.0
    %
 Further, 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 first screen for all securities 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 for a period greater than six months. Our ability and
intent to retain the investment for a sufficient 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 24




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##### Table of Contents



investment advisors or outside consultants, improving financial
performance of the issuer, or valuation of underlying assets specifically
pledged to support the credit. Should we conclude that the 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. Unrealized Gains and Losses The following table summarizes by category our unrealized gains and losses
in our securities portfolio at September 30, 2004: Cost or
    
    Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    FairCost
    
    Gains
    
    Losses
    
    ValueFixed maturity securities:Corporate
    
    $
    23,870
    
    
    $
    2,761
    
    
    $
    27
    
    
    $
    26,604U.S. Government
    
    
    13,892
    
    
    
    124
    
    
    
    107
    
    
    
    13,909Mortgage-backed
    
    
    76
    
    
    
    7
    
    
    
    
    
    
    
    83State and municipal
    
    
    383,914
    
    
    
    15,293
    
    
    
    274
    
    
    
    398,933Subtotal, debt
securities
    
    
    421,752
    
    
    
    18,185
    
    
    
    408
    
    
    
    439,529Equity securities
    
    
    10,197
    
    
    
    1,948
    
    
    
    301
    
    
    
    11,844Total securities
    
    $
    431,949
    
    
    $
    20,133
    
    
    $
    709
    
    
    $
    451,373
 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 the 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. The preponderance of the gross unrealized losses on debt securities
shown above related to bonds with a maturity date in excess of ten years. The
largest individual unrealized loss on any one security at September 30, 2004
was approximately $75,000 on common stock of a pharmaceutical company with a
cost of approximately $299,000. This security became impaired during the third
quarter of 2004 upon the discontinuance of a major product of the issuer. We
believe the impairment was a short-term market reaction and that the long-term
outlook for the issuer is favorable. We will continue to monitor this
investment in future quarters to determine if its impairment is other than
temporary. Of the $709,000 of gross unrealized losses at September 30, 2004, the only
security that had a fair value to cost or amortized cost ratio of less than 80%
was the equity security mentioned above. 25




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##### Table of Contents



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 have identified as potentially distressed. Our
current evaluation of other-than-temporary impairments reflects our intent to
hold certain securities for a reasonable period of time sufficient for our
forecasted recovery of fair value. However, we may subsequently decide to sell
certain of these securities in future periods within the overall context of our
portfolio management strategies. If we make the decision to dispose of a
security with an unrealized loss, we will write down the security to its fair
value if we have not sold it by the end of the reporting period. Realized Gains, Losses and Impairments During the third quarter of 2004 and first nine months of 2004, we wrote
down five securities by a total of approximately $165,000 and $304,000,
respectively. Further details on the significant write-downs in the third
quarter of 2004 are as follows:  
    
    Approximately $67,000 write-down on common stock of a
pharmaceutical company for which the fair value had fluctuated
to approximately 86% of cost for the past seven to nine months.
We currently intend to dispose of this security in the near
future. This impairment had no impact on any of our other
securities.
    
    Approximately $53,000 write-down on preferred stock
in an international airline for which the value had fluctuated
below 80% of amortized cost for over a year. We had previously
written down this security by approximately $139,000 in prior
quarters. The additional write-down in the third quarter
resulted from our assessment that the security was other than
temporarily impaired because of a further reduction in credit
quality by rating agencies. However, this particular security
is not currently in default. We hold no other securities in the
airline industry. 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 $51.9 million
in the first nine months of 2004 compared to $39.5 million for the same period
of 2003. The increase in cash flow from operating activities reflects the
growth in premiums and investment income in excess of increases in claims and
other operating expenses paid. Our business does not routinely require
significant capital expenditures other than for enhancements to our computer
systems and technological capabilities. Positive cash flows are invested
pending future payments of claims and expenses. 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 26




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##### Table of Contents



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 Triad Guaranty Inc. and
Triad or its subsidiaries. We cede business to captive reinsurance subsidiaries 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 $418.2 million at September 30,
2004 from $369.9 million at December 31, 2003. This increase resulted
primarily from net income for the first nine months of 2004 of $43.2 million
and an increase in additional paid-in-capital of $4.3 million resulting from
the exercise of stock options and the related tax benefit. Net unrealized
gains on invested assets classified as available-for-sale also increased $1.4
million after taxes. Total statutory policyholders surplus for our insurance subsidiaries
increased to $131.3 million at September 30, 2004 from $128.2 million at
December 31, 2003. The primary difference between statutory policyholders
surplus and equity computed under generally accepted accounting principles is
the statutory contingency reserve. The balance in the statutory contingency
reserve was $352.0 million at September 30, 2004, compared to $302.7 million at
December 31, 2003. Statutory capital, for the purpose of computing the total
risk in force to statutory capital, includes both policyholders surplus and
the contingency reserve. Statutory capital amounted to $483.3 million at
September 30, 2004, compared to $430.9 million at December 31, 2003. Triads 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 Triads ability to write additional insurance. A number of states
also generally limit Triads risk-to-capital ratio to 25-to-1. As of September
30, 2004, Triads risk-to-capital ratio was 14.4-to-1 as compared to 15.3-to-1
at December 31, 2003, and 9.9-to-1 for the industry at December 31, 2003,
according to the industry data available. The risk-to-capital ratio is
calculated using net risk in force, which takes into account risk ceded under
reinsurance arrangements, including captive risk-sharing arrangements and any
applicable stop-loss limits, as the numerator, and statutory capital as the
denominator. There have been no changes in our financial ratings or outlook by the
rating agencies since December 31, 2003 as detailed in our Form 10-K. Triad is
rated AA by 27




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##### Table of Contents



both Standard & Poors Ratings Services and Fitch Ratings and Aa3 by Moodys
Investors Service. A reduction in Triads rating or outlook could adversely
affect our operations. There have been legislative and regulatory proposals to change the
oversight of both Fannie Mae and Freddie Mac. Significant changes in the
regulation of these entities could impact Triad and the entire mortgage
industry. Off Balance Sheet Arrangements and Aggregate Contractual Obligations 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. We also provide fee-based contract underwriting services that enable our
customers to improve the efficiency of their operations by outsourcing part or
all of their mortgage loan underwriting. In the event that Triad fails to
properly underwrite a loan subject to the lenders underwriting practices,
Triad may be required to provide monetary or other remedies to the lender
customer. In the opinion of management, the potential exposure to the Company
to remedy contract underwriting errors would not adversely affect our financial
position or results of operations. Safe Harbor Statement under the Private Securities Litigation Reform Act of
1995 Managements 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,
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 Enterprises,
specifically, and the financial services industry in general; 28




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##### Table of Contents




    
    rating agencies may revise methodologies for
determining our financial strength ratings and may revise or
withdraw the assigned ratings at any time;
    
    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, 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 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. 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 Companys market risk exposures at September 30, 2004 have not
materially changed from those identified in Form 10-K for the year ended
December 31, 2003. 29




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##### Table of Contents



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 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 identified in connection with the
evaluation described in the above paragraph that occurred during the
third quarter 2004 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 -  A previous lawsuit filed against the Company alleging violations of the
Real Estate Settlement Procedures Act was settled on August 11, 2004
for an immaterial amount. 
 Item 2. Changes in 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 and Reports on Form 8-K  (a)
    
    Exhibits  See exhibit index on page 31.   30




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##### Table of Contents



(b)
    
    Reports onForm 8-Ksince December 31, 2003  January 30, 2004  Triad Guaranty Inc. issued a news release
announcing its financial results for the fourth quarter and the
fiscal year ended December 31, 2003.April 27, 2004  Triad Guaranty Inc. issued a news release announcing
its financial results for the first quarter of 2004.July 29, 2004  Triad Guaranty Inc. issued a news release announcing
its financial results for the second quarter of 2004.October 29, 2004  Triad Guaranty Inc. issued a news release
announcing its financial results for the third quarter of 2004. 
 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. TRIAD GUARANTY INC.Date: November 5, 2004/s/ Kenneth S. DwyerKenneth S. DwyerVice President and Chief Accounting Officer
 31




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EXHIBIT INDEX Exhibit Number
    
    Description31(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.
 32