The Company rents office space in Hamilton, Bermuda under an operating lease that expires in July 2003. CGAIM rents office space in New York under an operating lease that expires in 2003 and has one option for a renewal period of five years. Total rent expense was approximately $443,000, $438,000 and $355,000 in 2000, 1999 and 1998 respectively. Future minimum rental commitments under the leases are expected to be approximately $500,000 per annum.
Although the par value of new insured business volume for the year was only $791 million, Commercial Guaranty Assurance's net premiums earned in 2000 was $13.3 million, 9% higher than in 1999. This increase was achieved primarily from premiums generated by prior years' business volume. This revenue, along with investment income of $9.3 million, management fees of $2.3 million, and appreciation in the value of Commercial Guaranty Assurance's investment portfolio of $8 million, enabled the Company to limit the decline in shareholders' equity to $2.0 million, or 3% for the year. Such a decline, which is after paying $13.3 million in preferred stock pay-in-kind dividends, reflects the fact that the Company was operating at a reduced level for most of the year due to the uncertainty of its "AAA" rating. The Company also discounted its premiums and management fees by over $3.2 million during 2000 to assist clients with liquidity issues that arose during the fourth quarter of 1998.
The Company's operating expenses and policy acquisition costs were only slightly higher than last year. Losses and loss adjustment expenses were $4.0 million in 2000 compared to $16.7 million in 1999, reflecting the increase in case basis reserves for Commercial Financial Services, Inc. ("CFS") in 1999 (See Item 1 - -"Business--Risk Management--Claims"). Commercial Guaranty Assurance did have one claim for $2.6 million in 2000 in connection with a home equity loan securitization held by St. George. The CFS reserves that were so detrimental to the Company's operations in 1998 and 1999 did not affect 2000 results, thereby enabling the Company to report net income of $3.9 million.
The net premiums earned in 2000 of $13.3 million were derived from $14.4 million of gross premiums written, of which $0.9 million were ceded under reinsurance agreements, and offset by a $0.2 million change in unearned premiums. As mentioned above, the growth in net premiums earned was limited by the uncertainty over Commercial Guaranty Assurance's "AAA" rating and primarily attributable to insurance in force as of the prior year. Premiums written were further depressed during 2000 as a result of premium discounts provided to St. George of approximately $2.6 million, which Commercial Guaranty Assurance agreed to in an effort to help St. George with continuing liquidity issues.
Net premiums earned in 1998 of $9.2 million were derived from $49.2 million of gross premiums written, of which $39.4 million were ceded under reinsurance agreements, and offset by a $0.6 million change in unearned premiums. The gross premiums written and ceded premiums included approximately $39 million from one transaction. The transaction was entered into by Commercial Guaranty Assurance to mitigate risks related to its exposure in connection with guarantees of two credit facilities for St. George. As a result of turmoil in certain areas of the capital markets during the month of October 1998, the spreads over treasuries at which investors were willing to purchase certain securities widened considerably. This spread widening caused a decrease in the market value of many of the securities used as collateral for two of St. George's insured credit facilities. The facilities had requirements that the lender's operating ratio, (the portfolio market value divided by the loan outstanding) be maintained above certain levels. In the event that an operating ratio fell below the required level and was not brought into compliance within a cure period, the lender could liquidate the collateral and require Commercial Guaranty Assurance to pay any remaining balance outstanding under the credit facility. On October 30, 1998, Commercial Guaranty Assurance provided asset specific guarantees and obtained third party credit support on a "cut-through" basis on approximately $382 million par amount of securities within the two insured investment portfolios. The three parties that provided such credit support are institutional investors in the Company. The effect of this third party credit support was to substantially increase the market value and reduce the future market value volatility of the credit enhanced securities. In connection with these arrangements, Commercial Guaranty Assurance received a premium of $38.95 million from its two clients, and ceded an aggregate of $38.7 million to the institutions that provided the cut-through credit enhancement. In April 1999, the credit support arrangements were cancelled and $29.5 million of premium was refunded to St. George.
Management fees decreased to $2.3 million in 2000 from $8.2 million in 1999. The decrease results primarily from there being no finance origination fees or resecuritization structuring fees earned in 2000, whereas $5.2 million of such fees where earned in 1999. Investment management fees were approximately $3 million in 1999. The $0.7 million reduction in 2000 results principally from fee discounts provided to St. George of approximately $0.6 million during 2000 to help St. George with the liquidity difficulties discussed above.
Management fees increased to $8.2 million in 1999 from $3.3 million in 1998. The $8.2 million is comprised of $1.7 million of structuring fees earned in connection with three resecuritizations, $3.5 million of finance origination fees, and approximately $3.0 million of investment management fees. No structuring or finance origination fees were earned in 1998. During 2000, CGA Investment Management's assets under management decreased by 8% to $2.3 billion at December 31, 2000 from $2.5 billion as of December 31, 1999. During 1999 assets under management increased by 39% from $1.8 billion as of December 31, 1998.
The amount of Commercial Guaranty Assurance's insured portfolio decreased by $9 million during 2000, resulting in a relatively constant $2.2 billion net par as of December 31, 2000 and 1999. Although new volume of $791 million occurred during 2000, it was offset by the resecuritizations and amortization.
interest income of $9.3 million and appreciation of $8 million. In April 1999, $47 million was added to the portfolio with proceeds from CGA Group's rights offering. Cumulative unrealized gains in the portfolio as of December 31, 2000 were $1.5 million compared to $6.5 million of unrealized losses as of December 31, 1999. The unrealized gains in the portfolio resulted from the decrease in interest rates during 2000, whereas the unrealized losses in the portfolio at December 31, 1999 resulted from the increase in interest rates during 1999. The average yield to maturity on the investment portfolio was 5.97% at December 31, 2000 compared to 6.86% at December 31, 1999 and 4.82% at December 31, 1998.
Operating expenses for the year ended December 31, 2000 were approximately $13.3 million, $13.0 million for 1999 and $14.0 million for the year ended December 31, 1998. These costs are primarily personnel related, which totaled $9.0 million for 2000, $8.8 million for 1999 and $7.4 million for 1998. Although the Company experienced staff reductions through attrition during 2000, compensation levels for the remaining staff were increased to maintain them at market levels and to ensure retention of staff during the period of the "AAA" rating uncertainty. The primary reason for the operating expense reduction in 1999 compared to 1998 was due to a non-recurring expense of $1.2 million of client acquisition costs in 1998 which had previously been capitalized. These costs were incurred by CGA Investment Management to set up new investment programs and funding sources for its clients. The majority of the other operating expenses are comprised of occupancy costs, professional fees, travel, information services, and administration.
In 1998 the Accounting Standards Executive Committee issued Statement of Position 98-5, "Reporting on Costs of Start-Up Activities", which required the Company to expense organization costs as incurred. The Company expensed the remaining unamortized organization costs totaling $3.9 million in 1998 which is reflected in the financial statements as a change in accounting principle.
CGA Group has two reportable segments: Commercial Guaranty Assurance and CGA Investment Management (see description of each segment in Note 1). CGA Group's management has identified the operating segments on the basis that they are separate entities with each entity carrying on a different type of business and their performances are evaluated separately by management. Commercial Guaranty Assurance provides financial guaranty insurance and CGA Investment Management provides investment management services. North America comprises 94% of the insured obligations geographic exposure. Other countries include Turkey, Greece, Poland and Portugal, each of which comprise 1.5% or less of the geographic exposure. The accounting policies of each of the segments are the same as those described in the summary of significant accounting policies.
In 1997, CGA Group capitalized Commercial Guaranty Assurance with $125 million. On March 31, 1999, CGA Group contributed an additional $27.2 million to Commercial Guaranty Assurance using proceeds from the sale of CGA Group's Series C preferred stock. In June 1999, CGA Group contributed an additional $7.1 million to Commercial Guaranty Assurance. Alliance Capital Management Corporation manages Commercial Guaranty Assurance's entire investment portfolio. These funds are invested in foreign corporate and government debt securities which are rated "Double-A" or higher and denominated in U.S. dollars. The portfolio maintains a weighted average duration of two to five years. As of December 31, 2000, the duration of the portfolio was 3.2 years. The investment portfolio had a return of 10.3% for the year ended December 31, 2000, while the Merrill Lynch Eurodollar High Quality 3-5 Year Index, against which the portfolio's performance is measured, returned 10.54%.
CGA Investment Management was capitalized with $3 million. It has required additional funding from CGA Group since its commencement of operations through December 31, 2000 of $23.9 million to cover its operations. It is projected to require additional funding at least through 2005 while it continues to build its assets under management up to an amount that generates sufficient fee income to cover its operations.
On April 26, 1999, CGA Group sold 973,483 shares of Series C preferred stock to employees of CGA Group and its subsidiaries. The shares were sold for $1.20 each, for a total of $1.2 million. The shares were 90% financed by CGA Group at 7% per annum with equal principal installments due annually over a three-year period.
Commercial Guaranty Assurance has a $20 million excess of loss reinsurance facility agreement and may also arrange reinsurance on an as needed basis to manage its exposure. CGA Group also has commitments which expire June 17, 2002, from certain institutional shareholders to purchase an aggregate of $60 million of Series B preferred stock which would pay quarterly dividends in kind at 7% per annum. Should those commitments be called upon, the proceeds would be used to increase the capital of Commercial Guaranty Assurance. The commitments must be funded in the event that Fitch notifies CGA Group at least 45 days prior to June 17, 2002 that Commercial Guaranty Assurance's rating will otherwise be downgraded below a "Triple-A" rating.
As a result of Fitch's downgrade of Commercial Guaranty Assurance's financial strength from AAA to AA, the Company has notified all shareholders that provided capital commitments that the full $60 million of these commitments must be funded by close of business on April 23, 2001. To the extent that any of these investors are not rated at least "Double-A" by one or more nationally recognized statistical rating organizations, such investors have secured their obligations in respect of their capital commitment by posting a letter of credit or comparable form of credit support from a financial institution rated at least "Double-A" by one or more such rating organizations. Because the amount of these commitments are already included in determining Commercial Guaranty Assurance's claims-paying resources, the funding of the commitments will have no net effect on Commercial Guaranty Assurance's claims-paying resources as assessed by the rating agencies.
As stated earlier, on March 14, 2001 Fitch downgraded Commercial Guaranty Assurance's financial strength rating to `AA', and its rating remains on "Rating Watch Negative". Fitch's downgrade of Commercial Guaranty Assurance's financial strength rating will have a material adverse effect on its ability to write new financial guaranty insurance business. Many of Commercial Guaranty Assurance's competitors in the area of providing credit enhancement are rated "Triple-A" by one or more of the major rating agencies. Being rated AA by Fitch will place Commercial Guaranty Assurance at a distinct competitive disadvantage as compared to providers of credit enhancement with higher ratings. The Fitch downgrade will significantly decrease the desirability of Commercial Guaranty Assurance's insurance for many investors, and materially adversely affect both the volume of new business Commercial Guaranty Assurance will be able to write, as well as the premiums Commercial Guaranty Assurance will be able to charge for its insurance. In addition, it is possible that Fitch's action may prompt one or more of the other rating agencies that currently rates Commercial Guaranty Assurance's financial strength to lower its rating of Commercial Guaranty Assurance. Nevertheless, a "Double-A" rating is still a high "investment grade" rating, Commercial Guaranty Assurance's claims-paying resources of almost $250 million remain unimpaired, and Fitch's action will have no adverse impact on Commercial Guaranty Assurance's ability to meet its obligations to policyholders.
In June 1998, the Financial Accounting Standards Board (the FASB) issued Statement No. 133 Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"), subsequently amended by SFAS No. 137 and SFAS No. 138, which CGA Group is required to adopt effective January 1, 2001. SFAS 133 requires all derivatives to be recognized on the balance sheet as either assets or liabilities and measured at fair value. Upon implementation, credit default swaps will be valued at fair value in accordance with this statement. The impact of adopting SFAS 133 as of December 31, 2000 would have resulted in a $4.2 million charge against earnings presented in the statement of operations as a cumulative effect of a change in accounting principle.