UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
Form 10-Q
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x |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the Quarter Ended June 30, 2007 |
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or |
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 1-33111
ACA Capital Holdings, Inc.
(Exact name of registrant as specified in its charter)
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Delaware |
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75-3170112 |
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(State or other
jurisdiction of |
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(I.R.S. Employer
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140 Broadway
New York, New York 10005
(212) 375-2000
(Address, including zip code, and telephone number, including
area code, of registrant’s principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer o |
Accelerated filer o |
Non-accelerated filer x |
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of August 10, 2007, 35,749,818 shares of Common Stock, par value $0.10 per share, were outstanding.
INDEX
2
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements of ACA Capital Holdings, Inc. and Subsidiaries (Unaudited)
ACA CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
AS OF JUNE 30, 2007 AND DECEMBER 31, 2006
(Dollars in thousands)
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June 30, |
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December 31, |
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2007 |
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2006 |
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ASSETS |
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Investments: |
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Fixed-maturity securities available for sale at fair value, amortized cost of $4,843,922 and $5,043,239, respectively |
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$ |
4,636,105 |
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$ |
5,026,276 |
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Fixed-maturity securities trading at fair value, amortized cost of $408,627 and $251,884, respectively |
|
406,432 |
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251,825 |
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Securities purchased under agreements to resell |
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3,408 |
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10,248 |
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Guaranteed investment contract |
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119,340 |
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119,340 |
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Total investments |
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5,165,285 |
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5,407,689 |
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Cash: |
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Cash and cash equivalents |
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328,824 |
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379,905 |
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Restricted cash |
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46,155 |
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67,061 |
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Total cash |
|
374,979 |
|
446,966 |
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Accrued investment income |
|
22,439 |
|
21,222 |
|
||
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Derivative assets |
|
232,267 |
|
19,730 |
|
||
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Deferred policy acquisition costs, net |
|
48,498 |
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48,810 |
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||
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Deferred debt issuance costs, net |
|
30,776 |
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34,104 |
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Receivable for securities sold |
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8,145 |
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824 |
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Prepaid reinsurance premiums |
|
494 |
|
528 |
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Deferred income taxes |
|
126,363 |
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— |
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||
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Other assets |
|
82,996 |
|
58,321 |
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Total assets |
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$ |
6,092,242 |
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$ |
6,038,194 |
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LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS’ EQUITY |
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LIABILITIES |
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Unearned premiums |
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$ |
195,667 |
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$ |
189,537 |
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Reserve for losses and loss adjustment expenses |
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45,923 |
|
42,113 |
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Short-term debt |
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2,779,513 |
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2,677,828 |
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Long-term debt |
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1,836,461 |
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2,125,914 |
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Related party debt |
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100,000 |
|
100,000 |
|
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Securities sold under agreements to repurchase |
|
372,936 |
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232,227 |
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Derivative liabilities |
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311,061 |
|
33,874 |
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Accrued interest payable |
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15,797 |
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17,900 |
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Accrued expenses and other liabilities |
|
76,058 |
|
61,855 |
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Payable for securities purchased |
|
2,110 |
|
9,628 |
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Current income tax payable |
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15,765 |
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7,056 |
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Deferred income taxes |
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— |
|
258 |
|
||
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Total liabilities |
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5,751,291 |
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5,498,190 |
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MINORITY INTEREST |
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14,645 |
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30,190 |
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COMMITMENTS AND CONTINGENCIES |
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STOCKHOLDERS’ EQUITY |
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Common stock of 100,000,000 shares authorized at June 30, 2007 and December 31, 2006; 37,444,873 and 37,375,123 shares issued and outstanding at June 30, 2007 and December 31, 2006, respectively; par value of $0.10 |
|
3,744 |
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3,737 |
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Gross paid-in and contributed capital |
|
441,545 |
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438,935 |
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Treasury stock at cost — 851,847 shares at June 30, 2007 and December 31, 2006 |
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(12,088 |
) |
(12,088 |
) |
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Notes receivable from stockholders |
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(3,121 |
) |
(3,121 |
) |
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Deferred compensation |
|
(290 |
) |
(870 |
) |
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Accumulated other comprehensive loss — net of deferred income tax of $(57,420) and $(1,760) at June 30, 2007 and December 31, 2006, respectively |
|
(106,594 |
) |
(3,308 |
) |
||
|
Retained earnings |
|
3,110 |
|
86,529 |
|
||
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Total stockholders’ equity |
|
326,306 |
|
509,814 |
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Total liabilities, minority interest and stockholders’ equity |
|
$ |
6,092,242 |
|
$ |
6,038,194 |
|
See notes to unaudited condensed consolidated financial statements.
3
ACA CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
(Dollars and shares in thousands, except per share amounts)
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Three Months Ended |
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Six Months Ended |
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June 30, |
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June 30, |
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||||||||
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2007 |
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2006 |
|
2007 |
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2006 |
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REVENUES: |
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Gross premiums written |
|
$ |
15,478 |
|
$ |
15,727 |
|
$ |
20,519 |
|
$ |
20,515 |
|
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Less premiums ceded |
|
(630 |
) |
(61 |
) |
(761 |
) |
(186 |
) |
||||
|
Net premiums written |
|
14,848 |
|
15,666 |
|
19,758 |
|
20,329 |
|
||||
|
Increase in unearned premium reserve - net |
|
(6,403 |
) |
(7,191 |
) |
(6,164 |
) |
(6,972 |
) |
||||
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Premiums earned |
|
8,445 |
|
8,475 |
|
13,594 |
|
13,357 |
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||||
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Net insured credit swap revenue |
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(44,183 |
) |
7,931 |
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(40,484 |
) |
22,111 |
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||||
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Net investment income |
|
90,627 |
|
82,452 |
|
180,547 |
|
160,164 |
|
||||
|
Net realized and unrealized losses on investments |
|
(110,142 |
) |
(1,256 |
) |
(113,850 |
) |
(3,223 |
) |
||||
|
Net realized and unrealized gains on derivative instruments |
|
3,256 |
|
2,497 |
|
5,336 |
|
6,139 |
|
||||
|
Other net credit swap revenue |
|
3,851 |
|
2,631 |
|
16,157 |
|
5,544 |
|
||||
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Fee income |
|
7,596 |
|
6,955 |
|
13,928 |
|
11,073 |
|
||||
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Other income |
|
299 |
|
53 |
|
355 |
|
104 |
|
||||
|
Total revenues |
|
(40,251 |
) |
109,738 |
|
75,583 |
|
215,269 |
|
||||
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|
|
|
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|
||||
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EXPENSES: |
|
|
|
|
|
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|
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||||
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Loss and loss adjustment expenses |
|
1,859 |
|
1,661 |
|
3,232 |
|
3,682 |
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||||
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Policy acquisition costs |
|
3,042 |
|
2,768 |
|
4,519 |
|
4,160 |
|
||||
|
Other operating expenses |
|
15,564 |
|
12,681 |
|
31,717 |
|
23,294 |
|
||||
|
Interest expense |
|
76,337 |
|
70,964 |
|
152,745 |
|
137,383 |
|
||||
|
Depreciation and amortization |
|
2,278 |
|
2,225 |
|
4,537 |
|
4,717 |
|
||||
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Total expenses |
|
99,080 |
|
90,299 |
|
196,750 |
|
173,236 |
|
||||
|
Income of minority interest |
|
(1,265 |
) |
(1,074 |
) |
(2,144 |
) |
(2,229 |
) |
||||
|
Income (loss) before income taxes |
|
(140,596 |
) |
18,365 |
|
(123,311 |
) |
39,804 |
|
||||
|
Provision for income tax expense (benefit) |
|
(47,260 |
) |
6,323 |
|
(41,392 |
) |
13,615 |
|
||||
|
Net income (loss) |
|
$ |
(93,336 |
) |
$ |
12,042 |
|
$ |
(81,919 |
) |
$ |
26,189 |
|
|
|
|
|
|
|
|
|
|
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|
||||
|
Share and Per Share Data |
|
|
|
|
|
|
|
|
|
||||
|
Earnings (loss) per share |
|
|
|
|
|
|
|
|
|
||||
|
Basic |
|
$ |
(2.55 |
) |
$ |
0.53 |
|
$ |
(2.24 |
) |
$ |
1.15 |
|
|
Diluted |
|
$ |
(2.55 |
) |
$ |
0.40 |
|
$ |
(2.24 |
) |
$ |
0.87 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Weighted average shares outstanding |
|
|
|
|
|
|
|
|
|
||||
|
Basic |
|
36,577 |
|
22,858 |
|
36,558 |
|
22,830 |
|
||||
|
Diluted |
|
36,577 |
|
30,085 |
|
36,558 |
|
29,846 |
|
||||
See notes to unaudited condensed consolidated financial statements.
4
ACA CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2007 AND 2006
(Dollars in thousands, except for share amounts)
|
|
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|
|
|
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Gross |
|
|
|
Notes |
|
|
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Accumulated |
|
|
|
|
|
|||||||||
|
|
|
Preferred Stock |
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Common Stock |
|
Paid in and |
|
|
|
Receivable |
|
|
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Other |
|
|
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Total |
|
|||||||||||||
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Par |
|
Contributed |
|
Treasury |
|
from |
|
Deferred |
|
Comprehensive |
|
Retained |
|
Stockholders’ |
|
|||||||||||
|
|
|
Shares |
|
Amount |
|
Shares |
|
Value |
|
Capital |
|
Stock |
|
Stockholders |
|
Compensation |
|
Income (Loss) |
|
Earnings |
|
Equity |
|
|||||||||
|
BALANCE—January 1, 2006 |
|
2,786,857 |
|
$ |
226,460 |
|
6,442,950 |
|
$ |
644 |
|
$ |
125,184 |
|
$ |
(5,500 |
) |
$ |
(1,355 |
) |
$ |
(2,030 |
) |
$ |
11,132 |
|
$ |
29,778 |
|
$384,313 |
|
|
|
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||
|
Net income |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
26,189 |
|
26,189 |
|
|||||||||
|
Change in unrealized gain on investments, net of change in deferred income tax of $(1,528) |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
(3,999 |
) |
— |
|
(3,999 |
) |
|||||||||
|
Change in derivative hedges, net of change in deferred income tax of $2,987 |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
5,547 |
|
— |
|
5,547 |
|
|||||||||
|
Total comprehensive income |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
27,737 |
|
|||||||||
|
Vesting of Series B senior conv. prf stock to CEO |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
580 |
|
— |
|
— |
|
580 |
|
|||||||||
|
Exercise of stock options by former executives |
|
— |
|
— |
|
663,540 |
|
66 |
|
8,024 |
|
— |
|
— |
|
— |
|
— |
|
— |
|
8,090 |
|
|||||||||
|
Common stock purchased from former executive |
|
— |
|
— |
|
— |
|
— |
|
— |
|
(6,588 |
) |
— |
|
— |
|
— |
|
— |
|
(6,588 |
) |
|||||||||
|
Stock based compensation-stock options |
|
— |
|
— |
|
— |
|
— |
|
350 |
|
— |
|
— |
|
— |
|
— |
|
— |
|
350 |
|
|||||||||
|
Issuance of note receivable from stockholder |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
(2,262 |
) |
— |
|
— |
|
— |
|
(2,262 |
) |
|||||||||
|
Discharge of note receivable from stockholders |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
496 |
|
— |
|
— |
|
— |
|
496 |
|
|||||||||
|
Senior convertible preferred stock dividend |
|
25 |
|
1,957 |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
(1,957 |
) |
— |
|
|||||||||
|
BALANCE—June 30, 2006 |
|
2,786,882 |
|
$ |
228,417 |
|
7,106,490 |
|
$ |
710 |
|
$ |
133,558 |
|
$ |
(12,088 |
) |
$ |
(3,121 |
) |
$ |
(1,450 |
) |
$ |
12,680 |
|
$ |
54,010 |
|
$ |
412,716 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||
|
BALANCE—January 1, 2007 |
|
— |
|
$ |
— |
|
37,375,123 |
|
$ |
3,737 |
|
$ |
438,935 |
|
$ |
(12,088 |
) |
$ |
(3,121 |
) |
$ |
(870 |
) |
$ |
(3,308 |
) |
$ |
86,529 |
|
$ |
509,814 |
|
|
Effect of adoption of FIN 48 |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
(1,500 |
) |
(1,500 |
) |
|||||||||
|
Comprehensive loss: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||
|
Net loss |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
(81,919 |
) |
(81,919 |
) |
|||||||||
|
Change in unrealized loss on investments, net of change in deferred income tax of $(56,453) |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
(104,841 |
) |
— |
|
(104,841 |
) |
|||||||||
|
Change in derivative hedges, net of change in deferred income tax of $792 |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
1,472 |
|
— |
|
1,472 |
|
|||||||||
|
Foreign exchange unrealized gain |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
83 |
|
— |
|
83 |
|
|||||||||
|
Total comprehensive loss |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
|
|
(185,205 |
) |
|||||||||
|
Vesting of CEO restricted common stock |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
— |
|
580 |
|
— |
|
— |
|
580 |
|
|||||||||
|
Offering costs |
|
— |
|
— |
|
— |
|
— |
|
63 |
|
— |
|
— |
|
— |
|
— |
|
— |
|
63 |
|
|||||||||
|
Stock based compensation—restricted stock |
|
— |
|
— |
|
— |
|
— |
|
476 |
|
— |
|
— |
|
— |
|
— |
|
— |
|
476 |
|
|||||||||
|
Stock based compensation—stock options |
|
— |
|
— |
|
— |
|
— |
|
1,349 |
|
— |
|
— |
|
— |
|
— |
|
— |
|
1,349 |
|
|||||||||
|
Exercise of common stock options |
|
— |
|
— |
|
69,750 |
|
7 |
|
722 |
|
— |
|
— |
|
— |
|
— |
|
— |
|
729 |
|
|||||||||
|
BALANCE—June 30, 2007 |
|
— |
|
$ |
— |
|
37,444,873 |
|
$ |
3,744 |
|
$ |
441,545 |
|
$ |
(12,088 |
) |
$ |
(3,121 |
) |
$ |
(290 |
) |
$ |
(106,594 |
) |
$ |
3,110 |
|
$ |
326,306 |
|
See notes to unaudited condensed consolidated financial statements.
5
ACA CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2007 AND 2006
(Dollars in thousands)
|
|
|
2007 |
|
2006 |
|
||
|
CASH FLOWS FROM OPERATING ACTIVITIES: |
|
|
|
|
|
||
|
Net income (loss) |
|
$ |
(81,919 |
) |
$ |
26,189 |
|
|
Adjustments to reconcile net income (loss) to net cash provided by operating activities: |
|
|
|
|
|
||
|
Depreciation and amortization |
|
4,537 |
|
4,717 |
|
||
|
Accrual of discount and amortization of premium on investment—net |
|
194 |
|
(208 |
) |
||
|
Income of minority interest |
|
2,144 |
|
2,229 |
|
||
|
Net realized losses on fixed-maturity securities-available-for-sale |
|
111,632 |
|
3,203 |
|
||
|
Net realized and unrealized losses on fixed-maturity securities- trading |
|
2,219 |
|
20 |
|
||
|
Net realized and unrealized gains on derivative instruments |
|
(5,336 |
) |
(6,139 |
) |
||
|
Net realized and unrealized (gains) losses on net insured credit swap revenue |
|
82,846 |
|
(829 |
) |
||
|
Net realized and unrealized gains on other net credit swap revenue |
|
(10,627 |
) |
(291 |
) |
||
|
Net foreign exchange loss |
|
43 |
|
— |
|
||
|
Share based compensation expense |
|
1,825 |
|
350 |
|
||
|
Discharge of note receivable from shareholders |
|
— |
|
496 |
|
||
|
Deferred compensation |
|
580 |
|
580 |
|
||
|
Purchase of securities under agreement to resell |
|
6,840 |
|
— |
|
||
|
Purchases of fixed-maturity securities-trading |
|
(222,150 |
) |
— |
|
||
|
Proceeds from sales of fixed-maturity securities- trading |
|
64,183 |
|
— |
|
||
|
Securities sold under agreement to repurchase |
|
140,709 |
|
— |
|
||
|
|
|
|
|
|
|
||
|
Changes in assets and liabilities: |
|
|
|
|
|
||
|
Income taxes payable |
|
8,709 |
|
343 |
|
||
|
Deferred income tax expense |
|
(70,921 |
) |
2,967 |
|
||
|
Prepaid reinsurance premiums |
|
34 |
|
228 |
|
||
|
Derivative liabilities |
|
307 |
|
(1,905 |
) |
||
|
Accrued expenses and other liabilities |
|
(7,298 |
) |
(2,591 |
) |
||
|
Deferred policy acquisition costs |
|
312 |
|
(661 |
) |
||
|
Unearned premium reserve |
|
6,130 |
|
6,743 |
|
||
|
Loss and loss adjustment expenses |
|
3,810 |
|
2,938 |
|
||
|
Interest payable |
|
(2,103 |
) |
632 |
|
||
|
Interest receivable |
|
(1,217 |
) |
(2,052 |
) |
||
|
Other |
|
5,472 |
|
1,272 |
|
||
|
Net cash provided by operating activities |
|
40,955 |
|
38,231 |
|
||
|
|
|
|
|
|
|
||
|
CASH FLOWS FROM INVESTING ACTIVITIES: |
|
|
|
|
|
||
|
Net deposit of restricted cash |
|
20,906 |
|
(3,881 |
) |
||
|
Purchases of fixed maturity securities available for sale |
|
(538,170 |
) |
(519,582 |
) |
||
|
Proceeds from sales of fixed maturity securities available for sale |
|
78,568 |
|
83,662 |
|
||
|
Proceeds from maturities of fixed maturity securities available for sale |
|
533,395 |
|
524,052 |
|
||
|
Net purchase of property and equipment |
|
(2,759 |
) |
(230 |
) |
||
|
Net cash provided by investing activities |
|
91,940 |
|
84,021 |
|
||
|
|
|
|
|
|
|
||
|
CASH FLOWS FROM FINANCING ACTIVITIES: |
|
|
|
|
|
||
|
Paydown of commercial paper—net |
|
(361 |
) |
(393 |
) |
||
|
Paydown on long-term debt |
|
(187,407 |
) |
(72,507 |
) |
||
|
Payment of issuance costs for debt |
|
— |
|
(308 |
) |
||
|
Proceeds from issuance of equity in Credit Fund |
|
3,000 |
|
— |
|
||
|
Proceeds from exercise of common stock options |
|
729 |
|
— |
|
||
|
Purchase of treasury stock |
|
— |
|
(759 |
) |
||
|
Offering costs |
|
63 |
|
— |
|
||
|
Net cash used in financing activities |
|
(183,976 |
) |
(73,967 |
) |
||
|
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS |
|
(51,081 |
) |
48,285 |
|
||
|
|
|
|
|
|
|
||
|
CASH AND CASH EQUIVALENTS—beginning of period |
|
379,905 |
|
174,420 |
|
||
|
CASH AND CASH EQUIVALENTS—end of period |
|
$ |
328,824 |
|
$ |
222,705 |
|
|
|
|
|
|
|
|
||
|
SUPPLEMENTAL CASH FLOW DISCLOSURES: |
|
|
|
|
|
||
|
Federal and local income taxes paid |
|
$ |
10,356 |
|
$ |
11,049 |
|
|
|
|
|
|
|
|
||
|
Interest paid |
|
$ |
154,848 |
|
$ |
136,752 |
|
|
|
|
|
|
|
|
||
|
SUPPLEMENTAL DISCLOSURES OF NON-CASH FINANCING ACTIVITIES: |
|
|
|
|
|
||
|
Common stock acquired in exchange for note receivable |
|
$ |
— |
|
$ |
2,262 |
|
See notes to unaudited condensed consolidated financial statements.
6
ACA CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
1. BUSINESS, ORGANIZATION AND OPERATIONS
ACA Capital Holdings, Inc. (“ACA” or the “Company”), is a Delaware domiciled holding company that provides financial guaranty insurance products to participants in the global credit derivatives markets, structured finance capital markets and public finance capital markets, as well as providing asset management services. The Company’s principal activities include financial guaranty insurance of public finance obligations, structured credit risk assumption through insured credit derivatives and collateralized debt obligation asset management. ACA conducts its business through three principal wholly-owned indirect subsidiaries. Its financial guaranty insurance business is conducted through ACA Financial Guaranty Corporation (“ACA Financial Guaranty”), a Maryland domiciled insurance company. ACA Financial Guaranty is licensed to conduct financial guaranty insurance business, which provides credit enhancement on public finance and other debt obligations, in all 50 states, the District of Columbia, Guam, the U.S. Virgin Islands and Puerto Rico. Standard & Poor’s Rating Services (“S&P”) has assigned a financial strength rating of “A” to ACA Financial Guaranty. ACA Financial Guaranty also provides the credit support for the Company’s Structured Credit business activities. The Company conducts its U.S.-based CDO Asset Management business primarily through ACA Service L.L.C. and ACA Management, L.L.C. This business encompasses the origination (in collaboration with investment banks), structuring and management of collateralized debt obligations (including collateralized loan obligations and other similarly securitized asset classes, collectively “CDOs”). In January 2007, the Company’s wholly-owned indirect subsidiary, ACA Capital Management (U.K.) Pte. Limited, became authorized and regulated by the Financial Services Authority as an investment manager to manage CDOs in the United Kingdom and most of Europe.
The Company’s business is composed of three distinct continuing lines of business or segments. They are Public Finance, Structured Credit and CDO Asset Management. A fourth line of business, Other, includes business in areas and markets in which the Company is no longer active. Although the Public Finance and Structured Credit businesses are reported in separate segments, together they form the Company’s financial guaranty insurance business. Public Finance primarily provides financial guaranty insurance policies guaranteeing the timely payment of scheduled principal and interest on public finance and other debt obligations. Structured Credit structures and sells credit protection, principally in the form of insured credit default swaps (“CDS” or “credit swaps”), against a variety of asset classes in the institutional fixed income markets. CDO Asset Management focuses on CDO origination, structuring and management. The Company will at times assume risk in the CDOs it manages through investment in some portion of the capital structure.
ACA was originally incorporated in Delaware on January 3, 1997. On November 22, 2002, ACA changed its jurisdiction of incorporation from Delaware to Bermuda. During 2004, the Board of Directors determined that re-domesticating to Delaware would eliminate certain adverse consequences of remaining in Bermuda, facilitate ACA’s access to U.S. capital markets, simplify its tax filings, accounting and operations, and reduce the costs of compliance with two sets of filing obligations and laws (as ACA stockholders are U.S. entities and individuals). On September 15, 2004, therefore, ACA re-domesticated from Bermuda to Delaware through a process called a “discontinuation” under Bermuda law and “domestication” under Delaware law. As a result, it became a Delaware domiciled holding company and changed its name from American Capital Access Holdings, Ltd. to its current name.
On November 9, 2006, the Company priced its initial public offering of 6,875,000 shares of newly issued common stock and 23,541 shares of existing common stock. The Company realized gross proceeds of $13 per share on the newly issued common stock, or $89.4 million. Net proceeds to the Company were $79.2 million, after issuance costs. On November 10, 2006, the Company’s common stock commenced trading on the New York Stock Exchange under the symbol “ACA.” In conjunction with the initial public offering, the Company’s senior convertible preferred stock, convertible preferred stock and series B senior convertible preferred stock all converted to common stock concurrently with the closing of our offering on November 15, 2006 at their conversion ratios of 6,000:1 shares, 6,000:1 shares and 6:1 shares, respectively.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
These unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (“GAAP”) for complete financial statements and should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 (“Form 10-K”), filed with the SEC on April 2, 2007. These unaudited condensed consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, that we consider necessary for the fair presentation of our financial position and results of operations for these periods. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Operating results for the three and six months ended
7
June 30, 2007 are not necessarily indicative of the results that may be expected for the year ended December 31, 2007.
In August 2006, the Company’s Board of Directors authorized a dividend of stock in order to effect a six-for-one stock split. All prior share and per share amounts have been restated to reflect the stock split.
Valuation of Insured Credit Swap Transactions – The Company values its insured credit swap transactions either by obtaining market quotes from dealers or through the application of the Company’s valuation model. During the quarter ended June 30, 2007, the Company refined its valuation model to estimate fair value of its insured credit swap transactions. The change was implemented to be more consistent with models that the Company understands other market participants utilize, including many of ACA’s insured credit swap counterparties. The relatively young market for credit swaps has continued to evolve over time and, while there is still substantial variance in valuation models among market participants, the trend is toward increasing convergence in this area. Under its refined model, the Company fully uses market spread data as a proxy for default probabilities in the determination of fair value. For transactions in which the underlying exposure is to corporate credits, the Company uses individual market spreads as proxies for defaults as they are readily available. For synthetic asset-backed transactions, the Company uses a current weighted average portfolio spread because individual spread information historically has not been consistently reliable and often has been unavailable. As the availability and quality of individual asset-backed spread data improves, the Company may make further refinements to its valuation model. The Company believes that its new model will inherently increase the volatility of these valuations, but provide a better estimate of the cost or benefit of unwinding the related transaction.
3. RELEVANT RECENT ACCOUNTING PRONOUNCEMENTS
On April 18, 2007, the Financial Accounting Standards Board (“FASB”) released an exposure draft entitled “Accounting for Financial Guarantee Insurance Contracts—An Interpretation of FASB Statement No. 60” (the “Proposed Statement”). While FASB Statement No. 60, “Accounting and Reporting by Insurance Enterprises”, sets out accounting standards for property and casualty and life insurance enterprises, it has historically not specifically considered financial guaranty insurance. This new interpretation is intended to address the specific attributes of this type of insurance. The principal items addressed in the exposure draft relate to revenue recognition, the establishment of claim reserves and disclosures around such reserves. The Proposed Statement would be effective for financial statements issued for fiscal years beginning after December 15, 2007. While certain provisions of the Proposed Statement are still being analyzed, management believes that the cumulative effect of initially applying the Proposed Statement could be material to the Company’s financial statements. Until the final interpretation is issued by the FASB, the Company continues to apply the accounting policies as disclosed in its Form 10-K.
In February 2007, the FASB issued Financial Accounting Standard (“FAS”) 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“FAS 159”). FAS 159 permits reporting entities to choose to remeasure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The fair value option may be applied instrument by instrument, is irrevocable and is applied only to entire instruments and not to portions of instruments. FAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. FAS 159 is effective for fiscal years that begin after November 15, 2007. The Company did not elect to early adopt FAS 159. Management is currently evaluating the potential impact, if any, which the adoption of FAS 159 will have on the Company’s financial statements.
On January 1, 2007, the Company adopted FAS 155, “Accounting for Certain Hybrid Financial Instruments” (“FAS 155”), an amendment of FAS 133, “Accounting for Derivative Instruments and Certain Hedging Activities” (“FAS 133”) and FAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“FAS 140”). The implementation of this statement did not have a material impact on the Company’s financial statements.
On January 1, 2007, the Company adopted FASB Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109” (“FIN 48”). The adoption of FIN 48 resulted in a decrease to stockholders’ equity as of January 1, 2007 of $1.5 million (see Note 6).
In September 2006, the FASB issued FAS 157, “Fair Value Measurements” (“FAS 157”). FAS 157 enhances existing guidance for measuring assets and liabilities using fair value, such as emphasizing that fair value is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest priority being quoted prices in active markets. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Management is currently evaluating the potential impact, if any, which the adoption of FAS 157 will have on the Company’s financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”, which provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The provisions of SAB 108 were put in effect at December 31, 2006. The adoption of this statement did not have a material impact on the Company’s financial statements.
In April 2006, the FASB issued Staff Position (“FSP”) FIN 46(R)-6, “Determining the Variability to Be Considered in Applying FASB Interpretation No. 46(R)” (“FSP FIN 46(R)-6”). FSP FIN 46(R)-6 addresses whether certain arrangements associated with variable interest entities (VIEs) should be treated as variable interests or considered as creators of variability, and indicates that the variability to be considered shall be on based on an analysis of the design of the entity. FSP FIN 46(R)-6 was adopted on June 15,
8
2006. The adoption of this statement did not have a material impact on the Company’s financial statements.
In March 2006, the FASB issued FAS 156, “Accounting for Servicing of Financial Assets” (“FAS 156”), an amendment of FAS 140. FAS 156 requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable, and permits for subsequent measurement using either fair value measurement with changes in fair value reflected in earnings or the amortization and impairment requirements of FAS 140. The subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value eliminates the necessity for entities that manage the risks inherent in servicing assets and servicing liabilities with derivatives to qualify for hedge accounting treatment and eliminates the characterization of declines in fair value as impairments or direct write-downs. FAS 156 is effective for an entity’s first fiscal year beginning after September 15, 2006. The implementation of this statement did not have a material impact on the Company’s financial statements.
In September 2005, Statement of Position (“SOP”) 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts”, (“SOP 05-1”), was issued. This SOP provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacement of insurance and investment contracts other than those specifically described in FAS No. 97, “ Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments”. SOP 05-1 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006. The adoption of this SOP did not have a material impact on the Company’s financial statements.
4. CDO ASSET MANAGEMENT BUSINESS
One of the ways the Company participates in the structured finance market is through structuring and managing CDOs originated in collaboration with investment banks. CDOs can be issued in funded, unfunded or partially funded form. Funded CDOs issue debt instruments and purchase investment assets, while unfunded CDOs synthetically acquire assets and issue liabilities (i.e., assets and liabilities are in derivative form). Partially funded CDOs are a combination of these two forms. From an accounting perspective, funded and partially funded CDOs are determined to be VIEs. Each time such CDOs are formed, the Company performs an analysis to determine whether it is the primary beneficiary and thus required to consolidate the CDO under the provisions of FSP FIN 46(R)-6.
The following table lists each of the Company’s CDOs outstanding as of June 30, 2007 (dollars in millions):
|
|
|
Year |
|
|
|
|
|
|
|
|
|
Original |
|
|
|
First |
|
|
|
||
|
|
|
Deal |
|
Transaction |
|
|
|
Notional |
|
|
|
Investment in |
|
Retained |
|
Optional |
|
Maturity |
|
||
|
CDO name |
|
Closed |
|
Type |
|
Collateral Type (1) |
|
Deal Size (3) |
|
Consolidated |
|
Retained Equity |
|
Equity % |
|
Call Date(4) |
|
Date |
|
||
|
Asset-Backed CDOs: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
|
ACA ABS 2002-1 |
|
2002 |
|
Funded |
|
Investment Grade |
|
$ |
404 |
|
Yes |
|
$ |
18.0 |
|
100 |
|
8/2005 |
|
8/2037 |
|
|
ACA ABS 2003-1 |
|
2003 |
|
Funded |
|
Investment Grade |
|
400 |
|
Yes |
|
18.0 |
|
100 |
|
6/2007 |
|
6/2038 |
|
||
|
Grenadier Funding |
|
2003 |
|
Funded |
|
High-Grade |
|
1,500 |
|
Yes |
|
22.5 |
|
100 |
|
8/2008 |
|
8/2038 |
|
||
|
ACA ABS 2003-2 |
|
2003 |
|
Funded |
|
Investment Grade |
|
725 |
|
Yes |
|
33.5 |
|
100 |
|
12/2007 |
|
12/2038 |
|
||
|
ACA ABS 2004-1 |
|
2004 |
|
Funded |
|
Investment Grade |
|
450 |
|
Yes |
|
10.0 |
|
61 |
|
7/2007 |
|
7/2039 |
|
||
|
Zenith Funding |
|
2004 |
|
Funded |
|
High-Grade |
|
1,511 |
|
Yes |
|
13.0 |
|
52 |
|
12/2009 |
|
12/2039 |
|
||
|
ACA ABS 2005-1 |
|
2005 |
|
Funded |
|
Investment Grade |
|
452 |
|
No |
|
4.4 |
|
24 |
|
4/2008 |
|
4/2040 |
|
||
|
ACA ABS 2005-2 |
|
2005 |
|
Funded |
|
Investment Grade |
|
450 |
|
No |
|
2.1 |
|
10 |
|
9/2009 |
|
12/2044 |
|
||
|
Khaleej II |
|
2005 |
|
Partially funded |
|
Investment Grade |
|
750 |
|
No |
|
4.5 |
|
14 |
|
9/2009 |
|
9/2040 |
|
||
|
Lancer Funding |
|
2006 |
|
Funded |
|
High-Grade |
|
1,500 |
|
No |
|
1.5 |
|
10 |
|
7/2010 |
|
4/2046 |
|
||
|
ACA Aquarius 2006-1 |
|
2006 |
|
Partially funded |
|
Investment Grade |
|
2,000 |
|
No |
|
— |
|
— |
|
9/2010 |
|
9/2046 |
|
||
|
ACA ABS 2006-1 |
|
2006 |
|
Funded |
|
Investment Grade |
|
750 |
|
No |
|
1.4 |
|
5 |
|
12/2009 |
|
6/2041 |
|
||
|
ACA ABS 2006-2 |
|
2006 |
|
Funded |
|
Investment Grade |
|
750 |
|
No |
|
3.5 |
|
11 |
|
1/2011 |
|
1/2047 |
|
||
|
ACA ABS 2007-1 |
|
2007 |
|
Partially funded |
|
Investment Grade |
|
1,500 |
|
No |
|
1.4 |
|
5 |
|
3/2010 |
|
5/2047 |
|
||
|
Millbrook |
|
2007 |
|
Unfunded |
|
Investment Grade |
|
62 |
|
No |
|
— |
|
— |
|
3/2010 |
|
10/2052 |
|
||
|
Abacus |
|
2007 |
|
Unfunded |
|
Investment Grade |
|
192 |
|
No |
|
— |
|
— |
|
6/2010 |
|
3/2038 |
|
||
|
ACA ABS 2007-2 |
|
2007 |
|
Partially funded |
|
Investment Grade |
|
750 |
|
No |
|
— |
|
— |
|
7/2011 |
|
7/2045 |
|
||
|
Lancer II |
|
2007 |
|
Partially funded |
|
High-Grade |
|
1,000 |
|
No |
|
— |
|
— |
|
7/2011 |
|
7/2047 |
|
||
|
Total Asset-Backed CDOs |
|
|
|
|
|
|
|
15,146 |
|
|
|
133.8 |
|
|
|
|
|
|
|
||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
|
Corporate Credit CDOs: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
|
ACA CDS 2002-2 |
|
2003 |
|
Unfunded |
|
Investment Grade |
|
1,000 |
|
No |
|
25.0 |
|
100 |
|
N/A |
|
3/2008 |
|
||
|
Argon 49 |
|
2005 |
|
Funded |
|
Investment Grade |
|
67 |
(2) |
No |
|
— |
|
— |
|
N/A |
|
6/2015 |
|
||
|
Argon 57 |
|
2006 |
|
Funded |
|
Investment Grade |
|
67 |
(2) |
No |
|
— |
|
— |
|
N/A |
|
6/2013 |
|
||
|
Tribune |
|
2006 |
|
Unfunded |
|
Investment Grade |
|
356 |
(5) |
No |
|
— |
|
— |
|
N/A |
|
9/2016 |
|
||
|
Dolomite |
|
2007 |
|
Unfunded |
|
Investment Grade |
|
66 |
(2) |
No |
|
— |
|
— |
|
N/A |
|
7/2014 |
|
||
|
Total Corporate Credit CDOs |
|
|
|
|
|
|
|
1,556 |
|
|
|
25.0 |
|
|
|
|
|
|
|
||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
|
Leveraged Loan CDOs: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
|
ACA CLO 2005-1 |
|
2005 |
|
Funded |
|
Non-Investment Grade |
|
300 |
|
No |
|
5.0 |
|
21 |
|
10/2009 |
|
10/2017 |
|
||
|
ACA CLO 2006-1 |
|
2006 |
|
Funded |
|
Non-Investment Grade |
|
350 |
|
No |
|
— |
|
— |
|
7/2009 |
|
7/2018 |
|
||
|
ACA CLO 2006-2 |
|
2006 |
|
Funded |
|
Non-Investment Grade |
|
300 |
|
No |
|
2.2 |
|
10 |
|
1/2011 |
|
1/2021 |
|
||
|
ACA CLO Euro 2007-1 |
|
2007 |
|
Funded |
|
Non-Investment Grade |
|
555 |
(2) |
No |
|
5.5 |
|
10 |
|
6/2010 |
|
6/2024 |
|
||
|
ACA CLO 2007-1 |
|
2007 |
|
Funded |
|
Non-Investment Grade |
|
350 |
|
No |
|
2.7 |
|
10 |
|
6/2011 |
|
6/2022 |
|
||
|
Total Leveraged Loan CDOs |
|
|
|
|
|
|
|
1,855 |
|
|
|
15.4 |
|
|
|
|
|
|
|
||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
|
Total |
|
|
|
|
|
|
|
$ |
18,557 |
|
|
|
$ |
174.2 |
|
|
|
|
|
|
|
Note: As of June 30, 2007, the Company’s risk under corporate credit CDO ACA CDS 2002-1 expired.
(1) Investment grade collateral is rated “BBB-” or better; however certain of our investment grade CDOs include the ability to invest a minority portion (20% or less) in non-investment grade assets. High-grade is “A-” or better.
9
(2) The original notional deal sizes for Argon 49 and Argon 57 were €50 million each, and that for Dolomite was €49 million and $1 million. The original deal size for ACA CLO Euro 2007-1 was €400 million. For purposes of this chart, we have converted the amounts to U.S. dollars at the prevailing currency exchange rate on June 30, 2007.
(3) Notional deal size is defined as total liabilities at the deal’s inception.
(4) Cash flow CDOs are generally callable once per quarter by a majority or greater vote of the equity holders on a specific date as negotiated, which is referred to as the First Optional Call Date.
(5) Tribune is comprised of 13 distinct trades some of which are denominated in Euros or Yen. For purposes of this chart, we have converted the respective amounts to U.S. dollars at the prevailing currency exchange rates on June 30, 2007.
As of June 30, 2007 and December 31, 2006, consolidated liabilities include non-recourse debt from consolidated CDOs of $4,525.9 million and $4,711.8 million, respectively. Also, as of June 30, 2007 and December 31, 2006, consolidated assets include investments in CDO related fixed maturity securities and guaranteed investment contracts of $4,193.3 million and $4,656.0 million, respectively, and cash of $238.0 million and $265.0 million, respectively.
5. NET INSURED CREDIT SWAP REVENUE AND OTHER NET CREDIT SWAP REVENUE
Net insured credit swap revenue includes insured credit swap premiums received for credit protection the Company has sold under its insured credit swaps as well as realized and unrealized gains and losses related to those transactions. Realized losses arise upon the occurrence of credit events requiring payment by the Company under the related credit swap and, additionally, realized gains or losses could occur if a transaction is terminated in advance of its scheduled termination date. Unrealized gains and losses represent the adjustments for changes in fair value that are recorded in each reporting period, under FAS 133. The fair value of the Company’s insured credit swaps are recorded as either a derivative liability or derivative asset in the consolidated balance sheets.
The following table disaggregates net insured credit swap revenue into its component parts for the three months and six months ended June 30, 2007 and 2006:
|
|
|
Three Months Ended |
|
Six Months Ended |
|
||||||||
|
|
|
June 30, |
|
June 30, |
|
||||||||
|
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||
|
|
|
(in thousands) |
|
||||||||||
|
Net insured credit swap revenue |
|
|
|
|
|
|
|
|
|
||||
|
Insured credit swap premiums earned |
|
$ |
23,600 |
|
$ |
11,218 |
|
$ |
42,362 |
|
$ |
21,282 |
|
|
Unrealized losses on insured credit swaps |
|
(67,783 |
) |
(5,075 |
) |
(82,846 |
) |
(1,180 |
) |
||||
|
Realized gains on insured credit swaps |
|
— |
|
1,788 |
|
— |
|
2,009 |
|
||||
|
Total net insured credit swap revenue |
|
$ |
(44,183 |
) |
$ |
7,931 |
|
$ |
(40,484 |
) |
$ |
22,111 |
|
Of the $(67.8) million unrealized loss recorded in the three months ended June 30, 2007, $(67.5) million was related to valuation changes in the Company’s Structured Credit transactions. The residential mortgage-backed securities (“RMBS”) portion of the Structured Credit portfolio incurred valuation losses of $253.0 million for the three months ended June 30, 2007. However, no realized or actual losses were incurred on this portfolio based on its very high credit quality, with over 99.8% of the portfolio constructed of exposures attaching above the “AAA” rated level of subordination. These valuation losses were precipitated by the severe level of delinquencies and defaults that have occurred in the residential mortgage market, particularly in the sub-prime and second lien segments, which constitute a significant portion of the assets underlying the RMBS included in the pools of assets referenced by certain of our Structured Credit transactions. Partially offsetting the valuation losses on the Structured Credit RMBS portfolio was an unrealized gain in the amount of $185.5 million on Structured Credit’s corporate credit portfolio. The valuation gains on the corporate portfolio resulted from tighter spreads at June 30, 2007, on a portion of the portfolio, compared to spreads when the transactions were originated, and the refinement in the Company’s valuation model to fully use market spread data as a proxy for default probabilities (see Note 2). In addition, pricing declined as more seasoned transactions reached maturity without experiencing losses, resulting in unrealized gains. As a result of the Company’s intention to generally hold its insured credit swaps to term, absent credit losses, these unrealized amounts will revert to $0 at contract expiration.
Other net credit swap revenue includes revenues received from a partially funded CDS CDO, which sells credit protection under credit swaps for which it receives fixed quarterly fees as well as the residual returns on two synthetic equity participations. Other net credit swap revenue also includes net realized and unrealized gains and losses associated with these transactions, if any. As of June 30, 2007, the Company’s risk to the partially funded CDS CDO and one of the synthetic equity participation had expired. These revenues are included in the Company’s consolidated statement of operations.
The following table disaggregates other net credit swap revenue into its component parts for the three months and six months ended June 30, 2007 and 2006:
10
|
|
|
Three Months Ended |
|
Six Months Ended |
|
||||||||
|
|
|
June 30, |
|
June 30, |
|
||||||||
|
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||
|
|
|
(in thousands) |
|
||||||||||
|
Other net credit swap revenue |
|
|
|
|
|
|
|
|
|
||||
|
Credit swap fees earned |
|
$ |
1,643 |
|
$ |
2,534 |
|
$ |
5,811 |
|
$ |
5,253 |
|
|
Unrealized gain on credit protection purchased |
|
3,110 |
|
— |
|
11,565 |
|
— |
|
||||
|
Unrealized gains (losses) on credit swaps |
|
(902 |
) |
97 |
|
(1,219 |
) |
291 |
|
||||
|
Total other net credit swap revenue |
|
$ |
3,851 |
|
$ |
2,631 |
|
$ |
16,157 |
|
$ |
5,544 |
|
6. INCOME TAXES
Effective January 1, 2007, the Company adopted the provisions of FIN 48. As a result of the implementation of FIN 48, the Company recorded a $1.5 million reserve for uncertain tax positions and a corresponding decrease to the 2007 opening retained earnings. The Company’s effective tax rate would be increased if $1.5 million of unrecognized tax expense were recognized. It is unlikely that the unrecognized tax expense will significantly change in the next 12 months.
The Company files income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2003.
The Company records interest and penalties related to unrecognized tax benefits in income taxes. $470,000 in accrued interest and penalties is included in the $1.5 million reserve for uncertain tax positions related to our adoption of FIN 48.
Our tax provision for interim periods is determined using an estimate of our annual effective tax rate. The 2007 effective tax rate is estimated to be lower than the 35% statutory rate primarily due to the Company’s investment in securities for which the interest payable is exempt from federal income tax.
7. LITIGATION
In May 2006, the Company paid a judgment in the amount of $3.7 million in satisfaction of a damages award in connection with an employment contract dispute with a former executive of the Company plus accrued interest through the date of payment. Also in May 2006, the Company settled the former executive’s attorney’s fees at an additional amount of $0.6 million. The Company had recorded a reserve of $4.2 million to cover these costs in December 2005. A judicial satisfaction of the judgment has been filed and the Company has no additional liability with respect to this matter.
The Company is not aware of any pending or threatened litigation that it believes could reasonably be likely to result in a material adverse effect on the Company’s financial position, results of operations or cash flows.
8. SEGMENT INFORMATION
The Company’s reportable segments are as follows:
(1) Structured Credit, which structures and sells credit protection, principally in the form of insured credit swaps, against a variety of asset classes in the institutional fixed income markets;
(2) Public Finance, which provides insurance guaranteeing the timely payment of principal and interest on public finance and other debt obligations;
(3) CDO Asset Management, which originates, structures and manages assets, primarily corporate obligations or asset-backed securities, in funded, partially funded or synthetic CDOs; and
(4) Other, which primarily includes trade credit insurance business and financial guaranty insurance on certain other sectors, each of which the Company is no longer engaged in.
The Company’s reportable segments are strategic business units that offer different products and services. They are managed separately since each business requires different marketing strategies, personnel skill sets and technology.
Where determinable, the Company specifically assigns assets to each segment, otherwise, the Company allocates assets based on estimates. In general, allocation percentages for assets are determined based on each line’s estimated capital utilization from a rating agency perspective.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates segment performance based on its income (loss) before income taxes. Reportable segment results are presented net of material inter-segment transactions. The following tables summarize the Company’s operations and allocation of assets as of and for the three months and six months ended June 30, 2007 and 2006 (dollars in thousands):
11
|
|
|
Three Months Ended June 30, 2007 |
|
|||||||||||||
|
|
|
Structured |
|
Public |
|
CDO Asset |
|
|
|
Consolidated |
|
|||||
|
|
|
Credit |
|
Finance |
|
Management |
|
Other |
|
Totals |
|
|||||
|
REVENUES: |
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Gross premiums written |
|
$ |
47 |
|
$ |
15,371 |
|
$ |
— |
|
$ |
60 |
|
$ |
15,478 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Premiums earned |
|
$ |
47 |
|
$ |
8,228 |
|
$ |
— |
|
$ |
170 |
|
$ |
8,445 |
|
|
Net insured credit swap revenue |
|
(44,628 |
) |
284 |
|
161 |
|
— |
|
(44,183 |
) |
|||||
|
Net investment income |
|
6,973 |
|
4,266 |
|
78,337 |
|
1,051 |
|
90,627 |
|
|||||
|
Net realized and unrealized gains (losses) on investments |
|
(714 |
) |
2 |
|
(109,430 |
) |
— |
|
(110,142 |
) |
|||||
|
Net realized and unrealized gains on derivative instruments |
|
292 |
|
— |
|
2,964 |
|
— |
|
3,256 |
|
|||||
|
Other net credit swap revenue |
|
(237 |
) |
— |
|
4,088 |
|
— |
|
3,851 |
|
|||||
|
Fee and other income |
|
230 |
|
253 |
|
7,412 |
|
— |
|
7,895 |
|
|||||
|
Total revenues |
|
(38,037 |
) |
13,033 |
|
(16,468 |
) |
1,221 |
|
(40,251 |
) |
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
EXPENSES: |
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Loss and loss adjustment expenses |
|
— |
|
1,614 |
|
— |
|
245 |
|
1,859 |
|
|||||
|
Policy acquisition costs |
|
— |
|
2,841 |
|
— |
|
201 |
|
3,042 |
|
|||||
|
Other operating expenses |
|
6,408 |
|
2,832 |
|
6,322 |
|
2 |
|
15,564 |
|
|||||
|
Interest expense |
|
4,475 |
|
391 |
|
71,378 |
|
93 |
|
76,337 |
|
|||||
|
Depreciation and amortization |
|
159 |
|
132 |
|
1,987 |
|
— |
|
2,278 |
|
|||||
|
Total expenses |
|
11,042 |
|
7,810 |
|
79,687 |
|
541 |
|
99,080 |
|
|||||
|
Income of minority interest |
|
(141 |
) |
— |
|
(1,124 |
) |
— |
|
(1,265 |
) |
|||||
|
Income (loss) before income taxes |
|
(49,220 |
) |
5,223 |
|
(97,279 |
) |
680 |
|
(140,596 |
) |
|||||
|
Provision for income tax expense (benefit) |
|
(16,520 |
) |
1,736 |
|
(32,702 |
) |
226 |
|
(47,260 |
) |
|||||
|
Net income (loss) |
|
$ |
(32,700 |
) |
$ |
3,487 |
|
$ |
(64,577 |
) |
$ |
454 |
|
$ |
(93,336 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Segment Assets |
|
$ |
661,100 |
|
$ |
598,761 |
|
$ |
4,701,093 |
|
$ |
131,288 |
|
$ |
6,092,242 |
|
|
|
|
Three Months Ended June 30, 2006 |
|
|||||||||||||
|
|
|
Structured |
|
Public |
|
CDO Asset |
|
|
|
Consolidated |
|
|||||
|
|
|
Credit |
|
Finance |
|
Management |
|
Other |
|
Totals |
|
|||||
|
REVENUES: |
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Gross premiums written |
|
$ |
192 |
|
$ |
15,301 |
|
$ |
— |
|
$ |
234 |
|
$ |
15,727 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Premiums earned |
|
$ |
210 |
|
$ |
7,575 |
|
$ |
— |
|
$ |
690 |
|
$ |
8,475 |
|
|
Net insured credit swap revenue |
|
7,699 |
|
(30 |
) |
262 |
|
— |
|
7,931 |
|
|||||
|
Net investment income |
|
882 |
|
4,133 |
|
76,482 |
|
955 |
|
82,452 |
|
|||||
|
Net realized and unrealized losses on investments |
|
(35 |
) |
(81 |
) |
(1,120 |
) |
(20 |
) |
(1,256 |
) |
|||||
|
Net realized and unrealized gains on derivative instruments |
|
— |
|
— |
|
2,497 |
|
— |
|
2,497 |
|
|||||
|
Other net credit swap revenue |
|
(11 |
) |
— |
|
2,642 |
|
— |
|
2,631 |
|
|||||
|
Fee and other income |
|
153 |
|
54 |
|
6,801 |
|
— |
|
7,008 |
|
|||||
|
Total revenues |
|
8,898 |
|
11,651 |
|
87,564 |
|
1,625 |
|
109,738 |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
EXPENSES: |
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Loss and loss adjustment expenses |
|
— |
|
1,539 |
|
— |
|
122 |
|
1,661 |
|
|||||
|
Policy acquisition costs |
|
— |
|
2,518 |
|
— |
|
250 |
|
2,768 |
|
|||||
|
Other operating expenses |
|
4,746 |
|
2,292 |
|
5,643 |
|
— |
|
12,681 |
|
|||||
|
Interest expense |
|
90 |
|
427 |
|
70,359 |
|
88 |
|
70,964 |
|
|||||
|
Depreciation and amortization |
|
161 |
|
121 |
|
1,943 |
|
— |
|
2,225 |
|
|||||
|
Total expenses |
|
4,997 |
|
6,897 |
|
77,945 |
|
460 |
|
90,299 |
|
|||||
|
Income of minority interest |
|
(7 |
) |
— |
|
(1,067 |
) |
— |
|
(1,074 |
) |
|||||
|
Income before income taxes |
|
3,894 |
|
4,754 |
|
8,552 |
|
1,165 |
|
18,365 |
|
|||||
|
Provision for income tax expense |
|
1,351 |
|
1,633 |
|
2,941 |
|
398 |
|
6,323 |
|
|||||
|
Net income |
|
$ |
2,543 |
|
$ |
3,121 |
|
$ |
5,611 |
|
$ |
767 |
|
$ |
12,042 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Segment Assets |
|
$ |
56,390 |
|
$ |
452,947 |
|
$ |
5,139,289 |
|
$ |
96,877 |
|
$ |
5,745,503 |
|
12
|
|
|
Six Months Ended June 30, 2007 |
|
|||||||||||||
|
|
|
Structured |
|
Public |
|
CDO Asset |
|
|
|
Consolidated |
|
|||||
|
|
|
Credit |
|
Finance |
|
Management |
|
Other |
|
Totals |
|
|||||
|
REVENUES: |
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Gross premiums written |
|
$ |
134 |
|
||||||||||||