(1) The following table presents the statements of income for (i) the six-month period ended June 30, 1992 for Original Holdings prior to the Acquisition; (ii) the six-month period ended December 31, 1992 for Holdings after the Acquisition and (iii) the condensed pro forma income statement for the year ended December 31, 1992 assuming that the Acquisition had occurred on January 1, 1992. The pro forma information reflects adjustments relating to (a) lower investment income due to the reduction in the investment portfolio as a result of the Distribution made in connection with the Acquisition; (b) higher benefits expense due to establishment of the Employee Stock Option Plan ("ESOP"); (c) lower policy acquisition costs due to the assumed write-off of deferred acquisition costs at January 1, 1992 and (d) lower interest expense due to recapitalization. The pro forma information does not purport to represent what the results of operations would actually have been if the Acquisition had occurred on January 1, 1992 or to be indicative of the future results of operations of Holdings.
(2) Earnings per share ("EPS") has been computed using the modified treasury stock method and the market value of the shares has been determined by an independent consulting firm in connection with an annual valuation for the ESOP, except for the market values at December 31, 1996 and 1995, which are based on the closing market price on the New York Stock Exchange on such dates. EPS for the six-month period ending December 31, 1992 was $0.62.
(3) These ratios and statistics relate solely to CapMAC. The GAAP loss ratio is losses and loss adjustment expenses incurred (inclusive of additions to the Supplemental Loss Reserve) divided by net premiums earned. The SAP loss ratio is losses and loss adjustment expenses incurred (exclusive of additions to the Supplemental Loss Reserve) divided by net premiums earned. The GAAP expense ratio is underwriting and operating expenses and policy acquisition costs, divided by net premiums earned. The SAP expense ratio is SAP underwriting and operating expenses, divided by net premiums written. The combined ratio on both a GAAP and SAP basis is the sum of the applicable loss and expense ratios.
(5) Shares outstanding do not include the common stock equivalents (i.e., warrants, stock options, restricted stock units and unallocated ESOP shares).
CapMAC Holdings Inc. ("Holdings" or the "Company"), a Delaware corporation, is the sole stockholder of Capital Markets Assurance Corporation ("CapMAC"), CapMAC Financial Services, Inc. ("CFS"),and CapMAC Financial Services (Europe) Limited ("CFS (Europe)"), a subsidiary of CFS. The Company is also a lead investor in CapMAC Asia Ltd. ("CapMAC Asia").
CFS and CFS (Europe) provide advisory, consulting and structuring services to third parties. CFS also provides various services, including underwriting, reinsurance, marketing, data processing and other services to Holdings, CapMAC and CFS (Europe), in connection with the operation of the business.
CapMAC Asia is a subsidiary of the Company formed for the purpose of making investments in Asia in connection with the Company's strategy to expand its Asian structured finance business. The Company currently owns 30.7% of the equity of CapMAC Asia. Through its investment in CapMAC Asia and pursuant to a shareholders' agreement among the other shareholders of CapMAC Asia, the Company has the right to designate a majority of the board of CapMAC Asia and thereby controls substantially all of CapMAC Asia's operations.
Gross premiums written $ 72,838 $57,476 $44,662 Year to year change 27% 29% 79% Net premiums earned 40,557 29,242 23,103 Year to year change 39% 27% 32% Advisory and other fees 27,143 16,968 11,318 Year to year change 60% 50% 127% Net income 33,568 23,528 17,066 Year to year change 43% 38% 37% Net par outstanding(1) ($ in millions) 19,655 12,628 9,397 Year to year change 56% 34% 68% Gross par written(2) ($ in millions) 13,114 16,945 9,572 Year to year change (23%) 77% 90% - --------------------------------------------------------------------------------
The data presented below are not recognized as financial statement measures under generally accepted accounting principles ("GAAP"). However, the Company considers these measures as meaningful indicators to assess business originated in a given period as well as business which is outstanding as of the given date.
The Company reported record net income of $33.6 million, a 43% increase over net income of $23.5 million reported during 1995. Primary earnings per share and earnings per share on a fully diluted basis were $1.92 and $1.89, respectively, in 1996, compared to $1.73 and $1.65, respectively, during the same period in 1995. Operating earnings per share on a fully diluted basis for 1996 was $1.95, an increase of 23% from $1.58 in 1995. Operating earnings exclude the impact of realized capital gains and losses, net of tax. Earnings per share comparisons between 1996 and 1995 are affected by the impact of Holdings' December 1995 initial public offering, which significantly increased the weighted average number of shares outstanding.
included a single master surety bond in the principal amount of $6.2 billion that was issued with respect to a conduit formed for the purpose of funding a diverse pool of securities. Excluding this single master surety bond from the 1995 gross par written would result in a 22% increase in 1996 gross par written as compared to 1995.
Advisory and other fees increased 60% to $27.1 million in 1996 from $17.0 million in 1995 due to the Company's continued focus on the structuring and financial engineering business. Advisory fees are received by CFS in relation to the closing of transactions which involve significant advisory and structuring services provided by CFS. Fees collected for such services amounted to $21.6 million in 1996, an increase of 49% from $14.5 million in 1995. Advisory fees related to international business were $18.1 million and $12.3 million in 1996 and 1995, respectively. Advisory fees are generally earned upon the closing of transactions. Therefore, the timing and number of transactions generating fees as well as the amount of such fees may result in significant fluctuations in revenues attributable to such fees from period to period. In addition to advisory fees, CFS also collects recurring fees payable on a monthly and quarterly basis (other fees) primarily related to the administration of third-party owned and managed funding vehicles. The amount related to other fees was $5.5 million in 1996 compared to $2.4 million in 1995, an increase of 127% over the prior year primarily due to the increased utilization of the funding vehicles.
Total expenses were $36.0 million in 1996, an increase of 29% from $28.0 million in 1995. Total expenses included additions to the reserve for losses and loss adjustment expenses, underwriting and operating expenses, policy acquisition costs, and interest expense.
In 1996 and 1995, the Company had a net tax expense of $14.7 million and $11.1 million, respectively. The Company's effective tax rate was 30.7% and 32.1% for 1996 and 1995, respectively. The effective tax rates during these periods were lower than the statutory tax rate of 35% in 1996 and 1995 primarily due to tax-exempt interest income. As of December 31, 1996, tax-exempt interest income of $9.7 million represented 20.0% of earnings before taxes ("EBT") compared to $7.8 million which represented 22.5% of EBT in the prior year.
Business originated or renewed in 1995 was estimated to generate $89.5 million of PFR, an increase of $38.6 million or 76% over the same period in 1994. Correspondingly, the amount of guarantees issued
(gross par written) increased from $9.6 billion in 1994 to $16.9 billion in 1995, representing an increase of 77%. At December 31, 1995, CapMAC's outstanding policies are expected to generate $155.4 million of PFR, up approximately 58% from $98.1 million at December 31, 1994. The discount rate used for purposes of the PFR calculation was 7% for 1995 and 1994. Unearned premiums, representing premiums collected but not yet earned, increased by $19.9 million from December 31, 1994 to a total of $45.8 million at December 31, 1995.
At December 31, 1995, net par insured and outstanding was $12.6 billion, up 34% from $9.4 billion at December 31, 1994. The remaining weighted average life of the insured portfolio was estimated to be 6.0 years at December 31, 1995 and 5.0 years at December 31, 1994.
Advisory and other fees increased 50% from $11.3 million in 1994 to $17.0 million in 1995. The increase in fees received by CFS related to the closing of several transactions which involved extensive advisory and structuring services provided by CFS.
Other income increased $2.3 million from $0 in 1994 to $2.3 million in 1995. The increase was primarily due to the Company's sale without recourse in 1995 of its interest in potential future cash flows from certain transactions included in its insured portfolio for a net amount of $2.2 million.
In September 1995, CapMAC incurred its first claim on a financial guarantee policy. Based on its current estimate, the Company expects the aggregate amount of the claim and related loss adjustment expenses with respect to such policy not to exceed $2.7 million, although no assurance can be given that such claims and related expenses will not exceed that amount. Such amount was covered through a recovery under a quota share reinsurance agreement of $0.2 million and a reduction in the SLR of $2.5 million. The portion of the claim and related expenses not covered under the quota share agreement is being funded through payments to CapMAC from the Lureco Trust Account. (See - Liquidity and Capital Resources). At December 31, 1995, the Company had a case basis loss reserve of $0.6 million and reinsurance recoverable of $69,000.
Underwriting and operating expenses were $16.4 million in 1995, a 31% increase from $12.5 million in 1994. Underwriting and operating expenses consisted of gross underwriting and operating expenses, reduced by the deferral to future periods of certain costs related to CapMAC's acquisition of new business and ceding commission income. Gross underwriting and operating expenses were $33.9 million and $26.7 million in 1995 and 1994, respectively. The increase in underwriting and operating expenses was due to increased compensation costs and other operating costs offset by increased ceding commission income. Staff and benefit-related expenses, including payment of discretionary bonuses to employees, constituted approximately 73% of gross underwriting and operating expenses in 1995 compared to 69% in 1994. The Company maintains a discretionary bonus plan under which aggregate annual bonuses of $7.8 million and $5.3 million were awarded to employees in 1995 and 1994, respectively. Underwriting and operating expenses deferred by CapMAC were $14.1 million and $17.5 million in 1995 and 1994, respectively.
In 1995 and 1994, the Company had net tax expense of $11.1 million and $7.8 million, respectively. The Company's effective tax rate was 32.0% and 31.4% for 1995 and 1994, respectively. The effective tax rates during these periods were lower than the statutory tax rate of 35% in 1995 and 34% in 1994 primarily due to tax-exempt interest income. As of December 31, 1995, tax-exempt interest income of $7.8 million represented 22.5% of EBT compared to $5.7 million which represented 22.9% of EBT in the prior year.
The Company and Holdings. The operations of the Company are conducted primarily through CapMAC and CFS, wholly owned subsidiaries of Holdings. The liquidity of Holdings both on a short-term (less than twelve months) and long-term (twelve months or longer) basis will be dependent on several factors including borrowings, equity issuances and dividends from CFS and CapMAC. Holdings requires liquidity for payment of dividends to shareholders, investment in international and other business ventures and debt service. While CFS has from time to time paid dividends to Holdings, currently no dividends are expected to be received by Holdings from CapMAC.
During the fourth quarter of 1996, the Company incorporated a wholly owned subsidiary, CapMAC Investment Management, Inc. ("CIM"). CIM will engage in the funds management business and will sponsor and manage funds targeted to both domestic and international institutional investors and high net worth individuals. Where appropriate, CapMAC may also provide credit enhancement for these funds. CIM is expected to be initially capitalized with $2 million and commence operations in early 1997.
Management believes that the Company's operating liquidity needs, both on a short-term basis and long-term basis, can be funded exclusively from its operating cash flow. The Company has a number of sources of liquidity which it expects to have available to pay claims and other obligations on a short- and long-term basis: the cash flow from its written premiums, advisory fees collected, its investment portfolio and the earnings thereon, its bank line of credit, its reinsurance arrangements with third-party reinsurers, the capital markets and, with respect to claims under certain circumstances, realizations from collateral underlying its insured transactions.
The Company has no material commitments for capital expenditures, although it has the investment commitments referred to above. The total liquidity resources of the Company represented by its investment income, its premium and advisory fees collections and its liquidity arrangements are, in management's opinion, adequate to meet the Company's cash needs.
In 1994, CapMAC and Luxembourg European Reinsurance LURECO S.A. ("Lureco"), entered into a Per Annum Aggregate Reinsurance Treaty (the "Lureco Treaty") pursuant to which Lureco reinsures CapMAC for certain losses and related expenses, including all amounts which have been incurred by CapMAC for anticipated settlement of claims regardless of whether such amounts have been paid by CapMAC. The Lureco Treaty provides that the annual reinsurance premium payable by CapMAC to Lureco, after deduction of the reinsurer's fee payable to Lureco, be deposited in a trust account (the "Lureco Trust Account") to be applied by CapMAC, at its option, to offset losses and loss expenses incurred by CapMAC in connection with incurred claims. Amounts on deposit in the Lureco Trust Account which have not been applied against claims are contractually due to CapMAC at the termination of the treaty. The agreement is renewable annually at CapMAC's option, subject to certain conditions. The agreement was renewed for the 1996 policy year and provides $7 million of loss coverage in excess of the premium deposit amount of $5 million retained in the Lureco Trust Account. Additional coverage is provided for losses incurred in excess of 200% of the net premiums earned up to $4 million for any one agreement year. In September 1995, claims incurred of approximately $2.5 million on an insurance policy were applied against the Lureco Trust Account.
At December 31, 1996, CapMAC had statutory qualified capital, which consisted of statutory capital, unassigned surplus and contingency reserves, of $260.2 million, up from $239.9 million at December 31, 1995. CapMAC's policyholders' leverage ratio, which is measured by the ratio of net principal and interest insured to statutory qualified capital, was 90 to 1 at December 31, 1996 and 63 to 1 at December 31, 1995. CapMAC's claims-paying resources as defined by the Company (which includes statutory qualified capital, PFR and stop-loss reinsurance) stood at $542.9 million and $445.3 million at December 31, 1996 and 1995, respectively.
We have audited the accompanying consolidated balance sheets of CapMAC Holdings Inc. and subsidiaries as of December 31, 1996 and 1995 and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
CapMAC Holdings Inc. and Subsidiaries Consolidated Statements of Income (Dollars in thousands, except per share data)
CapMAC Holdings Inc. and Subsidiaries Consolidated Statements of Stockholders' Equity (Dollars in thousands)
CapMAC Holdings Inc. and Subsidiaries Consolidated Statements of Cash Flows (Dollars in thousands)
1) Background CapMAC Holdings Inc. ("Holdings" or the "Company"), a Delaware corporation, is the sole stockholder of Capital Markets Assurance Corporation ("CapMAC"), CapMAC Financial Services, Inc. ("CFS"), and CapMAC Financial Services (Europe) Ltd. ("CFS (Europe)"), a subsidiary of CFS, and a lead investor in CapMAC Asia Ltd. ("CapMAC Asia").
CapMAC is a New York-domiciled monoline stock insurance company which engages only in the business of financial guarantee and surety insurance. CapMAC is licensed in all 50 states in addition to the District of Columbia, the Commonwealth of Puerto Rico and the territory of Guam. CapMAC insures structured asset-backed, corporate, municipal and other financial obligations in the U.S. and international capital markets. CapMAC also provides financial guarantee reinsurance for structured asset-backed, corporate, municipal and other financial obligations written by other major insurance companies.
CapMAC's claims-paying ability is rated "Aaa" by Moody's Investors Service, Inc. ("Moody's"), "AAA" by Standard & Poor's Ratings Group ("S&P"), "AAA" by Duff & Phelps Credit Rating Co. ("Duff & Phelps"), and "AAA" by Nippon Investors Service, Inc., a Japanese rating agency. Such ratings reflect only the views of the respective rating agencies, are not recommendations to buy, sell or hold securities and are subject to revision or withdrawal at any time by such rating agencies.
CFS and CFS (Europe) receive fees for providing advisory, consulting and structuring services to third parties. CFS also provides various services, including underwriting, reinsurance, marketing, data processing and other services to Holdings, CapMAC and CFS (Europe). Holdings, CapMAC and CFS (Europe) pay CFS a fee for providing such services, but not in excess of CFS' cost for such services.
In December 1995, as part of its strategy to expand into Asia, the Company purchased 36.3% of CapMAC Asia. As of December 31, 1996, the Company currently owns 30.7% of CapMAC Asia. CapMAC Asia has a 33.33% investment in Asia Credit Services (Pte) Ltd ("Asia Services"). Asia Services owns all of the stock of Asian Securitization & Infrastructure Assurance (Pte) Ltd ("ASIA Ltd"), a regional financial guarantee company located in Singapore. ASIA Ltd was formed to provide guarantees of high quality debt securities in the primary and secondary Asian fixed income capital markets and, together with Asia Services, to engage in related business activities in the Asian capital markets and to provide technical advice and assistance in connection with Asian securitization transactions.
2) Significant Accounting Policies Significant accounting policies used in the preparation of the accompanying consolidated financial statements are as follows:
Short-term investments are those investments having a maturity of less than one year at purchase date. Short-term investments are carried at amortized cost which approximates fair value.
Investment in affiliates is accounted for in accordance with the equity method of accounting. The investment in affiliates consists of the Company's investment in Asia Services and P.T. ABS Finance Indonesia (formerly P.T. Citimas Capital (Pte) Ltd.) ("ABS Finance").
c) Premium Revenue Recognition Premiums which are payable monthly to CapMAC are reflected in income when due, net of amounts payable to reinsurers. Premiums which are payable quarterly, semi-annually or annually are reflected in income, net of amounts payable to reinsurers, on an equal monthly basis over the corresponding policy term. Premiums that are collected as a single premium at the inception of the policy and have a term longer than one year are earned, net of amounts payable to reinsurers, by allocating premium to each bond maturity based on the principal amount and earning it straight-line over the term of each bond maturity. For the years ended December 31, 1996 and 1995, 91% of net premiums earned were attributable to premiums payable in installments and 9% were attributable to premiums collected on an up-front basis.
f) Reserve for Losses and Loss Adjustment Expenses The reserve for losses and loss adjustment expenses consists of a supplemental loss reserve ("SLR") and a case basis loss reserve. The SLR is established for expected levels of losses resulting from credit failures on currently insured issues and reflects the estimated portion of earned premiums required to cover those losses.
A case basis loss reserve is established for insured obligations when, in the judgment of management, a default in the timely payment of debt service is imminent. For defaults considered temporary, a case basis loss reserve is established in an amount equal to the present value of the anticipated defaulted debt service payments over the expected period of default. If the default is judged not to be temporary, the present value of all remaining defaulted debt service payments is recorded as a case basis loss reserve. Anticipated salvage recoveries are considered in establishing case basis loss reserves when such amounts are reasonably estimable. Case basis loss reserves may be allocated from any SLR outstanding at the time the case basis reserves are established.
inherently uncertain process involving estimates and subjective judgments by management, and therefore there can be no assurance that ultimate losses in CapMAC's insured portfolio will not exceed the current estimate of loss reserves.
h) Income Taxes Deferred income taxes are provided with respect to temporary differences between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date.
i) Earnings Per Share Earnings per share ("EPS") has been computed using the modified treasury stock method. For periods prior to the offering, the average market value of the shares was determined by an independent consulting firm. Total weighted average number of common stock and common stock equivalents used in calculating the primary earnings per share, for the years ended December 31, 1996, 1995 and 1994 were approximately 17,441,000, 13,636,000 and 13,645,000, respectively. Total weighted average number of common stock and common stock equivalents used in calculating the fully diluted earnings per share, for the years ended December 31, 1996, 1995 and 1994 were approximately 17,792,000, 14,337,000 and 13,645,000, respectively.
3) Insured Portfolio At December 31, 1996 and 1995, the principal amount of financial obligations insured by CapMAC was $24.5 billion and $16.9 billion, respectively, and net of reinsurance (net principal outstanding), was $19.7 billion and $12.6 billion, respectively, with a weighted average life of 6.4 years and 6.0 years, respectively. CapMAC's insured portfolio was broadly diversified by geographic distribution and type of insured obligations, with no single insured obligation in excess of statutory single risk limits, after giving effect to any reinsurance and collateral, which are a function of CapMAC's statutory qualified capital (the sum of statutory capital and surplus and mandatory contingency reserve). At December 31, 1996 and 1995, the statutory qualified capital was approximately $260 million and $240 million, respectively.
At December 31, 1996 and 1995, the principal and interest amount of financial obligations insured by CapMAC was $29.8 billion and $20.3 billion, respectively, and net of reinsurance (net principal and interest outstanding), was $23.3 billion and $15.1 billion, respectively. At December 31, 1996, approximately 93% of CapMAC's insured portfolio was comprised of structured asset-backed transactions. Under these structures, a pool of assets covering at least 100% of the principal amount guaranteed under its insurance contract is sold or pledged to a special purpose bankruptcy remote entity. CapMAC's primary risk from such insurance contracts is the impairment of cash flows due to delinquency or loss on the underlying assets. CapMAC, therefore, evaluates all the factors affecting past and future asset performance by studying historical data on losses, delinquencies and recoveries of the underlying assets. Each transaction is reviewed to ensure that an appropriate legal structure is used to protect against the bankruptcy risk of the originator of the assets. Along with the legal structure, an additional level of first loss protection is also created to protect against losses due to credit or dilution. This first level of loss protection is usually available from reserve funds, excess cash flows, overcollateralization, or recourse to a third party. The level of first loss protection depends upon the historical losses and dilution of the underlying assets, but is typically several times the normal historical loss experience for the underlying type of assets.
During 1995, the Company sold without recourse its interest in potential cash flows from transactions included in its insured portfolio and recognized $2,200,000 of income which has been included in other income in the accompanying consolidated financial statements.
Actual maturities may differ from contractual maturities because borrowers may call or prepay obligations with or without call or prepayment penalties.
Proceeds from sales of investment securities were approximately $57.2 million, $53.9 million and $42.1 million in 1996, 1995 and 1994, respectively. Gross realized capital gains of $772,000, $1,486,000, and $781,000, and gross realized capital losses of $536,000, $135,000 and $898,000 were realized on those sales for the years ended December 31, 1996, 1995 and 1994, respectively.
Investments include bonds having a fair value of approximately $3,884,000 and $3,985,000 which are on deposit at December 31, 1996 and 1995, respectively, with state regulators as required by law.
In 1995, the Company purchased, for approximately $11.0 million, 36.3% of CapMAC Asia. In 1996, Holdings invested an additional $1.2 million and sold 5.6%, or $1.9 million, of its investment in CapMAC Asia to its employees, directors and shareholders. CapMAC Asia has a 33.33% investment in Asia Services which amounted to $33.4 million and $30.7 million at December 31, 1996 and 1995, respectively. Asia Services owns 100% of the stock of ASIA Ltd.
In connection with the strategic alliance, Holdings was issued a warrant to purchase 17.7% of the common stock of each of the companies in TMG Group at an aggregate initial purchase price of $10.0 million, as increased over time under a LIBOR-based formula. On a monthly basis, the strike price will be adjusted upwards by a one-month LIBOR rate until the warrants are exercised. To the extent that Holdings has not exercised this warrant prior to February 27, 2000, TMG Group may require that Holdings exercise the warrant, at which time Holdings would be obligated to invest up to approximately $13.0 million in TMG Group, which amount is based upon assuming a constant LIBOR rate of 5%. The occurrence of certain other events involving an insolvency of TMG Group or a change of control of the Company that has a material adverse effect on TMG Group entitles TMG Group to require Holdings to exercise the warrants prior to February 27, 2000. The Company values the warrants based upon the difference between the exercise price adjusted by the LIBOR-based formula and the estimated fair value of its percentage share of ownership of TMG Group.
The change in unrealized appreciation (depreciation) on available-for-sale securities and warrants is included as a separate component of stockholders' equity as shown below:
6) Employee Benefits The Company, through CFS, maintains an incentive compensation plan for its employees. The plan is an annual discretionary bonus award. For the years ended December 31, 1996, 1995 and 1994, the Company had provided approximately $10,416,000, $7,804,000 and $5,253,000, respectively, for the annual discretionary bonus plan. CFS also provides health and welfare benefits to substantially all of its employees. The Company incurred $884,000, $710,000 and $621,000 of expenses for the years ended December 31, 1996, 1995 and 1994, respectively, for such plans. The Company also has a defined contribution retirement plan which allows participants to make voluntary contributions by salary reduction pursuant to section 401(k) of the Internal Revenue Code. The Company provides for the administrative costs for the 401(k) plan.
The Company has reserved shares for grants of different types of awards, such as stock options, restricted stock, stock appreciation rights, other stock-based grants or any combination of the foregoing under the Omnibus Stock Incentive Plan ("Omnibus Plan"). Additionally, the Company has reserved shares for stock option grants under the 1992 Stock Option Plan and the 1994 Stock Option Plan. The three aforementioned plans are referred to collectively as the "Plans". Key employees of the Company and its affiliates are eligible. The Company has authorized 4,425,000 options and has 1,370,366 shares remaining and available for grant under the Plans.
The Company applies APB 25 in accounting for its Plans and, accordingly, no compensation cost has been recognized for its stock options in the financial statements. As described previously, the Company has recognized compensation expense for the restricted stock as per APB 25. The compensation expense would be the same if the Company had adopted SFAS No. 123. Under the fair value based method of accounting as prescribed by SFAS No. 123, the per share weighted-average fair value of stock options on the date of grant during 1996 and 1995, using the Black Scholes option-pricing model, was $11.17 and $6.13, respectively, with the following weighted-average assumptions: 1996 - expected dividend yield 0.2%, risk-free interest rate of 5.0%, volatility level of 0.22, and an expected life of 7 years; 1995 - expected dividend yield 0.4%, risk-free interest rate of 5.0%, volatility level of 0.23, and an expected life of 6 years.
Had the Company determined compensation cost using the fair value based method of accounting, as defined by SFAS No. 123, for its stock options, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
Pro forma net income reflects only options granted in 1996 and 1995. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net income amounts presented above because the estimated compensation cost will be recognized over the options' vesting periods and options granted prior to January 1, 1995 are not considered in the determination of the compensation cost.
7) Employee Stock Ownership Plan On June 25, 1992, Holdings adopted an ESOP to provide its employees the opportunity to obtain beneficial interests in the stock of Holdings through a trust (the "ESOP Trust"). The ESOP Trust purchased 750,000 shares at $13.33 per share of Holdings' stock. The ESOP Trust financed its purchase of common stock with a loan from Holdings in the amount of $10 million. The ESOP loan is evidenced by a promissory note delivered to Holdings. An amount representing unearned employee compensation, equivalent in value to the unpaid balance of the ESOP loan, is recorded as a deduction from stockholders' equity (unallocated ESOP shares).
8) Reserve for Losses and Loss Adjustment Expenses The reserve for losses and loss adjustment expenses consists of a case basis loss reserve and the SLR.
10) Income Taxes Pursuant to a tax sharing agreement with Holdings, CapMAC and CFS file a consolidated U.S. Federal income tax return. Each company's annual Federal income tax liability is determined by computing its pro rata share of the consolidated group Federal income tax liability. CFS (Europe) files a separate income tax return with the U.K. Inland Revenue.
$ in thousands Federal State & Local Foreign Total - -------------------------------------------------------------------------------- Year Ended December 31, 1996 - -------------------------------------------------------------------------------- Current $8,654 1,753 4,092 14,499 Deferred 992 (779) -- 213 - -------------------------------------------------------------------------------- Total $9,646 974 4,092 14,712 ================================================================================ Year Ended December 31, 1995 - -------------------------------------------------------------------------------- Current $3,814 1,529 2,580 7,923 Deferred 3,244 (59) -- 3,185 - -------------------------------------------------------------------------------- Total $7,058 1,470 2,580 11,108 ================================================================================ Year Ended December 31, 1994 - -------------------------------------------------------------------------------- Current $2,561 1,473 928 4,962 Deferred 2,868 (38) -- 2,830 - -------------------------------------------------------------------------------- Total $5,429 1,435 928 7,792 ================================================================================
$ in thousands December 31, 1996 December 31, 1995 - -------------------------------------------------------------------------------- Deferred tax assets: Deferred compensation $ 4,202 2,120 Loss on investment in TMG Group warrants 1,839 457 Losses and loss adjustment expenses 1,527 1,002 Unearned premiums 866 852 Other, net 108 275 - -------------------------------------------------------------------------------- Total gross deferred tax assets 8,542 4,706 - -------------------------------------------------------------------------------- Deferred tax liabilities: Deferred acquisition costs 15,883 12,307 Unrealized capital gains on investments 1,091 1,769 Other, net 1,158 1,406 - -------------------------------------------------------------------------------- Total gross deferred tax liabilities 18,132 15,482 - -------------------------------------------------------------------------------- Net deferred tax liability $ 9,590 10,776 ================================================================================
A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. Management believes that the deferred tax assets will be fully realized in the future.
11) Insurance Regulatory Restrictions CapMAC is subject to insurance regulatory requirements of the State of New York and other states in which it is licensed to conduct business. Generally, New York insurance laws require that dividends be paid from earned surplus and restrict the amount of dividends in any year that may be paid without obtaining approval for such dividends from the Superintendent of Insurance to the lower of (i) net investment income as defined or (ii) 10% of statutory surplus as of December 31 of the preceding year. No dividends were paid by CapMAC to Holdings during the years ended December 31, 1996, 1995 and 1994. No dividends could be paid during these periods because CapMAC had negative earned surplus. Statutory surplus at December 31, 1996 and 1995 was approximately $193,726,000 and $195,018,000, respectively. Statutory surplus differs from stockholders' equity determined under GAAP principally due to the mandatory contingency reserve required for statutory accounting purposes and differences in accounting for investments, deferred acquisition costs, SLR and deferred taxes provided under GAAP. Statutory net income was $18,737,000, $9,000,000 and $4,543,000 for the years ended December 31, 1996, 1995 and 1994, respectively. Statutory net income differs from net income determined under GAAP principally due to deferred acquisition costs, SLR and deferred income taxes.
Rent expense, commercial rent taxes and electricity for the years ended December 31, 1996, 1995 and 1994 amounted to $2,451,000, $2,398,000 and $2,374,000, respectively.
The Company is required to purchase common stock in TMG Group for approximately $13 million no later than February 27, 2000. Additionally, the Company has agreed, upon request of ASIA Ltd, to make an additional investment of up to $4.9 million in Asia Services through its affiliate CapMAC Asia.
CapMAC Investment Management, Inc. ("CIM"), a new subsidiary of Holdings, was incorporated in Delaware in October 1996 as a registered investment advisor. CIM will provide investment advice regarding asset-backed structures, mortgage-backed securities, foreign and domestic fixed income and equity securities, and other securities based on the client's investment objectives, financial needs and goals. CIM is expected to be initially capitalized with $2 million and will commence operations in early 1997.
14) Foreign Operations The Company provides advisory services in Europe through CFS (Europe). The revenue generated from this business for the years ended December 31, 1996 and 1995 was $13.4 million and $7.8 million, respectively, and for the period from inception of CFS (Europe) on July 14, 1994 through December 31, 1994 was $3.1 million. The net income for the years ended December 31, 1996 and 1995 was $8.3 million and $5.1 million, respectively, and for the period from inception of CFS (Europe) on July 14, 1994 through December 31, 1994 was $2.0 million. The total assets for CFS (Europe) as of December 31, 1996 and 1995 were $4.9 million and $9.6 million, respectively.
16) Capitalization On November 27, 1995, the Company effected a 3-for-2 common stock split which has been reflected in the accompanying consolidated financial statements for all periods presented.
On July 5, 1996, Holdings completed a secondary public offering by some of its stockholders of 3,737,500 shares of common stock at an offering price of $28. The Company did not receive any proceeds from the offering but incurred costs of approximately $360,000.
Selected quarterly financial data for 1996 and 1995 are presented below: