Triad Guaranty Inc. Q1 2008 Earnings Call Transcript

| About: Triad Guaranty (TGIC)

Triad Guaranty Inc. (OTC:TGIC) Q1 2008 Earnings Call May 13, 2008 10:00 AM ET


Kenneth Jones - Senior Vice President, Chief Financial Officer, Director

Mark Tonnesen - President, Chief Executive Officer, Director


Peter Horn - Gates Capital

Jerry Bruni - J.V. Bruni & Company


Welcome to the Triad Guaranty Inc. first quarter 2008 conference call. (Operator Instructions) Your host today is Ken Jones, Senior Vice President and Chief Financial Officer. I would now like to turn the conference over to Mr. Jones.

Kenneth Jones

Joining me on the call is Mark Tonnesen, our Chief Executive Officer, Bruce Van Fleet, our Executive Vice President of Sales and Marking 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 and other reports and the Safe Harbor statement that we've included in the management discussion and analysis section of our Form 10- K and other reports, which outline some of the various risk 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. We also filed our first quarter 10-Q last night, which provides a detailed description of the first quarter results in our financial condition. I encourage everyone to review the 10-Q as well as our most recent 10-K and amendment.

I will open with some brief comments on our financial results for the quarter and Mark will update you about the proposed transaction with Lightyear Capital. Following his comments, we will open up the line for questions.

Our earning release that was distributed last night includes additional financial and statistical information about Triad’s quarterly results that we will refer to you during the call and also include certain non-GAAP financial measures, which we believe are relevant and useful to investor in understanding our business. Furthermore, we have updated the supplemental information in the Investor Relations section of our website that provides expanded disclosures on our product lines, our portfolio characteristics and portfolio performance.

We do not plan to go through all of the details of what has been posted on the website but I would encourage you have that information available as we will reference it in our prepared remarks and possibly in the Q-&-A session. We believe this type of transparency into the composition and performance of you our insured portfolio is beneficial to an informed analysis about future performance. The earnings release and supplemental information may be accessed on the Investor Relations page of our website located at

The net loss for the first quarter was a $150 million or $10.09 per share compared to net earnings of $17.3 million or $1.16 per share for the first quarter of 2007. Book value at March 31st 2008 was $22.39 per share compared to $33.43 per share at December 31st 2007 and $39.38 per share a year ago. The most significant factor affecting our first quarter results continues to be the increase in incurred losses, which resulted in a loss ratio of 307% for the first quarter compared to 51% a year ago.

For the quarter, incurred losses were $221 million consisting of paid losses of $40 million, loss adjustment expenses of $6 million and an increase in reserves of $175 million. For the first quarter of 2007 we reported incurred losses of $33 million. Our 2008 first quarter results were also affected by recording of a net $49.8 million pre-tax charge, related to establishing a premium deficiency reserve.

More on this in a minute, but first I'd like to address the continuing loss trends. The conditions in the housing and mortgage markets continue to deteriorate in the first quarter and specifically within California, Florida, Arizona and Nevada. States that we have identified as distress markets, our loss reserves increased by $175 million during the first quarter and 68% of this increase or $119 million was contributed by the distressed markets.

The number of reserved delinquent loans increased by 26% from the fourth quarter levels while the related risk in default increased by 42%. As we saw in the fourth quarter, the percentage increase was greater in risk and default due the concentration of new defaults in the distressed markets, which in general have larger loan sizes. The delinquency rate is now at 5.9% compared to 4.4% at year end and 2.5% one year ago.

We see that approximately $15.9 million of loss reserves in the first quarter to lender affiliated captive re-insurers, in which incurred losses exceeded the respective attachment points under the contract. We expect the number of captive structures reaching the respective attachment points will continue to rise during the remainder of the year. We also recorded reserves of $24.1 million for Modified Pool defaults that exceeded the respective deductible amounts in the contracts.

Paid losses during the first quarter of 2008 were $40.1 million compared to $36.3 million and $17.7 million in the fourth quarter and first quarter of 2007 respectively. The average paid loss severity increased to 47,000 compared to 44,800 in the fourth quarter and 30,600 in the first quarter of 2007. The increase in average paid severity is primarily the result of the higher percentage of claims from the most recent books and from the distressed markets, both of which reflect larger loan balances.

At the end of the first quarter, the total risk and default in our filed claim inventory was approximately $88 million compared to approximately $55 million at the end of the fourth quarter with the average risk and default in filed claims reaching 64,000 at March 31st compared to 57,000 at December 31st. We recorded a net pretax charge of $49.8 million as a result of the premium deficiency computation performed at the end of the first quarter. For the purposes of this computation, we considered our entire existing portfolio as a single segment.

A premium deficiency reserve is necessary if the present value of the expected future cash outflows, which consist of projected paid claims, loss adjustment expenses and maintenance expenses. Net of the present value of expected cash inflows, which consist of renewal premiums, exceeds the recorded net reserves. The mechanics of the recognition of premium deficiency reserve in the financial statements is not a straight-forward process and it's not easy to explain in this setting, but I would at least like to point out the line item impact on our financial statements.

The premium deficiency flows through the statement of operations in two parts. First, we reduced the remaining deferred acquisition cost asset to zero and recorded a corresponding pretax charge of $34.8 million in the policy acquisition cost line of our expenses. Second, we recorded the net increase in the premium deficiency reserve of $15 million, as a separate line item in our expenses. The balance sheet is impacted in three places by the premium deficiency reserve.

First is the elimination of the deferred acquisition cost asset. Additionally, we set up a liability of $96.1 million for the gross premium deficiency reserve, which was offset by $81.1 million related to the expected benefit of reinsurance recoverable from lender sponsored captives included in the calculations. The computation of the premium deficiency reserve requires significant judgments regarding the assumption utilized in the expected future cash flows. There could be a significant amount of volatility in this computation going forward and there is a table in the 10-Q that provides an indication of the sensitivity of the calculations to changes and assumptions.

Also, the statistical supplement on our website provides the frequency, severity and average life assumptions we used in calculating the premium deficiency. Last week, we made the decision to discontinue our Canadian efforts, as our attempt to sell the subsidiary has not been successful. We were disappointed with this result, but believe this is the right decision at this time. We recognize the $2 million charge in the first quarter of 2008 as a result of this decision and we expect to eventually repay approximately $4 million of remaining capital to the holding company.

Our primary flow in new insurance written was $1.9 billion for the first quarter down from $2.7 billion written in the fourth quarter of 2007. Due to our recent rating downgrades and capital limitations, our ability to continue to write new insurance has been placed at risk. We are working with both the GSE as well as the Illinois division of insurance so that we can write new insurance as we continue negotiations with Lightyear Capital on a transaction that would lead to the creation of a new mortgage insurance company.

We believe the quality of the business we are writing today is excellent. We currently expect second quarter production to be down from first quarter levels as certain customers await the formation of the new company. Total insurance in force decreased less than 1% from year end reflecting the decline in first quarter production. Annual primary persistency continues to increase and was 83. 3% at March 31st 2008 compared to 81.4% at December 31st 2007 and 77.5% a year ago.

Excluding the write down of the DAC asset, due to the premium deficiency as well as cost associated with terminating the Canadian subsidiary, total operates expenses increased 8% from the fourth quarter and 12% compared with the first quarter of 2007.

The March 31st, 2008 statutory risk to capital ratio of Triad Guaranty Insurance Corporation stood at 27.7 to 1, which is above the maximum allowed by the Illinois Division of Insurance and many other states insurance regulations. Typically, such a risk to capital ratio would prohibit the writing of new insurance policies. However, as I mentioned earlier, we are working with the Illinois Division of Insurance regarding risk to capital ratio and with the acknowledgement of the Illinois Division of Insurance, we currently continue to write new business.

Before I turn the call over to Mark, I want to mention recent developments with our excessive loss reinsurance agreement. As of March 31st, the terms triggering coverage under this agreement were met. However, our re-insurer notified us that they believe we have not complied with certain covenants in the agreement and it has asserted that coverage is terminated. Our re-insurer did not specify the covenants that it contends were violated. It has not provided us with any explanation for its action.

We strongly disagree with the reinsurance position and intend to vigorously pursue recovery from the re-insurer and have asserted our right to arbitration under the agreement. No benefit was recorded in our financial statements during the first quarter regarding this matter. Additional information on the matter can be found in the current development sections you have of our 10-Q. During the question and answers session, please understand that this is ongoing legal matter and will limited us to what we can say.

Now, I'd like to turn the call over to Mark for an update on the proposed transaction with Lightyear Capital.

Mark Tonnesen

On the proposed transaction, the first thing I want to tell you is that I wish I could tell you more, but since we are currently in negotiations we are limited on what we can say. I know that this is frustrating and I wish we could get into more of the details, but I will tell you what I can tell you.

We have an exclusive arrangement with a great company, Lightyear Capital, and we are negotiating definitive agreements that would result in the formation of a new mortgage insurance company. We have cleared many hurdles to get to where we are today, but there are more ahead. We started the capital raising process in late 2007. Since then, the housing market has continued its unprecedented decay and performance of our book has continued to deteriorate. Our capital base has diminished to a level unimagined a year ago, and our stock price has suffered tremendously.

At first, we looked for a direct investment, but were unable to find a company willing to take on the legacy risk of our portfolio. Even if we had been successful in finding a party willing to invest, the dilution to the existing shareholder base would have been extreme.

Would a direct investment have been the best outcome? I don't know, and that point has moved since it was not an available option.

In light of the currents industry conditions, and capital raising environment, I believe the proposed transaction with Lightyear is in the best interest of our stockholders, employees, customers and policyholders, and without this transaction voluntary run-up would be almost certain, but without the benefits associated with the transaction.

I want to take a moment and mention that Goldman Sachs has been our trusted financial advisor throughout this process. I want to thank them for their assistance, their hard work and their valuable insights. Our goal has always been to maximize the value of the company and we continue to work towards that goal. Going forward, what we believe will be critically important for Triad Guaranty is to have an orderly and efficient runoff. We believe the proposed transactions with Lightyear will help us accomplish this.

Yes, under the proposed transaction, some of our key employees would move to the new company, but at first, that is expected to be mainly the I.T, sales, marketing, compliance, underwriting and certain operations personnel. We are attempting to design and negotiate a transaction in which the personnel who are critical to the success of an orderly and efficient runoff will stay at Triad Guaranty, while they need to be here. These transactions are expected to be helpful in that regard.

Personally, I am committed to Triad Guaranty and my efforts will be focused on the interests of Triad Guaranty stockholders and employees. Negotiations with Light Year Capital are progressing well and our focused primarily on operational matters and the logistics of creating and launching the new company. It is important to note that neither Triad nor its stockholders will initially have any ownership interest in the new company. We are encouraged by what we have accomplished so far, but realize that there is much work to be done. As we can provide more information, we will and I look forward to being able to update you on details of this transaction and to answer your questions. With that, operator, I would like to open the lines and invite

Question and Answer Session


(Operator Instructions) Your first question comes from Peter Horn - Gates Capital.

Peter Horn - Gates Capital

Would the existing policyholders of Triad have any recourse to the new entity? Is that contemplated in any fashion whatsoever?

Mark Tonnesen

No, it is not.


Your next question comes from Jerry Bruni - J.V. Bruni & Company.

Jerry Bruni - J.V. Bruni & Company

If you could elaborate on why existing Triad shareholders who represent ownership in the existing company, without which there could be no subsequent company. Why they would have no ownership interest or beneficial interest in the formation of the new company?

Mark Tonnesen

Right now, we can't go into the specifics of the transaction. What we hope to be able to do is, within the next 30 days sign a definitive agreement and at that point in time, we will be able to expose the details of the transaction. As we do so, we'll be providing all those details.

Jerry Bruni - J.V. Bruni & Company

Lay out your general categories of reasoning as to why this is in the interest of the existing shareholders?

Mark Tonnesen

Number one is there is compensation to be provided to Triad Guaranty and its shareholders, the specifics of which again we will be in a position to detail, once the definitive agreement has been signed. Second is what we see in the future at Triad Guaranty is a runoff of the existing book, with the value to be determined by the ultimate claims and premiums collected. What we tried to do is to make sure that we minimize our costs and maximize our effectiveness in that runoff strategy.

We believe that the proposed transaction will help to reduce the costs associated with Triad Guaranty as it affects the runoff as well as improve the efficiency. That will happen as we transfer some of our fixed costs and some of our costs that are associated with existing employees over to the new company to help it get started up and also, to insure that our talent that’s required to maximize the effectiveness and efficiency of the runoff are maintained.


Your next question is a follow-up from Peter Horn - Gates Capital.

Peter Horn - Gates Capital

The business that you wrote in the first quarter, can you not provide color on exactly who your customers were, but were you writing to the GSEs, or to individual banks? Or who comprised your customer base?

Mark Tonnesen

Our customer base includes the largest mortgage lenders in the country and their correspondence and a wide array of mortgage organizations throughout the United States.

Peter Horn - Gates Capital

So the profile of who you wrote business with in Q1 is roughly similar to the same companies that you did business in prior quarters?

Mark Tonnesen

Roughly, that would be correct, of course, we always have some changes.

Peter Horn - Gates Capital

No, no, no, of course. I didn't know if there was a material change or not. My second question is, given the development obviously, the adverse development that has occurred and your risk to capital ratio clearly exceeding the 25 to 1. What I believe to be I guess more than a guideline, a strict line in the sand, and compounded with the formation of a new business, basically insuring the runoff of the existing book. Can you explain any color or provide any insight into why either the regulators and/or your customer base is comfortable doing business with the legacy business? No, obviously not the newly capitalized entity but the existing mortgage insurer?

Mark Tonnesen

First of all, let me tell you a little bit about what we're writing and these are actually from our April production figures, but 96% of the volume that we wrote is what's called prime, 2% was in Alt-A and 2% in A minus. Our average loan-to-value was 91%, and we wrote only 12% greater than 95% LTV. We wrote 0% NegAm or potential NegAm products, so the quality of the business that we're writing is very good. As you may know or may know Peter, we took early action to help lead this industry in its flight to quality, and I believe that that's respected by both, our customer base, the GSEs as well as the Illinois regulator.

We work very closely with Illinois and the GSEs to keep them abreast of every single step that we've taken, and they are the ones that control the decision on Triad writing business. We provided them with the details of the new company and all would like to see the new company succeed. So with the profitability of both our existing writing, a high quality, the actions that we took at the end of last year, we've got an excellent support from the regulator and from the GSEs thus far.

What they hope to be able to do is to help us fashion the advantages associated with the new capital that the new company would bring in board, and make that as smoother transition as is possible. Our customers have been wonderful. Now, in the Maine, our customers continue to believe that Triad Guaranty provides excellent service, quality pricing and good value to their customer base.

We provided our customers with great transparency into the prospects for Triad Guaranty. As we have this quarter, with the details on the premium deficiency reserve, if you look into the premium deficiency reserve calculation, you can see some of the rather harsh expectations that we have on the current portfolio.

We've shared all of that with our customers as well as the GSEs, and so they realize that the expectations are that we'll be able to fully pay all of our claims in the future, and while there’s no guarantee for that, there's good basis upon which we've made that forecast. Finally, I think our customers are astute enough to understand that continuing to do business and writing profitable business on to the Triad Guaranty books today, is in their best interest because those profits will accumulate to pay future claims.

So I think that there are a lot of excellent reasons. We have done everything that we can do to make sure that we follow our strategy from the get-go, which was to provide the highest level of transparency in the industry. We feel that we've taken the appropriate actions to bring the quality of the business back to where it needed to be, and all those things are helping our customers to have the confidence in Triad as well as the regulators and the GSE's.

Peter Horn - Gates Capital

And the new business written. So it's not housed anything temporarily in the existing Triad Guaranty. It will remain in the Triad Guaranty, irrespective of the development going forward. There is nothing embedded contractually that will allow this new business written, the Q1 business to move to the new entity or anything like that?

Mark Tonnesen

That's correct. What we do want to do is we want the transaction to be finalized as quickly as possible. Part of the expectations of the GSE's who have really been terrific through this whole situation not only with us, but with the entire mortgage insurance industry and continue to accept the Triad certs as we move forward, has been to try to advance the new company formation as quickly as possible. Illinois has been extremely helpful in this regard, thus far. So what we want to do is, we want to move to a point where new risk will accumulate onto the balance sheet of the new companies as quickly as possible. We expect that to happen on finalization of the transaction.


Your next question is a follow-up from Jerry Bruni - J.V. Bruni & Company.

Jerry Bruni - J.V. Bruni & Company

You've characterized the assumptions in the determination of your reserves and provisions as harsh and these provisions lower your book value to roughly $22 a share. If the stock is roughly $20 a share less than that trading, can you try to resolve that seeming disconnect?

Mark Tonnesen

I think I can do it literally, Jerry, but I don't know that I can do it fully. We've made our calculations on the future value, future net present value of the book of business and it's created the premium deficiency reserve that we booked. It's true that implicit in that is our expectation that the current book value of the business is secure.

However, as Ken mentioned in his comments, that is not without some risk to it. What we find, Jerry, is that since about June of last year, the model builders in the industry, whether they be on Wall Street, or elsewhere in the industry, have really reversed themselves. While in 2005, 2006, the models suggested that you couldn't write a bad mortgage. Today's models forecasts exactly the opposite and expect that you can hardly collect on any mortgage. I'm not going to try to refute these models, but the expectations on our portfolio have a wide variance and there are significant modelers out there and companies that would not agree with our premium deficiency calculation and suggest that it could be significantly worse.

That's the technical and the mathematical explanation for this, Jerry, but you know that there have been a lot of people that have been betting against the mortgage market for quite a while, and they have been right over the last year. Eventually they will be wrong and we will have to see when that time comes.

Jerry Bruni - J.V. Bruni & Company

Will there be a vote of Triad shareholders on the proposed transaction?

Mark Tonnesen

Jerry, the current transaction is not a changing control transaction and our lawyers are of the opinion that a shareholder transaction may not be required. However, our board and our Chairman have suggested that they want the shareholders to take a close look and examination of this transaction and we do anticipate bringing it forward for a shareholder vote.


There are no further questions at this time.

Kenneth Jones

Okay, we appreciate everybody's interest today, and as always thanks for taking time for the participation in the call and everyone have a good day.

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