(1) Periods have been restated to reflect the three-for-two stock split on June 28, 1996, and the two-for-one stock split on October 28, 1997. (2) Based on statutory accounting practices and derived from consolidated statutory financial statements of Triad.
Management's Discussion and Analysis of Financial Condition and Results of Operation.
Net income for 1997 increased 54.0% to $17.2 million compared to $11.2 million in 1996. This improvement was primarily attributable to a 55.8% increase in earned premiums, a 14.5% increase in net investment income and an improved combined loss and expense ratio.
The Company also benefited from the January 1997 upgrade of Triad's claims-paying ability rating from "AA-" to "AA" by Standard & Poor's Corporation. In January 1998, Standard & Poor's Corporation affirmed Triad's "AA" claims-paying ability rating.
Net investment income for 1997 was $6.2 million, a 14.5% increase over $5.4 million in 1996. This increase resulted from the growth in the average book value of invested assets to $103.8 million at December 31, 1997 from $89.6 million at December 31, 1996. The yield on average invested assets was 6.0% for 1997 compared to 6.1% for 1996. This slight decrease is attributable to the Company's continued investment in lower yielding municipal tax-preferred securities. The portfolio's tax-equivalent yield was 8.0% for 1997 up from 7.7% for 1996. Approximately 71.8% or $68.7 million of the Company's fixed maturity portfolio at December 31, 1997 was composed of state and municipal tax-preferred securities as compared to 53% at December 31, 1996 and 37% at December 31, 1995.
The Company's loss ratio (the ratio of incurred losses to earned premiums) was 13.4% for 1997 compared to 13.3% for 1996. The loss ratio was 12.1% for the fourth quarter of 1997 compared to 14.3% for the same period of 1996. The Company's favorable loss ratio reflects the low level of delinquencies compared to the number of insured loans and the fact that approximately 73% of the Company's insurance in force was originated in the last 36 months. Management believes, based upon its experience and industry data, that claims incidence for it and other private mortgage insurers is generally highest in the third through
During periods of significant refinancing activity, it is possible that policies on stronger loans may lapse and that weaker loans may remain in force, thus potentially increasing the loss ratio on older business. Substantial increases in production of new business during these periods can offset the increased loss ratio on the older business.
Amortization of deferred policy acquisition costs increased by 27.4% to $4.1 million in 1997 compared to $3.2 million for 1996. The increase in amortization reflects a growing balance of deferred policy acquisition costs to amortize as the Company builds its total insurance in force.
The expense ratio (ratio of underwriting expenses to net premiums written) for 1997 was 37.5% compared to 43.8% for 1996. Contributing to this improvement is the higher level of written premiums partially offset by the increase in expenses.
The effective tax rate for 1997 was 31.7% compared to 31.0% in 1996. This increase is primarily the result of the phase-in of the 35% federal statutory income tax rate applicable to companies with annual taxable income above $10 million. Management expects the Company's effective tax rate to increase slightly as new funds from the debt offering in January 1998 are invested in taxable securities and the Company's taxable income grows faster than its tax preferred investment income.
Other operating expenses increased to $7.3 million for 1996 compared to $4.8 million for 1995. This increase in expenses was primarily attributable to personnel, facilities and equipment costs required to support Triad's geographic expansion and increased production coupled with a reduction in ceding commissions earned following changes in the Company's reinsurance program for 1996. Ceding commissions paid to the Company are reported as a reduction in other operating expenses and decreased to $572,000 in 1996 compared to $1.5 million in 1995.
The effective tax rate for all of 1996 was 31.0% compared to 30.9% for 1995. In 1996, the Company began a phase-in of the 35% Federal statutory income tax rate applicable to companies with annual taxable income above $10 million.
The Company's sources of operating cash flow consist primarily of premiums written and investment income. Operating cash flow is applied primarily to the payment of claims and expenses.
For 1997, the Company generated positive cash flow from operating activities of $17.9 million compared to $12.5 million for 1996. The increase in Triad's operating cash flow reflects the growth in renewal premiums and insurance written that has more than offset the increases in claims paid and other expenses.
The Company's business does not routinely require significant capital expenditures. 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.
Consolidated invested assets were $119.9 million at December 31, 1997, including a total of $111.2 million in fixed maturity securities and equity securities classified as available-for-sale. Net unrealized investment gains were $2.8 million on equity securities and $4.0 million on fixed maturity securities at December 31, 1997.
Total stockholders' equity increased to $111.8 million at December 31, 1997 from $91.7 million at December 31, 1996. This increase resulted primarily from net income of $17.2 million for 1997 and an increase in net unrealized gains on invested assets classified as available-for-sale of $2.8 million (net of income tax).
Triad's ability to write insurance depends on the adequacy of its statutory 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 limit Triad's risk-to-capital ratio to 25-to-1. As of December 31, 1997 Triad's risk-to-capital ratio was 19.3-to-1, and as of December 31, 1996 was 15.8-to-1, as compared to 19.4-to-1 for the industry as a whole at December 31, 1996, the latest industry data available.
Rating agencies also require capital levels based on a company's performance sensitivity to various depression scenarios. In determining capital levels, the rating agencies allow the use of different forms of capital including statutory capital, reinsurance and debt. The effect of the Company's contribution of $25 million of its $35 million senior note offering to the capital of Triad in January 1998 will be to improve its risk-to-capital ratio and to provide additional capital considered in the rating agency's depression models. Had the contribution been made as of year end 1997, Triad's risk-to-capital ratio would have been approximately 15.9-to-1. There can be no assurance that the Company will continue to meet such capital requirements.
In June 1997, the Financial Accounting Standards Board issued Statement No. 130, Reporting Comprehensive Income, which is effective for fiscal years beginning after December 31, 1997. The Statement establishes standards for the reporting and display of comprehensive income and its components in financial statements. The Company expects to adopt the provisions of Statement No. 130 in the first quarter of 1998 and will present the financial statements for earlier periods provided for comparative purposes as required by the Statement. The application of the new rules will not have an impact on the Company's financial position or results of operations.
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 from their current levels; housing transactions and mortgage issuance may decrease for many reasons including changes in interest rates or economic conditions; the Company's market share may change as a result of changes in underwriting criteria or competitive products or rates; the amount of new insurance written could be 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; rating agencies may revise methodologies for determining the Company's claims-paying ability ratings and may revise or withdraw the assigned ratings at any time; the Company's performance may be impacted by changes in the performance of the financial markets and general economic conditions. Economic downturns in regions where Triad's risk is more concentrated could have a particularly adverse affect on Triad's financial condition and loss development. Accordingly, actual results may differ from those set forth in the forward looking statements. Attention is also directed to other risk factors set forth in documents filed by the Company with the Securities and Exchange Commission.