Triad Guaranty Inc. Q4 2007 Earnings Call Transcript

Feb.18.08 | About: Triad Guaranty (TGIC)

Triad Guaranty Inc.(OTC:TGIC) Q4 2007 Earning Call February 14, 2008 10:00 AM ET

Executives

Ken Jones - SVP and CFO

Mark Tonnesen - CEO

Bruce Van Fleet - EVP of Sales and Marketing

Steve Haferman - SVP and Chief Risk Officer

Analysts

Mike Grasher - Piper Jaffray

Damon McLaughlin - Huntington Partners

Ron Bobman - Capital Returns

Juan Black - Check Capital

Michael Nannizz - Bear Stearns

Ed Groshans - Fortress

James Gilligan - Equity Group Investments

Steve Stelmach - FBR Capital Market

Frank Latuda - Kennedy Capital

Operator

I would like to welcome everyone to the Triad Guaranty Inc. fourth quarter 2007 earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speaker remarks we will conduct a question-and-answer session.

(Operator Instructions)

As a reminder, ladies and gentlemen, this conference call is being recorded today, Thursday, February 14, 2008. If you have any objections to participating in a recorded call, please disconnect at this time. Your host for today is Ken Jones, Senior Vice President and Chief Financial Officer.

I would now like to turn the conference over to Mr. Jones. Please go ahead, sir.

Ken Jones

Good morning and thanks for joining the call today. My name is Ken Jones and I'm the Chief Financial Officer of Triad. Joining me on the call is Mark Tonnesen, our Chief Executive Officer; Bruce Van Fleet, Executive Vice President of Sales and Marketing, and Steve Haferman, Senior Vice President and Chief Risk Officer.

Just as a reminder, the information that we will be discussing today may include certain forward-looking statements that are protected under the Private Securities Litigation Reform Act of 1995. Obviously, our actual results could differ materially from those projected and I'd like to direct your attention to the risk factors included in Item 1A of our Form 10-K, updated in our third quarter Form 10-Q and the Safe Harbor statement that we've included in the management's discussion and analysis section of the Form 10-K, which outlines some of the various factors that could cause our actual results to differ. If we do make forward-looking statements, we undertake no obligation to update those statements in the future in light of subsequent events.

I will open with the brief comments on our financial results for the quarter and Mark will update you about our perspectives on the market and our business. Following his comments, we'll open up the lines for questions.

Our earnings release that was distributed last night includes additional financial and statistical information about Triad's quarterly results that we will refer to during the call and also includes certain non-GAAP financial measures, which we believe are relevant and useful to investors in understanding our business.

Furthermore, we have updated the supplemental information in the investor relations section of our web site that provides greatly expansive disclosures on our product lines, our portfolio characteristics and our portfolio performance. We understand that this information, which we first provided last quarter was well received. While we will not go through all the details of what has been posted on the web site, I would encourage you to have that information available, as we will refer to it in our prepared remarks and possibly in the Q&A section.

We believe that this type of transparency into the composition and performance of our insured portfolio is beneficial to an informed analysis about future performance. The earnings release and the supplemental information may be accessed on the investor relations page of our web site, located at www.triadguaranty.com.

The net loss for the fourth quarter was $75 million or $5.05 per share compared to net earnings of $8.1 million or $0.54 per share for the 2006 fourth quarter. We ended the year with a book value of $33.43 per share, compared to $38.38 per share at December 31, 2006. For the full year the net loss was $77.5 million or $5.22 per share, compared to net earnings of $65.6 million or $4.40 per share for 2006.

The most significant factor affecting our fourth quarter results was the increasing incurred losses, which resulted in an incurred loss ratio of 262% for the quarter, compared to 71% a year ago.

For the quarter, incurred losses were $192 million consisting of paid losses of $36 million, loss adjustment expenses of $5 million and an increase in the reserves of $151 million. For the fourth quarter of 2006, we reported incurred losses of $41 million.

The conditions in the housing and mortgage markets continued to deteriorate in the fourth quarter. During the third and fourth quarters of 2007, we noticed specific states, California, Florida, Arizona and Nevada that were experiencing declining home prices and rapidly increasing default rates at a faster pace than other states. We collectively refer to these four states as distressed markets.

These distressed markets contributed $86 million or 57% of our total reserve increase experienced during the fourth quarter. Overall, our portfolio default rate was 4.4% at December 31st, compared to 3.3% at September 30th. While our fourth quarter results were significantly impacted by the performance in the distressed markets, other geographic regions played a role as well, in the default rate for our portfolio.

Excluding the distressed markets, the default rate grew from 2.8% at the end of the third quarter to 3.5% at December 31st 2007. The 3.5% default rate in the other geographic regions compares to a 5.7% default rate in the distressed market at December 31st.

The fourth quarter reserve increase was primarily driven by a 38% increase in reserve default, producing a 53% increase in risk and default. The percentage increase was greater in risk and default, due to the concentration in new defaults in the distressed markets, which in general have larger loan sizes.

The average severity and frequency assumption utilized in our reversing methodology were increased during the quarter, reflecting the current market conditions and declining cure rates, with the factor changes contributing approximately $35 million of the fourth quarter reserve increase.

During the fourth quarter, for the first time in our history, we had Modified Pool contracts structured with deductibles where the incurred losses exceeded the respected deductibles. Pricing reserves on the three contracts where incurred losses exceeded deductibles added about $5.5 million to reserves during the quarter.

At the opposite end of the spectrum, during the fourth quarter, we exceeded approximately $6.9 million of loss reserves to lender affiliated captive reinsurers where the incurred losses exceeded the respective attachment points under the contract. In the supplemental information on our website, we have provided information on the captive reinsurance structures that share or limit certain risks in our portfolio.

Based upon our results over the second half of 2007, we expect that the number of structured default deals exceeding the deductibles and the number of captive structures reaching the respective attachment points will rise significantly in 2008.

At December 31, 2007, our reserves as a percentage of risk and default amounted to 49.2%, compared to 32.6%, one year earlier. Policies originated during 2006 and 2007 comprised 61% of the reserves at December 31st, reflecting the higher loan amount and poor relative performance compared to the prior policy years.

Paid losses of $36.3 million were up 28% from the third quarter as both the number of claims paid and the average severity of those claims continued to increase during the fourth quarter. The average paid loss severity increased to $44,800 for the quarter compared to $37,700 in the third quarter of 2007. The increase in average paid severity is primarily the result of higher percentage of claims from the more recent books and from the distressed markets, both of which reflect larger loan balances.

At the end of December 2007, the total risk and default in our filed claim inventory was approximately $55 million, compared to approximately $39 million at September 30th, with the average risk and default in filed claims reaching 57,000 at December 31st, compared to 51,500 at September 30th.

Primary flow in new insurance written was $2.7 billion for the quarter, down 39% from the third quarter, primarily reflecting the underwriting guideline changes that we instituted during the quarter and the management of lender's volumes, where the lender products differed markedly from our portfolio of targets.

We did not report any new insurance written in the in the Primary Bulk, or Modified Pool channels. Total insurance in force increased 20% from year-end 2006 levels, was basically flat from third-quarter levels, reflecting the decline in production in the fourth quarter.

The increase in insurance in force led to the growth in revenues and earned premiums on a year-over-year basis. Earned premiums increased 26%, when compared to the fourth quarter of 2006; however only 1% compared to the third quarter of 2007, while the strong production primarily in the first two quarters of 2007, contributed to the year-over-year growth, persistency has also been a significant factor to the sequential growth. Annual Primary persistency at December 31st 2007 was 81.4%, compared to 79.1% at September 30th 2007 and 76.6% a year ago.

Total expenses, declined slightly from the third quarter 2007 and increased 14% compared with the fourth quarter of 2006. Premium growth more than offset the impact of the expense growth during the year, resulting in an expense ratio of 20.8% for the fourth quarter of 2007, compared to 22.8% for the fourth quarter of 2006.

The December 31st, 2007 statutory risk-to-capital ratio at Triad Guaranty Insurance Corporation stood at 20.5 to 1, an increase from 17.8 to 1 at September 30th 2007. This is a regulatory risk-to-capital ratio and is not adjusted to reflect the specific credit characteristics of our portfolio. This ratio also does not reflect the benefit of capital residing in captive insurance trusts of $200 million or the $95 million excess of loss reinsurance which is considered by rating agencies in analyzing our capital adequacy.

During the fourth quarter, we contributed $50 million of additional capital to the operating company Triad Guaranty Insurance Corporation from the holding company.

At year-end we remained very liquid with $122 million in cash and another $4 million in short-term investments at the US operating company and cash flow from operations remained strong.

Now, I would like to turn the call over to Mark, for an update on our business.

Mark Tonnesen

Thanks Ken. We remain in the midst of the challenging times and housing and the mortgage market. And our financial results continue to be negatively impacted by the deterioration in house prices and rapidly increasing default rates in certain markets.

The distressed markets of California, Florida, Arizona and Nevada in total and especially California and Florida have contributed greatly to the disappointing financial results for the quarter.

The 2006 and 2007 vintage years, which not surprisingly include a significantly volume from the distressed markets have performed poorly when compared to earlier vintages and have materially impacted our performance over the last two quarters.

These vintage years also contain a significant amount of pay option ARM on all paid products, which have experienced the sharper default rate growth, in our prime portfolio.

The rapid and significant deterioration in the housing and mortgage markets and the resulting impact on our portfolio’s performance has prompted us to concentrate primarily on four strategic imperatives.

First, we are focused on our objective of writing quality business. Second, we are committed to improving our capital resources. Third, we are adding resources and creating new strategies to help mitigate losses. And lastly, we are working to manage our talent and reduce expenses appropriately during these turbulent times.

The prospects of declining home prices and continued uncertainty in the economy have made us cautious, as we write new business going forward. In this regard, during the fourth quarter we implemented tighter underwriting guidelines.

Our new underwriting guidelines address loan to value limitations, credit scores and loan documentation and also incorporate volume limitations in distressed markets.

Additionally, we have eliminated products and programs that present high volatility. Although, we believe that these guidelines will go a long way towards ensuring a long-term quality portfolio, the short-term consequence will be to restrict our overall volume of business. This is evidenced by our fourth quarter production, which fell by 39% from the third quarter levels and 56% from our fourth quarter 2006.

While our actions may limit or eliminate our business with certain lender that do not have quality products that meet our guidelines, we remain committed to maintaining positive customer relationships with most of our key lenders during these turbulent times.

Our sales force has done a remarkable job, implementing our restrictions and educating our customers on the need to do so. With our statutory risk-to-capital increasing over the past year, driven equally by significant increases in production in the first half of the year and operating losses in the last two quarters, we are focusing our efforts and resources on capital needs. We have developed and are actively pursing a plan to manage and enhance our capital resources. We have consulted and are continuing to work with the rating agencies and the GSEs to better understand their individual perspectives regarding our capital position and ratings, as well as their perspective on our capital enhancement initiatives.

Although at this time we can give no assurance that we will be able to successfully implement our plan, we realize these efforts are critically important to the future of Triad Guaranty, thus enhancing our capital resources is a top priority.

As we consider the optimum use of our existing capital we made the decision in the fourth quarter to withdraw from Canada. Subsequent to year-end, we repatriated approximately $39 million US of the original $45 million and that's been in our Canadian venture. We keep a sufficient amount of funds in Canada to meet minimum regulatory guidelines and are exploring strategic alternatives to maximize the value of the remaining investment.

With declining home prices in many markets, the usual loss mitigation techniques employed in the past must be enhanced. In addition, actions must be taken to identify fraud and assert the rights available to us through our master policy provisions. As defaults continue to proliferate during the first year of coverage, especially in the '06 and '07 vintage years, we have increased our diligence, surrounding these early payment defaults in order to better and more quickly identify fraudulently obtained loans.

Our loss adjustment expense has grown more than 300% over the last year as the volume of defaults and claims under investigation has increased. During the last four months of 2007, we investigated approximately 1,600 early payment defaults and rescinded coverage on approximately 19% of those.

Lastly, we have begun the difficult task of addressing our current cost structure and matching it against the realities of the current marketplace. We have closed the majority of our underwriting offices and made some difficult headcount decisions. We will challenge all expenses and help make sure that we spend our resources in a wise and efficient manner, while working to ensure that we have the talent necessary to succeed.

So, in conclusion, we are disappointed by our short-term results, and we have taken aggressive action to reduce or cease our business in problem areas. We are actively pursuing a plan to manage and enhance our existing capital, and while we cannot predict the outcome of these results, we are dedicating substantial resources to this priority. The coming year presents many challenges but I believe that we are prepared for the hard work ahead.

With that operator, I would like to open the line and invite questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mike Grasher with Piper Jaffray.

Mike Grasher - Piper Jaffray

Good morning, gentlemen. First question, I guess just with regards to expenses, as you move forward, I think operating expenses were around $43 million, $45 million. Where would you expect that to head during 2008?

Mark Tonnesen

Thanks, Mike. Well, most of the expense reductions are focused on the sales force and that falls in the deck expense line. And so those will be amortized and won't change a lot. Regarding the other expenses, it depends on exactly the area, but generally I would say that will be flat. And the reason that that it will be flat is we will have reductions in certain areas, for instance in our support of the Canadian operation but we will have increase in other areas, such as in loss mitigation and our quality assurance areas.

Mike Grasher - Piper Jaffray

Okay, so a modest drop then in the overall expense?

Mark Tonnesen

That would be my expectation in the short-term, Mike.

Mike Grasher - Piper Jaffray

Okay. And then Ken, you spoke about the cash flow or the cash at the holding company. What are the demands on cash at the holding company?

Ken Jones

Well, Mike we don't have a regular dividend program. We do have, I think a $35 million notes outstanding, that's our only significant cash flow commitment is debt service on that note. So they are very minimal.

Mike Grasher - Piper Jaffray

So its debt service on the $35 million and that's it?

Ken Jones

Correct. Today, we still -- as you recall, we drew down $80 million under a line of credit in August and that remains still outstanding to the holding company offset by assets. So today, we have the interest earnings and interest expense offsetting, but again as far as permanent obligations as a holding company the debt service on the $35 million is there.

Mike Grasher - Piper Jaffray

Okay. And then Mark, could you comment on the impact of the Freddie Mac news out this morning?

Mark Tonnesen

Sure. Mike. Earlier this morning Freddie Mac put out a news release and there were a couple of important points that were in that. I am not sure that all the callers were able to catch up with that. But Freddie Mac -- and both the GSEs really are working very closely with Triad as well as the rest of the mortgage insurance industry to develop their own perspective on the books of business.

The feedback that we've gotten from the GSEs is that they are satisfied currently with the resources that are available to paid claims at both Triad, as well as the industry at large.

With that I think that the GSEs are in a much better position today than they ever been to make their own decisions about the credit quality. And with the rating agencies perspective being useful, what the GSEs today are saying to themselves is we got to have our own perspective, and I think as they develop that they've been able to take a closer look at some of their eligibility guidelines.

So today they suspended the utilization. Freddie did, suspend the utilization of the Type 2 category, saying that they would make their own decisions regarding the eligibility of mortgage insurers. They have also given us a series of activities that they expect us to undertake, none of which are problematic to us, they basically have to do with ensuring that Freddie has a clear understanding of exactly what the risks are, embedded in the portfolios of the mortgage insurance companies.

In addition to that, they announced that effective on July 1st or June 1st, effective on June 1st there will no longer be any of what has typically been referred to as the deep-cede captives. They have set a cap on the amount of contribution that a mortgage insurance company can place in a captive, setting that as a maximum of 25% of premiums. And Mike, the current, the preponderance of captives is what's called the deep-cede captive were 40% of the premiums are supplied to the captive reinsurance company for a 10% layer of risk assumed by the private captive.

So the short-term impact on the mortgage insurance industry is some relief from the guidelines that Freddie put in place regarding the way in which Type 1 and Type 2 qualification, and I think that's a very positive move forward on their part.

The second thing they have done is, they have created higher levels of premium growth and profitability in the short-term for mortgage insurance companies.

So a very aggressive move on Freddy's part to show, I think, A, their support of the mortgage insurance industry. And B, the quality of the work that they have done themselves in reviewing overall risk in the industry.

I apologize for such a long answer to such a short question.

Mike Grasher - Piper Jaffray

Okay. It's helpful and provide some good background. Final question and I will get back in the queue. Regarding capital, I know you touched on it, I know it is sensitive in terms of what you can and you can’t say, but could you give us any sense of the dollar amount that you are looking to raise as you look at your budget in '08 and even in to '09? What should your requirements might be?

Mark Tonnesen

Great. Well, first of all, regarding capital, there are many sources of capital that are available to any mortgage insurance company. Today, we have got significant support that's being afforded by the structures that are in place in the portfolio, both in terms of captive reinsurance as well as the structures that surround our Modified Pool. We anticipate, Mike, that we are going to get, as we move forward, a lot of earnings support from those captives.

We also have reinsurance agreements that are in place today. We mentioned the $95 million of support that we have from the excess of loss coverage. So, reinsurance is also a possible strategy for capital enhancement. In addition to that, we have got the $80 million line of credit and terming that out and thereby creating a more satisfactory rating agency capital structure for our debt, would also be a strategy and then there is the development of equity capital.

So right now we're in the process of exploring all avenues of capital support. We've got a sophisticated plan that we are implementing against -- and I think, Mike that we're going to have more to say on that prior to the end of next quarter.

Mike Grasher - Piper Jaffray

Fair enough.

Operator

Your next question comes from [Eugene Loper] a stockholder.

Eugene Loper - Stockholder

Good morning, Mark, Gene Loper. Gentlemen, I got on to your call late. The first number given to me didn’t get through. All I got was a background noise. But my question is, since I got in very, very late, I didn't hear what the losses were and etcetera and so forth, but I but I assume that we are still keeping our AAA rating, so we can continue to ensure mortgages and etcetera and I would like to say, if you could just answer that one question I assume everything else will fall in place. Thank you.

Mark Tonnesen

Eugene, first of all, we apologize for the trouble of getting in and glad that you are on the line. The ratings for Triad Guaranty currently stand at the AA minus level. S&P announced yesterday an overall review of the industry and placed Triad Guaranty at the --continuing to place Triad Guaranty at the AA minus level and also on CreditWatch with negative implications. We believe that that primarily has to do with the capital position of the company and as I just mentioned to Mike, there is lot of activity underway here at Triad Guaranty to ensure that the capital is satisfactory to all of our stakeholders, including the rating agencies.

The news from Freddie is also very encouraging because it takes a bit off the pressure on ratings off of the industry. So, today our ratings are satisfactory to continue to be a Type 1 supplier to both Freddie and Fannie. We've been encouraged by conversations we've had with both of the agencies. We have also been extraordinarily transparent as we have with our shareholders putting out the supplemental information on our portfolio. We have been equally transparent with the GSEs and the rating agencies to ensure that they have no surprises and they are able to make a good qualified opinion on Triad. Gene, thanks again for the question.

Eugene Loper - Stockholder

Mark, thank you.

Operator

Your next question comes from [Damon McLaughlin] with Huntington Partners.

Damon McLaughlin - Huntington Partners

Yes. I was just curious if you could may be walk us through some of the primary -- some of the larger primary reasons for a lot of the delinquencies and I realized that there is a number of factors involved but what would you say is going to be driving the foreclosures more so, unemployment or the high LTV loans that are currently outstanding and people basically owning more on the mortgage than the house is worth?

Mark Tonnesen

Damien thanks for that question. In our view the situation is much simpler than most people would generally say. People talk about a lot of the complexities in the business and we think that that's generally confusing. Our point of view is that the problems in the industry are manifest in Florida, California, Arizona and Nevada and we call those the distressed markets. Now, surely there are other distressed markets in the industry there is places, neighborhoods outside of Washington DC and there is Edison, New Jersey and there is Detroit, Michigan, but for analytical purposes it's easiest to think about California, Arizona, Nevada and Florida.

And there the whole issue is home price. It's the home price path, which is driving the LTVs and the correlation between loan to value and loss is very, very clear. Now you take a look at Florida as an example, Florida's default rate a year and a half ago was less than 1% and now we have got default rates of double digits in our Florida region.

In addition to that, a year ago we have one month cure rates in Florida, that were around 11%, that is 11% of delinquencies were curing the month to follow. So anything that was in the default only 89% of them would remain in default the following month. That's now less than 1%. So your ability to cure those parts of loans has significantly changed.

The rest of the country, while it is not better, it is not so much worse that it should cause significant concern. One of the reasons being that we have taken this tact of breaking out the data, the way that we have broken it out in our supplemental information is that, so people can do the analysis on the appropriate segments. Our point of view is that most of the business, the vast majority of the business that we have written is fine, and some of the business that we have written is bad. And the bad parts of the portfolio are concentrated in places where home prices are under pressure.

What we are looking for before we relax about the overall quality of the business available to us is, we want to see some stabilization in home prices and perhaps more importantly, a balance in supply and demand. We continue to see the months of supply increase in the -- of homes increase in the distressed markets, and we are looking to see that trend stop. When supply and demand gets into a more reasonable balance, we are going to have a much improved confidence about the business being offered. Meanwhile, we continue to work hard on the problem areas, that minority of the portfolio, which is causing distress on our P&L.

Damon McLaughlin - Huntington Partners

Okay. Great. Thank you very much for that. I appreciate it. And my last question is, when you go into this capital raising environment, I understand you are looking at a multiple avenues that's available. How will you be looking at the fact that the current stock price is dramatically lower than what current book value is, and how will you be taking that into consideration to your current shareholders and the fact of -- hoping to try to alleviate any delusion, if any.

Mark Tonnesen

It’s an excellent point and observation, Damon. First of all, our primary focus is, as we are evaluating the options going forward, is our current stockholder base and the long-term success of the company. So in each and every single one of the strategies, we evaluated first and foremost from a current stockholder perspective. So, obviously strategies have different effects on delusion and that influences greatly our view as to the opportunities that might be available. So I would tell you that, in addition to the management team's current evolvement in all of the capital raising activities, the Chairman of our Board, Will Ratliff has been intimately involved.

We've also established at the Board level a special committee to review financing and capital raising alternatives and as Will is a significant shareholder himself, we feel very, very confident that all of our activities are undergoing the scrutiny that our shareholders would want us to undertake.

Damon McLaughlin - Huntington Partners

Having that said, would all shareholders be potentially -- if you were going to look to raise equity, would you look to your current shareholders first as a source of that capital?

Mark Tonnesen

There are number of strategies that we will be reviewing and beyond that, I am not able comment on any particular strategy or its likelihood.

Damon McLaughlin - Huntington Partners

Understood. Thank you very much for your time.

Mark Tonnesen

Thank you.

Operator

Your next question comes from Ron Bobman with Capital Returns.

Ron Bobman - Capital Returns

Hi, thanks for taking the question. I have a question about -- I'll use the term claim audits. I forgot exactly how you characterize them but you sort of talked about an increased effort to sort of review quick defaults and I think you ultimately said that on 19% of the claims audit my term you actually rescinded coverage and if I am describing it's as generally accurately, could you describe what was the -- in general, what was the leading act that caused you to effect of recession? What was the most common behavior or action, your underwriting action or whatever might have been that gave you cause to do that? And then I don't know if your book, it is such that -- were these recessions sort of concentrated in any one lender or were they sort of fairly spread across the various lenders that produced the business for you? Thank you.

Mark Tonnesen

Well, thank you very much for the question. Early payment default out of the 2006 and 2007 vintage have been an area of focus for us.

As you probably know, in the vast majority of circumstances, mortgage insurers do not insure fraud. And so we take a look at the early payment defaults as a place where possible fraud has been introduced.

But importantly, the critical business purpose for mortgage insurance is the paid claims. And we are 100% committed to paying all legitimate claims. We paid about 811 claims in the fourth quarter of the year and obviously given the trends we expect to pay more as we go forward. We reviewed 1600 early payment defaults and rescinded coverage our 19% or roughly 300 of those early payment defaults during the quarter. This is a very significant activity, but I want to emphasize that our commitment is to our customers and our commitment to pay the legitimate claims that they submit.

When we undertake a review of an early payment default or any recession, we go at that activity in a very, very thorough way. Taking a look at all aspects of the loan, contacting the borrowers, reviewing the property, taking a look at all of the documentation, we hire outside investigators to take a look at the situation. We come back with a file that's probably an inch thick on every single one of these -- on every single one of these loans. We then review that by our legal department and then send it along for a final review by our lenders.

So it's a very thorough process and many things can go and can create the problem. And usually there is multiple reasons why a loan would be rescinded. If we are going to choose the one, its' generally undisclosed debts that have created for us the recession.

In terms of...

Ron Bobman - Capital Returns

That will be a borrower misrepresentation.

Mark Tonnesen

That will be a borrower misrepresentation. In addition, there are differences by lender. Obviously that's not, that wouldn't be information that we would disclose, but we work closely with all of our lenders to make sure that they understand what we are seeing, that they are able to take the appropriate mitigation on their part, to make sure that they take out of their system, at the earliest possible time, any problems that they might have.

Ron Bobman - Capital Returns

Thank you.

Ken Jones

You are welcome.

Mark Tonnesen

Thanks for the question.

Operator

Your next question comes from Juan Black with Check Capital.

Juan Black - Check Capital

Hi, guys. How are you doing. Thanks for taking the call.

Ken Jones

Sure.

Juan Black - Check Capital

I was hoping you could shed some light on something for me. Can you please explain how your Q4 new insurance written decreased to $2.7 billion, but the Q4 direct premiums written increased to $90.5 million, up from $70.6?

Mark Tonnesen

Sure. We can. If you take a look at the insurance in force, you would see that our insurance in force went up slightly from the third quarter to the fourth quarter but up significantly on a year-over-year basis. So, the residual affect of the writings that we have done in the first and second and third quarters have created a continued increase in the premiums during the fourth quarter.

Juan Black - Check Capital

Thanks guys. Rock on.

Mark Tonnesen

Thank you.

Operator

(Operator Instructions) Your next question comes from Mike Grasher with Piper Jaffray.

Mike Grasher - Piper Jaffray

Hi. Just a couple follow-ups here. With regard to, I guess, current environment, things are getting worse or not, do you have anything for us in terms of new delinquencies? I guess, I am thinking specifically by vintage year, '05 versus '06 versus '07. Have '05 delinquencies sort of leveled off than past peak -- is '06 still climbing? Can you give us a little background on that?

Mark Tonnesen

Sure. Mike first of all, one of the new disclosures that we began with last quarter was to delineate all of the product and vintage performance for the entire portfolio. So we published that again at the end of this quarter and all of the detail on our vintages and our products and our channels are detailed there and I think that that will be very helpful as you try to forecast out the performance of Triad Guaranty.

Regarding '05, '06 and '07, '05 is slightly worse that '04 was, '06 is worse than '05 at about 30% or 40% and '07 is slightly worse than '06. So, nothing there has changed. All of the performance problems again are concentrated in the distressed market. We have broken out some of the data on all of our market delinquencies and defaults by geography, and by product, so you will be able to take a look at that too. No surprises, Mike, in terms of the trends, and they are detailed in the supplemental information.

Mike Grasher - Piper Jaffray

Fair enough. Thank you.

Mark Tonnesen

You're welcome.

Operator

Your next question comes from Michael Nannizz with Bear Stearns.

Michael Nannizz - Bear Stearns

I have just a couple of questions. What is the balance in the captive trusts right now?

Mark Tonnesen

Michael, we've got about $210 million of balances in the trusts. That's growing by approximately $15 million a quarter.

Michael Nannizz - Bear Stearns

Okay. Great. Thanks. And then second question is, about the $80 million line, I know that there is a net worth covenant I believe and then a risk-to-capital covenant.

If you do decide to term it out, how does that -- I mean, you guys are 20.5 now. I know for some reason it's not quality adjusted but as far as that $80 million line is concerned, can you just talk about those covenants and how those may be impacted by the decision to term out the facility? Thank you.

Mark Tonnesen

Sure. Thanks for that question Michael and I'll ask Ken Jones to chime in here. The $80 million line was created to provide short-term flexibility and liquidity for our company and it's proved its value this last quarter. As an example, when we made the decision to place more capital in the US insurance company, we decided concurrent with that to bring that capital from Canada. As we went through the process to bring back that capital, we utilized that line to inject the funds down into the insurance company as the funds came back from Canada, which has happened now. They have been replenished at the holding company.

So it is utilized for liquidity and flexibility and its value is worth the small cost of that line. In order to have it account for rating agency capital, we need to term that out. So that as we do that the issue of covenants will be very, very important and obviously we won't enter into any agreement where we think that the covenants would prove problematic. Ken.

Ken Jones

Yes as you said there are networks covenants as well as risk-to-capital covenants under the existing line of credits. As we look to what makes sense in terms of capital formation for the future, if we look to term out something, it would be under a different facility, subject to negotiation as Mark said, for appropriate covenant for our view of the business going forward and anything in the existing facility wouldn't necessary carry over.

Mark Tonnesen

So with this, with the current utilization of the line and remember that the current the line, the funds from the line today are not included in the risk-to-capital ratio for the company. These funds sit at the holding company and therefore aren't a part of the risk-to-capital ratio. As we move forward, we'll be very cautious in the way in which we create our ultimate capital formation strategy.

Michael Nannizz - Bear Stearns

Okay. Thank you very much

Operator

Your next question comes from Ed Groshans with Fortress.

Ed Groshans - Fortress

Good morning Mark. Thank you for taking my call.

Mark Tonnesen

Ed Groshans from Fortress?

Ed Groshans - Fortress

Yes, I switched to the buy side now.

Mark Tonnesen

Well, congratulations.

Ed Groshans - Fortress

Thank you very much. I have two questions. You talked about S&P putting you on rating, watch negative. And then I was wondering, are Moody's and Fitch there also? Or do they still have you stable.

Ken Jones

Yeah, this is Ken Jones. I think we are at the same place at all the agencies right now, which is basically the AA Minus and under negative outlook at CreditWatch, so consistent across the three agencies.

Ed Groshans - Fortress

So, I guess, really I just wanted to know, because my next question is really, so what are the conversations you are having with them are, when they are looking at your AA Minus or your AAA, whatever their rating is and looking forward to what's going on in the mortgage market, are they under the impression that, there is more to come, and so are they doing the same thing that we are seeing in the sub-prime world.

We are also in the same world, where we thought cumulative losses were be going to be axed and now they are raising them to 16% or doubling or tripling them, then coming back and looking at Triad, and saying, Well, with this type of loss scenario, we think that maybe your capital doesn't support the AA Minus anymore? Is that the kind of conversation you happen to have? And then how much more are they going to be seeking do you think?

Mark Tonnesen

You have asked a very complicated question, Ed, and a very good one at the same time. The rating agencies, when we talk about the rating agencies, you are not talking about a homogenous group. You are talking about three companies with varying techniques in both their capital model, as well as the way in which they evaluate any company. Some are more sophisticated on the qualitative side. Some on the quantitative side.

So our tact has been that we need to be in constant communications with them. We need to be completely transparent. They need to understand clearly the structural supports that are provided by captives, as well as our Modified Pool structure. They need to understand exactly the development of our portfolio. The fact that our portfolio has no subprime product in it. They need to understand the efforts that we're taking in order to ensure that the quality of business is being written and they need to understand our possible strategies for capital raise and then what we do is we look for their input to make sure that at the end of the process from their point of view, we will maintain the kind of ratings that are important in the development of our business.

Each one has got a different personality and a different interest point. Each has got a different level of sophistication in their models. We're working very closely with all three agencies in their development of their models, not because ours is particularly difficult forecast to make but the way that the structures into play with the loss forecast can be a little bit tricky. We've given the detail on that to the shareholders in our supplemental information and we're quite willing to work with anyone that wants to make sure that they've got that right.

So for right now, capital is the watchword at the rating agencies and we're in the deep dialogue with all three, as well as the GSEs to make sure that that we understand everybody's perspective very, very clearly.

Ed Groshans - Fortress

Thank you, Mark. And then, my question is you talked about the captives and the attachment points. And I guess from your opening comments, did you say you're hitting some of the attachment points now and actually moving some of the losses to the captives. Are we getting close to that point?

Ken Jones

Ed, this is Ken Jones. That's correct. We are hitting them now. I think in the scripts we indicated that about $7 million of losses have [seen to] captive and that's on an incurred basis. So basically, what we are doing today is as we setup reserves that pushes past the attachment point on the respective captives we will be exceeding losses. We are not exceeding paid losses yet, that will come perhaps later in the '08 and significantly into '09 but on an incurred basis we have [ceded] losses and we expect to cede significantly more losses to the captives during 2008 and 2009.

Ed Groshans - Fortress

So that actually keeps your loss ratio a little bit lower in the current quarter as a result of that or?

Mark Tonnesen

$5 million.

Ken Jones

Yeah. Minimally lower in the current quarter, but it will have a much more significant impact going forward as more captives from the '05, '06, '07 books attach or incurred losses exceed the attachment point on those into the future.

Ed Groshans - Fortress

Great. And then Ken when you look at that, is the $7 million or so is that a cross '05, '06, '07 or do you see a concentration sort of like -- are you -- is it really just the late '05 book that you are starting to hit the attachments on and you are going to work your way through beginning of '06, late '06 or late '07?

Ken Jones

Yeah. What we are doing now are largely the earlier ones that's in the '05 and '06 years, so the '07 based on our current loss expectations for the book, we expect to see captive support for those books as well, but those are still a ways away from hitting.

Ed Groshans - Fortress

And then, I'll make this my last question. There is -- the way I understand that the recession is, the captives take losses for whether its 5 to 10 or 4 to 8. How is your looking at it now? Are your models given the stressed environment showing that you are going to pierce the top layers, so it's going to be come back to Triad or you are not seeing that yet?

Ken Jones

Well structurally you are correct. The captives pick up a risk layer, they are either 5-5-25s, which would take the first 5% of the risk with the captives picking up the next five so that will take you to a 10% insurance rate or a 4-10-40, which we pick up the first 4% of the risk layer of the captive and the next can take you to 14. So obviously those are pretty insurance rates, but if you get above those insurance rates the losses would come back to us. And again each of these as measured on a book-year basis with each individual lender.

We have in the supplemental data provided because this is a complicated subject and one that's not well understood. In our supplemental data we have provided an illustration, exactly how a captive would work and you can see based on loss rates and insurance rates how the losses emerge and where the captive protection begins. So I would encourage you to look at that, it does a very good job explaining the methodology of these captives and for understanding us and understanding the industry that's very important going forward.

Ed Groshans - Fortress

Okay. I understand like, there is expectations out there of certain sub-prime books in home equity products where the loss rates were getting well above, I guess what the original expectations were and while 14% sounds like a lot, if accumulative losses on some prime books are expected to be 18% if that turns out to be true, that means that there is more points coming back to Triad at the tail end of that book. And so, I guess the way I would put it is, you are closer to the ground on this and you have a better sense of, how things are developing. Is that in the realm of possibility or does that seem still a bit of a stress before you think it will come back at the top end of the third layer of risk, I guess?

Mark Tonnesen

Well Ed, I understand your question clearly. We are not, we have not given guidance. What we have provided is, we have provided transparency, so that you can put your view in to the forecast. As you just mentioned an 18% forecast is out there on sub-primes and that an 18% forecast on a 4-10-40 you would go up to 4, you would go past 14 and that would be a small amount of losses that would exceed the captive coverage on a 4-10-40, that’s a sub-prime forecast. You need to take that sub-prime forecast then modify it for the kind of quality that you find in the Triad book.

Another statistic we have mentioned before is the history of the industry and in fact I think that Genworth has published the exact charts most recently, which show that 1983 was the highest incidence rate for the mortgage insurance industry on a total book basis that had an incidence rate of 13%. If you dug down underneath that you would find that they were in fact portions of the country that were significantly higher than that, the Southwest Central area was the worst of all of the regions and in 1983 that book year had in that region had a incidence rate of about 25, contributing to that overall incidence rate of 13 on the book.

So I think that you are getting some pretty good benchmarks there Ed to make some pretty good stress scenarios. That's the kind of conversations that we're having with the rating agencies and with the GSEs. It's an excellent way to think about the way that the portfolio might perform.

Ed Groshans - Fortress

Excellent. Thank you Ken and Mark very much.

Mark Tonnesen

You're welcome, Ed.

Operator

Your next question comes from James Gilligan with Equity Group Investments.

James Gilligan - Equity Group Investments

Hi, guys. I have a quick question. I was wondering if you could help clarify the difference between your Bulk Business and what you call Modified Pool.

Mark Tonnesen

Sure. And thanks very much James for that question. Modified pool is a bulk execution that has a structure that surrounds it and over 75% of our portfolio, our bulk transactions have that structural support. The other bulk transactions that we've done are the Primary Bulk and we've broken out that the details of that separate in our supplemental information.

So about 20%, 25% of our risk in force is in Primary Bulk. In Primary Bulk, there are two differences, one I've mentioned which is the structural support, the other is that all of the modified pool business is below 80% LTV at origination, while the Primary Bulk transactions are over 80% LTV at the time of origination.

James Gilligan - Equity Group Investments

Is there difference in the source of loans, GSE versus let say Wall Street institutions?

Mark Tonnesen

Portion of the Modified Pool and in fact the majority of the Modified Pool is a GSE based origination. Some of the early Modified Pools that we did were with Wall Street, but the majority that we did since then were done through the GSEs. There is an exception to that. We did do a group of pay option ARM, Modified Pool business in 2006 and the performance of that has been detailed out in some of the supplemental information has been very good.

The Primary Bulk is primarily a non-GSE execution. So a bit of a mix there Jim, but we found that the originator itself whether or not it's been involved in a GSE is the critical element of performance, as well as the underwriting.

James Gilligan - Equity Group Investments

Have you talked with your accounts about establishing a premium deficiency reserve for either of those pools or potential write-downs near those that is?

Mark Tonnesen

I'll let -- I’ll be an accountant practicing without a license here and then I ask Ken to correct me when I go too far wrong.

Our basic point of view is that if you start to segment out the portfolio for premium deficiency reserves or other things you should do so very, very carefully, because the accounting can get tricky and the reporting can get tricky.

So, premium deficiency reserve calculations from our point of view need to be done on a portfolio basis. Now that's not to say, that if you abandon a particular product you wouldn't take a different point of view. But picking and choosing a deal or a vintage or a product or geography or any other way that you want to segment it and separating that out and taking premiums deficiency reserves on that basis would not be something that we favor and we have had those conversations with the accounts. That’s also not to say that we wouldn't change our part point of view on that as we move forward. Ken

Ken Jones

Then I’d just to reiterate what Mark said, we obviously as part of our year end reporting and periodic reporting do test forward -- defer acquisition cost, recoverability, as well as premium deficiency. And we have done those tests and at this point of time we have obviously not recorded a premium deficiency reserve.

James Gilligan - Equity Group Investments

All right. Thanks guys.

Operator

Your next question comes from Steve Stelmach with FBR Capital market.

Steve Stelmach - FBR Capital Market

Hi good morning. The majority of my questions have been answered, but thank you. Just somewhat house-keeping. Divested capital the minimum divested capital on the line of credit that's 25 to 1, is that not correct?

Mark Tonnesen

22 to 1.

Steve Stelmach - FBR Capital Market

22 to 1. Okay, and then the minimum of the net worth covenant is what is the dollar amount?

Ken Jones

I think it's around 480, 490 million if I recall correctly.

Steve Stelmach - FBR Capital Market

So you are right there at the moment.

Ken Jones

No actually our net worth is I think it's a , let me look at the book value reflected here in sort the financial segment.

Steve Stelmach - FBR Capital Market

Yeah 498, 499 got it. Okay and then I know it is sort a generic measure, risk-to-capital, but when you think about your capital plans, where do you think optimally that number should be for you?

Mark Tonnesen

I'm sorry can you say that again please, Steve?

Steve Stelmach - FBR Capital Market

Sure. In terms of risk-to-capital measure and I know there are shortcomings to it in terms of gauging relative capital standards, but how do you think about it? Where do you think the risk-to-capital measure optimally as for you guys?

Mark Tonnesen

That’s not a question Steve that you can answer that simply. But let me tell a couple of things, in general on the portfolio, if and, at the current pricing levels if the incidence runs at about a 5 and a 5 incidence rate would kind to be the average over the cycle, with now obviously being higher than that and for the vast majority of the years has been significantly lower than that. The mode on the incidence rate runs at about 2, so at a 5 incidence rate, at the posted prices, we make between a 15% and 20% return on equity, at a 15 to 1 risk-to-capital ratio.

So that’s, of course persistency would could change that but at normal levels that’s kind of an underpinning -- there some underpinning economics to the business. What we believe it is critically important in the evaluation of deals of our business, of our customers, is our ability to establish an economic capital that is required for each one of the bits of business, so economic capital varies with risk, and therefore risk-to-capital of 15 to 1 would not be appropriate for some of the higher risk portions of a portfolio. It would need to be lower than that, but on a majority of our portfolio where it's prime that would be too high a risk-to-capital ratio. So, it depends, but that's a way to think about it Steve.

Steve Stelmach - FBR Capital Market

Okay. And then in that context, given your mix of business, how should we think about that? Clearly there was a capital to measure for your [quality] of book of business, where are we on that 15 to 1 spectrum? I mean I know where we are today, but where would you like to be?

Mark Tonnesen

On that we haven't talked about the support from captives, which is a critical component. We haven' talked about the excessive loss and so we do not manage our business towards a risk-to-capital ratio, rather we work closely with the rating agencies to make sure that the total capital position of the company, as well as the expected support that would come in the form of future premiums is well understood. And that needs to be done at basically at loan level basis. So, that's not the way that we manage our company.

That said, the risk that is embedded in the portfolio today deserves more capital and therefore we're putting together our plans to ensure that the capital is adequate to support the ratings that are necessary in our business to be a cost effective supplier of mortgage insurance to the GSEs and others.

Steve Stelmach - FBR Capital Market

Okay. And thank you very much.

Mark Tonnesen

Steve, thank you.

Operator

Your final question comes from Frank Latuda with Kennedy Capital.

Frank Latuda - Kennedy Capital

Hi. My question is regarding the news out this morning regarding the Freddie Mac guidelines.

Mark Tonnesen

Yes sure.

Frank Latuda - Kennedy Capital

With respect to the maximum premium modification would that apply only to certificates going forward or is there some modification that would occur on existing certificates?

Mark Tonnesen

Only certificates going forward Frank.

Frank Latuda - Kennedy Capital

Okay. And then secondly, would that also result in a modification of attach rates?

Mark Tonnesen

Yes, it would. Today, we've got, as Ken mentioned before we've got two typical structures the 5-5-25, in which 25% of the premium are ceded for a band of 5% of the risk that attaches at 5% loss rate or a 4-10-40 where 40% is ceded at a 4% attachment point through the 14%.

So the amount of premium ceded and the amount of risks ceded is calculation that needs to be undertaken.

Frank Latuda - Kennedy Capital

Okay. So it would effectively eliminate the 4-10-40?

Mark Tonnesen

It would effectively eliminate the 4-10-40.

Frank Latuda - Kennedy Capital

Understood. Thank you.

Mark Tonnesen

You are welcome.

Operator

At this time there are no further questions, I would like to turn the call back over to management for closing remark.

Ken Jones

Well, thanks very much and just one point. We had a question on the debt covenants on our existing credit facility today. The risk-to-capital is 22:1 and there is minimum net worth covenants and again this is filed information and based on the calculation that's around $400 million today we think. So just to update the information we provided on that.

And in closing we appreciate the participation and the interest always. So thank you for your participation today and have a good day. Thank you very much.

Operator

Ladies and gentlemen, this concludes today's conference. Webcast replays will be available on the TGIC Web site at www.triadguaranty.com. Thank you for participating and you may now disconnect.

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