The Company rents office space in Hamilton, Bermuda under an operating lease which expires in July 2000, but is expected to be renewed in April 2000. CGAIM rents office space in New York under an operating lease which expires in 2003 and has one option for a renewal period of five years. Total rent expense was approximately $438,000 and $355,000 in 1999 and 1998 respectively. Future minimum rental commitments under the leases, are expected to be approximately $500,000 per annum.
(1) The Company's first fiscal year-end was March 31, 1997. The fiscal year-end was subsequently changed to December 31.
CGA Group, Ltd., a holding company, was incorporated in Bermuda in June 1996. CGA Group has two wholly owned subsidiaries. Commercial Guaranty Assurance, Ltd., was incorporated in Bermuda in October 1996. Commercial Guaranty Assurance is licensed as a class 3 insurer under the Act. This act authorizes Commercial Guaranty Assurance to carry on insurance business of all classes in or from within Bermuda subject to its compliance with the solvency margin, liquidity ratio and other requirements imposed on it by the act. Commercial Guaranty Assurance has a "Triple-A" "claims paying ability" rating from Duff & Phelps Credit Rating Company and is also rated in the highest rating category assigned by each of the two Canadian rating agencies, Dominion Bond Ratings Service and Canadian Bond Ratings Service. Commercial Guaranty Assurance issues financial guaranty insurance policies, which are the functional equivalent of direct-pay letters of credit, to insure payment of interest, principal and other amounts payable in respect of notes, securities, and other financial obligations.
CGA Investment Management, Inc. was incorporated in the state of Delaware, in July 1996. CGA Investment Management is registered as an investment advisor with the United States Securities and Exchange Commission under the Investment Advisors Act of 1940, as amended. CGA Investment Management provides investment management and financial advisory services primarily to specialized investment vehicles and for the U.S. and international structured finance markets.
CGA Group and its subsidiaries were inactive until June 17, 1997, on which date CGA Group's private placement offering was completed and CGA Group was recapitalized with (a) two classes of preferred stock totaling $105 million, (b) common stock totaling $45.5 million and (c) conditional commitments to purchase $60 million of additional preferred stock. On March 31, 1999 CGA Group sold 43,997,863 shares of its Series C preferred stock to existing shareholders for an aggregate sales price of approximately $51 million. Concurrent with the sale of the Series C preferred stock, all the outstanding shares of Series B preferred stock were converted to shares of common stock. On April 26, 1999 CGA Group sold 973,483 shares of Series C preferred stock to employees of CGA Group and its subsidiaries for an aggregate sales price of approximately $1.2 million.
Financial comparisons with the nine month period ended December 31, 1997 have limited meaning, as the Company did not commence operations until after the private placement offering was completed on June 17, 1997. Accordingly, 1997 financial results reflect only six months of operations during a period in which the Company was focused on hiring personnel and commencing operations.
The net premiums earned in 1999 of $12.2 million were derived from $16.3 million of gross premiums written, of which $2.0 million were ceded under reinsurance agreements, and offset by a $2.1 million change in unearned premiums. Ceded premiums in 1999 were affected by approximately $1.0 million of charges due to recognition of upfront reinsurance premiums related to Commercial Financial Services securities. As a result of claims paid in 1999 related to the Commercial Financial Services securities by Commercial Guaranty Assurance's reinsurer, the reinsured exposure decreased from approximately $154 million to approximately $58 million, thereby requiring early recognition of the $1.0 million charge. Commercial Guaranty Assurance paid an up-front premium of $1.3 million for the reinsurance in October 1998. Most of the increase in unearned premiums during 1999 was from one transaction for which CGA received an up-front premium of approximately $1.8 million, of which only $11 thousand was earned in 1999. Net premiums earned increased by approximately $3 million, or 32% for 1999 compared to 1998. The increase is primarily the result of a 43% increase in insurance in force as of December 31, 1999 compared to December 31, 1998.
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, CGA 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.
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 orgination fees were earned in 1998.
CGA Investment Management's assets under management increased by 39% to $2.5 billion at December 31, 1999 from $1.8 billion as of December 31, 1998. However, investment management fees earned during 1999 decreased by 11% compared to 1998. The decrease in management fees earned as a percentage of assets under management is attributable to certain clients of CGA Investment Management having resecuritized approximately $924 million in assets over the period between September 30, 1998 and December 31, 1999. The asset management fees earned from these resecuritization transactions are lower than the asset management fees earned while these assets remained in such clients' investment portfolios. In addition, at the request of certain clients, CGA Investment Management reduced the amount of the asset management fee by 60% to assist them with the liquidity difficulties that arose in the fourth quarter of 1998. This fee reduction totaled approximately $1.3 million for 1999. There were no investment management or advisory fees earned in 1997.
The credit quality of the portfolio improved during 1998 and 1999 as non-investment grade exposure decreased from 28% at December 31, 1997 to 11% at December 31, 1999. The portfolio includes one problem credit consisting of charged-off credit card receivable transactions. These transactions comprised less than one percent of CGA's net par insured portfolio as of December 31, 1999 and three percent as of December 31, 1998. CGA has established a case basis reserve for this exposure which is more fully described below.
Net investment income was $8.6 million for the year ended December 31, 1999, $8.5 million for 1998, and $2.9 million for the period ended December 31, 1997. Net investment income is presented after deducting the cost of
external investment management fees that totaled $0.1 million for 1999, $0.3 million for 1998 and $0.2 million for the period ended December 31, 1997. Commencing in September 1998, CGA modified its investment strategy to have the investment portfolio closely match the returns of a "Double-A" or better three to five year Eurodollar bond index. This strategy results in a less actively managed portfolio, which resulted in the management fee being reduced by approximately twenty basis points per annum. The new strategy also resulted in above normal turnover of the portfolio and contributed to the significant gains realized during 1998. The total market value of the investment portfolio, other investments, cash and accrued interest receivable at December 31, 1999, was $163.5 million compared to $136.8 million at December 31, 1998. In April 1999 $47 million was added to the portfolio with proceeds from CGA Group's rights offering. Cumulative unrealized losses in the portfolio as of December 31, 1999 were $6.5 million compared to $0.9 million of unrealized gains as of December 31, 1998. The unrealized losses in the portfolio resulted from the increase in interest rates during 1999. The average yield on the investment portfolio was 6.86% at December 31, 1999 compared to 4.82% at December 31, 1998.
REVENUES Net premiums earned .................. $ 502,995 $ -- Net investment income ................ 2,955,601 -- Net realized gains ................... 885,422 -- ------------ ----------- Total revenues ....................... 4,344,018 -- ------------ -----------
EXPENSES Operating expenses ................... 597,883 5,313,368 Acquisition costs .................... 53,590 -- Commitment fees ...................... 323,836 -- Excess of loss facility .............. 107,671 -- Losses & LAE ......................... 55,000 -- ------------ ----------- Total expenses ....................... 1,137,980 5,313,368 ------------ ----------- Net income (loss) 3,206,038 (5,313,368) ------------ -----------
On March 31, 1999 CGA Group sold 43,997,863 shares of Series C preferred stock, par value $.01 per share, to existing shareholders for an aggregate sales price of $50,996,795. Concurrent with the sale of the Series C preferred stock, the outstanding 1,600,000 of Series B preferred stock and the 668,678 shares of Series B preferred stock declared as pay-in-kind dividends thereon, totaling 2,268,678 shares valued at $56,716,950, were exchanged for 18,905,648 shares of common stock based on an exchange price of $3 per share of common stock.
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.
CGA Group does not expect to pay cash dividends to its shareholders. Commercial Guaranty Assurance's Board of Directors has passed a resolution that Commercial Guaranty Assurance will not declare or pay cash dividends during the first five years of operations. After such five-year period, Commercial Guaranty Assurance intends to comply with dividend restrictions, if any, imposed by Duff & Phelps subject to covenants contained in the subscription agreements for the various classes of CGA Group's stock. In addition, Commercial Guaranty Assurance's dividend payments are subject to certain limitations under Bermudian insurance regulations that require minimum solvency margins and liquidity ratios.
Commercial Guaranty Assurance monitors its exposure on a routine basis and stays in close contact with its rating agencies to ensure that its "Triple-A" rating is maintained. Commercial Guaranty Assurance has a $20 million excess of loss reinsurance facility agreement and can 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 additional Series B preferred stock. 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 Duff & Phelps 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.
On March 7, 2000, Fitch announced that it intended to acquire DCR, subject to obtaining all requisite shareholder and regulatory approvals. CGA is not currently rated by Fitch. If such acquisition is consummated, it is unclear what action, if any, Fitch will take in respect of CGA's "AAA" rating from DCR. If Fitch were to rate CGA's claims paying ability at less than "AAA", such action could have a material adverse effect on CGA's business, financial condition and prospects.
On March 13, 2000, the Company hired Donaldson, Lufkin & Jenrette ("DLJ"), an investment banking firm, to act as the Company's exclusive financial advisor for the purpose of raising additional capital. At this time, Management is unable to predict whether or to what extent DLJ will be successful in these capital raising efforts.