The selected financial data set forth below should be read in conjunction with the consolidated financial statements of the Company and the notes thereto set forth herein, as well as the Management's Discussion and Analysis of Financial Conditions and Results of Operations which is also set forth herein.
On December 19, 1995 Holdings sold 2,500,000 new shares of its common stock in an initial public offering ("the Offering"). In conjunction with the Offering, Holdings also sold 500,000 shares to Centre Reinsurance Limited ("Centre Re"), a wholly-owned subsidiary of The Zurich Insurance Company in a private placement. This investment reflects the intent of the Company and Centre Re to establish a strategic alliance to jointly pursue the development of new financial products.
In July 1995, the Company sold 500,001 shares of common stock to ORIX USA Corporation ("ORIX"), a subsidiary of ORIX Corporation, a leading Japanese leasing company.
Of the proceeds received by the Company from the Offering and the private placements, $59 million were contributed to CapMAC.
To illustrate the growth of the Company's business, presented below are selected financial and statistical data for calendar years 1994, 1995 and 1996.
PFR written(3),(4) $110,580 $ 89,585 $50,921 Year to year change 23% 76% 33% PFR outstanding(3) 232,669 155,411 98,059 Year to year change 50% 58% 53%
- ---------- (1) The amount of principal or other obligations guaranteed and outstanding under an insurance policy or a reinsurance agreement, net of ceded reinsurance. (2) The amount of principal or other obligations guaranteed under an insurance policy or a reinsurance agreement in a given period. (3) CapMAC collects premiums primarily on an installment basis over the term of the insurance policy and, to a lesser extent, on a one-time, up-front basis at the time the insurance policy is issued. In 1996, 1995 and 1994, premiums collected on an installment basis constituted 91%, 91% and 96%, respectively, of net premiums earned. Due to the annuity nature of premium income, CapMAC has an embedded future revenue stream which will be collected
and recognized as revenue not just in the year an insurance policy is issued, but over the full term such policy is outstanding. CapMAC reflects a relatively small portion of the expected future revenue on the business written in the current period as premium earnings in the same period. The total estimated present value of future revenues, "PFR," includes installment and up-front premiums (net of ceded premiums) and ceding commission income contractually due to or to be earned by CapMAC in the future under outstanding policies ("PFR outstanding"). PFR is not recognized as a financial measure under GAAP. The determination of the amount of PFR for a given policy is based primarily on the premium rate specified for such policy, the contractual term of the policy and the expected outstanding amount of the obligations insured under such policy discounted to a present value at an assumed discount rate. The Company believes that measuring the PFR provides useful information in evaluating its business growth and potential future revenue during a given period. However, the actual amount of future revenue may differ from the estimates due to various factors such as early termination, renewal of insurance contracts, changes in projected rates at which insured obligations are repaid, or variations in the utilization of insured structured programs. (4) Present value of future revenue stream, net of premiums ceded to reinsurers, embedded in the business written in a given period, which is expected to be recognized over the term of the book of business. A portion of the PFR written for a given period, as reflected above, is included in net premiums earned for such period.
In 1996 gross premiums written were $72.8 million, an increase of $15.3 million or 27% from $57.5 million for the same period in 1995. This increase was principally due to $9.6 million of premiums written with respect to international transactions, $5.1 million of premiums written with respect to domestic corporate transactions and $4.2 million of premiums written with respect to domestic consumer transactions, offset by lower premiums written with respect to the municipal business of $3.6 million. The amount of premiums ceded to reinsurers decreased to $15.1 million in 1996 from $16.0 million in 1995. On January 1, 1996, CapMAC reassumed the liability for all policies previously reinsured by Winterthur Swiss Insurance Company ("Winterthur"). As a result, CapMAC reassumed approximately $1.4 billion of principal insured by Winterthur as of December 31, 1995. In connection with this reassumption of liability, Winterthur commuted and returned to CapMAC unearned premiums, net of ceding commission and Federal excise tax, of $2.0 million. Net premiums earned were $40.6 million in 1996, an increase of 39% from $29.2 million in 1995. Unearned premiums, representing premiums collected but not yet earned, increased by $22.5 million from December 31, 1995 to a total of $68.3 million at December 31, 1996 primarily due to large up-front premiums received from international transactions and the reassumption of the reinsurance from Winterthur referred to above.
At December 31, 1996, CapMAC had 607 policies outstanding which are expected to generate $232.7 million of PFR, up approximately 50% from $155.4 million at December 31, 1995 relating to 476 policies outstanding at such date. The discount rate used for purposes of the PFR calculation was 7% at December 31, 1996 and 1995.
At December 31, 1996, net par insured and outstanding was $19.7 billion, up 56% from $12.6 billion at December 31, 1995 as a result of an increase in consumer receivable transactions of 49% from $7.0 billion at December 31, 1995 to $10.4 billion at December 31, 1996 and an increase in trade and corporate obligations of 72% from $4.9 billion at December 31, 1995 to $8.4 billion at December 31, 1996. The remaining weighted average life of the insured portfolio was estimated to be 6.4 years at December 31, 1996 versus 6.0 years at December 31, 1995.
Other income decreased $2.0 million from $2.2 million in 1995 to $0.2 million in 1996. In 1995, the Company recorded the sale, without recourse, of its interest in potential future cash flows from certain transactions included in its insured portfolio for a net amount of $2.2 million.
Net investment income was $17.9 million in 1996, an increase of 39% from $12.8 million in 1995. Average assets available for investment increased to $323.1 million in 1996 from $238.4 million in 1995. The increase was primarily due to the investment of the proceeds of the December 1995 initial public offering and private placement of the Company's common stock to Centre Reinsurance Limited and the July 1995 private placement to ORIX. The average annualized pre-tax yield on the investment portfolio increased to 5.6% in 1996 from 5.5% in 1995. The average after-tax yield on the investment portfolio was 4.5% in 1996 and 1995. The amount of tax-exempt securities held in the Company's investment portfolio decreased to 53% at December 31, 1996 from 57% at December 31, 1995. Net realized capital losses in 1996 were $1.8 million as compared to $1.4 million of net realized capital gains in 1995. In the fourth quarter of 1996, the Company recorded a pre-tax capital loss of $2.0 million related to Holdings' investment in three derivatives products subsidiaries of the Mutual Life Assurance Company of Canada (such subsidiaries, the "TMG Group"). This represents a partial write-off of the approximately $11 million that Holdings is committed to invest in the TMG Group as of December 31, 1996. The Company will continue to monitor this investment, and if any further impairment occurs, there would be additional write-offs in the future.
CapMAC maintains a reserve for losses and loss adjustment expenses which consists of a supplemental loss reserve ("SLR") and, if appropriate, a case basis loss reserve for expected levels of defaults resulting from credit failures on currently insured issues. The SLR is based on estimates of the portion of earned premiums required to cover those claims. 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. Corresponding to the growth in the insured portfolio, the losses and loss adjustment expenses were $4.8 million in 1996 compared to $3.1 million in 1995. Apart from additions to the SLR the Company incurred no losses in 1996.
Policy acquisition costs represent the amortization of DAC, which are those expenses incurred by CapMAC in acquiring new business. The increase in policy acquisition costs to $7.8 million in 1996 from $7.2 million in 1995 lags the increase in premiums earned in the corresponding periods primarily due to the increasing average life of the insured portfolio. Interest expense related to the senior debt was $1.2 million in 1996 and 1995.
The Company reported net income of $23.5 million or $1.73 per share during 1995, a 38% increase over net income of $17.1 million or $1.23 per share reported in 1994. Earnings per share on a fully diluted basis were $1.65 in 1995, a 34% increase over $1.23 in 1994. Operating earnings per share on a fully diluted basis for 1995 was $1.58, an increase of 27% from $1.24 in 1994.
In 1995, gross premiums written were $57.5 million, an increase of 29% from $44.7 million for the same period in 1994. Net premiums earned were $29.2 million in 1995, an increase of 27% from $23.1 million in 1994.
Net investment income was $12.8 million in 1995 and $10.3 million in 1994. Average assets available for investment increased from $198.0 million in 1994 to $238.4 million in 1995. The increase was primarily due to the investment of the proceeds of the Offering and private placements. The average annualized pre-tax yield on the investment portfolio increased from 5.3% in 1994 to 5.5% in 1995 due to a higher interest rate environment. The average after-tax yield on the investment portfolio increased from 4.3% in 1994 to 4.5% in 1995. Net realized capital gains in 1995 were $1.5 million higher than 1994. The amount of tax-exempt securities held in the Company's investment portfolio decreased from 61% at December 31, 1994 to 57% at December 31, 1995. Total expenses were $28.0 million in 1995, an increase of 42% from $19.7 million in 1994. Total expenses included additions to the reserve for losses and loss adjustment expenses, underwriting and operating expenses, policy acquisition costs, and interest expense.
Policy acquisition costs represent the amortization of DAC, which are those expenses incurred by CapMAC in acquiring new business. The increase in policy acquisition costs from $4.5 million in 1994 to $7.2 million in 1995 relates to the increase in premiums earned in the corresponding periods. Interest expense related to the senior debt was $1.2 million in 1995 and 1994.
Holdings is currently committed to purchase common stock in the TMG Group for approximately $11 million. Holdings must fund its investment in TMG Group no later than February 27, 2000 at which time the commitment amount would have contractually increased to approximately $13 million. Holdings has also agreed to invest, if required, an additional amount of $4.9 million in CapMAC Asia.
CapMAC, in early 1997, has made an investment of 50 million French Francs (approximately 10 million U.S. dollars) in CapMAC Assurance, S.A., an insurance subsidiary to be established in Paris, France. CapMAC Assurance is licensed to write financial guarantee insurance in the European Union member states.
CapMAC. CapMAC's primary sources of funds are from premiums received and earnings from its investment portfolio. Currently CapMAC's primary use of funds is to pay operating expenses. In the event of a default by an issuer of an insured obligation and upon exhaustion of other liquidity sources in the transaction, such as the cash flow from any assets collateralizing such obligations, funds from CapMAC's
investment portfolio may be required to satisfy claims. The insurance policies issued by CapMAC provide, in general, that payment of principal, interest and other amounts insured by CapMAC may not be accelerated by the holder of the obligation but are paid by CapMAC in accordance with the obligation's original payment schedule or, at CapMAC's option, on an accelerated basis. These policy provisions prohibiting acceleration of certain claims serve to reduce CapMAC's liquidity requirements.
CapMAC has available a $150 million, standby corporate liquidity facility presently scheduled to terminate in September 1999 which, if necessary, is available (subject to satisfaction of customary drawing conditions) to provide funds for any claim payments under its policies. Such drawing conditions include a requirement that CapMAC maintain at least $165 million of "Tangible Net Worth," which is defined as the difference between the market value of CapMAC's portfolio of marketable securities plus the amount of its cash on hand and the total liabilities and reserves of CapMAC determined in accordance with GAAP, excluding any loans made under the liquidity facility. As of December 31, 1996, CapMAC's Tangible Net Worth was $228.7 million. The liquidity facility is provided by a consortium of banks headed by Bank of Montreal, as agent, which is rated A1+ and P1 by S&P and Moody's, respectively. As of December 31, 1996, CapMAC has never borrowed under this corporate liquidity facility.
The Company has a conservative investment strategy of investing in U.S. government and agency obligations and securities that are rated "A" or better by the major rating agencies. The Company has readily marketable, high quality, fixed income securities and short-term investments in its investment portfolio. The average contractual maturity of securities within the investment portfolio was 6.1 years and 4.7 years at December 31, 1996 and December 31, 1995, respectively. The average duration of the investment portfolio at December 31, 1996 and December 31, 1995 was 4.3 years and 3.5 years, respectively. At December 31, 1996, the amortized cost of the Company's investment portfolio was approximately $336.0 million (fair value of $339.2 million). The Company manages its investments with the objectives of preserving its capital and claims-paying ability, maintaining a high level of liquidity, minimizing taxes and, within these constraints, optimizing long-term total return.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CapMAC Holdings Inc. and subsidiaries as of December 31, 1996 and 1995 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996 in conformity with generally accepted accounting principles.
CapMAC Holdings Inc. and Subsidiaries Consolidated Balance Sheets (Dollars in thousands, except per share data)
CapMAC Holdings Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 1996 and 1995
On December 19, 1995 Holdings sold 2,500,000 new shares of its common stock in an initial public offering ("the Offering"). In conjunction with the Offering, Holdings also sold 500,000 shares to Centre Reinsurance Limited (Centre Re), a wholly owned subsidiary of The Zurich Insurance Company, in a private placement (see note 16).
In July 1995, the Company sold 500,001 shares of common stock to ORIX USA Corporation ("ORIX"), a subsidiary of ORIX Corporation, a leading Japanese leasing company (see note 16).
a) Basis of Presentation The accompanying consolidated financial statements are prepared on the basis of generally accepted accounting principles ("GAAP") and include the accounts of Holdings and its wholly owned subsidiaries, principally CapMAC and CFS, and its investment in CapMAC Asia. The remaining shareholders in CapMAC Asia are accounted for as minority interest. All significant intercompany transactions have been eliminated in consolidation.
b) Investments As of December 31, 1996 and 1995, all of the Company's securities have been classified as available-for-sale. Available-for-sale securities are recorded at fair value. Fair value is generally based upon quoted market prices. Unrealized holding gains and losses, net of the related tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of stockholders' equity until realized. Transfers of securities between categories are recorded at fair value at the date of transfer. A decline in the fair value of any available-for-sale security below cost that is deemed other than temporary is charged to earnings resulting in the establishment of a new cost basis for the security.
d) Advisory Fee Revenue Recognition CFS and CFS (Europe) collect advisory fees for advising clients as to the most appropriate structure to use for a given securitization transaction based on the nature of the assets and financial objective of the customer. Advisory fees received by CFS or CFS (Europe) are generally earned when a transaction closes. Such amounts are non-refundable and are for services provided prior to the close of a transaction.
e) Deferred Acquisition Costs Certain costs incurred by CapMAC, which vary with and are primarily related to the production of new business, are deferred. These costs include direct and indirect expenses related to underwriting, marketing and policy issuance, rating agency fees and premium taxes, net of reinsurance ceding commissions. The deferred acquisition costs are amortized over the period in proportion to the related premium earnings. The actual amount of premium earnings may differ from projections due to various factors such as renewal or early termination of insurance contracts or different run-off patterns of exposure resulting in a corresponding change in the amortization pattern of the deferred acquisition costs.
Management believes that the current level of reserves is adequate to cover the ultimate net cost of claims and the related expenses with respect to financial guarantees issued by CapMAC. The establishment of the appropriate level of loss reserves is an
g) Depreciation Leasehold improvements, furniture, fixtures and electronic data processing equipment are being amortized or depreciated over the lease term or useful life, whichever is shorter, using the straight-line method.
j) Accounting for Stock Issued to Employees In October 1995, the Financial Accounting Standards Board ("FASB") issued SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 establishes accounting and reporting standards for stock-based employee compensation plans. This Statement allows companies to choose between the "fair value based method of accounting" as defined in this Statement and the "intrinsic value based method of accounting" as prescribed by Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." The Company has elected to remain with the accounting requirements under APB 25. The pro forma disclosures of net income and earnings per share required by SFAS No. 123, as if the fair value based method of accounting had been applied, are included in note 6.
The following entities each accounted for, through referrals and otherwise, 10% or more of total revenues for each of the periods presented:
Year Ended Year Ended Year Ended December 31, 1996 December 31, 1995 December 31, 1994 - -------------------------- ------------------- --------------------- % of % of % of Name Revenues Name Revenues Name Revenues - -------------------------- ------------------- --------------------- Bear, Stearns & 11.8 Citicorp 11.7 Citicorp 14.3 Co. Inc. Citicorp 10.8
4) Investments The amortized cost, gross unrealized gains, gross unrealized losses and estimated fair value for available-for-sale securities by major security type at December 31, 1996 and 1995 were as follows ($ in thousands):
The amortized cost and estimated fair value of investments in debt securities at December 31, 1996 by contractual maturity are shown below ($ in thousands):
Amortized Estimated Securities Available-for-sale Cost Fair Value - -------------------------------------------------------------------------------- Due in one year or less $ 16,524 16,541 Due after one year through five years 31,821 32,815 Due after five years through ten years 76,450 78,200 Due after ten years 83,757 84,928 - -------------------------------------------------------------------------------- Sub-total 208,552 212,484 Mortgage-backed securities 127,484 126,690 - -------------------------------------------------------------------------------- Total $ 336,036 339,174 ================================================================================
Investment income is comprised of interest and dividends, net of related expenses, and is applicable to the following sources:
In 1995, Holdings acquired three million shares of ABS Finance for approximately $1,350,000. ABS Finance is a corporation established to develop securitization in Indonesia for obligations that are backed by assets originated in Indonesia or that are issued by Indonesian entities. ABS Finance participates as a principal in the securitization markets in Indonesia. Simultaneously with the execution of the joint venture agreement with the other investors in ABS Finance, CFS entered into a technical assistance agreement with ABS Finance to provide technical and advisory assistance to ABS Finance in exchange for certain fees. At December 31, 1996 and 1995, Holdings' investment represents an equity interest of approximately 14.3% and 15%, respectively, in ABS Finance. At December 31, 1996 and 1995, the investment amounted to $1,439,000 and $1,339,000, respectively.
In 1995, Holdings entered into a strategic alliance with The Mutual Life Assurance Company of Canada and three of its derivatives products subsidiaries (such subsidiaries, "TMG Group"). TMG Group provides a broad range of derivative products, including investment agreements and long dated interest rate swaps. In addition, TMG Group provides interest rate swaps and currency swaps. Because the obligations of TMG Group under its derivative transactions are guaranteed by The Mutual Life Assurance Company of Canada, TMG Group is rated AA by S&P and Aa3 by Moody's.
During 1996, the estimated fair value of the warrants has declined from a loss (pre-tax) of $1.3 million at December 31, 1995 to a loss (pre-tax) of $5.2 million at December 31, 1996. The total decrease in the fair value of the warrants of $5.2 million (pre-tax) has been recorded as a contra asset in "Other Assets" in the accompanying consolidated balance sheet as of December 31, 1996. The Company believes that a portion of this decline in value is other-than-temporary, and accordingly, it has recorded a realized loss (pre-tax) of $2.0 million in 1996. The remaining unrealized loss (pre-tax) of $3.2 million is reflected as a separate component of stockholders' equity, or $2.1 million on a net of tax basis.
No single issuer, except for investments in U.S. Treasury and U.S. government agency securities, exceeds 4% and 3% of stockholders' equity as of December 31, 1996 and 1995, respectively.
5) Deferred Acquisition Costs The following table reflects acquisition costs deferred by CapMAC and amortized in proportion to the related premium earnings:
On June 25, 1992, certain officers of CapMAC were granted 182,633 restricted stock units ("RSU") at $13.33 a share in respect of certain deferred compensation. On December 7, 1995, the RSU's were converted to cash in the amount of approximately $3.7 million, and such officers agreed to defer receipt of such cash amount in exchange for receiving the same number of new shares of restricted stock ("RS") as the number of RSU's such officers previously held. The RS's were granted under the Omnibus Plan discussed in the following paragraph. The cash amount is held by Holdings and invested in accordance with certain guidelines. Such amount, including the investment earnings thereon amounted to $3.7 million at December 31, 1996 and will be paid to each officer upon the occurrence of certain events but no later than December 2000. Compensation expense related to the RS's and RSU's was approximately $1,401,000, $1,502,000 and $132,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
The following table sets forth the activity and terms of the Plans:
The following table summarizes the options and restricted stock granted and outstanding for each of the last three years:
Year Ended Year Ended ($ in thousands, except per share data) December 31, 1996 December 31,1995 - ------------------------------------------------------------------------------- Net income As reported $ 33,568 $ 23,528 Pro forma $ 32,162 $ 23,339
Primary As reported $ 1.92 $ 1.73 Pro forma $ 1.86 $ 1.72
Fully diluted As reported $ 1.89 $ 1.65 Pro forma $ 1.82 $ 1.64 - -------------------------------------------------------------------------------
CFS is required to make contributions to the ESOP Trust, which enables the ESOP Trust to service its loan to Holdings. The ESOP expense is calculated using the shares allocated method. Shares are released for allocation to the participants and held in trust for the employees based upon the ratio of the current year's principal and interest payment to the sum of principal and interest payments estimated over the life of the loan. As of December 31, 1996 and 1995 approximately 343,000 shares and 263,000 shares, respectively, were allocated to the participants. Compensation expense related to the ESOP was approximately $2,402,000, $1,588,000 and $1,407,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
In 1995, CapMAC incurred its first claim on a financial guarantee policy. Based on its current estimate, the Company expects the aggregate amount of claims and related expenses not to exceed $2.7 million, although no assurance can be given that such claims and related expenses will not exceed that amount. Such loss amount was covered through a recovery under a quota share reinsurance agreement of $0.2 million and a reduction in the SLR of $2.5 million. The portion of such claims and expenses not covered under the quota share agreement is being funded through payments to CapMAC from the Lureco Trust Account (see note 13).
The following is a summary of the activity in the case basis loss reserve account and the components of the reserve for losses and loss adjustment expenses ($ in thousands):
1996 1995 1994 - -------------------------------------------------------------------------------- Case basis loss reserve: Net balance at January 1 $ 620 -- -- - -------------------------------------------------------------------------------- Incurred related to: Current year -- 2,473 -- Prior years -- -- -- - -------------------------------------------------------------------------------- Total incurred -- 2,473 -- - -------------------------------------------------------------------------------- Paid related to: Current year -- 1,853 -- Prior years 309 -- -- - -------------------------------------------------------------------------------- Total paid 309 1,853 -- - -------------------------------------------------------------------------------- Net balance at December 31 311 620 -- Reinsurance recoverable -- 69 -- - -------------------------------------------------------------------------------- Gross balance at December 31 311 689 -- - -------------------------------------------------------------------------------- Supplemental loss reserve: Balance at January 1 5,859 5,191 3,762 - -------------------------------------------------------------------------------- Additions to supplemental loss reserve 4,815 3,141 1,429 Allocated to case basis reserve -- (2,473) -- - -------------------------------------------------------------------------------- Balance at December 31 10,674 5,859 5,191 - -------------------------------------------------------------------------------- Total reserve for losses and loss adjustment expenses $10,985 6,548 5,191 ================================================================================
9) Senior Notes On December 15, 1992, Holdings sold $15,000,000 principal amount of 7.52% Senior Notes to certain financial institutions. The Senior Notes are due in equal annual installments of $3,750,000 beginning December 15, 1999 through December 15, 2002. Interest is payable semiannually on the fifteenth day of June and December of each year commencing June 15, 1993.
The tax effects of temporary differences that give rise to significant portions of the deferred tax liability are as follows:
12) Commitments and Contingencies Holdings' lease agreement for the space occupied in New York expires on November 20, 2008. Holdings also has a lease agreement for its London office, which expires on October 1, 2002. As of December 31, 1996, future minimum payments under the lease agreements are as follows:
$ in thousands Payment - -------------------------------------------------------------------------------- 1997 $ 2,647 1998 2,715 1999 3,077 2000 3,152 2001 and thereafter 28,660 - -------------------------------------------------------------------------------- Total $ 40,251 ================================================================================
CapMAC has available a $150,000,000 standby corporate liquidity facility (the "Liquidity Facility") scheduled to terminate in September 1999. The Liquidity Facility is provided by a consortium of banks, headed by Bank of Montreal, as agent, which is rated "A-1+" and "P-1" by S&P and Moody's, respectively. Under the Liquidity Facility, CapMAC will be able, subject to satisfying certain conditions, to borrow funds from time to time in order to enable it to fund any claim payments or payments made in settlement or mitigation of claim payments under its insurance contracts. There have been no draws under the Liquidity Facility.
Certain officers of Dillon, Read & Co. Inc. are directors of Holdings, and receive no compensation from the Company. Dillon, Read & Co. Inc., which serves as investment manager for Saratoga Partners II, a principal stockholder of the Company, received an advisory retention fee of $200,000 in each of the years ended December 31, 1995 and 1994.
CapMAC has agreed to make an investment of 50 million French Francs (approximately 10 million U.S. dollars) in CapMAC Assurance, S.A., an insurance subsidiary to be established in Paris, France. This investment is anticipated to be made in 1997.
13) Reinsurance In the ordinary course of business, CapMAC cedes exposure under various treaty and facultative reinsurance contracts, both on a pro rata and excess of loss basis, primarily designed to minimize losses from large risks and protect the capital and surplus of CapMAC.
In 1994, CapMAC entered into a reinsurance agreement (the "Lureco Treaty") with Luxembourg European Reinsurance LURECO S.A. ("Lureco"), a European-based reinsurer. The agreement is renewable annually at the Company's option, subject to satisfying certain conditions. The agreement reinsured and indemnified the Company for any loss incurred by CapMAC during the agreement period up to the limits of the agreement. 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 premium deposit amounts in the Lureco Trust Account have been reflected as assets by CapMAC during the term of the agreement. Premiums in excess of the deposit amounts have been recorded as ceded premiums in the consolidated statements of income. For the 1996 policy year, the agreement 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, a claim of approximately $2.5 million on an insurance policy was applied against the Lureco Trust Account.
In addition to its capital (including statutory contingency reserves) CapMAC has other reinsurance available to pay claims under its insurance contracts. Effective November 30, 1995, CapMAC entered into a Stop-loss Reinsurance Agreement with Mitsui Marine and Fire Insurance Co. (the "Mitsui Stop-loss Agreement"). Under the Mitsui Stop-loss Agreement, Mitsui Marine and Fire Insurance Co. ("Mitsui") will be required to pay any losses in excess of $100 million in the aggregate incurred by CapMAC during the term of the Mitsui Stop-loss Agreement on the insurance policies in effect on December 1, 1995 and written during the one-year period thereafter, up to an aggregate limit payable under the Mitsui Stop-loss Agreement of $50 million. The Mitsui Stop-loss Agreement has a term of seven years and is subject to early termination by CapMAC in certain circumstances. Effective January 1, 1997 the stop-loss reinsurance coverage increased to $75 million in excess of incurred losses of $150 million increasing annually based on increases in CapMAC's statutory qualified capital. The new stop-loss reinsurance is provided by Mitsui, AXA Re Finance S.A. ("AXA Re"), and Munchener Ruckversicherungs-Gesellschaft ("Munich Re").
Effective November 30, 1995, CapMAC canceled the quota share reinsurance agreement with Winterthur Swiss Insurance Company ("Winterthur") pursuant to which Winterthur had the right to reinsure on a quota share basis 10% of each policy written by CapMAC. As a result, CapMAC reassumed approximately $1.4 billion of principal insured by Winterthur on January 1, 1996. In connection with the commutation, Winterthur returned $2.0 million of unearned premiums, net of ceding commission and Federal excise tax.
15) Disclosures About Fair Value of Financial Instruments The following table presents the carrying amounts and estimated fair values of the Company's financial instruments at December 31, 1996 and 1995. The fair value amounts were determined by the Company using independent market information when available, and appropriate valuation methodologies when market information was not available. Such valuation methodologies require significant judgment and are not necessarily indicative of the amount the Company could recognize in a current market exchange.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments summarized above:
Available-for-sale Securities The fair values of fixed maturities are based upon quoted market prices. The fair value of short-term investments approximates amortized cost. The fair value of the warrants which is recorded as a contra asset in "Other Assets" is determined based upon the difference between the exercise price adjusted by the LIBOR-based formula and the estimated fair value of the Company's percentage share of ownership of TMG Group.
Financial Guarantees Outstanding The fair value of financial guarantees outstanding consists of (1) the current unearned premium reserve, net of prepaid reinsurance and (2) the fair value of installment revenue which is derived by calculating the present value of the estimated future cash inflow to CapMAC of policies in force having installment premiums, net of amounts payable to reinsurers, at a discount rate of 7% at December 31, 1996 and 1995. The amount calculated is assumed to be equivalent to the consideration that would be paid by CapMAC under market conditions prevailing at the reporting dates to transfer CapMAC's financial guarantee business to a third party under reinsurance and other agreements. Ceding commission represents the expected amount that would be paid to CapMAC to compensate CapMAC for originating and servicing the insurance contracts. In constructing estimated future cash inflows, management makes assumptions regarding prepayments for amortizing asset-backed securities which are consistent with relevant historical experience. For revolving programs, assumptions are made regarding program utilization based on discussions with program users. The amount of future installment revenue actually realized by CapMAC could be reduced in the future due to factors such as early termination of insurance contracts, accelerated prepayments of underlying obligations or lower than anticipated utilization of insured structured programs, such as commercial paper conduits. Although increases in future installment revenue earnings due to renewals of existing insurance contracts historically have been greater than reductions in future installment revenue due to factors such as those described above, there can be no assurance that future circumstances might not cause a material net reduction in the future installment revenue.
On December 19, 1995, Holdings sold 3,710,000 shares of its common stock at a price of $20.00 per share in the Offering. Of the 3,710,000 common shares, 2,500,000 shares were sold by the Company and 1,210,000 shares by certain existing stockholders. Proceeds to the Company, net of underwriting and other expenses, were $45.2 million. Dillon, Read & Co. Inc. was the managing underwriter of the Offering and has in that capacity received $3,500,000 from the Company. Concurrent with the Offering, the Company also issued 500,000 shares to Centre Re for a price per share that was 5% less than the Offering price of $20 per share. Net proceeds to the Company were $9.5 million. A portion of the net proceeds from the Offering and the private placement in the amount of $50.0 million was contributed to CapMAC in December 1995.
On June 25, 1992, Holdings granted approximately 2,250,000 warrants to non-employee stockholders of Holdings to purchase common stock at an exercise price of $13.33 per share. The warrants expire on June 25, 1999. During 1996, 551,390 warrants were exercised. The exercise of the warrants being cashless resulted in the issuance of 321,758 shares of common stock.