-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Stlk0J0d+7I8GPBwS8u9Is/HIzqmE+0yPzYzI/osN7gJeZ4ciXLt13+C7rx7fonO e+PtsvYGQON3q828xmej8Q== 0000928385-97-000575.txt : 19970401 0000928385-97-000575.hdr.sgml : 19970401 ACCESSION NUMBER: 0000928385-97-000575 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: CAPITAL RE CORP CENTRAL INDEX KEY: 0000829277 STANDARD INDUSTRIAL CLASSIFICATION: SURETY INSURANCE [6351] IRS NUMBER: 521567009 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 001-10995 FILM NUMBER: 97569766 BUSINESS ADDRESS: STREET 1: 1325 AVE OF THE AMERICAS STREET 2: 18TH FLR CITY: NEW YORK STATE: NY ZIP: 10019 BUSINESS PHONE: 2129740100 MAIL ADDRESS: STREET 1: 1325 AVENUE OF THE AMERICAS STREET 2: 18TH FL CITY: NEW YORK STATE: NY ZIP: 10019 10-K405 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996 Commission file number 1-10995 - ------------------------------------------- ------------------------------- Capital Re Corporation ---------------------- (Exact name of registrant as specified in its charter) Delaware 52-1567009 - ------------------------------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1325 Avenue of the Americas, New York, N.Y. 10019 - -------------------------------------------- ------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 212-974-0100 ------------ Securities registered pursuant to Section 12(b) of the Act: Common Stock, $.01 par value, and Capital Re LLC 7.65% Cumulative Guaranteed Monthly Income Preferred Shares, Series A (guaranteed by Capital Re Corporation) New York Stock Exchange, Inc. ------------------------------------------ ----------------------------- (Title of Class) (Name of each exchange on which registered) Securities registered pursuant to Section 12(g) of the Act: None ---- (Title of Class) Indicate by check mark whether registrant (1) has filled 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 --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form-10-K. [X] The approximate aggregate market value of voting stock held by non-affiliates of the registrant as of March 25, 1997 was $702,148,469. The number of shares of Common Stock outstanding as of March 25, 1997 was 15,867,762. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrants Annual Report to Stockholders for the year ended December 31, 1996 are incorporated by reference into Part II hereof. Portions of the registrant's 1997 definitive Proxy Statement are incorporated by reference into Part III hereof. PART I ITEM 1. BUSINESS. A. GENERAL: (1) Company Overview - - --- ---------------- Capital Re Corporation (the "Company" or "Capital Re") is an insurance holding company for a group of reinsurance companies that provide value-added products in specialty insurance markets. The Company provides reinsurance capacity to insurers in four principal areas of specialization: financial guaranty insurance, mortgage guaranty insurance, trade credit insurance and title insurance. Additionally, during 1996, the Company expanded its participation in the global market for specialty insurance and reinsurance by acquiring a Lloyd's of London managing general agency, and forming a Bermuda-based joint venture company to write financial reinsurance products. The Company intends to continue to diversify into additional specialty insurance and reinsurance markets on an opportunistic basis. The foundation of the Company's specialty reinsurance business has been financial guaranty reinsurance, which the Company began providing in 1988 through its subsidiary, Capital Reinsurance Company (''Capital Reinsurance''). More recently, the Company's strategy of diversifying into other specialty reinsurance businesses has contributed to the Company's continued growth in revenues and earnings. For the year ended December 31, 1996, financial guaranty reinsurance accounted for 45.2% of net premiums written, mortgage guaranty reinsurance accounted for 38.9% of net premiums written, trade credit reinsurance accounted for 14.2% of net premiums written, and title reinsurance accounted for 1.7% of net premiums written. The Company provides reinsurance products through five wholly-owned insurance subsidiaries: Capital Reinsurance, Capital Mortgage Reinsurance Company (''Capital Mortgage''), KRE Reinsurance Ltd. (formerly, Capital Mortgage Reinsurance Company (Bermuda) Ltd.) (''KRE''), Capital Credit Reinsurance Company Ltd. (''Capital Credit'') and Capital Title Reinsurance Company ("Capital Title"). It also has established a corporate member at Lloyd's of London, CRC Capital Ltd., which supports underwriting on the syndicates managed by RGB Underwriting Agencies Ltd., the Lloyd's managing general agency that the Company acquired in November 1996. Capital Reinsurance is a professional reinsurance company dedicated to serving the U.S. domestic and international financial guaranty insurance markets. Capital Reinsurance has established itself as a leading specialty reinsurer (by market share) of financial guaranties of investment grade debt obligations, principally municipal debt obligations. Capital Reinsurance also reinsures financial guaranties of investment grade non-municipal debt obligations and, to a limited extent, reinsures mortgage guaranty, trade credit and other specialty insurance lines. The claims-paying ability of Capital Reinsurance is rated AAA by Standard and Poor's Corporation (''S&P'') and Moody's Investors Service, Inc. (''Moody's''). Capital Reinsurance's underwriting process is premised on a general policy of reinsuring only those obligations that are investment grade on the date reinsured and where there is no expectation of loss on the risk reinsured. Nevertheless, losses can be expected to occur in Capital Reinsurance's existing and future reinsured portfolio. The Company entered the mortgage guaranty reinsurance business through Capital Mortgage and its subsidiary, KRE, in February 1994. Capital Mortgage is a professional reinsurer dedicated to serving the mortgage guaranty insurance market. Mortgage guaranty reinsurance is underwritten with the expectation that losses will occur regularly. The claims-paying ability of Capital Mortgage is rated AA by S&P. KRE is rated AA- by S&P and provides reinsurance capacity to the mortgage guaranty and financial guaranty insurance markets as well as retrocessional support to Capital Reinsurance and Capital Mortgage. 2 Capital Credit, a Bermuda-domiciled insurance company, commenced operations in February 1990 and since 1994 has provided reinsurance principally to the international trade credit insurance markets. Trade credit insurance protects sellers of goods and services from the risk of non-payment on trade receivables. Capital Credit also reinsures surety, political risk, financial guaranty and mortgage guaranty insurance. Portfolio losses will also occur regularly in the trade credit reinsurance line of the Company's business. Early in 1996, the Company entered the title reinsurance business through the formation of Capital Title, a New York domiciled insurance company. Capital Title is dedicated to providing structured reinsurance products to the title insurance industry. Capital Title is rated AA- by S&P and Duff & Phelps Credit Rating Co. ("Duff & Phelps"). In November 1996, the Company, through a newly formed United Kingdom holding company, Capital Re (UK) Holdings, acquired 100% of the issued shares of Tower Street Holdings Limited (now known as RGB Holdings, Ltd.), the holding company for RGB Underwriting Agencies Ltd. ("RGB"). RGB is a managing agency and presently manages five syndicates operating in the Lloyd's of London insurance market. In connection with this acquisition, the Company established a corporate name at Lloyd's to support underwriting on the managed syndicates. For the 1997 year of account, the corporate name participates in a non-marine and a life syndicate. In December 1996, the Company entered into a joint venture with GCR Holdings Limited to form a Bermuda based insurer, Capital Global Underwriters Limited ("CGUL"), which will specialize in financial reinsurance, including financial guaranty, mortgage guaranty and finite risk reinsurance. The Capital Re corporate group also includes Capital Re Management Corporation, a New York reinsurance intermediary, and Capital Re LLC, a Turks & Caicos Islands finance subsidiary organized in 1993 to issue $75 million of Company obligated mandatorily redeemable preferred stock, the proceeds of which were loaned to Capital Re. Set forth below is the organizational structure of Capital Re, its subsidiaries and affiliates: [CHART APPEARS HERE] 3 At December 31, 1996, 86.5% of the Company's investment portfolio consisted exclusively of fixed income securities rated AAA or A-1+ by S&P or Aaa or P-1 by Moody's, or issues by the U.S. Government or its agencies or instrumentalities. Overall portfolio weighted average quality is AAA. In 1996, the Company's Board of Directors approved revisions to the Company's investment strategy to permit greater investment diversification designed to improve the total risk/return profile of the Company's investment portfolio. The Company has expanded its investment guidelines to permit investments in investment grade non-dollar denominated bonds and other financial instruments. See ''Business-- Investments.'' (2) Financial Guaranty Reinsurance - - --- ------------------------------ (a) Overview of Financial Guaranty Insurance Market - Financial guaranty insurance is a type of credit enhancement in the form of a surety which is regulated under the insurance laws of various jurisdictions. The insurance provides an unconditional and irrevocable guaranty which indemnifies the insured against nonpayment of principal and interest when due by an obligor on an insured debt obligation. The two largest nationally recognized rating agencies, S&P and Moody's, assign the claims-paying ability rating of a financial guaranty insurance company to the obligations insured by that company. Because all of the major U.S. primary financial guaranty insurance companies have AAA claims-paying ratings from these rating agencies, bonds insured by those companies are rated AAA. Both issuers of and investors in financial instruments may benefit from financial guaranty insurance. Issuers benefit because the insurance may have the effect of lowering an issuer's cost of borrowing in the public and private debt markets. The borrowing costs are lowered to the extent that the insurance premium is less than the value of the difference between the yield on the AAA insured obligation and the yield on the obligation if sold on the basis of its uninsured credit rating. Financial guaranty insurance also increases the marketability of obligations issued by infrequent or unknown issuers. Investors benefit from increased liquidity in the secondary market, reduced exposure to price volatility caused by changes in the credit quality of the underlying insured issue, and added protection against loss in the event of the obligor's default on its obligation. Upon nonpayment by an obligor, the financial guaranty insurance company is obligated to pay the principal of and interest on the insured obligation in accordance with the original payment schedule as if no default had occurred. The majority of financial guaranty insurance premiums are paid in full at policy inception, although on certain financial guaranties, such as guaranties of most non-municipal obligations, premiums are paid on an installment basis and typically earned in the period paid. Financial guaranty premiums are non- refundable and those paid in full are earned over the term of the related insured obligation. Because most obligations insured by the financial guaranty insurers have long maturities, the portion of premiums earned on a policy in any year represents a relatively small percentage of initial premium received. This methodology generates a predictable contribution to revenues over time that is relatively independent of new business written in any given year. Premium rates are generally calculated as a percentage of the principal amount of the insured obligation or the principal and interest scheduled to come due during the stated term of the insured obligation. A number of factors are considered in the setting of premium rates including the type of credit obligation, collateral security, maturity and rating agency capital charge. The financial guaranty insurance market consists of two main product sectors: municipal bond insurance and insurance of non-municipal debt obligations. Municipal bond insurance provides credit enhancement of debt obligations issued by or on behalf of states or their political subdivisions (counties, cities, towns and villages, utility districts, public universities and hospitals, public housing and transportation authorities) and other public and quasi-public entities (including non-U.S. sovereigns and subdivisions thereof). Insurance provided to the municipal bond market has been and continues to be the major source of revenue for the financial guaranty insurance industry. 4 The volume of long-term municipal debt issuances and municipal bond insurance has increased significantly since 1983. In 1985, pending federal tax legislation relating to municipal bonds prompted an unusual rise in total long-term new issue municipal bond volume. The market for new issues returned to more normal volumes in 1987 and grew steadily through 1991. In 1992 and 1993, historically low interest rates prompted a dramatic increase in new issue volume, in part arising from the refinancing of refunding activity. This increase ended in 1994 as rising interest rates and other market uncertainties developed throughout the year. The table below sets forth the volume of long-term municipal bonds and the volume of insured long-term municipal bonds issued over the period from 1983 through 1996.
NEW TOTAL NEW INSURED NEW INSURED VOLUME YEAR VOLUME VOLUME AS A PERCENT OF NEW (IN BILLIONS) (IN BILLIONS) TOTAL VOLUME 1983 $ 83.3 $ 12.8 15.4% - ----------------------------------------------------------- 1984 101.9 16.2 15.9 - ----------------------------------------------------------- 1985 204.3 44.4 21.7 - ----------------------------------------------------------- 1986 151.3 24.8 16.4 - ----------------------------------------------------------- 1987 105.0 19.1 18.2 - ----------------------------------------------------------- 1988 117.3 27.1 23.1 - ----------------------------------------------------------- 1989 125.0 31.1 24.9 - ----------------------------------------------------------- 1990 127.8 33.5 26.2 - ----------------------------------------------------------- 1991 172.4 51.9 30.1 - ----------------------------------------------------------- 1992 234.6 80.8 34.4 - ----------------------------------------------------------- 1993 291.9 108.0 37.0 - ----------------------------------------------------------- 1994 164.6 61.4 37.3 - ----------------------------------------------------------- 1995 160.3 68.5 42.7 - ----------------------------------------------------------- 1996 184.4 85.2 46.2 - -----------------------------------------------------------
Source: Figures for 1983-1985 are based upon data provided by The Bond Buyer, December 10, 1992; figures for 1986-1996 are based upon data provided by The Bond Buyer, January 2, 1997. Amounts under the New Insured Volume column include only the insured portion of an issue. Amounts under the New Total Volume and New Insured Volume columns represent gross principal amounts issued or insured, as the case may be, during such year. The primary financial guaranty insurers also insure municipal bond investment vehicles, such as unit investment trusts and mutual funds, and outstanding municipal bonds trading in the secondary market. The non-municipal financial guaranty insurance market is newer and more diverse than the municipal bond insurance market. The types of securities supported by guaranties of non-municipal debt obligations include various asset-backed securities, including consumer and trade receivable-backed securities and commercial and residential mortgage-backed securities, corporate bonds and mutual funds. Although this market has been slower to develop than the municipal market, demand for this type of insurance is being stimulated by innovations in both domestic and foreign capital markets coupled with increasing investor and issuer awareness of the value provided by financial guaranties. There are currently six primary U.S. financial guaranty insurance companies active in the business, the first four of which dominate the insured market: Municipal Bond Investors Assurance Company (''MBIA''), AMBAC Indemnity Company (''AMBAC''), Financial Guaranty Insurance Company (''FGIC''), Financial Security Assurance Inc. (''FSA''), Capital Markets Assurance Company (''CapMAC''), and Connie Lee Insurance Company (''Connie Lee''). 5 (b) Financial Guaranty Reinsurance Market - Reinsurance is a transaction whereby the reinsurer agrees to indemnify the primary insurance company against part or all of the loss which the latter may sustain under a policy which it has issued. The reinsurer may also assume reinsurance from other reinsurers (''retrocessions''). In the event of loss, the reinsured generally remains liable on its obligation to indemnify the insured. The two major kinds of reinsurance are treaty and facultative. Treaty reinsurance requires the reinsured to cede and the reinsurer to assume specific classes of risk underwritten by the ceding company over a period of time, typically one year. Facultative reinsurance is the reinsurance of part or all of one or more reinsurance policies which is subject to separate negotiation for each cession. It offers the option of accepting or rejecting individual submissions by a ceding company as distinguished from the obligation to accept specified classes of risk as a treaty reinsurer. Ceding companies generally will seek facultative agreements when treaty terms preclude the cession or inclusion of a particular risk, when the capacity of the treaty program is insufficient for a given risk (for instance, when policy limits are in excess of the treaty limits) or when special coverage is needed to comply with regulatory or other capacity restrictions. Reinsurance is written on a proportional or non-proportional basis. Proportional reinsurance includes: (i) quota share reinsurance, whereby the assumed risk is a fixed percentage of the reinsured's risk, (ii) surplus share reinsurance, whereby the percentage of risk assumed is a multiple of the reinsured's net retention up to a stated maximum, and (iii) variable quota share reinsurance, whereby the percentage of assumed risk increases with the risk size to a stated maximum. There are many possible variations of these three types of proportional reinsurance. Non-proportional reinsurance includes: (i) risk assumption per risk and per occurrence in excess of a reinsured's retention, subject to a specified limit, and (ii) stop loss or aggregate excess of loss reinsurance, whereby the reinsurer assumes an aggregate loss incurred over a specific time period (for specific risks) above the reinsured's retention of loss incurred, up to a stated maximum. The purposes of reinsurance in the financial guaranty industry are to (i) increase the insurance capacity of the reinsured, (ii) assist the reinsured in meeting applicable regulatory and rating agency requirements, (iii) augment the reinsured's financial strength, and (iv) manage the reinsured's risk exposure. State insurance laws and regulations, as well as the rating agencies, impose minimum capital requirements on financial guaranty companies, limiting the aggregate amount of insurance which may be written and the maximum size of any single risk which may be insured. Reinsurance allows the reinsured to increase its capacity to write new business by effectively reducing the reinsured's gross liability on an aggregate and single risk basis. Furthermore, primary insurers manage the risk of their insured portfolios based on internal underwriting criteria and portfolio management guidelines. Reinsurance is instrumental in achieving those portfolio risk management goals. There are currently two domestic reinsurance companies, Capital Reinsurance and Enhance Reinsurance Company, specializing in the reinsurance of financial guaranties. Several non- U.S. multiline insurers and a small number of domestic multiline insurers, also participate in this reinsurance market. Based upon the 1996 annual statutory statements filed by each of the U.S. primary financial guaranty insurers, the Company believes that the Company and its principal competitor assumed most of the reinsurance ceded by the U.S. primary financial guaranty insurers in 1996. The size and growth of the financial guaranty reinsurance market is dependent on (i) the size of the primary insurance market, (ii) the percentage of aggregate risk that the primary insurers cede to the reinsurers, (iii) regulatory, rating agency and other external risk retention limitations imposed on the primary insurers and (iv) the price and availability of substitute AAA rated capital facilities. 6 (3) Mortgage Guaranty Reinsurance - - --- ----------------------------- (a) Overview of Mortgage Guaranty Insurance Market - Mortgage guaranty insurance is a specialized class of credit insurance, providing protection to mortgage lending institutions against the default of borrowers on mortgage loans which at the time of the advance had a loan-to-value (''LTV'') ratio in excess of 80%. The market for mortgage guaranty insurance is competitively shared by three sectors: governmental agencies, principally the Federal Housing Administration (''FHA'') and the Veterans Administration (''VA''), private mortgage guaranty insurers, and the lending institutions which choose to self-insure against the risk of loss on high LTV mortgage loans. The private mortgage insurance industry, comprised of only monoline insurance companies, as required by law, provides two basic types of coverage: primary insurance, which protects lenders against default on individual residential mortgage loans by covering losses on such loans to a stated coverage percentage; and pool insurance, which protects lenders against aggregate default levels in an underlying pool of individual mortgages by covering the full amount of loss (less the proceeds from any primary insurance coverage that may be in place) on individual residential mortgage loans in such pool of loans, with an aggregate limit usually expressed as a percentage of the initial loan balances of the pool of loans. Primary insurance also facilitates the sale of high LTV mortgage loans in the secondary mortgage market, principally to the Federal Home Loan Mortgage Corporation and Federal National Mortgage Association, while pool insurance is often used to provide credit support for mortgage-backed securities and other secondary mortgage market transactions. There are eight private mortgage guaranty insurers writing new business: General Electric Mortgage Insurance Company (''GEMICO''); Mortgage Guaranty Insurance Company; PMI Mortgage Insurance Co. (''PMI''); United Guaranty Residential Insurance Company; Commonwealth Mortgage Assurance Company (''CMAC''); Republic Mortgage Insurance Company; Amerin Guaranty Corporation; and Triad Mortgage Insurance Company. Mortgage guaranty insurers do not underwrite risk to a zero loss underwriting standard as in the financial guaranty insurance industry; rather, they underwrite with a view to target loss ratios ranging from 45% to 60%. A critical factor to successfully underwriting this class of business is the ability to consistently control the quality and diversity of insurance in-force, avoiding catastrophic losses from regional depressions and declines in residential real estate prices, by effective geographic and product dispersion. (b) Mortgage Guaranty Reinsurance Market - The purposes of reinsurance in the mortgage guaranty insurance industry are to (i) increase the insurance capacity of the reinsured, (ii) assist the reinsured in meeting applicable regulatory and rating agency requirements, (iii) augment the reinsured's financial strength and (iv) manage the reinsured's risk exposure. Except for the Company, the external reinsurance capacity for the industry is provided almost exclusively by European multiline insurers and reinsurers, who offer modest amounts of traditional reinsurance products. Mortgage guaranty insurers have traditionally relied upon proportional reinsurance for their risk management needs. Recently, the need to profitably utilize invested capital and the need to manage risk have become equally important and the trend has shifted away from proportional reinsurance products. In addition to external reinsurance support, primary mortgage insurers have developed a system of risk sharing relationships with their own affiliates and other companies in the industry. The profitable nature of the mortgage guaranty business over the last several years has caused primary mortgage insurers to be reluctant to cede business to reinsurers. Low loss ratios, higher premiums and streamlined operations have allowed mortgage insurers to bolster capital thereby diminishing the need for reinsurance support. The mortgage insurers, however, continue to rely on reinsurance due to a combination of factors including regulations imposing more stringent limits on exposure to risk, increased pressure to optimize financial results and the 7 strengthening of rating agency constraints on allocation of risk. The Company, which through Capital Mortgage is the only dedicated mortgage guaranty reinsurer, has been able to capitalize on these factors by providing sophisticated mortgage reinsurance products in addition to the quota share reinsurance products historically offered. Rating agencies currently impose more stringent requirements on risk-to-capital ratios for mortgage guaranty insurers than the 25:1 ratio imposed by applicable law. Generally, S&P and Moody's require that AA rated mortgage guaranty insurers operate at a risk-to-capital ratio of less than 20:1. The maintenance or improvement of high quality (AA or better) claims-paying ratings directly influences an insurer's ability to compete in the market and access capital resources to support its book of business. (4) Title Reinsurance - - --- ----------------- (a) Overview of Title Insurance Market - Title insurance is currently written by seven national and dozens of regional companies throughout the United States, all of which are required by statute to be monoline insurers. Title insurance essentially provides the acquirer or the mortgagor of real property with two forms of coverage. The first assures that the search and examination of the real estate records upon which the acquirer or mortgagor is relying for good and clean title was properly performed. In insuring that a process was in fact properly done and recorded, the title insurer is providing risk exclusion. The second form of coverage assures that all previously existing mortgages and liens will be paid off from the proceeds of the sale or refinancing of the property. In insuring that the existing mortgages and liens are extinguished, the title insurer is providing risk assumption. (b) Title Reinsurance Market - Capital Title was formed to take advantage of the strategic opportunities presented by the recent trends in the title insurance business discussed above. Specifically, reinsurance needs are becoming more complex as primary insurers strive to react to the trends detailed above by diversifying reinsurance recoverable risk, optimizing financial results and maintaining high quality claims paying ability ratings. Risk syndication and access to larger, independent pools of capital to support ever increasing industry exposure is an important issue as the industry begins to compete in a rated environment. To address the concerns of rating agencies and the resulting capital adequacy and profitability issues, title insurers are adjusting their business practices, especially with regard to commercial transactions. Rating agencies, lenders, and regulators are increasingly concerned with the level of risk being taken by insurer's on large commercial transactions. Single-risk limits on the order of 20% to 30% of policyholders surplus have been, and are likely to continue to be, imposed on insurers. Accordingly, third party reinsurance, such as that provided by Capital Title, to build single risk capacity and as an overall capital substitute, has become important. Capital Title applies its financial, reinsurance, rating agency, underwriting and legal expertise to provide reinsurance solutions tailored to the particular rating agency, financial, regulatory and risk management needs of each primary title insurer. Capital Title represents a independent source of capacity in an industry which has historically relied on a closed system of reinsurance capacity provided by the industry's primary insurers. Capital Title offers several specific products to the title insurance industry, all of which are derived from two basic reinsurance product types, excess of loss and quota share. 8 (5) Trade Credit Reinsurance - - --- ------------------------ (a) Overview of Trade Credit Insurance Market - Trade credit insurance protects sellers of goods and services from the risk of non-payment of trade receivables and is a large, well-established specialty insurance product, particularly in Western Europe. Policyholders are generally covered for short-term exposures (generally less than 180 days and averaging 60- 90 days) to insolvency or payment defaults by domestic and/or foreign buyers. Some export credit policies also cover political events which can disrupt either the flow of goods and services or payment for goods and services. Specialist underwriters dominate the market, using sophisticated information management systems to provide rapid approval of policy requests while maintaining underwriting controls. Credit insurance relies on credit analysis and portfolio diversification techniques similar to those employed in financial guaranty and mortgage guaranty insurance. Results are heavily dependent upon macroeconomic conditions, with typical loss ratios of 30-50% during healthy economies and rising to 80-100% during recessions. (b) Trade Credit Reinsurance Market - The reinsurance market is led by traditional multi-line players, principally Munich Re and Swiss Re, who have been able to maintain their dominant market position in part through their ownership interests in many of the leading primary companies. Capital Credit has attempted to identify areas of opportunity where its specialty focus provides some advantage over the traditional players. Revenue targets have been set conservatively with the intention of selectively choosing participations. The product mix combines quota share and structured excess participations that are geared to produce results that outperform the overall credit insurance market. B. BUSINESS OF CAPITAL RE: (1) Business Strategy - - --- ----------------- The Company is an insurance holding company for a group of reinsurance companies that provide value-added products in specialty insurance markets. The Company provides reinsurance capacity to insurers in four principal areas of specialization: financial guaranty insurance, mortgage guaranty insurance, trade credit insurance and title insurance. Additionally, during 1996, the Company expanded its participation in the global market for specialty insurance and reinsurance by acquiring a Lloyd's of London managing general agency, and forming a Bermuda-based joint venture company to write financial reinsurance products. The Company intends to continue to diversify into additional specialty insurance and reinsurance markets on an opportunistic basis. The foundation of the Company's specialty reinsurance business has been financial guaranty reinsurance, which the Company began providing in 1988 through its subsidiary, Capital Reinsurance. More recently, the Company's strategy of diversifying into other specialty reinsurance businesses has contributed to the Company's growth in revenues and earnings. For the year ended December 31, 1996, financial guaranty reinsurance accounted for 45.2% of net premiums written, mortgage guaranty reinsurance accounted for 38.9% of net premiums written, trade credit reinsurance accounted for 14.2% of net premiums written, and title reinsurance accounted for 1.7% of net premiums written. The Company provides reinsurance products through five wholly-owned insurance subsidiaries: Capital Reinsurance, Capital Mortgage, KRE, Capital Credit and Capital Title. Capital Reinsurance's focus on the municipal bond reinsurance business recognizes the fact that historically municipal bond insurance has been a proven revenue source in the financial guaranty insurance market which, when managed properly, can provide predictable revenues from an associated deferred premium revenue account. 9 In support of this strategy, Capital Reinsurance acquired several municipal bond reinsurance portfolios to increase the Company's in-force book of business and the diversification of its own reinsurance portfolio as to revenue source, geography, maturity and exposure to ceding companies. Moreover, Capital Reinsurance has sought to assume business with what it believes is a lower risk profile and higher than average pricing for the municipal bond insurance industry. At the same time, consistent with its ''zero loss'' underwriting policies, Capital Reinsurance has pursued the reinsurance of investment grade non- municipal debt obligations, minimizing its exposure to commercial real estate and directing its capacity to the reinsurance of financial guaranties of asset- backed securities. In the case of both municipal bond reinsurance and the reinsurance of non-municipal debt obligations, Capital Reinsurance has emphasized facultative reinsurance, which Capital Reinsurance believes better permits it to maintain portfolio diversification, pricing discipline and conformity to its underwriting policies, because through facultative reinsurance the reinsurer may exercise control over risks assumed as they are accepted only on a risk-by-risk basis. The successful establishment of Capital Reinsurance as a leading specialty reinsurer (by market share) of financial guaranties of municipal bonds in the U.S. domestic market, together with the creation of a quality reinsurance portfolio that provides a substantial base of recurring revenues, have given the Company a foundation to facilitate its diversification strategy. The first stage in the execution of this strategy was the Company's expansion into mortgage guaranty reinsurance through the organization and capitalization of Capital Mortgage, which commenced operations in February 1994. Capital Mortgage has become a leading reinsurer of mortgage guaranty insurance. Capital Mortgage's strategy is based on the development of creative reinsurance programs targeted to the individual capital, risk and portfolio management demands of the primary mortgage guaranty insurers. In order to optimize capital utilization, the business plan of Capital Mortgage includes the assumption of financial guaranty insurance business by its subsidiary, KRE, both as a retrocessionaire of Capital Reinsurance and directly from the U.S. primary financial guaranty insurers, as well as the reinsurance of mortgage guaranty insurance business by KRE, both as a retrocessionaire of Capital Mortgage and directly from the primary mortgage guaranty insurers. In 1994, the Company identified an opportunity to further its diversification by the expansion of its trade credit reinsurance activities in the U.S. and Europe through Capital Credit. Trade credit reinsurance is a logical extension of the Company's underwriting focus, relying on trade credit analysis and portfolio diversification techniques similar to those employed in financial guaranty and mortgage guaranty reinsurance. Capital Credit's strategy is to build a limited portfolio of trade credit reinsurance business from the leading European and U.S. primary trade credit insurers, which outperforms the overall market by combining quota share and structured excess of loss participations. Trade credit insurance protects sellers of goods and services from the risk of non-payment of trade receivables. Policyholders are covered for short-term exposure (generally 60 to 90 days) to insolvency or payment default by domestic and overseas buyers. Some export sales policies also cover political events which can disrupt either the flow of goods or payment for goods. Specialist underwriters, predominantly European insurers, dominate the private primary market, using sophisticated information management systems to provide approval of policy requests while maintaining underwriting controls. In early 1996, the Company entered the title reinsurance business through a newly formed, New York domiciled, monoline insurance company, Capital Title. Opportunities in the field of title reinsurance have arisen due to rapid consolidation among title insurers, an increased focus in the title insurance industry on relatively high margin commercial business, and increased scrutiny of title insurers' capital adequacy from financial institutions, rating agencies and the National Association of Insurance Commissioners. Currently, there are no dedicated title reinsurers, and only intra-industry facultative reinsurance is available to support large commercial title insurance policies. Capital Title provides coverages designed to aid title insurers in meeting capital adequacy concerns and to achieve desired claims-paying ability ratings from nationally recognized rating agencies. Capital Title derives business from relationships with primary title insurers, financial institutions active in commercial real estate 10 lending and professionals involved in the real estate industry. Capital Title offers excess of loss and quota share reinsurance products on both a treaty and facultative basis. During 1996, the Company expanded its participation in the global market for specialty insurance and reinsurance by acquiring a Lloyd's of London managing general agency, RGB Underwriting Agencies Ltd., and forming a Bermuda based joint venture company to specialize in financial reinsurance, including financial guaranty, mortgage guaranty and finite risk reinsurance. The Company's strategy is to continue to diversify into additional specialty reinsurance businesses as opportunities become available. (2) Insurance in Force - - --- ------------------ The information below is presented on a consolidated basis for Capital Reinsurance, Capital Mortgage (including KRE), Capital Credit and Capital Title, unless expressly indicated otherwise. The information includes estimates derived from the accounting and statistical records of Capital Reinsurance, Capital Mortgage (including KRE), Capital Credit and Capital Title. Capital Mortgage and KRE were not in operation before February 1994 and are not included in the information reported below for years prior to 1994 and Capital Title was not in operation before February 1996 and is not included in the information reported below for years prior to 1996. The table below sets forth gross and net premiums written and net premiums earned by line of business. PREMIUMS BY LINE OF BUSINESS (DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31, --------------------------- 1996 1995 1994 - ----------------------------------------------------------- Gross Premiums Written: - ----------------------------------------------------------- Municipal $ 48,411 $ 44,201 $56,875 - ----------------------------------------------------------- Mortgage 53,683 39,111 30,148 - ----------------------------------------------------------- Non-Municipal 10,902 17,244 5,264 - ----------------------------------------------------------- Credit 15,070 7,043 2,564 - ----------------------------------------------------------- Title 1,752 0 0 - ----------------------------------------------------------- Total Gross Premiums Written $129,818 $107,599 $94,851 - ----------------------------------------------------------- - ----------------------------------------------------------- Net Premiums Written: - ----------------------------------------------------------- Municipal $ 36,707 $ 38,120 $50,073 - ----------------------------------------------------------- Mortgage 40,936 27,584 23,848 - ----------------------------------------------------------- Non-Municipal 10,902 17,244 6,310 - ----------------------------------------------------------- Credit 14,891 6,560 2,564 - ----------------------------------------------------------- Title 1,752 0 0 - ----------------------------------------------------------- Total Net Premiums Written $105,188 $ 89,508 $82,795 - ----------------------------------------------------------- - ----------------------------------------------------------- Net Premiums Earned: - ----------------------------------------------------------- Municipal $ 27,540 $ 25,633 $34,510 - ----------------------------------------------------------- Mortgage 43,882 22,072 16,775 - ----------------------------------------------------------- Non-Municipal 7,199 6,433 5,307 - ----------------------------------------------------------- Credit 12,239 5,959 2,258 - ----------------------------------------------------------- Title 1,576 0 0 - ----------------------------------------------------------- Total Net Premiums Earned $ 92,436 $ 60,097 $58,850 - -----------------------------------------------------------
11 The following charts sets forth certain information regarding gross premiums written on insurance ceded to the Company by its largest primary insurance clients in each material line of business in 1996, 1995, and 1994. GROSS PREMIUMS WRITTEN BY PRIMARY FINANCIAL GUARANTY INSURER (DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------------------------------------- 1996 1995 1994 - ------------------------------------------------------------------------ PRIMARY GROSS PERCENT GROSS PERCENT GROSS PERCENT INSURER PREMIUMS OF TOTAL PREMIUMS OF TOTAL PREMIUMS OF TOTAL WRITTEN WRITTEN WRITTEN - ------------------------------------------------------------------------ AMBAC $ 8,766 15% $12,995 21% $ 6,756 11% - ------------------------------------------------------------------------ CapMAC 6,092 10 3,725 6 1,752 3 - ------------------------------------------------------------------------ FGIC 15,388 26 7,040 11 24,696 40 - ------------------------------------------------------------------------ FSA 8,590 14 15,968 26 10,303 16 - ------------------------------------------------------------------------ MBIA 19,589 33 19,474 32 18,765 30 - ------------------------------------------------------------------------ Other 888 2 2,243 4 (133) 0 - ------------------------------------------------------------------------ - ------------------------------------------------------------------------ Total $59,313 100% $61,446 100% $62,139 100% - ------------------------------------------------------------------------
GROSS PREMIUMS WRITTEN BY PRIMARY MORTGAGE GUARANTY INSURER (DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------------------------------------ 1996 1995 1994 - ------------------------------------------------------------------------------- PRIMARY GROSS PERCENT GROSS PERCENT GROSS PERCENT INSURER PREMIUMS OF TOTAL PREMIUMS OF TOTAL PREMIUMS OF TOTAL WRITTEN WRITTEN WRITTEN ------------------------------------------------------------------------------- PMI $13,897 26% $11,304 29% $17,755 59% - ------------------------------------------------------------------------------- CMAC 20,553 38 12,432 32 6,566 22 - ------------------------------------------------------------------------------- GEMICO 7,686 14 8,000 20 0 0 - ------------------------------------------------------------------------------- General 4,490 8 4,511 12 1,557 4 Accident (U.K.) - ------------------------------------------------------------------------------- Other 7,057 14 2,864 7 4,270 15 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Total $53,683 100% $39,111 100% $30,148 100% - -------------------------------------------------------------------------------
12 GROSS PREMIUMS WRITTEN BY PRIMARY CREDIT INSURER (DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------------------------------------ 1996 1995 1994 - ----------------------------------------------------------------------- PRIMARY GROSS PERCENT GROSS PERCENT GROSS PERCENT INSURER PREMIUMS OF TOTAL PREMIUMS OF TOTAL PREMIUMS OF TOTAL WRITTEN WRITTEN WRITTEN - ----------------------------------------------------------------------- AIU $ 4,176 28% $1,695 24% $ 0 0% - ----------------------------------------------------------------------- HERMES 3,513 23 1,263 18 410 16 - ----------------------------------------------------------------------- NCM 3,838 26 2,977 42 1,975 77 - ----------------------------------------------------------------------- Other 3,543 23 1,107 16 178 7 - ----------------------------------------------------------------------- - ----------------------------------------------------------------------- Total $15,070 100% $7,042 100% $2,563 100% - -----------------------------------------------------------------------
(3) Detail on Financial Guaranty Insurance in Force - - --- ----------------------------------------------- The following table sets forth the Company's gross premiums written, net premiums written and net premiums earned relating to its reinsured U.S. and non- U.S. risks for each of the three years ended December 31, 1996, 1995 and 1994. U.S. AND NON-U.S. PREMIUMS WRITTEN AND EARNED (DOLLARS IN THOUSANDS)
U.S. % NON-U.S.% U.S. NON-U.S. TOTAL TOTAL TOTAL YEAR ENDED DECEMBER 31, 1996 - ----------------------------------------------------------------------------------------- Gross Premiums Written $108,869 $20,949 $129,818 83.9% 16.1% - ----------------------------------------------------------------------------------------- Net Premiums Written 84,239 20,949 105,188 80.1 19.9 - ----------------------------------------------------------------------------------------- Net Premiums Earned 77,666 14,770 92,436 84.0 16.0 - ----------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, 1995 - ----------------------------------------------------------------------------------------- Gross Premiums Written $ 94,270 $13,329 $107,599 87.6% 12.4% - ----------------------------------------------------------------------------------------- Net Premiums Written 76,739 12,769 89,508 85.7 14.3 - ----------------------------------------------------------------------------------------- Net Premiums Earned 53,373 6,724 60,097 88.8 11.2 - ----------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, 1994 - ----------------------------------------------------------------------------------------- Gross Premiums Written $ 86,287 $ 8,564 $ 94,851 91.0% 9.0% - ----------------------------------------------------------------------------------------- Net Premiums Written 74,931 7,864 82,795 90.5 9.5 - ----------------------------------------------------------------------------------------- Net Premiums Earned 54,517 4,333 58,850 92.6 7.4 - -----------------------------------------------------------------------------------------
13 The following table shows the Company's ten largest financial guaranty single risk exposures by consolidated net par in force as of December 31, 1996. Collectively, these ten exposures accounted for 13.47% (consolidated net par) of the Company's reinsured financial guaranty portfolio. TEN LARGEST FINANCIAL GUARANTY SINGLE RISK EXPOSURES NET PAR IN FORCE (DOLLARS IN THOUSANDS)
- ----------------------------------------------------------------- Credit (1) As of December 31, 1996 - ----------------------------------------------------------------- Massachusetts State GO & Bay $757,687 Transportation Bonds - ----------------------------------------------------------------- California General Obligation Bonds 706,110 - ----------------------------------------------------------------- New York City General Obligation Bonds 701,687 - ----------------------------------------------------------------- Washington Public Power Supply System 567,501 - ----------------------------------------------------------------- New York City Municipal Water Finance Authority 517,570 - ----------------------------------------------------------------- New Jersey Transportation Trust Fund Authority 431,194 - ----------------------------------------------------------------- Los Angeles County California Metro Transportation 421,389 - ----------------------------------------------------------------- New York State General Obligation Bonds 419,562 - ----------------------------------------------------------------- Municipal Electric Authority of Georgia 405,269 - ----------------------------------------------------------------- Florida Department of Transportation - Turnpike 381,842 - -----------------------------------------------------------------
(1) All subject to non proportional Excess of Loss ("EOL") retrocessional program and/or Annual Debt Service ("ADS") retrocessional program. See "Business--Retrocessional Arrangements and Soft Capital Facilities." Although the Company generally does not write financial guaranty reinsurance on obligations that are non-investment grade at the time reinsured, the credit ratings of certain obligations may be reduced after the date such obligations are reinsured. The Company monitors its exposure to non-investment grade obligations and in this regard relies in part on information provided by its ceding companies, particularly with respect to certain municipal treaty business. The Company is familiar on an ongoing basis with the criteria used by S&P and Moody's for determining the investment grade status of the various credit sectors reinsured by the Company. These criteria are specific to, and vary considerably depending on, the line of business and type of credit reinsured. In certain cases, the Company and/or its cedants may obtain access to information on individual credits indicating that those credits no longer conform to the rating agencies' investment grade criteria, even through the rating agencies may not have yet reviewed those credits to determine their investment grade status. In such cases, the Company and/or its cedants may determine that certain individual credits are below investment grade quality. Based upon these procedures, the Company believes that approximately 1.05% of the reinsured financial guaranty portfolio (based on net par amount) or approximately $412.9 million, was rated below investment grade (i.e., not rated at least BBB- or Baa3 by either S&P or Moody's, or, if not rated, determined to be below investment grade in the opinion of the ceding company or the Company) at December 31, 1996. Capital Reinsurance has developed several non-proportional retrocessional programs which supplement its financial guaranty single risk capacity for a number of selected large volume issuers of municipal bonds. In some cases, these arrangements are effected on an excess of loss basis and involve the retention by Capital Reinsurance of a first loss exposure (liability for all losses related to a particular risk up to a stated dollar amount). Under these arrangements, Capital Reinsurance's potential annual payment liability (the annual amount of claims payments which Capital Reinsurance is obligated to pay) related to an issue default during the period of such first loss exposure may be several times Capital Reinsurance's net average annual debt service exposure to such reinsured issue. 14 The financial guaranty reinsured portfolio of the Company contained exposures in each of the fifty states, the District of Columbia, Puerto Rico and several foreign countries. The following table sets forth the distribution of consolidated net book of business by state as of December 31, 1996. DISTRIBUTION OF FINANCIAL GUARANTY NET BOOK OF BUSINESS BY STATE AS OF DECEMBER 31, 1996 (DOLLARS IN THOUSANDS) [PIE CHART APPEARS HERE] Total: $39,405,087 New York 10.65% California 11.07% Florida 6.52% Pennsylvania 4.70% Texas 5.02% New Jersey 3.47% Illinois 3.55% Massachusetts 3.16% Washington 2.70% Georgia 2.02% Others 47.14% (4) Marketing - - --- --------- The majority of the Company's business is derived from relationships it has established and maintains with the major U.S. primary financial guaranty, mortgage guaranty insurers and title insurers. European trade credit insurers, U.S. title insurers and United Kingdom mortgage guaranty insurers also provide a significant portion of the Company's business. These relationships provide business opportunities for the Company on both a treaty and facultative basis. The Company's international retrocessional relationships enable it to access international sources of reinsurance. These relationships link the Company's technical expertise in financial guaranty and related reinsurance risk underwriting with the market knowledge and capital strength of the Company's international retrocessionaires. See ''Business--Retrocessional Arrangements and Soft Capital Facilities.'' These relationships have also aided the Company's participation in the European financial guaranty business. Substantially all of the Company's business to date has been derived from reinsurance products written directly with insurers and not through intermediaries. However, the Company does use reinsurance brokers to access certain reinsurance opportunities, especially in the credit line of business. For the year ended December 31, 1996, intermediaries and brokers had accounted for 31% of U.S. gross premiums written and 79% of non-U.S. gross premiums written. The Company's relationships with these brokers do not commit or obligate the Company to accept business submitted by them. All applications for reinsurance from both new and existing ceding companies 15 are subject to review and acceptance by the Company in accordance with the Company's underwriting guidelines. Brokers are compensated based on a percentage of premium, which varies from transaction to transaction. Certain U.S. domestic mortgage guaranty, non-municipal and other special risk reinsurance opportunities may also be produced by reinsurance intermediaries and brokers. Capital Mortgage and KRE derive their mortgage guaranty reinsurance business principally through direct relationships with primary mortgage guaranty insurance companies. Reinsurance intermediaries and brokers are used in accessing reinsurance opportunities in the international market. Capital Credit has developed credit reinsurance business opportunities principally through reinsurance brokers and intermediaries. Capital Title has developed all of its business opportunities through direct contacts with primary title insurers. (5) Underwriting Guidelines, Policies and Procedures - - --- ------------------------------------------------ (a) Financial Guaranty Reinsurance - The underwriting process for the Company's financial guaranty insurance business is premised on the Company's policy of reinsuring investment grade obligations. Capital Reinsurance underwrites risks on a ''zero loss'' basis, meaning that each reinsured policy obligation has been evaluated by Capital Reinsurance under a standard of no loss expectation. However, losses in Capital Reinsurance's reinsured portfolio can be expected to occur, and there can be no assurance that these losses will not have a material adverse effect on financial condition and results of operations. See ''Business--Losses and Reserves.'' In addition, Capital Reinsurance's ongoing review of its portfolio does not involve any commitment by rating agencies or ceding companies to provide credit rating information on each assumed obligation. Capital Reinsurance has organized its underwriting procedures to provide for multiple levels of credit review and analysis. Facultative submissions, which form the majority of Capital Reinsurance's business, are initially reviewed by one of Capital Reinsurance's underwriting analysts who performs a detailed evaluation of each individual submission to assure compliance with Capital Reinsurance's underwriting guidelines and rating agency and regulatory criteria. The analyst's recommendation is presented to one of Capital Reinsurance's Underwriting Committees for consideration. There are separate committees for municipal and non-municipal financial guaranty risks. The Company's Chief Underwriting Officer must approve the decision of the Underwriting Committee before the risk is written by Capital Reinsurance. The Board of Directors of the Company also reviews underwriting policy and trends on a quarterly basis. Capital Reinsurance has established treaty reinsurance relationships with most of the U.S. primary financial guaranty insurance companies. Ceding insurers must be financially strong. Generally, each ceding company must also adhere to the underwriting standard of no loss expectation on financial guaranty insurance. Prior to initiating any treaty relationship, and on an annual basis thereafter, Capital Reinsurance conducts a review of the ceding company. Capital Reinsurance evaluates the ceding company's capital position, in-force book of business, reserves, cash flow, profitability and financial strength. The ceding company's underwriting process is analyzed to determine compliance with established credit guidelines and legal documentation requirements. Management of each ceding company is reviewed in the areas of credit control, monitoring and surveillance practices, claims administration and remedial management. After Capital Reinsurance completes its ceding company review, a report is prepared and presented to Capital Reinsurance's senior management and the Company's Board of Directors. All new treaty relationships must be approved by the appropriate Underwriting Committee and the Chief Underwriting Officer before the treaty is accepted by Capital Reinsurance. Treaty results and compliance are reviewed by Capital Reinsurance on quarterly and annual bases. Capital Reinsurance also conducts its own due diligence and credit surveillance of underlying credits in accordance with internally developed and maintained standards. Capital Reinsurance's Chief Underwriting Officer formulates 16 Capital Reinsurance's underwriting policy and is responsible for its administration. The Board of Directors of Capital Reinsurance regularly reviews Capital Reinsurance's underwriting policy. The underwriting staff is also responsible for the ongoing monitoring and review of ceding company underwriting practices and financial results. The annual underwriting reviews of the ceding companies described above measure adherence to the ceding company's own underwriting standards and monitor the relationship of pricing to risk on business being reinsured by Capital Reinsurance. The reviews are also used to monitor pricing by product line, bond type and risk classification in an effort to allocate capital effectively to specific portfolios and product areas that are considered to have a greater potential for profitability. Capital Reinsurance's ongoing credit management of its reinsured portfolio is overseen by the Chief Underwriting Officer and the underwriting staff. The underwriting analysts recommend appropriate bond and credit sector representations and distributions. Capital Reinsurance's single and aggregate risk underwriting policies, while complying with regulatory and rating agency requirements, reflect Capital Reinsurance's capital resources, liquidity capabilities and retrocessional programs. Portfolio diversification is monitored regularly to improve the balance of geographic distribution, credit quality, bond type and maturity. (b) Mortgage Guaranty Reinsurance - Unlike the "zero loss" standard applied in financial guaranty insurance underwriting, mortgage guaranty insurance is underwritten with the expectation of loss. Under normal economic conditions and in a stable interest rate environment, loss ratios in this line of business are generally in the 15% to 40% range and are associated with frictional unemployment, divorce and other social factors. By avoiding geographic concentrations and employing prudent underwriting, mortgage insurers are better able to manage their risk. Capital Mortgage has established underwriting standards, procedures and closely monitored controls. A senior Mortgage Underwriting Committee, comprised of seven voting members including the Chief Executive Officer and the Chief Underwriting Officer, must approve each underwriting submission. Submissions are made through preparation of a comprehensive underwriting report, which is derived from (i) extensive meetings with senior management and staff of the ceding company, (ii) underwriting, actuarial and financial analysis of detailed information including historic mortgage performance, portfolio composition, origination procedures, quality control, loss mitigation and claims management, and (iii) reinsurance structure and profitability analysis. Generally, ceding companies must demonstrate their capability to monitor economic trends in markets in which they are providing insurance and to exercise underwriting discipline. Capital Mortgage seeks to identify insurers having the capability to prospectively analyze economic trends in various markets based on local and regional market factors, political developments and global resource factors, such as energy prices. The ceding company is required to maintain analytical personnel dedicated to reviewing trends in local residential property markets. Capital Mortgage closely examines analytical methods by which the ceding company follows pricing adequacy and loss development patterns of its insurance in force. Ceding company loss mitigation and claims management procedures are evaluated and analyzed. The ceding company must demonstrate an adequate investigative capability, engaging in a systematic review of early payment defaults to detect fraud or potential defects in underwriting systems. Capital Mortgage's underwriting staff reviews all reinsurance in force and recommends portfolio balancing targets (e.g., amount of risk in force by region, underwriting year, ceding company, loan type). On-site reviews of all ceding companies are conducted on at least an annual basis, encompassing a review of overall company organization, financial performance, developments in sales and marketing, underwriting systems and operations, actuarial services and claims management. Underwriting department analysts are charged with following rating agency reviews and industry developments, including a detailed review of semi- annual portfolio reports submitted by each ceding company to the rating agencies. Quarterly reviews for the Company's Board of Directors are 17 prepared, including analysis of new business written, reports following ceding company audits and discussion of various trends in the mortgage insurance industry. (c) Trade Credit and Specialty Products Reinsurance - Credit sales expose the seller to numerous risks ranging from the ability and willingness of the buyer to make payments according to agreed terms to political events which could disrupt the relationship between the seller and the buyer. Credit insurance is available in a variety of forms, and in varying degrees of comprehensiveness, to cover many of the potential risks encountered by the seller of goods and services. There are two broad areas of risk assumed in credit insurance and, consequently, reinsurance: commercial risks, including bankruptcy of the buyer and political risks, which can interfere with the fulfillment of an otherwise valid contract. Credit insurance underwriters manage risk by modifying the terms of coverage, by diversifying exposures to control aggregations of risks to particular buyers, industries, or territories, and by developing sophisticated data bases of credit and political information. The Company also writes a limited portfolio of other specialty lines. The Company performs extensive diligence of prospective ceding companies to identify those expected to produce superior underwriting results, structures its reinsurance participation to eliminate unacceptable risks and actively monitors exposures to identify any deterioration in risk profile and control aggregation across participations. (d) Title Reinsurance - Similar to the "zero loss" standard applied in financial guaranty insurance underwriting, title reinsurance is underwritten without the expectation of any significant loss. Capital Title's underwriting decisions are, in major part, be based on the underwriting audits of its ceding companies, focusing on (i) underwriting policies, guidelines and procedures, the experience and quality of underwriting personnel, including knowledge of localized issues and quality control, (ii) financial performance and stability, reserve adequacy and liquidity, (iii) claims handling procedures and personnel and loss management techniques and procedures, with particular emphasis on salvage, (iv) record keeping and title plant to ensure that all are well maintained and up to date, (v) agent and branch office review procedures, and (vi) trust fund and escrow account procedures. Preference is given to those companies whose overall policies, procedures and personnel exhibit a strong commitment to quality underwriting and loss management. Capital Title automatically accepts for reinsurance all policies which fall within the parameters of its various treaties. However, policies which contain certain enumerated types of extraordinary risks will have to be submitted on a special acceptance basis and separately underwritten by Capital Title's underwriting staff. Such extraordinary risks may include insured interests created by, under or concerning bankruptcy or state insolvency laws, federal or state securities laws, mineral interests, Indian lands, wet lands, tide lands, and mechanic's lien issues. In designing and recommending various excess of loss reinsurance strategies, Capital Title pays particular attention to each ceding company's loss experience, including frequency, severity and type of loss, at various policy sizes and levels of business. In conjunction therewith, salvage practices and procedures are considered. Capital Title is also called upon to provide facultative reinsurance capacity to the industry, particularly on larger commercial transactions and securitized pools of real estate. Capital Title maintains an underwriting staff experienced in handling these types of transactions and familiar with the particular risks attendant thereto. (6) Retrocessional Arrangements and Soft Capital Facilities - - --- ------------------------------------------------------- The Company's business strategy places emphasis on the development of retrocessional relationships which provide the Company with a higher level of reinsurance risk capacity and serve as a means of accessing additional reinsurance opportunities. The Company's retrocessional strategy emphasizes building single-risk capacity and risk management. The Company retroceded 19.0% or $24.6 million of its gross premiums written in 1996, 16.8% or 18 $18.1 million of its gross premiums written in 1995, and 12.8% or $12.1 million of its gross premiums written in 1994. In 1992, Capital Reinsurance entered into a portfolio first loss and excess of loss reinsurance agreement with Centre Reinsurance Company of New York, a AA rated reinsurer. The agreement, which covered the entire reinsured portfolio of Capital Reinsurance, provided protection against currently unforeseen losses which, should they occur, would, in the absence of the reinsurance cover, require a significantly greater loss reserve in the year of occurrence. The cover also provided Capital Reinsurance with catastrophic loss protection. Capital Credit entered into a similar cover in 1992 with AXA Re. In 1993, in response to accounting standards adopted by the EITF, these arrangements were canceled and new agreements were entered into which effectively revised and significantly downsized the coverage provided. Under these arrangements, Capital Reinsurance has ceded $19.5 million in premium and Capital Credit has ceded $4.25 million. On January 31, 1994, Capital Reinsurance entered into an agreement with Deutsche Bank AG for a credit facility of up to $75 million specifically designed to provide rating agency qualified capital to further support the claims-paying resources of Capital Reinsurance. The agreement expires on January 27, 2004. As part of its original capital structure, in 1994 Capital Mortgage purchased $30 million of portfolio excess of loss reinsurance. Additionally, in 1994 Capital Reinsurance established a $100 million portfolio excess of loss reinsurance arrangement. Capital Credit's claims-paying resources are further supported through a portfolio aggregate excess of loss reinsurance agreement with Capital Reinsurance. The Company creates specialized retrocessional structures for establishing large financial guaranty single risk capacity, which the Company believes improve its competitive position with the primary financial guaranty insurance market. The Company believes that its ability to offer the primary financial guaranty market reinsurance capacity for the largest insurable debt issues is a significant marketing benefit, which allows it to access additional reinsurance opportunities. The Company's retrocessional treaty programs are its EOL Program and ADS Program. The EOL Program was a structured, non-proportional retrocessional treaty which (i) produced single risk capacity for the largest issuers of insurable municipal bonds, (ii) allowed international retrocessionaires to participate at a variety of risk levels, (iii) improved transactional profitability for the Company and (iv) complied with the Company's external risk limitations. The EOL Program was active through the end of 1991, and currently no new business is being ceded to it. The ADS Program is a proportional treaty covering annual payment obligations of the Company on issues reinsured under the EOL Program. The ADS Program was effective as of January 1, 1992. Capital Reinsurance ceded to Capital Credit $0 million, $1.3 million, and $1.6 million in premiums, and $0 billion, $1.1 billion, and $1.3 billion in par amounts, for the years ended December 31, 1996, 1995 and 1994, respectively. Capital Credit interacts with Capital Reinsurance, and may in the future interact with Capital Mortgage, as a captive retrocessionaire for reinsurance opportunities which might otherwise be constrained in the context of Capital Reinsurance's rating agency and regulatory limitations. In 1994, Capital Credit began a measured expansion into the reinsurance of the international credit insurance business. This business is being conducted directly with third party ceding companies. To further support Capital Credit's credit reinsurance business, Capital Credit entered into a reinsurance agreement with Capital Reinsurance under which Capital Reinsurance provides $25 million in aggregate excess coverage. KRE also provides retrocessional capacity to Capital Reinsurance and Capital Mortgage. For the year ended December 31, 1996, Capital Reinsurance retroceded to KRE $1.1 million of premiums. Approximately $85 million of per policy coverage is provided to Capital Title by KRE pursuant to a Per Policy Excess of Loss Retrocession Agreement. Under this agreement, KRE covers an amount of loss paid by Capital Title arising from each of its policies equal to $90 million minus Capital Title's retention under the agreement. Capital Title's retention under the agreement is equal to the greater of: (i) $5 million, and (ii) 20% of Capital 19 Title's policyholder's surplus. $25 million of additional coverage is provided by KRE to Capital Title pursuant to the Excess of Loss Retrocession Agreement. Under this agreement, KRE covers up to $25 million of loss paid by Capital Title arising from its policies in excess of the lesser of: (i) 100% of Capital Title's net written premium, and (ii) the amount by which Capital Title's statutory capital exceeds $25 million. Capital Reinsurance has guaranteed payment of all of KRE's title reinsurance obligations to the extent KRE is unable to satisfy those obligations. (7) Competition - - --- ----------- (a) Financial Guaranty Reinsurance - Capital Reinsurance competes directly with one U.S. financial guaranty reinsurer, Enhance Reinsurance Company, and indirectly with various international multiline reinsurers and insurers. Based upon the 1996 annual statutory statements filed by each of the primary U.S. financial guaranty insurers, the Company believes that the Company and its principal competitor assumed most of the reinsurance ceded by the primary U.S. financial guaranty insurers in 1996. U.S. multiline insurance companies generally do not provide reinsurance to the financial guaranty insurance industry. Although applicable state insurance regulations have mandated a specialized form for the transaction of primary financial guaranty insurance, multiline insurers may participate as reinsurers. However, the Company believes, based upon its own experience, that almost all U.S. multiline insurers have declined to participate in this market primarily because of their lack of the special expertise and underwriting skills necessary for this line of reinsurance. Numerous non-U.S. insurers participate in financial guaranty reinsurance treaties. Competition from international multiline reinsurance companies is best understood in the context of the financial guaranty reinsurance market in general. Cooperative channels of reinsurance capacity have developed throughout the reinsurance market in order to spread financial guaranty risk across a broad spectrum of insurers. As a result, international companies which may compete with Capital Reinsurance are frequently Capital Reinsurance's retrocessionaires and ceding companies. As the global market evolves, this interaction may become more pronounced. Competition in the financial guaranty reinsurance business is based upon many factors, including overall financial strength, pricing, service and evaluation of claims-paying ability by the major rating agencies, including S&P. S&P will grant credit against a primary company's capital requirements and single risk limits for reinsurance ceded, provided the reinsurer meets S&P claims-paying ability standards. The primary company receives a 100% credit for reinsurance ceded subject to the reinsurer's maintenance of a AAA claims-paying rating from S&P. A 70% credit is assigned if the reinsurer is rated AA and 30% if the reinsurer is rated A. Capital Reinsurance also faces competition indirectly from other AAA rated financial institutions which provide capital substitutes to the primary financial guaranty insurance companies. Several international commercial banks have developed credit facilities and letter of credit products that qualify as rating agency capital and therefore provide primary insurers with increased insurance capacity for rating agency purposes. However, these banking facilities cannot provide regulatory capital or credit against liabilities. Further, the current lack of substantial AAA bank credit has reduced banks as a competitive force in the reinsurance market. Competition is also a function of the ease with which primary insurers can raise capital in the private or public equity markets. Increased primary capital increases the ability of insurers to retain risk and the need for reinsurance in general is diminished. The Company believes that primary insurers have recently increased their primary capital base and that increased competition from foreign insurers is occurring. AXA Group Cie., one of France's largest insurers, established a subsidiary in 1995, AXA Re Finance S.A., in an effort to compete more effectively with AAA rated U.S. financial guaranty reinsurers. AXA Re Finance S.A. received a claims-paying ability rating of AAA from S&P and Fitch and reinsures U.S. financial guaranty insurance as well as European credit and surety insurance. 20 (b) Mortgage Guaranty Reinsurance - Capital Mortgage is not aware of any other U.S. professional reinsurer which specializes in mortgage guaranty reinsurance. Several U.S. multiline reinsurers offer capacity to the mortgage guaranty market but their participation has been limited. Substantially all of the external reinsurance capacity for the mortgage guaranty insurance industry is provided by European multiline insurers and reinsurers, who offer modest amounts of traditional reinsurance products. Capital Mortgage believes that those reinsurance providers typically lack the orientation and flexibility to address the current risk management, capital and financial problems of the mortgage guaranty insurance industry. Like financial guaranty reinsurance, competition is also a function of the ease with which primary insurers can raise capital in the private or public equity markets. Increased primary capital increases the ability of insurers to retain risk and reduces the need for reinsurance in general. (c) Trade Credit and Specialty Products Reinsurance - The reinsurance market is led by traditional multiline players, principally Munich Re and Swiss Re, which have been able to maintain their dominant market position in part through their ownership interests in many of the leading primary companies. In addition to the market leaders, there are a large number of mainly European and U.S. reinsurers that compete for the business. Reciprocal reinsurance arrangements between primary companies are widespread, thus adding to the degree of competition in the industry. (d) Title Reinsurance - Capital Title is the only U.S. professional reinsurer which specializes in third-party title reinsurance. To date, substantially all title reinsurance has been provided by the large title insurance companies, except for some minor excess coverage. The global reinsurance market has not been tapped to any significant extent by title insurers. (8) Ratings - - --- ------- (a) Financial Guaranty Reinsurance - Maintenance of an S&P and Moody's AAA rating is very important for the business of Capital Reinsurance, particularly in the area of financial guaranty reinsurance, because S&P will permit a AAA rated ceding company 100% credit for a cession only if the reinsurer is also AAA rated. The claims-paying ability of Capital Reinsurance has been rated AAA by S&P and Moody's. The major rating agencies have developed and published rating guidelines for rating financial guaranty reinsurers. These criteria follow the standards used to evaluate the claims-paying ability of primary financial guaranty insurers. The claims-paying ratings assigned by S&P and Moody's are based upon factors relevant to policyholders and are not directed towards the protection of investors in Capital Re. The claims-paying rating criteria used by S&P and Moody's focus on the following factors: capital resources, financial strength; demonstrated management expertise in financial guaranty and traditional reinsurance, credit analysis, systems development, marketing, capital markets and investment operations; and a minimum policyholders' surplus comparable to primary company requirements, with capital sufficient to meet projected growth as well as access to such additional capital as may be necessary to continue to meet standards for capital adequacy. S&P has published standards as to capital charges and single risk categories to which Capital Reinsurance and other AAA rated financial guaranty insurers and reinsurers must adhere in order to maintain their highest ratings. These standards weight numerous factors to types of obligations which are significantly more complex than an 21 insurance-in-force-to-capital ratio. In addition, capital adequacy is tested against an economic model that simulates a growth period followed by an economic depression which assumes no new business is written. The Company's ability to compete with other AAA rated financial guarantors, and its results of operations and financial condition, would be materially adversely affected by any reduction in the claims-paying rating of Capital Reinsurance. Under several treaties to which Capital Reinsurance is a party, the ceding companies may recapture business previously ceded to Capital Reinsurance in the event of a specified rating downgrade of Capital Reinsurance, which could result in a material adverse effect on the Company's deferred premium revenue and its recognition of future income from that reserve. (b) Mortgage Guaranty Reinsurance - Capital Mortgage's mortgage guaranty reinsurance business plan is premised on a claims-paying rating of at least AA. S&P has rated the claims-paying ability of Capital Mortgage AA and the claims-paying ability of KRE AA-. Although the rating agencies have not published explicit rules regarding rating agency credit for reinsurance in the mortgage guaranty insurance area, in practice, they provide 100% credit to a AA rated ceding company for reinsurance to AA rated reinsurers. Reinsurance to lesser rated reinsurers is substantially discounted. A reinsurer's financial ability to pay claims is the standard of value to its primary insurance market. The general standard of creditworthiness in the mortgage guaranty industry is AA. Certain national mortgage lenders and a large segment of the mortgage securitization market, including the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac"), generally will not purchase mortgages or mortgage-backed securities unless the private mortgage insurance on the mortgages has been issued by an insurer with a claims-paying ability rating of at least AA- from S&P or Fitch or at least Aa3 from Moody's. As a result, all of the eight U.S. primary mortgage guaranty insurers have claims-paying ratings of at least AA and generally seek similarly rated reinsurance security. Ratings of at least AA provide the ceding companies with confidence that the reinsurer has the financial strength to meet its policy obligations. (c) Title Reinsurance - Capital Title is rated AA- by S&P and Duff & Phelps. Although the rating agencies have not published explicit rules regarding rating agency credit for reinsurance in the title insurance area, in practice, the primary title insurers receive 100% credit for cessions to Capital Title. Title insurers are only beginning to obtain claims paying ability ratings; the general standard of creditworthiness that seems to be developing in the title insurance industry is A. (d) Other Ratings - The Company's senior debt is rated A by S&P and Aa3 by Moody's, and the MIPS issued by the Company's finance subsidiary, Capital Re LLC, are rated A- by S&P and A1 by Moody's. Capital Reinsurance, Capital Mortgage, KRE and Capital Title have not received ratings from A.M. Best Company, Inc. ("A.M. Best"), a major rating agency covering the insurance industry. A.M. Best rates insurance companies annually and provides statistical reports on their financial condition and history. However, A.M. Best has not rated financial guaranty insurers and reinsurers. Because the claims-paying ability ratings discussed above from S&P, Moody's and Duff & Phelps are generally considered far more important than A.M. Best ratings, the Company believes the absence of an A.M. Best rating has no impact on the Company's business or on its competitive position. 22 (9) NAIC-IRIS Ratios - - --- ---------------- The National Association of Insurance Commissioners' Insurance Regulatory Information System ("IRIS") was developed by a committee of state insurance regulators and is primarily intended to assist state insurance departments in executing their statutory mandates to oversee the financial condition of insurance companies operating in their respective states. IRIS identifies eleven industry ratios and specifies "usual values" for each ratio. Departure from the usual values on four or more of the ratios could lead to inquiries from individual state insurance commissioners as to certain aspects of a company's business. For the year ended December 31, 1996, Capital Reinsurance had no unusual values and Capital Mortgage fell outside the usual values for two of the eleven ratios. One ratio was the change in net writings and was outside the range because of the large increase in Capital Mortgage's gross premiums written from the prior year. The other ratio was investment yield which was low because Capital Mortgage received a capital infusion that it subsequently invested in an insurance subsidiary, therefore, preventing Capital Mortgage from earning any investment income on such capital infusion. (10) Losses and Reserves - - ---- ------------------- In the financial guaranty line of business, case basis loss reserves are required to be established under generally accepted accounting principles ("GAAP") and statutory accounting practices ("SAP") when a payment default on an insured obligation is probable and the amount of the probable loss can be reasonably estimated. Moreover, under its various reinsurance treaties and facultative agreements, Capital Reinsurance is obligated to establish and maintain SAP case basis loss reserves. Under GAAP, the amount of the case basis loss reserve is calculated as the present value of the losses expected to be incurred through the full term of the obligation, including loss adjustment expenses, net of anticipated salvage and subrogation. Under current Maryland insurance law, case basis loss reserves may not be discounted under SAP. In the mortgage guaranty reinsurance line, the Company's reserves are a function of the reserving methodologies of the primary insurance companies from which mortgage guaranty risk is assumed. A significant period of time may elapse between the occurrence of the borrower's default on mortgage payments (the event a potential future claim), the reporting of such default to the primary insurance company, the primary company's notification of loss to the reinsurer and the eventual payment of the claim related to the default. To recognize the liability for unpaid mortgage guaranty losses related to defaulted mortgages, primary mortgage guaranty insurers establish loss reserves in respect of such defaults based upon the claim rate and estimated average claim amount. Included in these loss reserves are Loss adjustment expense ("LAE") and Incurred But Not Reported Reserves. These reserves are estimates and there can be no assurance that they will prove adequate to cover ultimate loss developments on the reported defaults. The reserving process is premised on the assumption that historical experience relating to mortgage defaults, adjusted for the anticipated effect of current economic conditions and projected future economic trends, provides a reasonable basis for estimating future events. However, estimation of loss reserves is a difficult process, especially in light of the rapidly changing economic conditions that have affected certain regions of the United States. Additionally, economic conditions that have affected the development of the loss reserves in the past may not necessarily affect development patterns in the future. For the trade credit reinsurance business, loss reserves are established according to management's loss expectations which are based on historical loss development patterns experienced by the ceding companies on similar business as well as management's view of current macroeconomic conditions in the countries in which the policies apply. For the title reinsurance business, case basis loss reserves are required to be established under GAAP and SAP when a loss under a reinsured title policy is probable and the amount of the probable loss can be reasonably estimated. 23 The Chief Financial Officer of the Company is responsible for determining the appropriate timing and amount of loss reserves after consultation with the Company's Chief Executive Officer and Chief Underwriting Officer. In making his determination, the Chief Financial Officer will also confer with the ceding company which originally insured the obligation. The Company may, in its discretion, establish a loss reserve independent of the originating ceding company. As of December 31, 1996, the Company had established a net $18.1 million in GAAP case basis loss and LAE reserves (of which $5.8 million is classified as incurred but not reported reserves in the Company's statutory financial statements). The Company believes its loss and LAE reserves are adequate. The following table sets forth for the periods indicated certain information regarding the Company's loss experience.
YEAR ENDED DECEMBER 31 (DOLLARS IN THOUSANDS) --------------------------------------- 1996 1995 1994 - --------------------------------------------------------------------------- GAAP Net Premiums Earned $92,436 $60,097 $ 58,850 - --------------------------------------------------------------------------- Net Reserve for Unpaid Losses and LAE at 10,245 7,702 1,776 Beginning of Period - --------------------------------------------------------------------------- Incurred Losses and LAE 9,483 2,637 2,167 - --------------------------------------------------------------------------- Paid (Recovered) Losses and LAE 1,969 94 (3,759)/(1)/ - --------------------------------------------------------------------------- Unrealized Foreign Currency Loss on 310 14 0 Reserve Revaluation - --------------------------------------------------------------------------- Net Reserve for Unpaid Losses and LAE at 18,069 $10,259 $ 7,702 End of Period/(2)/ - --------------------------------------------------------------------------- Ratio of Losses Incurred and LAE to GAAP 10.3% 4.4% 3.7% Net Premiums Earned - ---------------------------------------------------------------------------
(1) Includes $4.0 million in recoveries received from retrocessionaires. (2) Net of reinsurance recoverable on ceded losses of (in thousands) $1,833, $2,524, and $1,310 for the years ended December 31, 1996, 1995 and 1994, respectively. (11) Investments - - ------ ------------- In managing its investment portfolio, the Company places a high priority on credit quality and liquidity. Investment policy is set by the Board of Directors and specific investments are managed by two outside advisers: Lazard Freres Asset Management, Inc. and Goldman Sachs Asset Management (the "Advisers"). The Advisers act as investment managers of the Company's portfolio under contracts terminable on 30 days' notice. Performance of the Advisers and the fees associated with these arrangements have been and will continue to be periodically reviewed by the Board of Directors of the Company. All investments made by the Advisers for the Company are in accordance with the general requirements and guidelines for investments established by the Board of Directors and Investment Committee thereof, including guidelines relating to average maturities, duration and quality, in accordance with applicable law. All investments in municipal bonds and certain asset backed securities are subject to prior approval by the Capital Reinsurance underwriting department. The Company's current investment policy only permits investment in investment grade fixed income securities. At December 31, 1996, 86.5% of the Company's investment portfolio consisted exclusively of fixed income securities rated AAA or A-1+ by S&P or Aaa or P-1 by Moody's, or issues by the U.S. Government or its agencies or instrumentalities. Overall weighted average credit quality is AAA. Two strategic changes to the Company's investment guidelines were approved by the Board of Directors in 1996. The first was to allow the purchase of securities rated BBB in order to increase returns without significantly increasing overall portfolio risk. The second strategic change was to allow tactical purchases of non-dollar fixed 24 income securities at the discretion of the Advisers and within the constraints established by the Board of Directors. The overall portfolio performance, however, remains benchmarked to composite domestic benchmarks. No assurance can be given that the Company's strategy of diversification will prove successful, or that losses will not be incurred in excess of those realized under the prior investment strategy. AGGREGATE INVESTMENT PORTFOLIO BY MATURITY AS OF DECEMBER 31 (DOLLARS IN THOUSANDS)
1996 1995 1994 - ------------------------------------------------------------------------------------------- CARRYING PERCENTAGE CARRYING PERCENTAGE CARRYING PERCENTAGE VALUE OF TOTAL VALUE OF TOTAL VALUE OF TOTAL MATURITY OF INVESTMENT INVESTMENT INVESTMENT INVESTMENTS PORTFOLIO PORTFOLIO PORTFOLIO - ------------------------------------------------------------------------------------------- Due in One Year or $ 76,606 8.5% $ 96,837 12.6% $ 80,251 12.6% Less - ------------------------------------------------------------------------------------------- Due After One Year 117,503 13.0% 70,365 9.1% 44,530 7.0% Through Five Years - ------------------------------------------------------------------------------------------- Due After Five Years 74,723 8.3% 47,177 6.1% 13,522 2.1% Through Ten Years - ------------------------------------------------------------------------------------------- Due After Ten Years 632,270 70.2% 557,388 72.2% 500,448 78.3% - ------------------------------------------------------------------------------------------- Total Investment $901,102 100% $771,767 100.0% $638,751 100.0% Portfolio - -------------------------------------------------------------------------------------------
AGGREGATE INVESTMENT PORTFOLIO AND YIELD BY TYPE OF SECURITY AS OF DECEMBER 31, 1996 (DOLLARS IN THOUSANDS)
CARRYING VALUE ESTIMATED FAIR WEIGHTED AVERAGE YIELD VALUE TO MATURITY/(1)/ INVESTMENT CATEGORY - ------------------------------------------------------------------------------------------------ Long-Term Investments: - ------------------------------------------------------------------------------------------------ Municipal Obligations $418,966 $418,966 6.47% - ------------------------------------------------------------------------------------------------ Corporate Securities 115,533 115,533 6.99% - ------------------------------------------------------------------------------------------------ U.S. Government and Agency Obligations 77,057 77,057 6.84% - ------------------------------------------------------------------------------------------------ Mortgage-Backed Securities 200,762 200,762 7.66% - ------------------------------------------------------------------------------------------------ Emerging Markets 13,360 13,360 7.67% - ------------------------------------------------------------------------------------------------ Total Long Term Investments 825,678 825,678 6.88% - ------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------ Short-Term Investments 75,424 75,424 5.17% - ------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------ Total Investment Portfolio $901,102 $901,102 6.73% - ------------------------------------------------------------------------------------------------
(1) Represents yield to maturity on long-term investments and current yield on short-term investments. All percentages are stated on a pre-tax basis, based on contractual maturity periods. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. At December 31, 1996, approximately $200.76 million or 22.3% of the Company's investment portfolio was comprised of mortgage-backed securities ("MBS"). Of the MBS portfolio, approximately $142.8 million or 71.1% 25 was backed by agencies or entities sponsored by the U.S. government as to the full amount of principal and interest. As of December 31, 1996, the entire MBS portfolio was invested in triple A rated securities. Prepayment risk is an inherent risk of holding MBS. However, the degree of prepayment risk is particular to the type of MBS held. The Company limits its exposure to prepayments by purchasing less volatile types of MBS. As of December 31, 1996, $52.2 million or approximately 26.0% of the MBS portfolio was invested in collateralized mortgage obligations ("CMOs") which are characterized as planned amortization class CMOs ("PACs"). PACs are securities whose cash flows are designed to remain constant over a variety of mortgage prepayment environments. Other classes in the CMO security are structured to accept the volatility of mortgage prepayment changes, thereby insulating the PAC class. Of the remaining MBS portfolio, $148.6 million, or 74.0%, was invested in mortgage- backed pass-throughs or sequential CMOs. Pass-throughs are securities in which the monthly cash flows of principal and interest (both scheduled and prepayments) generated by the underlying mortgages are distributed on a pro-rata basis to the holders of securities. A sequential MBS is structured to divide the CMO security into sequentially ordered classes. Receipt of principal payments within classes is contingent on the retirement of all previously paying classes. Generally, interest payments are made currently on all classes. While these securities are more sensitive to prepayment risk than PACs, they are not considered highly volatile securities. While the Company may consider investing in any tranche of a sequential MBS, the individual security's characteristics (duration, relative value, underlying collateral, etc.) along with aggregate portfolio risk management determine which tranche of sequential MBS will be purchased. At December 31, 1996, the Company had no securities such as interest only securities, principal only securities, or MBS purchased at a substantial premium to par that have the potential for loss of a significant portion of the original investment due to changes in the prepayment rate of the underlying loans supporting the security. (12) Banking Facilities - - ---- ------------------ On January 27, 1996, the Company arranged with Deutsche Bank AG for the provision of a $25 million liquidity facility which is available for general corporate purposes for one year. The Company has not borrowed any funds under this facility. Additionally, on August 20, 1996, the Company arranged with the Chase Manhattan Bank for the provision of a $25 million credit facility for general corporate purposes. On August 26, 1996, the Company utilized $16 million of this facility for the purpose of retiring its subordinated notes. The remaining $9 million was used to acquire RGB. (13) Data Processing - - ---- --------------- The Company believes that its data processing system is adequate to support its current needs and that such system has the capacity to support a greater volume of reinsurance business. The Company uses microcomputers on a Novell network. The network has two fileservers which provide for disk duplexing and complete data and application redundancy. System applications files and databases are backed up to tape daily. Backup tapes are shipped to an off-site storage facility monthly and on-site backup is stored in a fire-proof safe outside the data center. (14) Employees - - ---- --------- As of December 31, 1996, the Company employed 57 persons, of whom 29 were in administration, legal, finance and management, 11 were in underwriting and technical support, 11 in management information services and 6 in direct marketing. None of these employees is covered by collective bargaining agreements. The Company believes that its employee relations are excellent. 26 (15) Executive Officers - - ------ -------------------- The executive officers of the Company and their present ages and positions with the Company are set forth below.
Name Age Position and Term of Office - --------------------------- --- ---------------------------------------------- Michael E. Satz 48 Chairman of the Board, President and Chief Executive Officer (Officer since 1987) Jerome F. Jurschak 49 Executive Vice President and Chief Underwriting Officer (Officer since 1988) David A. Buzen 37 Executive Vice President and Chief Financial Officer (Officer since 1988) Alan S. Roseman 40 Senior Vice President, General Counsel and Secretary (Officer since 1989); First Vice President and Associate General Counsel of AMBAC Indemnity Corporation 1984 to 1989 Laurence C.D. Donnelly 38 Executive Vice President (Officer since 1988) Joseph W. Swain III 44 Senior Vice President (Officer since 1988)
(16) Regulatory Status of Insurance Subsidiaries - - ---- ------------------------------------------- Capital Reinsurance is licensed as a surety, property and casualty insurer (including mortgage guaranty insurance) in the State of Maryland and is licensed or authorized to transact reinsurance business in the States of New York, Florida and California and is an approved or accredited reinsurer in Alaska, Colorado, Kentucky, North Carolina, Pennsylvania and Texas. Under its New York license, Capital Reinsurance is authorized to reinsure risks of every kind or description permitted by its charter (including financial guaranty risks). Notwithstanding the breadth of its New York license, Capital Reinsurance has committed to the New York Insurance Department that it will act in the United States only as a reinsurer and intends to reinsure only financial guaranty and related special risks consistent with its business strategy as a specialty reinsurer. Capital Mortgage is licensed as a mortgage guaranty insurer in the State of New York and is thereby authorized to transact solely the business of mortgage guaranty reinsurance. Similarly, Capital Title is licensed as a title insurer in the State of New York and is thereby authorized to transact solely the business of title reinsurance. Capital Reinsurance is subject to the insurance laws and regulations of the State of Maryland and Capital Mortgage and Capital Title are subject to the insurance laws of the State of New York. Additionally, Capital Reinsurance, Capital Mortgage and Capital Title are subject to the laws of the other jurisdictions in which they are, or may be, licensed to transact business. In general, such insurance laws and regulations are primarily for the protection of the policyholders of these companies, i.e., their ceding insurers, and ultimately the policyholders of those ceding insurers. These laws and regulations, as well as the level of supervisory authority that may be exercised by the various state insurance departments, vary by jurisdiction, but generally require reinsurance companies to maintain minimum standards of business conduct and solvency, including the satisfaction of minimum capital requirements, and certain financial tests, the maintenance of deposits of securities with state insurance departments for the benefit of ceding insurers and the filing of certain reports with regulatory authorities. Capital Reinsurance, Capital Mortgage and Capital Title are required to file quarterly and annual SAP financial statements in each jurisdiction where they 27 are licensed and with the National Association of Insurance Commissioners, and are subject to certain risk limits and other statutory restrictions concerning the types and quality of, and limitations on, investments. The operations and accounts of Capital Reinsurance, Capital Mortgage and Capital Title are subject to periodic examination by the insurance departments of the jurisdictions in which they are licensed, authorized or accredited. The Maryland Insurance Administration, the regulatory authority of the domiciliary jurisdiction of Capital Reinsurance, conducts a triennial examination of insurance companies domiciled in Maryland. The most recent complete triennial report of Capital Reinsurance covered the period from January 1, 1990 through December 31, 1993 and the report on examination was issued on May 22, 1995. The report contained comments and recommendations concerning various compliance deficiencies found in several areas, which deficiencies were largely technical in nature. Capital Reinsurance responded to the comments and recommendations in a manner satisfactory to the Maryland Insurance Administration and has taken action to assure compliance in all areas noted the future. The New York Insurance Department, the regulatory authority of the domiciliary jurisdiction of Capital Mortgage and Capital Title, will conduct examinations of these companies on a periodic basis. Although the rates and policy terms of primary insurance agreements are generally closely regulated by state insurance departments, the terms and conditions of reinsurance agreements generally are not subject to regulation by any regulatory authority with respect to rates or policy terms. However, as a practical matter, the rates charged by the primary insurers have an effect on the rates that can be charged by reinsurers and, with respect to reinsurance of financial guaranty, mortgage guaranty and title primary insurers licensed in the States of California, Florida and New York, certain terms must often be included in the reinsurance agreement in order for such primary insurer to receive credit for the reinsurance on its statutory financial statements. Capital Credit and KRE are insurance companies registered and licensed as general insurers under the laws of the Islands of Bermuda. Each is subject to the Insurance Act of 1978, as amended, of the Islands of Bermuda. It is the policy of the government of Bermuda that the insurance industry be essentially self-regulating and the Insurance Act is drawn to require certification by the appropriate officers and professionals of each company of compliance with the applicable statutory standards. Capital Credit and KRE are required under the Act to prepare annual statutory financial statements and file a statutory financial return, including a declaration of compliance with the statutory ratios (premium to statutory surplus ratio; five-year operating ratio and change in statutory surplus ratio) and a general business solvency certificate demonstrating compliance with the Insurance Act's minimum solvency ratio. (17) Insurance Holding Company Regulations - - ---- ------------------------------------- The Company, Capital Reinsurance, Capital Mortgage and Capital Title are subject to regulation under the insurance holding company statutes of Maryland, the domiciliary state of Capital Reinsurance, New York, the domiciliary state of Capital Mortgage and Capital Title, and of other jurisdictions in which they are, or may be, licensed. The insurance holding company laws and regulations vary from jurisdiction to jurisdiction, but generally require an insurance holding company, such as the Company, and insurers and reinsurers that are subsidiaries of insurance holding companies, to register with the applicable state regulatory authorities and to file with those authorities certain reports describing, among other information, their capital structure, ownership, financial condition, certain inter-company transactions and general business operations. The insurance holding company statutes also require prior regulatory agency approval or, in certain circumstances, prior notice of certain material inter-company transfers of assets and certain transactions between insurance companies, their parent companies and affiliates. The insurance holding company statutes impose standards on certain transactions between affiliated companies within the holding company structure, which include, among other requirements, that all transactions be fair and reasonable and have terms no less favorable than terms that would result from transactions between parties negotiating at arm's length and that those exceeding specified limits receive prior regulatory approval. 28 (18) Maryland and New York Insurance Acquisitions Disclosure and Control Acts - - ---- ------------------------------------------------------------------------ Under the Maryland Insurance Code and New York Insurance Laws, unless certain filings are made with the Insurance Commissioner, no person may acquire any voting security, or security convertible into a voting security, of an insurance holding company, such as the Company, which controls a Maryland or New York insurance company, as applicable, such as Capital Reinsurance, Capital Mortgage or Capital Title, or merge with such holding company, if, as a result of such transaction, such person would "control" such insurance holding company. Under current law, the transaction may not proceed without prior approval or exemption by the Insurance Commissioner unless following the required provision of certain information to the Insurance Commissioner, the Insurance Commissioner affirmatively approves the acquisition within a specified time period. "Control" is presumed to exist if a person, directly or indirectly, owns or controls 10% or more of the voting securities of another person. This presumption may be rebutted by establishing by a preponderance of evidence that control does not exist in fact. (19) Restrictions on Dividends - - ---- ------------------------- (a) Maryland Law: The principal source of cash for the payment of debt service and dividends by the Company is the receipt of dividends from Capital Reinsurance. Under current Maryland insurance law, as it applies to Capital Reinsurance, any proposed payment of a dividend or distribution in excess of certain amounts is called an "extraordinary dividend." "Extraordinary dividends" must be reported to, and approved by, the Maryland Commissioner prior to payment. An "extraordinary dividend" is defined to be any dividend or distribution to stockholders, such as the Company, which together with dividends paid during the preceding twelve months, exceeds 10% of an insurance company's policyholders' surplus at the preceding December 31. Further, an insurer may not pay any dividend or make any distribution to its shareholders, such as the Company, unless the insurer notifies the Commissioner of the proposed payment within five business days following declaration and at least ten days before payment. The Commissioner may declare that such dividend not be paid if he finds that the insurer's policyholders surplus would be inadequate after payment of the dividend or could lead the insurer to a hazardous financial condition. Based on the Maryland restrictions, at December 31, 1996, the maximum amount available during 1997, with notice to, but without prior approval of the Maryland Insurance Administration, for payment of dividends by Capital Reinsurance to the Company which would not be characterized as "extraordinary dividends" is approximately $33 million. (b) New York Law: Capital Mortgage is subject to the dividend restrictions imposed under sections 4105 and 6502(b)(2) of the New York Insurance Law. Those sections provide that dividends may only be declared and distributed out of earned surplus. Additionally, no dividend may be declared or distributed in an amount which, together with all dividends declared or distributed by the company during the preceding twelve months, exceeds the lesser of 10% of the company's surplus to policyholders as shown by its last Annual Statutory Statement on file with the New York Department, or 100% of adjusted net investment income during such period, unless, upon prior application therefor, the superintendent approves a greater dividend distribution based upon his finding that the company will retain sufficient surplus to support its obligations and writings. "Earned surplus" is defined as the portion of the company's surplus that represents the net earnings, gains or profits, after deduction of all losses, that have not been distributed to shareholders as dividends or transferred to stated capital or capital surplus or contingency reserves or applied to other purposes permitted by law but does not include unrealized appreciation of assets. "Adjusted net investment income" is defined as net investment income for the twelve months immediately preceding the declaration of the dividend increased by the excess, if any, of net investment income over dividends declared or distributed during the period commencing thirty-six months before the declaration of the current dividend and ending twelve months prior thereto. 29 Capital Title is subject to the dividend restrictions imposed under sections 4105 and 6407 of the New York Insurance Law. Those sections provide that dividends may only be declared and distributed out of earned surplus and only if such dividends do not reduce the company's surplus to less than 50% of its outstanding capital shares, i.e., the value of its outstanding common equity. Additionally, no dividend may be declared or distributed in an amount which, together with all dividends declared or distributed by the company during the preceding twelve months, exceeds 10% of the company's outstanding capital shares, unless, after deducting such dividends, it has a surplus at least equal to 50% of its statutory reinsurance reserve or a surplus at least equal to $250,000, whichever is greater. "Earned surplus" is defined as the portion of the company's surplus is not attributable to contributions to surplus made in the preceding five years or to appreciation in the value of the company's investments not sold or otherwise disposed of. (c) Bermuda Law: Capital Credit and KRE have never declared nor paid dividends. Under Bermuda Law and the Bye-Laws of Capital Credit and KRE, dividends may be paid out of their profits (defined as accumulated realized profits less accumulated realized losses). Distributions to shareholders may also be paid out of their surplus limited by the requirements that they must at all times (i) maintain the minimum share capital required under Bermuda Law, and (ii) have relevant assets in an amount equal to or greater than 75% of relevant liabilities, all as defined under Bermuda Law. (20) Credit for Reinsurance - - ---- ---------------------- Through the "credit for reinsurance" mechanism, Capital Re's insurance subsidiaries are indirectly subject to the effects of regulatory requirements imposed by jurisdictions in which ceding primary insurers are licensed. In general, a ceding insurer will ordinarily enter into reinsurance agreements only if the ceding insurer can obtain credit for reinsurance on its statutory financial statements. Credit is allowed when the reinsurer is licensed, authorized or accredited in a jurisdiction where the ceding company is domiciled or, in some cases, licensed. In addition, many jurisdictions allow credit for reinsurance ceded to a reinsurer that is licensed in another jurisdiction and which meets certain financial requirements, provided, in some instances, that the jurisdiction has substantially similar reinsurance credit law requirements. Alternatively, most jurisdictions permit a ceding insurer to take credit for reinsurance on its statutory financial statements if the reinsurer is not licensed, accredited or authorized if the reinsurer provides security against the reserves ceded in the form of a letter of credit, funds withheld or through a trust fund mechanism. Capital Reinsurance is licensed, or meets the financial requirements in each of the jurisdictions in which the primary U.S. financial guaranty insurers are domiciled. Capital Mortgage is licensed, or meets the financial requirements in each of the jurisdictions in which the primary private U.S. mortgage guaranty insurers are domiciled. Capital Title is licensed or meets the financial requirements in each of the jurisdictions in which it has ceding companies and that impose such requirements. (21) SAP Reserves - - ---- ------------ (a) Financial Guaranty Contingency Reserve - Capital Reinsurance maintains the contingency reserves which the Company believes are required by the New York, California and Florida insurance laws to provide credit for reinsurance to ceding financial guaranty insurers licensed in New York, California and Florida. Under those laws, all financial guaranty insurers, or their reinsurers, are required to maintain a contingency reserve to protect policyholders against the impact of excessive losses occurring during adverse economic cycles. Under the New York Insurance Law, for financial guaranty policies written on and after July 1, 1989 contributions are required to be made to the contingency reserve equal to the greater of 50% of premiums written for the relevant 30 category of insurance or a percentage of the principal guaranteed, varying from 0.55% to 2.50%, depending upon the type of obligation. Contributions to the contingency reserve are required to be made as follows: (a) for municipal bonds, special revenue bonds and substantially equivalent obligations, by quarterly payments equal to one-eightieth of the total reserve required over a 20 year period; (b) for all other obligations, by quarterly payments equal to one- sixtieth of the total reserve required over a 15 year period. Contributions may be discontinued if the required total contingency reserve for all categories of obligations has been reached. The contingency reserves must be maintained for the period specified above, except that withdrawals by the insurer may be permitted, with the prior written approval of or written notice to the Superintendent of Insurance, under specified circumstances in the event that the actual incurred loss experience exceeds certain thresholds or if the reserve accumulated is deemed excessive in relation to the insurer's outstanding insured obligations. As of December 31, 1996, 1995 and 1994, the contingency reserve recorded on Capital Reinsurance's statutory financial statements was $87.4 million, $71.4 million, and $56.1 million, respectively. (b) Mortgage Guaranty Contingency Reserve: Under the New York Insurance Law, Capital Mortgage is required to establish a contingency reserve in an amount equal to 50% of earned premiums. Contributions to the contingency reserve made during each calendar year must be maintained for a period of one hundred and twenty months, except that withdrawals may be made by the company with the prior approval of the superintendent in any year in which the actual incurred losses exceed 35% of corresponding earned premiums. (c) Title Reinsurance Reserve: Under the New York Insurance Law, Capital Title is required to establish a reinsurance reserve in an amount equal to one-eightieth of one percent of the exposure assumed by it. Capital Title may release from the reinsurance reserve five percent of the amount added to the reinsurance reserve during each year following the year in which the sum was added. (22) Single and Aggregate Risk Limitations - - ---- ------------------------------------- (a) Financial Guaranty Business - The New York Insurance Law limits the single and aggregate risks that a financial guaranty insurer may insure on a net basis. Capital Reinsurance complies with the single and aggregate risk limits of the New York Insurance Law for financial guaranty insurers. For example, the New York Insurance Law limits the insured average annual debt service on insured municipal bonds, special revenue bonds and substantially equivalent obligations with respect to a single entity and backed by a single revenue source (net of qualifying collateral and reinsurance) to not more than 10% of the sum of the insurer's policyholders' surplus and contingency reserves. In addition, insured principal of municipal bonds attributable to any single risk, net of qualifying collateral and reinsurance, is limited to not more than 75% of the sum of the insurer's policyholders' surplus and contingency reserves. Single risk limits, which generally are more restrictive than the municipal bond single risk limit are also specified for several other categories of insured obligations. The New York Insurance Law also limits the aggregate insured outstanding principal and interest of guaranteed obligations, net of qualifying collateral and reinsurance, to certain multiples of the insurer's policyholders' surplus and contingency reserve. Aggregate risk limits vary for different categories of insured obligations. (b) Mortgage Guaranty Business: Capital Mortgage is subject to the various limitations and requirements of the New York Insurance Law governing mortgage guaranty insurance. For example, the aggregate risk (i.e., total liability under its aggregate insurance 31 and reinsurance policies) that a mortgage guaranty insurer may insure on a net basis cannot exceed twenty-five times its policyholders' surplus. The regulations promulgated under the New York Insurance Laws also contain detailed limitations on the conduct of mortgage pool insurance business by a New York licensed mortgage guaranty insurer. (c) Title Business: Capital Title is subject to the various limitations and requirements of the New York Insurance Law governing title insurance. For example, Capital Title may not assume any single risk in excess of its, capital, policyholders' surplus, statutory premium and voluntary reserves. ITEM 2. PROPERTIES. Capital Re Corporation, Capital Reinsurance and Capital Mortgage maintain offices at 1325 Avenue of the Americas, New York, New York 10019. The office comprises the entire 18th floor of the building, approximately 23,000 square feet of space. The companies began occupying these offices in April 1993. Prior to that, Capital Re and Capital Reinsurance maintained offices at 787 Seventh Avenue, New York, New York. The offices at 787 Seventh were sublet to a third party upon the move to 1325 Avenue of the Americas. ITEM 3. LEGAL PROCEEDINGS. There are no lawsuits pending, or to the knowledge of the Company threatened, to which the Company or any of its subsidiaries is a party or of which any of their properties is the subject. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable. 32 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The information concerning a market for the Company's Common Stock and the payment of dividends set forth on page 55 of the Company's 1996 Annual Report to Stockholders is incorporated herein by reference. Information concerning restrictions on the payment of dividends is set forth in Item 1 above, under the caption "Insurance Regulatory Matters - Restrictions on Dividends." As of March 25, 1997, there were 33 stockholders of record of the Company's Common Stock. ITEM 6. SELECTED FINANCIAL DATA. The information concerning selected financial data set forth on page 2 of the Company's 1996 Annual Report to Stockholders is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The information set forth on pages 22 through 30 of the Company's 1996 Annual Report to Stockholders is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The Company's 1996 Consolidated Financial Statements, the Report of Independent Auditors thereon and the unaudited "Quarterly Financial Information" set forth on pages 31 through 53 of the Company's 1996 Annual Report to Stockholders are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 33 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information concerning directors set forth under "Election of Directors" in the Company's 1997 Proxy Statement is incorporated herein by reference. Information concerning executive officers is set forth under PART I, Item 1 "BUSINESS OF CAPITAL RE: Executive Officers -" in this report. ITEM 11. EXECUTIVE COMPENSATION. The information concerning compensation of the Company's executive officers set forth in the Company's 1997 Proxy Statement is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information concerning security ownership of certain beneficial owners and management set forth in the Company's 1997 Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information concerning certain relationships and related transactions set forth in the Company's 1997 Proxy Statement is incorporated herein by reference. 34 PART IV ITEM 14. (a) Financial Statements, Financial Statement Schedules and Exhibits. 1. Financial Statements --------------------- Capital Re Corporation has incorporated by reference from the 1996 Annual Report to Stockholders the following consolidated financial statements of the Company:
1996 Annual Report to Stockholders ------------ CAPITAL RE CORPORATION AND SUBSIDIARIES Page(s) Report of Independent Auditors 31 Consolidated Balance Sheets at December 31, 1996 and 1995 32 - 33 Consolidated Statements of Income For the Years Ended December 31, 1996, 1995 and 1994 34 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1996, 1995 and 1994 35 Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994 36 Notes to Consolidated Financial Statements 37 - 53
2. Financial Statement Schedules ----------------------------- The Following Financial Statement Schedules are filed as part of this Report. Schedule Title -------- ----- II Condensed Financial Information of Registrant IV Reinsurance The report of the Registrant's independent auditors with respect to the above listed financial statement schedules is set forth in Exhibit 24.01 of this Report. All other schedules are omitted because they are either inapplicable or the required information is presented in the consolidated financial statements of the Company or the notes thereto. 3. Exhibits --------- The following are annexed as exhibits to this Report: Exhibit No. Exhibit ----------- ------- 3.01 Certificate of Incorporation of the Company, dated December 3, 1991, 1992 (Filed as exhibit 3.01 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 35 3.02 By-laws of the Company (Filed as exhibit 3.02 to the Company's Registration Statement on Form S-1 (Reg. No. 33- 45286) and incorporated herein by reference) 3.03 Certificate of Ownership and Merger of Capital Re Delaware Corporation and Capital Re Corporation (Filed as exhibit 3.03 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 4.01 Specimen Stock Certificate representing shares of Common Stock (Filed as exhibit 4.01 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 4.02 Form of Indenture between the Company and Morgan Guaranty Trust Company of New York, as Trustee including form of specimen Debenture (Filed as exhibit 4.01 to the Company's Registration Statement on Form S-1 (Reg. No. 33-53618) and incorporated herein by reference) 4.03 Form of Subordinated Promissory Notes (Filed as Exhibits 10.01 - 10.03 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 (Comm. File No. 1- 10995) and incorporated herein by reference) 4.04 Form of Payment and Guarantee Agreement between Capital Re LLC and the Company (Filed as exhibit 4.1 to the Company's Registration Statement on Form S-3 (Reg. No. 33-72090) and incorporated herein by reference) 4.05 Form of the Declaration of Terms of Capital Re LLC 7.65% Cumulative Monthly Income Preferred Shares, Series A (Filed as exhibit 4.2 to the Company's Registration Statement on Form S-3 (Reg. No. 33-72090) and incorporated herein by reference) 4.06 Form of Liability Assumption Agreement between Capital Re LLC and Capital Re Corporation (Filed as exhibit 99.2 to the Company's Registration Statement on Form S-3 (Reg. No. 33- 72090) and incorporated herein by reference) 4.07 Form of Loan Agreement between Capital Re LLC and Capital Re Corporation (Filed as exhibit 99.1 to the Company's Registration Statement on Form S-3 (Reg. No. 33-72090) and incorporated herein by reference) 4.08 $25 Million Credit Facility between the Company, Various Banks and Deutsche Bank AG, as Agent (Filed as Exhibit 4.08 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (Comm. File No. 1-10995) and incorporated herein by reference) 4.09 $75 Million Credit Facility between Capital Reinsurance, Various Banks and Deutsche Bank AG, as Agent (Filed as Exhibit 4.09 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (Comm. File No. 1- 10995) and incorporated herein by reference) 4.10 $25 Million Credit Facility between the Company, Various Banks and The Chase Manhattan Bank, as Agent, dated August 20, 1996. 36 9.01 Stockholders' Agreement dated as of January 17, 1992 by and among the Registrant, its institutional stockholders and certain of its management stockholders (Filed as exhibit 9.01 to the Company's Registration Statement on Form S-1 (Reg. No. 33-53618) and incorporated herein by reference) 9.02 First Amendment to Capital Re Corporation 1992 Stockholders Agreement dated December 28, 1992 (Filed as exhibit 9.03 to the Company's Annual Report on From 10-K for the fiscal year ended December 31, 1992 and incorporated herein by reference) 9.03 Modification of Credit Re Corporation Stockholders Agreement dated August 20, 1993 (Filed as Exhibit 10.31 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (Comm. File No. 1-10995) and incorporated herein by reference) * 10.01 Assumption Agreement dated as of February 3, 1988 between Capital Reinsurance and USF&G (Filed as exhibit 10.01 to the Company's Registration Statement on Form S-1 (Reg. No. 33- 45286) and incorporated herein by reference) 10.02 Credit Re Corporation Stockholders' Agreement dated February 23, 1990, as amended, by and among Credit Re Corporation and its stockholders (Filed as exhibit 10.02 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 10.03 Lease Agreements for the Company's prior principal offices at 787 Seventh Avenue, New York, New York (Filed as exhibit 10.03 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 10.04 Capital Re Corporation 1988 Stock Incentive Plan, as amended (the "1988 Plan") (Filed as exhibit 10.04 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 10.05 Form of 1988 Stock Incentive Plan Agreement (Filed as exhibit 10.05 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 10.06 Forms of Tax Equalization Loan Agreements related to 1988 Plan (Filed as exhibit 10.06 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 10.07 Form of Indemnity Agreement related to 1988 Plan (Filed as exhibit 10.07 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 10.08 1992 Stock Option Plan and related form of Non-Qualified Stock Option Agreement (Filed as exhibit 10.11 to the Company's Registration Statement on Form S-1 (Reg. No. 33- 45286) and incorporated herein by reference) 37 10.09 Facultative Reinsurance Agreement dated November 4, 1991, between Financial Guaranty Insurance Company and Capital Reinsurance Company (Filed as exhibit 10.13 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 10.10 Municipal Bond Investors Assurance Corporation Surplus Share Reinsurance Placement Slip dated January 9, 1992 by Capital Reinsurance Company (Filed as exhibit 10.14 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference)* 10.11 Agreement dated January 1, 1988 by and between Municipal Bond Investors Assurance Corporation and United States Fidelity and Guaranty Company (Filed as exhibit 10.15 to the Company's Registration Statement on Form S-1 (Reg. No. 33- 45286) and incorporated herein by reference)* 10.12 Reinsurance Memorandum No. Pima/Heron-5 USF&G dated May 20, 1991 for a Facultative Risk Cession pursuant to the Terms and Conditions of the Interests and Liabilities Contract and Treaty Effective January 1, 1990 (No. QS-2(1/1/90)) between Financial Security Assurance, Inc. and United States Fidelity and Guaranty Company (Filed as exhibit 10.16 to the Company's Registration Statement on Form S-1 (Reg. No. 33- 45286) and incorporated herein by reference)* 10.13 Facultative Reinsurance Agreement between Financial Security Assurance, Inc. and United States Fidelity and Guaranty Company dated as of May 4, 1988 (Filed as exhibit 10.17 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference)* 10.14 Interests and Liabilities Contract concerning the Quota Share Treaty between Financial Security Assurance, Inc. and Capital Reinsurance Company dated January 1, 1990, as revised (Filed as exhibit 10.18 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference)* 10.15 Interests and Liabilities Contract, dated January 9, 1992, concerning the Municipal Bond Insurance Quota Share Treaty between Financial Security Assurance, Inc. and Capital Reinsurance Company (Filed as exhibit 10.19 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference)* 10.16 1992 Municipal Quota Share Reinsurance Treaty, dated December 6, 1991, between Financial Guaranty Insurance Company and Capital Reinsurance Company (Filed as exhibit 10.20 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference)* 10.17 1991-1992 Structured Finance Quota Share Reinsurance Treaty dated November 4, 1991, between Financial Guaranty Insurance Company and Capital Reinsurance Company (Filed as exhibit 10.21 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference)* 38 10.18 1992 Pro Rata Reinsurance Agreement, dated as of January 1, 1992 between AMBAC Indemnity Corporation and Capital Reinsurance Company (Filed as exhibit 10.22 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference)* 10.19 Facultative Reinsurance Agreement, dated as of October 1, 1991, with Financial Guaranty Insurance Company (Filed as exhibit 10.22 to the Company's Registration Statement on Form S-1 (Reg. No. 33-53618) and incorporated herein by reference)* 10.20 1993 Municipal Quota Share Reinsurance Treaty dated January 20, 1993 with Financial Guaranty Insurance Company (Filed as Exhibit 10.24 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992 (Comm. File No. 1-10995) and incorporated herein by reference) * 10.21 Structured Finance Quota Share Treaty and Interest and Liabilities Contract dated February 10, 1993 with Financial Guaranty Insurance Company (Filed as Exhibit 10.25 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992 (Comm. File No. 1-10995) and incorporated herein by reference) * 10.22 First Amendment to the Interests and Liabilities Contract dated November 1, 1990 and the Municipal Bond Insurance Quota Share Treaty Attached thereto effective January 1, 1993 with Financial Security Assurance Inc. (Filed as Exhibit 10.26 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992 (Comm. File No. 1-10995) and incorporated herein by reference)* 10.23 First Amendment to the Interests and Liabilities Contract dated December 1, 1991 and the Quota Share Treaty Attached thereto effective January 1, 1992 with Financial Security Assurance Inc. (Filed as Exhibit 10.27 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992 (Comm. File No. 1-10995) and incorporated herein by reference) * 10.24 Placement Slip regarding Taxable Structured Finance Treaty effective January 1, 1993 with Municipal Bond Investors Assurance Corporation (Filed as Exhibit 10.28 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992 (Comm. File No. 1-10995) and incorporated herein by reference) * 10.25 Lease Agreement for the Company's principal office between Capital Reinsurance Company and 1325 Limited Partnership (Filed as Exhibit 10.29 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992 (Comm. File No. 1-10995) and incorporated herein by reference) * 39 10.26 Capital Re Corporation Directors' Stock Option Plan (Filed as Exhibit 10.26 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (Comm. File No. 1-10995) and incorporated herein by reference) * 10.27 1994 Pro Rata Reinsurance Placement Memorandum (including Endorsement No. 2) dated January 1, 1994, between Capital Reinsurance and AMBAC Indemnity Corporation (Filed as Exhibit 10.27 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (Comm. File No. 1-10995) and incorporated herein by reference) * 10.28 First Amendment to Interest and Liabilities Contract and Municipal Bond Quota Share Reinsurance Treaty dated January 1, 1993 between Capital Reinsurance Company and Financial Security Assurance Inc. (Filed as Exhibit 10.28 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (Comm. File No. 1-10995) and incorporated herein by reference) * 10.29 Municipal Bond Surplus Share Reinsurance Agreement (Endorsement No. 2) dated January 1, 1993 between Capital Reinsurance Company and Municipal Bond Investors Assurance Corporation (Filed as Exhibit 10.29 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (Comm. File No. 1-10995) and incorporated herein by reference) * 10.30 Taxable Structured Finance Securities Quota Share Reinsurance Placement Slip dated January 1, 1994 between Capital Reinsurance Company and Municipal Bond Investors Assurance Corporation. (Filed as Exhibit 10.30 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (Comm. File No. 1-10995) and incorporated herein by reference) 10.31 Municipal Variable Quota Share Treaty effective January 1, 1994, between Capital Reinsurance Company and Financial Guaranty Insurance Company (Filed as Exhibit 10.32 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (Comm. File No. 1-10995) and incorporated herein by reference) * 10.32 Amended and Restated Interests and Liabilities Contract and Quota Share Reinsurance Treaty, amended and restated January 1, 1994, by and between Capital reinsurance Company and Financial Security Assurance Inc. (Filed as Exhibit 10.33 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (Comm. File No. 1-10995) and incorporated herein by reference) * 10.33 First amendment Dated January 1, 1995 to Interests and Liabilities Contract and Quota Share Reinsurance Treaty as Amended and Restated January 1, 1994, by and between Capital Reinsurance Company and Financial Security Assurance Inc. (Filed as Exhibit 10.34 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (Comm. File No. 1-10995) and incorporated herein by reference) * 40 10.34 Municipal Bond Surplus Share Reinsurance Agreement (Endorsement Nos. 3 and 4) between Capital Reinsurance Company and Municipal Bond Investors Assurance Corporation (Filed as Exhibit 10.35 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (Comm. File No. 1-10995) and incorporated herein by reference) * 10.35 Taxable Structured Finance Securities Quota Share Reinsurance Agreement (Endorsements Nos. 1 and 2) between Capital Reinsurance Company and Municipal Bond Investors Assurance Corporate (Filed as Exhibit 10.36 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (Comm. File No. 1-10995) and incorporated herein by reference) * 10:36 Municipal Bond Surplus Share Reinsurance Placement Slip (1995 underwriting year) between Capital Reinsurance Company and Municipal Bond Investors Assurance Corporation. (Filed as Exhibit 10.37 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (Comm. File No. 1-10995) and incorporated herein by reference) * 10.37 Capital Re Corporation Deferred Compensation Plan. (Filed as Exhibit 10.37 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995 (Comm. File No. 1-10995) and incorporated herein by reference). 10.38 Capital Re Corporation Non-Qualified Profit Sharing Plan. (Filed as Exhibit 10.38 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995 (Comm. File No. 1-10995) and incorporated herein by reference). 10.39 Capital Re Corporation Performance Share Plan 11.01 Statement Re: Computation of Per Share Earnings 13.01 1996 Annual Report to Shareholders of Capital Re Corporation. Such report is furnished for the information of the Commission only and, except for those portions thereof which are expressly incorporated by reference in the Annual Report on Form 10-K, is not to be deemed filed as part of this Report. 22.01 Subsidiaries of Registrant 24.01 Consent of Ernst & Young LLP, Independent Auditors 25.01 Power of Attorney of the Board of Directors 27.01 Financial Data Schedule as of December 31, 1996 ___________ *Confidential treatment was afforded, or has been requested, for certain portions of these agreements (b) Reports on Form 8-K On October 9, 1996, the Company filed a Form 8-K announcing an agreement to acquire Tower Street Holdings Limited and its subsidiaries. 41 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: March 30, 1997 CAPITAL RE CORPORATION (Registrant) By:___________________ Name: Alan S. Roseman Title: Senior Vice President, General Counsel and Secretary Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Name Title Date - ---------------------- ------------------------------- --------------- Michael E. Satz* Chairman of the Board, March 30, 1997 Chief Executive Officer and President (Principal Executive Officer) David A. Buzen* Executive Vice President and March 30, 1997 Chief Financial Officer (Principal Financial and Accounting Officer) Harrison Conrad* Director March 30, 1997 Richard L. Huber* Director March 30, 1997 Steven D. Kesler* Director March 30, 1997 Steven Newman* Director March 30, 1997 Philip Robinson* Director March 30, 1997 Edwin Russell* Director March 30, 1997 Michael E. Satz* Director March 30, 1997 Dan R. Skowronski* Director March 30, 1997 Barbara Stewart* Director March 30, 1997 Jeffrey F. Stuermer* Director March 30, 1997
__________________________ *Alan S. Roseman, by signing his name hereto, does hereby sign this Annual Report on Form 10-K on behalf of each of the Directors and Officers of the Company named above pursuant to powers of attorney duly executed by such Directors and Officers and filed with the Securities and Exchange Commission as an exhibit to this report. By: ___________________________________ Alan S. Roseman, Attorney-in-fact 42 SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT - CONTINUED CAPITAL RE CORPORATION DECEMBER 31, 1996 NOTES TO CONDENSED FINANCIAL STATEMENTS The accompanying condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto of Capital Re Corporation and Subsidiaries. The Long-term debt of $74.8 million is senior unsecured debentures. See Note 7 to the consolidated financial statements of Capital Re Corporation and Subsidiaries for a description of Capital Re Corporation's debt. Of the $89.7 million intercompany balance with subsidiary, $94.9 million is a loan between the Corporation and its subsidiary, Capital Re LLC, a limited life company organized under the laws of the Turks and Caicos Islands. The $94.9 million loan consists of $75.0 million of proceeds received from the issuance of Company obligated mandatorily redeemable preferred securities of Capital Re LLC as well as the Corporation's $19.9 million common stock investment in Capital Re LLC. See Note 13 to the consolidated financial statements of Capital Re Corporation and Subsidiaries for an explanation of the loan. Also, $5.2 million is a loan between the Corporation and its subsidiary, Capital Re (UK) Holdings, whereby the Corporation loaned Capital Re (UK) Holdings $5.2 million to facilitate the purchase of RGB Holdings Ltd. See Note 1 to the consolidated financial statements of Capital Re Corporation and Subsidiaries for an explanation of the loan. The Corporation is obligated to invest under certain circumstances up to $15 million of additional capital into each of its subsidiaries, Capital Credit Reinsurance Company, Ltd. and KRE Reinsurance Ltd. SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT Capital Re Corporation December 31, 1996 (Dollars in thousands)
Condensed Balance Sheets As of As of - ------------------------ December 31, December 31, ASSETS 1996 1995 - ------------------------ ------------ ------------ Investment in affiliates $669,721 $593,284 Other assets 9,080 4,438 -------- -------- Total Assets $678,801 $597,722 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------ Long-term debt $74,781 $74,744 Subordinated notes payable 0 16,000 Bank note payable 25,000 0 Intercompany balance with affiliates 89,673 95,035 Stockholders' Equity 489,347 411,943 -------- -------- Total Liabilities and Stockholders' Equity $678,801 $597,722 ======== ======== Year Ended Year Ended Year Ended December 31, December 31, December 31, CONDENSED STATEMENTS OF INCOME 1996 1995 1994 - ------------------------------------- ------------ ------------ ------------ Revenues $183 $217 $311 Expenses 14,354 13,867 12,731 ------------ ------------ ------------ Total Operating (Loss) (14,171) (13,650) (12,420) Equity in net income of affiliates 66,086 54,132 47,002 ------------ ------------ ------------ Income before income tax (benefit) 51,915 40,482 34,582 Income tax (benefit) (4,610) (5,045) (5,224) ------------ ------------ ------------ Net Income $56,525 $45,527 $39,806 ============ ============ ============
See accompanying notes to Condensed Financial Statements 2 CAPITAL RE CORPORATION SCHEDULE IV - REINSURANCE (DOLLARS IN THOUSANDS)
Premiums Percentage Property Ceded to Assumed of Amount and Gross Other from Other Net Assumed to Liability Amount Companies Companies Amount Net - --------- ------ --------- ---------- -------- ---------- 1996 $0 $24,630 $129,818 $105,188 123.4% 1995 $0 $18,091 $107,599 $89,508 120.2% 1994 $0 $12,056 $94,851 $82,795 114.6%
3 EX-4.10 2 $25 MILLION CREDIT FACILITY Exhibit 4.10 =============================================================== CAPITAL RE CORPORATION _____________________________ CREDIT AGREEMENT Dated as of August 20, 1996 ______________________________ $25,000,000 ______________________________ THE CHASE MANHATTAN BANK, as Administrative Agent CHASE SECURITIES INC., as Arranger =============================================================== [Exhibits B-1, B-2, and C are photocopies of the opinions as delivered.] TABLE OF CONTENTS This Table of Contents is not part of the Agreement to which it is attached but is inserted for convenience of reference only. Page ----
Section 1. Definitions and Accounting Matters................ 1 1.01 Certain Defined Terms............................. 1 1.02 Accounting Terms and Determinations............... 15 1.03 Classes; Series; Types............................ 16 Section 2. Commitments, Loans, Notes and Prepayments......... 16 2.01 Loans............................................. 16 2.02 Borrowings........................................ 17 2.03 Changes in Aggregate Amount of Commitments........ 18 2.04 Commitment Fee.................................... 18 2.05 Several Obligations; Remedies Independent......... 18 2.06 Notes............................................. 18 2.07 Optional Prepayments of Loans..................... 19 2.08 Extension of Commitment Termination Date.......... 20 Section 3. Payments of Principal and Interest................ 21 3.01 Repayment of Loans................................ 21 3.02 Interest.......................................... 21 Section 4. Payments; Pro Rata Treatment; Computations; Etc... 22 4.01 Payments.......................................... 22 4.02 Pro Rata Treatment................................ 23 4.03 Computations...................................... 24 4.04 Minimum Amounts................................... 24 4.05 Certain Notices................................... 24 4.06 Non-Receipt of Funds by the Administrative Agent.. 25 4.07 Sharing of Payments, Etc.......................... 26 Section 5. Yield Protection, Etc............................. 27 5.01 Additional Costs.................................. 27 5.02 Limitation on Loans............................... 29 5.03 Illegality........................................ 30 5.04 Compensation...................................... 30 5.05 U.S. Taxes........................................ 31 5.06 Fair Allocation; Substitution of Banks............ 32 Section 6. Conditions Precedent.............................. 33 6.01 Initial Loan...................................... 33 6.02 Term Loans........................................ 35 6.03 Initial and Subsequent Loans...................... 35
Credit Agreement ---------------- Page ---- Section 7. Representations and Warranties.................... 36 7.01 Corporate Existence............................... 36 7.02 Financial Condition............................... 36 7.03 Litigation........................................ 37 7.04 No Breach......................................... 37 7.05 Action............................................ 38 7.06 Approvals......................................... 38 7.07 Margin Stock...................................... 38 7.08 ERISA............................................. 38 7.09 Taxes............................................. 38 7.10 Investment Company Act............................ 39 7.11 Public Utility Holding Company Act................ 39 7.12 Material Agreements and Liens..................... 39 7.13 Environmental Matters............................. 39 7.14 Capitalization.................................... 40 7.15 Subsidiaries, Etc................................. 40 7.16 True and Complete Disclosure...................... 41 Section 8. Covenants of the Company.......................... 41 8.01 Financial Statements; Information; Etc............ 41 8.02 Litigation........................................ 45 8.03 Existence, Etc.................................... 45 8.04 Insurance......................................... 46 8.05 Prohibition of Fundamental Changes................ 46 8.06 Limitation on Liens............................... 47 8.07 Indebtedness...................................... 49 8.08 Investments....................................... 50 8.09 Restricted Payments............................... 50 8.10 Financial Covenants............................... 51 8.11 Lines of Business................................. 51 8.12 Transactions with Affiliates...................... 51 8.13 Use of Proceeds................................... 52 8.14 Certain Obligations Respecting Subsidiaries....... 52 8.15 Modifications of Certain Documents................ 53 8.16 Ratings........................................... 53 8.17. Dividends to or Investments in the Company by Subsidiaries..................................... 53 Section 9. Events of Default................................. 53 Section 10. The Administrative Agent......................... 56 10.01 Appointment, Powers and Immunities............... 56 10.02 Reliance by Administrative Agent................. 57 10.03 Defaults......................................... 57 10.04 Rights as a Bank................................. 58 10.05 Indemnification.................................. 58 10.06 Non-Reliance on Administrative Agent and Other Banks........................................... 59
Credit Agreement ---------------- ii Page ---- 10.07 Failure to Act................................... 59 10.08 Resignation or Removal of Administrative Agent... 59 10.09 Arranger......................................... 60 Section 11. Miscellaneous.................................... 60 11.01 Waiver........................................... 60 11.02 Notices.......................................... 60 11.03 Expenses, Etc.................................... 61 11.04 Amendments, Etc.................................. 62 11.05 Successors and Assigns........................... 62 11.06 Assignments and Participations................... 62 11.07 Survival......................................... 64 11.08 Captions......................................... 64 11.09 Counterparts..................................... 65 11.10 Governing Law; Submission to Jurisdiction........ 65 11.11 Waiver of Jury Trial............................. 65 11.12 Treatment of Certain Information; Confidentiality................................. 65
SCHEDULE I - Material Agreements and Liens SCHEDULE II - Subsidiaries SCHEDULE III - Litigation EXHIBIT A-1 - Form of Revolving Credit Note EXHIBIT A-2 - Form of Term Loan Note EXHIBIT B-1 - Form of Opinion of General Counsel to the Company EXHIBIT B-2 - Form of Opinion of Special Counsel to the Company EXHIBIT C - Form of Opinion of Special New York Counsel to Chase EXHIBIT D - Form of Confidentiality Agreement EXHIBIT E - Form of Assignment and Acceptance Credit Agreement ---------------- iii CREDIT AGREEMENT dated as of August 20, 1996 among: CAPITAL RE CORPORATION, a corporation duly organized and validly existing under the laws of the State of Delaware (together with its successors and assigns, the "Company"); ------- each of the lenders named under the caption "BANKS" on the signature pages hereof (together with its successors and assigns, individually, a "Bank", ---- together, the "Banks"); and THE CHASE MANHATTAN BANK, a New York state chartered ----- banking corporation, as administrative agent for the Banks (in such capacity, together with its successors in such capacity, the "Administrative Agent"). -------------------- The Company has requested that the Banks make loans to it in an aggregate principal amount not exceeding $25,000,000 at any one time outstanding, and the Banks are prepared to make such loans upon the terms and conditions hereof. Accordingly, the parties hereto agree as follows: Section 1. Definitions and Accounting Matters. ---------------------------------- 1.01 Certain Defined Terms. As used herein, the following terms --------------------- shall have the following meanings (all terms defined in this Section 1.01 or in other provisions of this Agreement in the singular to have the same meanings when used in the plural and vice versa): ---- ----- "Affiliate" shall mean, as to any specified Person, any other Person --------- that directly or indirectly controls, or is under common control with, or is controlled by, such specified Person. As used in this definition, "control" ------- (including, with its correlative meanings, "controlled by" and "under common ------------- ------------ control with") shall mean possession, directly or indirectly, of power to direct - ------------ or cause the direction of management or policies (whether through ownership of securities or partnership or other ownership interests, by contract or otherwise), provided that, in any event, any Person that owns directly or -------- indirectly securities having 10% or more of the voting power for the election of directors or other governing body of a corporation or 10% or more of the partnership or other ownership interests of any other Person will be deemed to control such corporation or other Person. Notwithstanding the foregoing, (a) no individual shall be an Affiliate of any Person or any of its Subsidiaries solely by reason of such individual being a director, officer or employee of such Person or any of its Subsidiaries, (b) a Person and its Subsidiaries shall not be Affiliates of each other and (c) neither the Administrative Agent nor any Bank shall be an Affiliate of the Company or any of its Subsidiaries. Credit Agreement ---------------- "Applicable Insurance Regulatory Authority" shall mean, with respect ----------------------------------------- to any Insurance Subsidiary, the insurance department or similar insurance regulatory or administrative authority or agency of the jurisdiction in which such Insurance Subsidiary is domiciled. "Applicable Lending Office" shall mean, for each Bank, the "Lending ------------------------- Office" of such Bank (or of an affiliate of such Bank) designated on the signature pages hereof or such other office of such Bank (or of an affiliate of such Bank) as such Bank may from time to time specify to the Administrative Agent and the Company as the office by which its Loans are to be made and maintained. "Applicable Margin" shall mean: (a) with respect to Base Rate Loans ----------------- of any Class, 0.0%; (b) with respect to Eurodollar Loans that are Revolving Credit Loans, 0.40% per annum; and (c) with respect to Eurodollar Loans that are Term Loans, 0.50% per annum. "Bankruptcy Code" shall mean the Federal Bankruptcy Code of 1978, as --------------- amended from time to time. "Base Rate" shall mean, for any day, a rate per annum equal to the --------- higher of (a) the Federal Funds Rate for such day plus 1/2 of 1% and (b) the ---- Prime Rate for such day. Each change in any interest rate provided for herein based upon the Base Rate resulting from a change in the Base Rate shall take effect at the time of such change in the Base Rate. "Base Rate Loans" shall mean Loans that bear interest at rates based --------------- upon the Base Rate. "Basic Documents" shall mean, collectively, this Agreement and the --------------- Notes. "Business Day" shall mean any day (a) on which commercial banks are ------------ not authorized or required to close in New York City and (b) if such day relates to a borrowing of, a payment or prepayment of principal of or interest on, a Conversion of or into, or an Interest Period for, a Eurodollar Loan or a notice by the Company with respect to any such borrowing, payment, prepayment, Conversion or Interest Period, also on which dealings in Dollar deposits are carried out in the London interbank market. "Capital Credit" shall mean Capital Credit Reinsurance Company, Ltd., -------------- a Bermuda domiciled insurance company and, on the date hereof, Wholly-Owned Subsidiary of the Company. Credit Agreement ---------------- -2- "Capital Expenditures" shall mean, for any period, expenditures -------------------- (including, without limitation, the aggregate amount of Capital Lease Obligations incurred during such period) made by the Company or any of its Subsidiaries to acquire or construct fixed assets, plant and equipment (including renewals, improvements and replacements, but excluding repairs) during such period computed in accordance with GAAP. "Capital Lease Obligations" shall mean, for any Person, all ------------------------- obligations of such Person to pay rent or other amounts under a lease of (or other agreement conveying the right to use) Property to the extent such obligations are required to be classified and accounted for as a capital lease on a balance sheet of such Person under GAAP (including Statement of Financial Accounting Standards No. 13 of the Financial Accounting Standards Board), and, for purposes of this Agreement, the amount of such obligations shall be the capitalized amount thereof, determined in accordance with GAAP (including such Statement No. 13). "Capital Mortgage" shall mean Capital Mortgage Reinsurance Company, a ---------------- New York domiciled reinsurance company and, on the date hereof, Wholly-Owned Subsidiary of the Company. "Capital Mortgage Bermuda" shall mean Capital Mortgage Reinsurance ------------------------ Company (Bermuda), Ltd., a Bermuda domiciled reinsurance company and, on the date hereof, Wholly-Owned Subsidiary of the Company. "Change in Control" shall mean, with respect to the Company, the ----------------- occurrence of a state of facts where (a) any one Person, together with its Subsidiaries and Affiliates, or any "group" (within the meaning of Sections 13(d) or 14(d) of the Securities Exchange Act of 1934, as amended) acting together as a group (whether pursuant to a shareholders agreement, partnership or joint venture agreement or otherwise), other than the Existing Institutional Holders, shall own (beneficially or otherwise) 20% or more of the Voting Stock of the Company or (b) the Company is or would be required to register itself as a member of an insurance holding company system under Section 495 of the Maryland Insurance Code, or (c) the Company is or would be required under Section 494A of the Maryland Insurance Code to notify the Maryland Insurance Commissioner of a Person that controls or has acquired control of the Company, or (d) a Person has filed under Section 494 or 494A of the Maryland Insurance Code to obtain the prior approval of the Maryland Insurance Commissioner to acquire control of the Company and such approval has been obtained; provided -------- that a Change in Control shall not exist as a result of any action or state of facts referred to in clauses (b), (c) or (d) above occurring or existing prior to the date hereof. Credit Agreement ---------------- -3- "Chase" shall mean The Chase Manhattan Bank, a New York state ----- chartered banking corporation. "Class" shall have the meaning assigned to such term in Section 1.03 ----- hereof. "Closing Date" shall mean the date upon which the initial Loans ------------ hereunder are made. "Code" shall mean the Internal Revenue Code of 1986, as amended from ---- time to time. "Commitment" shall mean, as to each Bank, the obligation of such Bank ---------- to make Loans in an aggregate amount not exceeding the amount set opposite such Bank's name on the signature pages hereof under the caption "Commitment" (as the same may be reduced at any time or from time to time pursuant to Section 2.03 hereof). "Commitment Termination Date" shall mean August 19, 1997, as extended --------------------------- pursuant to Section 2.08 hereof. "Computation Date" shall have the meaning in Section 8.09 hereof. ---------------- "Consent Date" shall have the meaning assigned to such term in Section ------------ 2.08 hereof. "Continue", "Continuation" and "Continued" shall refer, in the case of -------- ------------ --------- a Term Loan, to the continuation pursuant to Section 2.09 hereof of such Term Loan as a Eurodollar Loan from one Interest Period to another. "Convert", "Conversion" and "Converted" shall refer, in the case of ------- ---------- --------- any Loan, to the conversion pursuant to Section 2.09 hereof of one Type of such Loan into another Type. "CRC" shall mean Capital Reinsurance Company, a Maryland domiciled --- reinsurance company and, on the date hereof, a Wholly-Owned Subsidiary of the Company. "CRLLC Preferred Securities" shall mean the Company obligated -------------------------- mandatorily redeemable preferred securities of Capital Re LLC, a limited life company organized under the laws of the Turks and Caicos Islands, outstanding on the date hereof. "Debentures" shall mean the 7.75% Debentures due 2002 issued by the ---------- Company pursuant to the Indenture in the aggregate principal amount of $75,000,000. Credit Agreement ---------------- -4- "Default" shall mean an Event of Default or an event that with notice ------- or lapse of time or both would become an Event of Default. "Dollars" and "$" shall mean lawful money of the United States of ------- - America. "EBIT" shall mean, for any period, for the Company and its ---- Subsidiaries (determined on a consolidated basis without duplication in accordance with GAAP), the sum of income before provision for income taxes for such period plus Interest Expense for such period minus net realized gains (or, ---- ----- in the case of net realized losses, plus the amount of such losses) for such ---- period. "Equity Rights" shall mean, with respect to any Person, any ------------- outstanding subscriptions, options, warrants, commitments, preemptive rights or agreements of any kind (including, without limitation, any stockholders' or voting trust agreements) for the issuance, sale, registration or voting of, or outstanding securities convertible into, any additional shares of capital stock of any class, or partnership or other ownership interests of any type in, such Person. "ERISA" shall mean the Employee Retirement Income Security Act of ----- 1974, as amended from time to time. "ERISA Affiliate" shall mean any corporation or trade or business that --------------- is a member of any group of organizations (a) described in Section 414(b) or (c) of the Code of which the Company is a member and (b) solely for purposes of potential liability under Section 302(c)(11) of ERISA and Section 412(c)(11) of the Code and the lien created under Section 302(f) of ERISA and Section 412(n) of the Code, described in Section 414(m) or (o) of the Code of which the Company is a member. "Eurodollar Base Rate" shall mean, with respect to any Eurodollar Loan -------------------- for any Interest Period therefor, the rate per annum (rounded upwards, if necessary, to the nearest 1/16 of 1%), as determined by the Administrative Agent to be equal to the rate per annum reported on display screen designated Page 3750 on Telerate Access Service (or such other display screen as may replace Page 3750 on Telerate Access Service) at approximately 11:00 a.m. (London time) (or as soon thereafter as practicable) on the date two Business Days prior to the first day of such Interest Period for Dollar deposits in the London interbank market having a term comparable to such Interest Period. If Telerate Access Service is not available on such second Business Day prior to the commencement of an Interest Period, the Eurodollar Base Rate for such Interest Period shall equal the Credit Agreement ---------------- -5- rate per annum (rounded upwards, if necessary, to the nearest 1/16 of 1%) quoted by Chase at approximately 11:00 a.m. (London time) (or as soon thereafter as practicable) on the date that two Business Days prior to the first day of such Interest Period for the offering by Chase to leading banks in the London interbank market of Dollar deposits having a term comparable to such Interest Period and in an amount comparable to the principal amount of the Eurodollar Loan to be made by Chase for such Interest Period. "Eurodollar Loans" shall mean Loans that bear interest at rates based ---------------- upon the Eurodollar Rate. "Eurodollar Rate" shall mean, for any Eurodollar Loan for any Interest --------------- Period therefor, a rate per annum (rounded upwards, if necessary, to the nearest 1/100 of 1%) determined by the Administrative Agent to be equal to the quotient of (a) the Eurodollar Base Rate for such Eurodollar Loan for such Interest Period divided by (b) the sum of (i) 1 minus (ii) the Reserve Requirement for ---------- ----- such Eurodollar Loan for such Interest Period. "Event of Default" shall have the meaning assigned to such term in ---------------- Section 9 hereof. "Existing Commitment Termination Date" shall have the meaning assigned ------------------------------------ to such term in Section 2.08 hereof. "Existing Institutional Holder" shall mean Minnesota Power & Light ----------------------------- Company, Constellation Investments, Inc., J.P. Morgan & Co., and their respective Subsidiaries and Affiliates. "Federal Funds Rate" shall mean, for any day, the rate per annum ------------------ (rounded upwards, if necessary, to the nearest 1/100 of 1%) equal to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers on such day, as published by the Federal Reserve Bank of New York on the Business Day next succeeding such day, provided that (a) if the day for which such rate is to -------- be determined is not a Business Day, the Federal Funds Rate for such day shall be such rate on such transactions on the next preceding Business Day as so published on the next succeeding Business Day and (b) if such rate is not so published for any Business Day, the Federal Funds Rate for such Business Day shall be the average rate charged to Chase on such Business Day on such transactions as reasonably determined by the Administrative Agent. "Fitch" shall mean Fitch Investors Service, L.P., or any successor ----- thereto. Credit Agreement ---------------- -6- "Funded Debt" shall mean Indebtedness of the Company and its ----------- Subsidiaries which by its terms becomes payable more than one year from the date of origination thereof or which is renewable at the option of the Company or any of its Subsidiaries beyond one year from the date of such origination. "GAAP" shall mean the generally accepted accounting principles which, ---- in accordance with Section 1.02(a) hereof, are to be used in preparing financial statements on the basis of which are to be made the calculations for purposes of determining compliance with the financial covenants in this Agreement. "Guarantee" shall mean a guarantee, an endorsement, a contingent --------- agreement to purchase or to furnish funds for the payment or maintenance of, or otherwise to be or become contingently liable under or with respect to, the Indebtedness, other obligations, net worth, working capital or earnings of any Person, or a guarantee of the payment of dividends or other distributions upon the stock or equity interests of any Person, or an agreement to purchase, sell or lease (as lessee or lessor) Property, products, materials, supplies or services primarily for the purpose of enabling a debtor to make payment of such debtor's obligations or an agreement to assure a creditor against loss, and including, without limitation, causing a bank or other financial institution to issue a letter of credit or other similar instrument for the benefit of another Person, but excluding endorsements for collection or deposit in the ordinary course of business; provided that the term Guarantee shall not include (i) any -------- financial guaranty insurance, credit insurance, mortgage insurance or residual value insurance (or any reinsurance of the same), or similar or related products, issued by any Insurance Subsidiary in the ordinary course of its business or (ii) guarantees issued by the Company to support insurance products referred to in clause (i) above. The terms "Guarantee" and "Guaranteed" used as --------- ---------- a verb shall have a correlative meaning. "Indebtedness" shall mean, for any Person: (a) obligations created, ------------ issued or incurred by such Person for borrowed money (whether by loan, the issuance and sale of debt securities or the sale of Property to another Person subject to an understanding or agreement, contingent or otherwise, to repurchase such Property from such Person); (b) all Redeemable Preferred Stock issued by such Person; (c) obligations of such Person to pay the deferred purchase or acquisition price of Property or services, other than trade accounts payable (other than for borrowed money) arising, and accrued expenses incurred, in the ordinary course of business so long as such trade accounts payable are payable within 90 days of the date the respective goods are delivered or the respective services are rendered; Credit Agreement ---------------- -7- (d) Indebtedness of others secured by a Lien on the Property of such Person, whether or not the respective Indebtedness so secured has been assumed by such Person; (e) obligations (contingent or otherwise) of such Person in respect of letters of credit, bankers' acceptances or similar instruments issued or accepted by banks and other financial institutions for account of such Person; (f) Capital Lease Obligations of such Person; and (g) Guarantees by such Person of Indebtedness of others; provided that the term Indebtedness shall not include -------- (i) insurance policies, guarantees and other instruments issued or sold in the ordinary course of the insurance business of any Insurance Subsidiary, (ii) liabilities or obligations arising in the ordinary course of the investment activities of any Insurance Subsidiary that have a maturity of 90 days or less, (iii) obligations in respect of letters of credit issued for account of any Insurance Subsidiary as part of a reinsurance arrangement consistent with industry practices and in the ordinary course of business and (iv) accrued profit commissions. "Indenture" shall mean the Indenture dated as of November 1, 1992, --------- between the Company and Morgan Guaranty Trust Company of New York, as in effect on the date hereof providing for the issuance of the Debentures. "Insurance Subsidiaries" shall mean CRC, Capital Mortgage, Capital ---------------------- Mortgage Bermuda and Capital Credit and any other Subsidiary of the Company that is licensed to do an insurance business by an Applicable Insurance Regulatory Authority. "Interest Coverage Ratio" shall mean, for any period, the ratio of (a) ----------------------- EBIT for such period to (b) Interest Expense for such period. "Interest Expense" shall mean, for any period, the sum, for the ---------------- Company and its Subsidiaries (determined on a consolidated basis without duplication in accordance with GAAP), of the following: (a) all interest in respect of Indebtedness accrued or capitalized during such period (whether or not actually paid during such period) plus (b) the net amounts payable (or minus ---- ----- the net amounts receivable) under Interest Rate Protection Agreements accrued during such period (whether or not actually paid or received during such period). "Interest Period" shall mean (a) with respect to any Eurodollar Loan, --------------- each period commencing on the date such Loan is made or Converted from a Base Rate Loan or, in the case of a Term Loan, the last day of the next preceding Interest Period for such Loan and ending on the numerically corresponding day in the first, second or third calendar month thereafter, as the Company Credit Agreement ---------------- -8- may select as provided in Section 4.05 hereof, except that each Interest Period that commences on the last Business Day of a calendar month (or on any day for which there is no numerically corresponding day in the appropriate subsequent calendar month) shall end on the last Business Day of the appropriate subsequent calendar month; and (b) with respect to any Base Rate Loan, the period commencing on the date such Base Rate Loan is made or Converted from a Eurodollar Loan or, in the case of a Term Loan, the last day of the next preceding Interest Period for such Base Rate Loan and ending on (i) the earlier of the first Quarterly Date thereafter or the Commitment Termination Date (in the case of a Revolving Credit Loan) or (ii) the next Principal Payment Date (in the case of a Term Loan). Notwithstanding the foregoing: (i) the Company may not select any Interest Period for any Revolving Credit Loan that ends after the Commitment Termination Date; (ii) no Interest Period for any Series of Term Loans may commence before and end after any Principal Payment Date for such Series of Term Loans unless, after giving effect thereto, the aggregate principal amount of Term Loans of such Series having Interest Periods that end after such Principal Payment Date shall be equal to or less than the aggregate principal amount of such Term Loans scheduled to be outstanding after giving effect to the payments of principal required to be made on such Principal Payment Date; and (iii) each Interest Period that would otherwise end on a day which is not a Business Day shall end on the next succeeding Business Day (or, if such next succeeding Business Day falls in the next succeeding calendar month, on the next preceding Business Day). "Interest Rate Protection Agreement" shall mean, for any Person, an ---------------------------------- interest rate swap, cap or collar agreement or similar arrangement between such Person and one or more financial institutions providing for the transfer or mitigation of interest risks either generally or under specific contingencies. "Investment" shall mean, for any Person: (a) the acquisition (whether ---------- for cash, Property, services or securities or otherwise) of capital stock, bonds, notes, debentures, partnership or other ownership interests or other securities of any other Person or any agreement to make any such acquisition (including, without limitation, any "short sale" or any sale of any securities at a time when such securities are not owned by the Person entering into such short sale); (b) the making of any deposit with, or advance, loan or other extension of credit to, any other Person (including the purchase of Property from another Person subject to an understanding or agreement, contingent or otherwise, to resell such Property to such Person, but excluding any such advance, loan or extension of credit having a term not exceeding 90 days representing the purchase price of inventory or supplies sold by such Person in the ordinary course of business) Credit Agreement ---------------- -9- and (without duplication) the entering into of any commitment to deposit funds with, advance or lend funds to or otherwise extend credit to such Person; (c) the entering into of any Guarantee of Indebtedness of any other Person; or (d) the entering into of any Interest Rate Protection Agreement; provided that the term "Investment" shall not include (i) the ownership interest of the Company and its Subsidiaries in the equity of any Subsidiary of the Company or (ii) any capital contribution or loan by the Company or by any Wholly Owned Subsidiary of the Company to the Company or to any Wholly Owned Subsidiary of the Company. "Lien" shall mean, with respect to any Property, any mortgage, lien, ---- pledge, charge, security interest or encumbrance of any kind in respect of such Property. For purposes of this Agreement and the other Basic Documents, a Person shall be deemed to own subject to a Lien any Property that it has acquired or holds subject to the interest of a vendor or lessor under any conditional sale agreement, capital lease or other title retention agreement (other than an operating lease) relating to such Property. "Loans" shall mean the Revolving Credit Loans and the Term Loans. ----- "Majority Banks" shall mean Banks having more than 50% of the -------------- aggregate amount of the Commitments or, if the Commitments shall have terminated, Banks holding more than 50% of the aggregate unpaid principal amount of the Loans. "Margin Stock" shall mean "margin stock" within the meaning of ------------ Regulations U and X. "Material Adverse Effect" shall mean a material adverse effect on (a) ----------------------- the Property, business, operations, financial condition, liabilities or capitalization of the Company and its Subsidiaries taken as a whole, (b) the ability of the Company to perform its obligations under any of the Basic Documents, (c) the validity or enforceability of any of the Basic Documents, (d) the rights and remedies of the Banks and the Administrative Agent under any of the Basic Documents or (e) the timely payment of the principal of or interest on the Loans or other amounts payable in connection therewith. "Material Subsidiary" shall mean all Subsidiaries of the Company other ------------------- than Credit Re Corporation, Capital Credit, Capital Re Management Corporation and Capital Title Reinsurance Company. "Moody's" shall mean Moody's Investors Service, Inc., or any successor ------- thereto. Credit Agreement ---------------- -10- "Multiemployer Plan" shall mean a multiemployer plan defined as such ------------------ in Section 3(37) of ERISA to which contributions have been made by the Company or any ERISA Affiliate and which is covered by Title IV of ERISA. "Net Worth" shall mean, as at any date, the sum, for the Company and --------- its Subsidiaries (determined on a consolidated basis without duplication in accordance with GAAP), of the following: (a) the amount of capital stock (other than any Redeemable Preferred Stock), plus ---- (b) the amount of additional paid-in capital and retained earnings (or, in the case of a retained earnings deficit, minus the amount of such ----- deficit), minus ----- (c) the amount of net unrealized gain on fixed maturity securities available for sale (or, in the case of a net unrealized loss, plus the ---- amount of such loss). "Notes" shall mean the Revolving Credit Notes and the Term Loan Notes. ----- "PBGC" shall mean the Pension Benefit Guaranty Corporation or any ---- entity succeeding to any or all of its functions under ERISA. "Person" shall mean any individual, corporation, company, voluntary ------ association, partnership, joint venture, trust, unincorporated organization or government (or any agency, instrumentality or political subdivision thereof). "Plan" shall mean an employee benefit or other plan established or ---- maintained by the Company or any ERISA Affiliate and that is covered by Title IV of ERISA, other than a Multiemployer Plan. "Post-Default Rate" shall mean, in respect of any principal of any ----------------- Loan or any other amount under this Agreement, any Note or any other Basic Document that is not paid when due (whether at stated maturity, by acceleration, by optional or mandatory prepayment or otherwise), a rate per annum during the period from and including the due date to but excluding the date on which such amount is paid in full equal to 2% plus the Base Rate as in effect from time to ---- time (provided that, if the amount so in default is principal of a Loan and the -------- due date thereof is a day other than the last day of the Interest Period therefor, the "Post-Default Rate" for such principal shall be, for the period from and including such due date to but excluding the last Credit Agreement ---------------- -11- day of such Interest Period, the greater of (i) 2% plus the interest rate for ---- such Loan as provided in Section 3.02(b) hereof or (ii) 2% plus the Base Rate as ---- in effect from time to time and, thereafter, the rate provided for above in this definition). "Prime Rate" shall mean the rate of interest from time to time ---------- announced by Chase at the Principal Office as its prime commercial lending rate. "Principal Office" shall mean the principal office of Chase, located ---------------- on the date hereof at 270 Park Avenue, New York, New York 10017. "Principal Payment Date" shall have the meaning assigned to such term ---------------------- in Section 3.01(b) hereof. "Property" shall mean any right or interest in or to property of any -------- kind whatsoever, whether real, personal or mixed and whether tangible or intangible. "Quarterly Dates" shall mean the last Business Day of each March, --------------- June, September and December in each year, the first of which shall be the first such day after the date of this Agreement. "Rating" shall mean, with respect to any Insurance Subsidiary, the ------ claims-paying rating for such Insurance Subsidiary assigned by Moody's or S&P. "Redeemable Preferred Stock" shall mean, for any Person, all preferred -------------------------- or preference stock issued by such Person that is by its terms mandatorily redeemable, or is redeemable at the option of the holder, within 20 years of its date of issuance. "Regulation A", "Regulation D", "Regulation U" and "Regulation X" ------------ ------------ ------------ ------------ shall mean, respectively, Regulation A, Regulation D, Regulation U and Regulation X of the Board of Governors of the Federal Reserve System (or any successor), as the same may be modified and supplemented and in effect from time to time. "Regulatory Change" shall mean, with respect to any Bank, any change ----------------- after the date of this Agreement in Federal, state or foreign law or regulations (including, without limitation, Regulation D) or the adoption or making after such date of any interpretation, directive or request applying to a class of banks including such Bank of or under any Federal, state or foreign law or regulations (whether or not having the force of Credit Agreement ---------------- -12- law and whether or not failure to comply therewith would be unlawful) by any court or governmental or monetary authority charged with the interpretation or administration thereof. "Reserve Requirement" shall mean, for any Interest Period for any ------------------- Loan, the average maximum rate at which reserves (including, without limitation, any marginal, supplemental or emergency reserves) are required to be maintained during such Interest Period under Regulation D by member banks of the Federal Reserve System in New York City with deposits exceeding one billion Dollars against "Eurocurrency liabilities" (as such term is used in Regulation D). Without limiting the effect of the foregoing, the Reserve Requirement shall include any other reserves required to be maintained by such member banks by reason of any Regulatory Change with respect to (i) any category of liabilities that includes deposits by reference to which the Eurodollar Base Rate is to be determined as provided in the definition of "Eurodollar Base Rate" in this Section 1.01 or (ii) any category of extensions of credit or other assets that includes the Loans. "Restricted Payment" shall mean dividends (in cash, Property or ------------------ obligations) on, or other payments or distributions on account of, or the setting apart of money for a sinking or other analogous fund for, or the purchase, redemption, retirement or other acquisition of, any shares of any class of stock of the Company or of any warrants, options or other rights to acquire the same (or to make any payments to any Person, such as "phantom stock" payments, where the amount thereof is calculated with reference to the fair market or equity value of the Company or any of its Subsidiaries), but excluding (i) dividends payable solely in shares of common stock of the Company and (ii) cash payments made pursuant to the Company's Performance Share Plan (Effective July 1, 1996), as amended from time to time, or any similar employee compensation plan. "Revolving Credit Loans" shall mean the loans provided for by Section ---------------------- 2.01(a) hereof. "Revolving Credit Notes" shall mean the promissory notes provided for ---------------------- by Section 2.06(a) hereof and all promissory notes delivered in substitution or exchange therefor, in each case as the same shall be modified and supplemented and in effect from time to time. "SEC ICA Regulations" shall mean the Regulations issued by the ------------------- Securities and Exchange Commission under the Investment Company Act of 1940, as amended, as in effect on the date hereof. Credit Agreement ---------------- -13- "Series" shall have the meaning assigned to such term in Section 1.03 ------ hereof. "S&P" shall mean Standard & Poor's Ratings Services, a division of The --- McGraw Hill Companies, Inc., or any successor thereto. "Statutory Statement" shall mean, as to any Insurance Subsidiary, a ------------------- statement of the condition and affairs of such Insurance Subsidiary, prepared in accordance with statutory accounting practices required or permitted by the Applicable Insurance Regulatory Authority, and filed with the Applicable Insurance Regulatory Authority. "Subsidiary" shall mean, with respect to any Person, any corporation, ---------- partnership or other entity of which at least a majority of the securities or other ownership interests having by the terms thereof ordinary voting power to elect a majority of the board of directors or other persons performing similar functions of such corporation, partnership or other entity (irrespective of whether or not at the time securities or other ownership interests of any other class or classes of such corporation, partnership or other entity shall have or might have voting power by reason of the happening of any contingency) is at the particular time in question directly or indirectly owned or controlled by such Person or one or more Subsidiaries of such Person or by such Person and one or more Subsidiaries of such Person. "Tangible Net Worth" shall mean, as at any date, the sum for the ------------------ Company and its Subsidiaries (determined on a consolidated basis without duplication in accordance with GAAP), of the following: (a) Net Worth, minus ----- (b) the sum of the following (without duplication of deductions in respect of items already deducted in arriving at Net Worth): cost of treasury shares and the book value of all assets which should be classified as intangibles but in any event including goodwill, minority interests, trademarks, trade names, copyrights, patents and franchises, unamortized debt discount and expense, deferred acquisition costs and any write-up in the book value of assets resulting from a revaluation thereof subsequent to December 31, 1995. "Term Loan Notes" shall mean the promissory notes provided for by --------------- Section 2.06(b) hereof and all promissory notes delivered in substitution or exchange therefor, in each case as Credit Agreement ---------------- -14- the same shall be modified and supplemented and in effect from time to time. "Term Loans" shall mean the loans provided for by Section 2.01(b) ---------- hereof. "Total Capitalization" shall mean the sum of (a) Funded Debt, (b) the -------------------- CRLLC Preferred Securities and (c) Net Worth. "Type" shall have the meaning assigned to such term in Section 1.03 ---- hereof. "Voting Stock" shall mean, at any date, the capital stock of any class ------------ or classes of a corporation having general voting power under ordinary circumstances to elect the board of directors of such corporation, or persons performing similar functions (irrespective of whether or not at the time stock or other securities of any other class or classes shall have or might have special voting power or rights by reason of the happening of any contingency). "Wholly-Owned Subsidiary" shall mean, with respect to any Person, any ----------------------- Subsidiary of such Person all of the equity securities or other ownership interests (other than, in the case of a corporation, directors' qualifying shares) of which are owned or controlled by such Person or one or more Wholly- Owned Subsidiaries of such Person. 1.02 Accounting Terms and Determinations. ----------------------------------- (a) Except as otherwise expressly provided herein, (i) all accounting terms used herein shall be interpreted, (ii) all financial statements and all certificates and reports as to financial matters required to be delivered to the Banks hereunder shall (unless otherwise disclosed to the Banks in writing at the time of delivery thereof in the manner described in subsection (b) below) be prepared and (iii) all calculations made for the purposes of determining compliance with this Agreement shall (except as otherwise expressly provided herein) be made in accordance with or by application of generally accepted accounting principles or statutory accounting practices, as the case may be, applied on a basis consistent with those used in the preparation of the most recent financial statements furnished to the Banks hereunder (or, prior to the delivery of the first financial statements under Section 8.01 hereof, the financial statements as at December 31, 1995 referred to in Section 7.02 hereof) unless (x) the Company shall notify the Banks of its objection thereto at the time of delivery of any financial statements pursuant to Section 8.01 hereof or (y) the Majority Banks shall notify the Company (through the Credit Agreement ---------------- -15- Administrative Agent) of their objection within 30 days after the delivery of any such financial statements, in either of which events such interpretations, statements, certificates, reports and calculations shall be made in accordance with, or by application of, generally accepted accounting principles or statutory accounting practices, as the case may be, on a basis consistent with those used in the preparation of the most recent financial statements as to which no such objection shall have been made (or, prior to the delivery of the first financial statements under Section 8.01 hereof, the financial statements as at December 31, 1995 referred to in Section 7.02 hereof). (b) The Company shall deliver to the Banks at the same time as the delivery of any annual or quarterly financial statement under Section 8.01 hereof (i) an identification of any material variation between the application of accounting principles employed in the preparation of such statement and the application of accounting principles employed in the preparation of the next preceding annual or quarterly financial statements as to which no objection has been made in accordance with the last sentence of paragraph (a) above and (ii) within five Business Days of the request of the Administrative Agent, reasonable estimates of the difference between such statements arising as a consequence thereof. (c) The Company will not, and will not permit any of its Subsidiaries to, change the last day of its fiscal year from December 31 of each year, or the last days of the first three fiscal quarters in each of its fiscal years from March 31, June 30 and September 30 of each year, respectively. 1.03 Classes; Series; Types. Loans hereunder are distinguished by ---------------------- "Class" and by "Type". The "Class" of a Loan refers to whether such Loan is a Revolving Credit Loan or a Term Loan, each of which constitutes, respectively, a "Class" of Loan. The "Type" of a Loan refers to whether such Loan is a Base Rate Loan or a Eurodollar Loan, each of which constitutes a "Type" of Loan. Loans are also distinguished by "Series". The Loans of any one Class made on the occasion of any borrowing constitute a "Series" of Loans. Section 2. Commitments, Loans, Notes and Prepayments. ----------------------------------------- 2.01 Loans. ----- (a) Revolving Credit Loans. Each Bank severally agrees, on the terms ---------------------- and conditions of this Agreement, at the request of the Company, to make revolving credit loans to the Company in Dollars during the period from and including the date hereof to but not including the Commitment Termination Date in an Credit Agreement ---------------- -16- aggregate principal amount at any one time outstanding up to but not exceeding the amount of the Commitment of such Bank as in effect from time to time (each such revolving credit loan being herein called a "Revolving Credit Loan" and --------------------- collectively the "Revolving Credit Loans"); provided that in no event shall the ---------------------- aggregate unpaid principal amount of all Revolving Credit Loans, together with the aggregate unpaid principal amount of all Term Loans, exceed the aggregate amount of the Commitments as in effect from time to time. Subject to the terms and conditions of this Agreement, during such period the Company may borrow, repay and reborrow the amount of the Commitments. (b) Term Loans. Each Bank severally agrees, on the terms and ---------- conditions of this Agreement, at the request of the Company, to make, on the maturity of any Revolving Credit Loan made by such Bank, a term loan (each such term loan being herein called a "Term Loan" and collectively the "Term Loans") --------- ---------- to the Company in Dollars in a principal amount up to but not exceeding the unpaid principal balance of such Revolving Credit Loan, the proceeds of which Term Loan shall be applied (and the Company hereby authorizes and instructs such Bank to apply such proceeds) to refinance, in whole or in part, the unpaid principal balance of such Revolving Credit Loan; provided that the Banks shall not be obligated to make any Series of Term Loans unless the aggregate principal amount of such Term Loans is equal to $5,000,000 or an integral multiple of $500,000 in excess thereof. (c) Limit on Revolving Credit Loans. No more than five separate ------------------------------- Revolving Credit Loans from each Bank may be outstanding at any one time. 2.02 Borrowings. The Company shall give the Administrative Agent ---------- (which shall promptly notify the Banks) notice of each borrowing hereunder as provided in Section 4.05 hereof. Not later than 2:00 p.m. New York time on the date specified for each borrowing of Revolving Credit Loans hereunder, each Bank shall make available the amount of the Revolving Credit Loan to be made by it on such date to the Administrative Agent, at an account designated by the Administrative Agent, in Dollars and immediately available funds, for account of the Company. The amount so received by the Administrative Agent shall, subject to the terms and conditions of this Agreement, be made available by the Administrative Agent to the Company by depositing the same, in immediately available funds, in an account of the Company maintained with Chase at the Principal Office designated by the Company. Credit Agreement ---------------- -17- 2.03 Changes in Aggregate Amount of Commitments. ------------------------------------------ (a) The aggregate amount of the Commitments shall be automatically reduced to zero on the Commitment Termination Date. (b) The Company shall have the right at any time or from time to time to terminate in whole, or to reduce in part, the aggregate unused amount of the Commitments; provided that (x) the Company shall give notice of each such -------- termination or reduction as provided in Section 4.05 hereof and (y) each partial reduction shall be in an integral multiple of $1,000,000. (c) The Commitments, once terminated or reduced, may not be reinstated. 2.04 Commitment Fee. The Company shall pay to the Administrative -------------- Agent for account of each Bank a commitment fee on the daily average unused amount of such Bank's Commitment (for which purpose the aggregate unpaid principal amount of the Revolving Credit Loans and Term Loans outstanding shall be deemed to constitute a use of the Commitments), for the period from and including the date of this Agreement to but not including the earlier of the Commitment Termination Date and the date such Commitment is otherwise terminated, at a rate per annum equal to 1/8 of 1%. Accrued commitment fee shall be payable on each Quarterly Date and on the earlier of the Commitment Termination Date and the date the Commitment is otherwise terminated, as the case may be. 2.05 Several Obligations; Remedies Independent. The failure of any ----------------------------------------- Bank to make any Loan to be made by it on the date specified therefor shall not relieve any other Bank of its obligation to make its Loan on such date, but neither any Bank nor the Administrative Agent shall be responsible for the failure of any other Bank to make a Loan to be made by such other Bank, and no Bank shall have any obligation to the Administrative Agent or any other Bank for the failure by such Bank to make any Loan required to be made by such Bank. The amounts payable by the Company at any time hereunder and under the Notes to each Bank shall be a separate and independent debt and each Bank shall be entitled to protect and enforce its rights arising out of this Agreement and the Notes, and it shall not be necessary for any other Bank or the Administrative Agent to consent to, or be joined as an additional party in, any proceedings for such purposes. 2.06 Notes. ----- (a) The Revolving Credit Loans made by each Bank shall be evidenced by a single promissory note of the Company Credit Agreement ---------------- -18- substantially in the form of Exhibit A-1 hereto, dated the date hereof, payable to such Bank in a principal amount equal to the amount of its Commitment as originally in effect and otherwise duly completed. (b) Each Term Loan made by each Bank shall be evidenced by a separate promissory note of the Company substantially in the form of Exhibit A-2 hereto, dated the date of such Term Loan, payable to such Bank in a principal amount equal to the amount of such Term Loan and otherwise duly completed. (c) The date, amount, interest rate and duration of Interest Period of each Revolving Credit Loan made by each Bank to the Company, and each payment made on account of the principal thereof, shall be recorded by such Bank on its books and, prior to any transfer of the Revolving Credit Note evidencing the Revolving Credit Loans held by it, endorsed by such Bank on the schedule attached to such Revolving Credit Note or any continuation thereof; provided -------- that the failure of such Bank to make any such recordation or endorsement shall not affect the obligations of the Company to make a payment when due of any amount owing hereunder or under such Revolving Credit Note in respect of the Revolving Credit Loans evidenced by such Revolving Credit Note. (d) No Bank shall be entitled to have its Notes subdivided, by exchange for promissory notes of lesser denominations or otherwise, except in connection with a permitted assignment of all or any portion of such Bank's relevant Commitment, Loans and Notes pursuant to Section 11.06(b) hereof. 2.07 Optional Prepayments of Loans. Subject to Section 4.04 hereof, ----------------------------- the Company shall have the right to prepay any Series of Revolving Credit Loans or any Series of Term Loans, in whole at any time or in part from time to time, provided that: - -------- (a) the Company shall give the Administrative Agent notice of each such prepayment as provided in Section 4.05 hereof (and, upon the prepayment date specified in any such notice of prepayment, the amount to be prepaid shall become due and payable hereunder); (b) the Company shall simultaneously pay interest on any principal so prepaid accrued to the date of such prepayment; (c) if any Eurodollar Loan is prepaid on any day other than the last day of the Interest Period therefor, the Credit Agreement ---------------- -19- Company shall simultaneously pay any amounts required by Section 5.04 hereof in respect of such prepayment; and (d) prepayments of any Series of Term Loans shall be in minimum amounts of $1,000,000 and shall be applied ratably to the outstanding installments of such Series of Term Loans. 2.08 Extension of Commitment Termination Date. The Company may, by ---------------------------------------- notice to the Administrative Agent (which shall promptly deliver a copy thereof to each of the Banks) not more than 90 days, nor fewer than 60 days, prior to the Commitment Termination Date then in effect hereunder (the "Existing -------- Commitment Termination Date"), request that the Banks extend the Commitment - --------------------------- Termination Date for an additional 360 day period. If each Bank, acting in its sole discretion, by notice to the Company and Administrative Agent given on the date (and only on the date) 30 days prior to the Existing Commitment Termination Date (provided, if such date is not a Business Day, then such notice date shall by the next succeeding Business Day) (the "Consent Date"), agrees to such ------------ request, then effective as of the Existing Commitment Termination Date, the Commitment Termination Date shall be extended to the date falling 360 days after the Consent Date (provided, if such date is not a Business Day, then such Commitment Termination Date as so extended shall be the next preceding Business Day); provided that such extension shall not be effective unless (i) no Default shall have occurred and be continuing on the date of the notice requesting such extension or on the Existing Commitment Termination Date and (ii) each of the representations and warranties of the Company in Section 7 hereof shall be true and correct on and as of each of the date of such notice and the Existing Commitment Termination Date with the same force and effect as if made on and as of each such date (or, if any such representation or warranty is expressly stated to have been made as of a specific date, as of such specific date). 2.09 Conversion or Continuations of Loans. Subject to Section 4.04 ------------------------------------ hereof, the Company shall have the right to Convert Loans of one Type into Loans of another Type or to Continue Term Loans of one Type as Term Loans of the same Type at any time or from time to time; provided that (a) the Company shall give -------- the Administrative Agent notice of each such Conversion or Continuation as provided in Section 4.05 hereof; (b) if Eurodollar Loans are Converted into Base Rate Loans on any day other than the last day of the Interest Period therefor, the Company shall simultaneously pay any amounts required by Section 5.04 hereof in respect of such Conversion; and (c) the Company shall simultaneously pay interest on the principal of any Loan Converted from a Loan of one Type to a Loan of another Type accrued to the date of such Conversion. Credit Agreement ---------------- -20- Section 3. Payments of Principal and Interest. ---------------------------------- 3.01 Repayment of Loans. ------------------ (a) The Company hereby promises to pay to the Administrative Agent for account of each Bank the outstanding principal amount of each of such Bank's Revolving Credit Loans, and each Revolving Credit Loan shall mature, on the last day of the Interest Period therefor. (b) The Company hereby promises to pay to the Administrative Agent for account of the Banks the aggregate principal amount of each Series of Term Loans in sixteen equal consecutive quarterly installments commencing on the date three months after the date of the making of such Series of Term Loans and thereafter on the quarterly anniversary dates of the date of the making of such Series of Term Loans (each a "Principal Payment Date"); provided that, if the ---------------------- date of the making of such Series of Term Loans is the last Business Day of a calendar month (or on any day for which there is no numerically corresponding date in the appropriate subsequent calendar month) the payment date shall be the last Business Day of the appropriate subsequent calendar month; and provided that, if any Principal Payment Date would fall on a day other than a Business Day, such Principal Payment Date shall be the next succeeding Business Day (or, if such next succeeding Business Day falls in the next succeeding calendar month, on the next preceding Business Day). 3.02 Interest. The Company hereby promises to pay to the -------- Administrative Agent for account of each Bank interest on the unpaid principal amount of each Loan made by such Bank for the period from and including the date of such Loan to but excluding the date such Loan shall be paid in full, at the following rates per annum: (a) during such periods as such Loan is a Base Rate Loan, for each Interest Period relating thereto, the Base Rate for such Loan; and (b) during such periods as such Loan is a Eurodollar Loan, for each Interest Period relating thereto, the Eurodollar Rate for such Loan for such Interest Period plus the Applicable Margin; ---- Notwithstanding the foregoing, the Company hereby promises to pay to the Administrative Agent for account of each Bank interest at the applicable Post- Default Rate on any principal of any Loan made by such Bank and on any other amount payable by the Company hereunder or under the Notes held by such Bank to or for account of such Bank, which shall not be paid in full when due (whether Credit Agreement ---------------- -21- at stated maturity, by acceleration, by mandatory prepayment or otherwise), for the period from and including the due date thereof to but excluding the date the same is paid in full. Accrued interest on each Loan shall be payable (i) on the last day of each Interest Period therefor and, if such Interest Period is longer than three months, at three-month intervals following the first day of such Interest Period, and (ii) upon the payment or prepayment or Conversion thereof (but only on the principal amount so paid or prepaid or Converted), except that interest payable at the Post-Default Rate shall be payable from time to time on demand of the Banks for whose account such interest is payable. Promptly after the determination of any interest rate provided for herein or any change therein, the Administrative Agent shall give notice thereof to the Banks to which such interest is payable and to the Company. Section 4. Payments; Pro Rata Treatment; Computations; Etc. ------------------------------------------------ 4.01 Payments. -------- (a) Except to the extent otherwise provided herein, all payments of principal, interest and other amounts to be made by the Company under this Agreement and the Notes, and, except to the extent otherwise provided therein, all payments to be made by the Company under any other Basic Document, shall be made in Dollars, in immediately available funds, without deduction, set-off or counterclaim, to the Administrative Agent at an account designated by the Administrative Agent with Chase at the Principal Office, not later than 2:00 p.m. New York time on the date on which such payment shall become due (each such payment made after such time on such due date to be deemed to have been made on the next succeeding Business Day). (b) Any Bank for whose account any such payment is to be made may (but shall not be obligated to) debit the amount of any such payment that is not made by such time to any ordinary deposit account of the Company with such Bank (with notice to the Company and the Administrative Agent). (c) The Company shall, at the time of making each payment under this Agreement or any Note for account of any Bank, specify to the Administrative Agent (which shall notify the intended recipient(s) thereof) the Loans or other amounts payable by the Company hereunder to which such payment is to be applied, in which case such payment shall be, subject to Section 4.02 hereof, so applied (and in the event that the Company fails to so specify, or if an Event of Default has occurred and is continuing, such payment shall be, subject to said Section 4.02, applied in payment of amounts due under this Agreement or any Credit Agreement ---------------- -22- Note in such manner as is determined to be appropriate by the Majority Banks or, if the Majority Banks fail to advise the Administrative Agent of their determination promptly following a request from the Administrative Agent for such a determination, by the Administrative Agent). (d) Each payment received by the Administrative Agent under this Agreement or any Note for account of any Bank shall be paid by the Administrative Agent promptly to such Bank, in immediately available funds, for account of such Bank's Applicable Lending Office for the Loan or other obligation in respect of which such payment is made. (e) If the due date of any payment under this Agreement or any Note would otherwise fall on a day that is not a Business Day, such date shall be extended to the next succeeding Business Day, and interest shall be payable on any principal so extended for the period of such extension. 4.02 Pro Rata Treatment. Except to the extent otherwise provided ------------------ herein: (a) the making, Conversion and Continuation of Loans of a particular Class, Series and Type shall be made pro rata among the Banks according to the amounts of their respective Commitments (in the case of making of Loans) or their respective Loans of such Class, Series and Type (in the case of Conversions and Continuations); and the then current Interest Period of Loans of a particular Class, Series and Type shall be coterminous; (b) each payment or prepayment of principal of Loans of a particular Class, Series and Type shall be made for account of the Banks pro rata in accordance with the respective unpaid principal amounts of the Loans of such Class, Series and Type held by the Banks; (c) each payment of interest on Loans of a particular Class, Series and Type shall be made for account of the Banks pro rata in accordance with the amounts of interest on Loans of such Class and Series then due and payable to the respective Banks; and (d) each payment of commitment fee under Section 2.04 hereof shall be made, and each termination or reduction of the amount of the Commitments shall be applied to the Commitments of the Banks, pro rata according to the respective amounts of the Commitments of the Banks. Credit Agreement ---------------- -23- 4.03 Computations. Interest on Eurodollar Loans, Base Rate Loans for ------------ which the Base Rate is being calculated by reference to the Federal Funds Rate and commitment fees shall be computed on the basis of a year of 360 days and actual days elapsed (including the first day but excluding the last day) occurring in the period for which payable; and interest on Base Rate Loans (other than Base Rate Loans for which the Base Rate is being calculated by reference to the Federal Funds Rate) shall be computed on the basis of a year of 365 or 366 days, as the case may be, and actual days elapsed (including the first day but excluding the last day) occurring in the period for which payable. 4.04 Minimum Amounts. Each borrowing, Conversion and partial --------------- prepayment of principal of Revolving Credit Loans shall be in an aggregate amount equal to $2,500,000 or any integral multiple of $500,000 in excess thereof. Each borrowing, or Conversion of Term Loans shall be in an aggregate amount equal to $5,000,000 or any integral multiple of $500,000 in excess thereof, and each partial prepayment of the principal of any Series of Term Loans shall be in an aggregate amount at least equal to $1,000,000. 4.05 Certain Notices. Notices by the Company to the Administrative --------------- Agent of terminations or reductions of Commitments, of borrowings, Conversions, Continuations and optional prepayments of Loans and of the duration of Interest Periods shall be irrevocable and shall be effective only if received by the Administrative Agent not later than 1:00 New York time on (in the case of Base Rate Loans), the same day as, and on (in the case of Eurodollar Loans and termination or reduction of Commitments) the date that is three Business Days prior to, the date of the relevant termination, reduction, borrowing, Conversion, Continuation or prepayment or the first day of such Interest Period. Each such notice of termination or reduction shall specify the amount of the Commitments to be terminated or reduced. Each such notice of borrowing, Conversion, Continuation or optional prepayment shall specify the Class, Series and Type of Loans to be borrowed or prepaid, the amount (subject to Section 4.04 hereof) of each Loan to be borrowed, Converted, Continued or prepaid, the date of borrowing Conversion, Continuation or optional prepayment (which shall be a Business Day), and the duration of the Interest Period for such Loan. The Administrative Agent shall promptly notify the Banks of the contents of each such notice. In the event that the Company fails to select the duration of any Interest Period for any Term Loan that is a Eurodollar Loan, within the time period and Credit Agreement ---------------- -24- otherwise as provided in this Section 4.05, such Eurodollar Loan shall automatically convert to a Base Rate Loan. 4.06 Non-Receipt of Funds by the Administrative Agent. Unless the ------------------------------------------------ Administrative Agent shall have been notified by a Bank or the Company (the "Payor") prior to the date on which the Payor is to make payment to the - ------ Administrative Agent of (in the case of a Bank) the proceeds of a Loan to be made by such Bank hereunder or (in the case of the Company) a payment to the Administrative Agent for account of one or more of the Banks hereunder (such payment being herein called the "Required Payment"), which notice shall be ---------------- effective upon receipt, that the Payor does not intend to make the Required Payment to the Administrative Agent, the Administrative Agent may assume that the Required Payment has been made and may, in reliance upon such assumption (but shall not be required to), make the amount thereof available to the intended recipient(s) on such date; and, if the Payor has not in fact made the Required Payment to the Administrative Agent, the recipient(s) of such payment shall, on demand, repay to the Administrative Agent the amount so made available together with interest thereon in respect of each day during the period commencing on the date (the "Advance Date") such amount was so made available by ------------ the Administrative Agent until the date the Administrative Agent recovers such amount at a rate per annum equal to the Federal Funds Rate for such day and, if such recipient(s) shall fail promptly to make such payment, the Administrative Agent shall be entitled to recover such amount, on demand, from the Payor, together with interest as aforesaid, provided that if the recipient(s) shall -------- fail to return, and the Payor shall fail to make, the Required Payment to the Administrative Agent within three Business Days of the Advance Date, then the Payor and the recipient(s) shall each be obligated to pay interest on the Required Payment (but without duplication) as follows: (a) if the Required Payment shall represent a payment to be made by the Company to the Banks, the Company and the recipient(s) shall each be obligated retroactively to the Advance Date to pay interest in respect of the Required Payment at the Post-Default Rate (and, in case the recipient(s) shall return the Required Payment to the Administrative Agent, without limiting the obligation of the Company under Section 3.02 hereof to pay interest to such recipient(s) at the Post-Default Rate in respect of the Required Payment); and (b) if the Required Payment shall represent proceeds of a Loan to be made by the Banks to the Company, the Payor and the Company shall each be obligated retroactively to the Advance Date to pay interest in respect of the Required Credit Agreement ---------------- -25- Payment at the rate of interest provided for such Required Payment pursuant to Section 3.02 hereof (and, in case the Company shall return the Required Payment to the Administrative Agent, without limiting any claim the Company may have against the Payor in respect of the Required Payment). 4.07 Sharing of Payments, Etc. ------------------------- (a) The Company agrees that, in addition to (and without limitation of) any right of set-off, banker's lien or counterclaim a Bank may otherwise have, each Bank shall be entitled, at its option, to offset balances held by it for account of the Company at any of its offices, in Dollars or in any other currency, against any principal of or interest on any of such Bank's Loans or any other amount payable to such Bank hereunder, that is not paid when due (regardless of whether such balances are then due to the Company), in which case it shall promptly thereafter notify the Company and the Administrative Agent thereof, provided that such Bank's failure to give such notice shall not affect -------- the validity thereof. (b) If any Bank shall obtain payment of any principal of or interest on any Loan of a particular Class and Series owing to it or payment of any other amount under this Agreement or any other Basic Document through the exercise of any right of set-off, banker's lien or counterclaim or similar right or otherwise (other than through the Administrative Agent as provided herein), and, as a result of such payment, such Bank shall have received a greater percentage of the principal of or interest on the Loans of such Class and Series or such other amounts then due hereunder or thereunder by the Company to such Bank than the percentage received by any other Bank, it shall promptly purchase from such other Banks participations in (or, if and to the extent specified by such Bank, direct interests in) the Loans of such Class and Series or such other amounts, respectively, owing to such other Banks (or in interest due thereon, as the case may be) in such amounts, and make such other adjustments from time to time as shall be equitable, to the end that all the Banks shall share the benefit of such excess payment (net of any expenses that may be incurred by such Bank in obtaining or preserving such excess payment) pro rata in accordance with the unpaid principal of and/or interest on the Loans of such Class and Series or such other amounts, respectively, owing to each of the Banks. To such end all the Banks shall make appropriate adjustments among themselves (by the resale of participations sold or otherwise) if such payment is rescinded or must otherwise be restored. Credit Agreement ---------------- -26- (c) The Company agrees that any Bank so purchasing such a participation (or direct interest) may exercise all rights of set-off, banker's lien, counterclaim or similar rights with respect to such participation as fully as if such Bank were a direct holder of Loans or other amounts (as the case may be) owing to such Bank in the amount of such participation. (d) Nothing contained herein shall require any Bank to exercise any such right or shall affect the right of any Bank to exercise, and retain the benefits of exercising, any such right with respect to any other indebtedness or obligation of the Company. If, under any applicable bankruptcy, insolvency or other similar law, any Bank receives a secured claim in lieu of a set-off to which this Section 4.07 applies, such Bank shall, to the extent practicable, exercise its rights in respect of such secured claim in a manner consistent with the rights of the Banks entitled under this Section 4.07 to share in the benefits of any recovery on such secured claim. Section 5. Yield Protection, Etc. ---------------------- 5.01 Additional Costs. ---------------- (a) The Company shall pay directly to each Bank from time to time such amounts as such Bank may determine to be necessary to compensate such Bank for any costs that such Bank determines are attributable to its making or maintaining of any Eurodollar Loans or its obligation to make any Eurodollar Loans hereunder, or any reduction in any amount receivable by such Bank hereunder in respect of any Eurodollar Loans or such obligation (such increases in costs and reductions in amounts receivable being herein called "Additional ---------- Costs"), resulting from any Regulatory Change that: - ----- (i) changes the basis of taxation of any amounts payable to such Bank under this Agreement or its Notes (other than taxes imposed on or measured by the overall net income of such Bank or of its Applicable Lending Office by the jurisdiction in which such Bank has its principal office or such Applicable Lending Office); or (ii) imposes or modifies any reserve, special deposit or similar requirements (other than the Reserve Requirement utilized in the determination of the Eurodollar Rate for such Loan) relating to any extensions of credit or other assets of, or any deposits with or other liabilities of, such Bank (including, without limitation, any of such Loans or any deposits referred to in the definition of "Eurodollar Base Rate" in Section 1.01 hereof), or any commitment of Credit Agreement ---------------- -27- such Bank hereunder (including, without limitation, the Commitment of such Bank); or (iii) imposes any other condition affecting this Agreement or its Notes or its Commitment. (b) Without limiting the effect of the provisions of paragraph (a) of this Section 5.01, in the event that, by reason of any Regulatory Change, any Bank either (i) incurs Additional Costs based on or measured by the excess above a specified level of the amount of a category of deposits or other liabilities of such Bank that includes deposits by reference to which the interest rate on Eurodollar Loans is determined as provided in this Agreement or a category of extensions of credit or other assets of such Bank that includes Eurodollar Loans or (ii) becomes subject to restrictions on the amount of such a category of liabilities or assets that it may hold, then, if such Bank so elects by notice to the Company (with a copy to the Administrative Agent), the obligation of such Bank to make or Continue, or to Convert Base Rate Loans into, Eurodollar Loans hereunder shall be suspended until such Regulatory Change ceases to be in effect (in which case the Loans theretofore made by such Bank shall bear interest at the Base Rate from the last day of the then current Interest Period for such Loans). (c) Without limiting the effect of the foregoing provisions of this Section 5.01 (but without duplication), the Company shall pay directly to each Bank from time to time on request such amounts as such Bank may determine to be necessary to compensate such Bank (or, without duplication, the bank holding company of which such Bank is a subsidiary) for any costs that it determines are attributable to the maintenance by such Bank (or any Applicable Lending Office or such bank holding company), pursuant to any law or regulation or any interpretation, directive or request (whether or not having the force of law and whether or not failure to comply therewith would be unlawful) of any court or governmental or monetary authority (i) following any Regulatory Change or (ii) implementing any risk-based capital guideline or other requirement (whether or not having the force of law and whether or not the failure to comply therewith would be unlawful) hereafter issued by any government or governmental or supervisory authority implementing at the national level the Basel Accord (including, without limitation, the Final Risk-Based Capital Guidelines of the Board of Governors of the Federal Reserve System (12 C.F.R. Part 208, Appendix A; 12 C.F.R. Part 225, Appendix A) and the Final Risk-Based Capital Guidelines of the Office of the Comptroller of the Currency (12 C.F.R. Part 3, Appendix A)), of capital in respect of its Commitment(s) or Loans (such compensation to include, without limitation, an amount equal to any reduction of the rate of Credit Agreement ---------------- -28- return on assets or equity of such Bank (or any Applicable Lending Office or such bank holding company) to a level below that which such Bank (or any Applicable Lending Office or such bank holding company) could have achieved but for such law, regulation, interpretation, directive or request). For purposes of this Section 5.01(c), "Basel Accord" shall mean the proposals for risk-based ------------ capital framework described by the Basel Committee on Banking Regulations and Supervisory Practices in its paper entitled "International Convergence of Capital Measurement and Capital Standards" dated July 1988, as amended, modified and supplemented and in effect from time to time or any replacement thereof. (d) Each Bank shall notify the Company of any event occurring after the date of this Agreement entitling such Bank to compensation under paragraph (a) or (c) of this Section 5.01 as promptly as practicable; provided that the Company shall not be required to pay any amounts under this Section 5.01 to the extent the amount requested to be paid is allocable to a period or date prior to the date which is 45 days before the date of such notice by such Bank to the Company. Each Bank will designate a different Applicable Lending Office for the Loans of such Bank affected by such event if such designation will avoid the need for, or reduce the amount of, such compensation and will not, in the sole good faith opinion of such Bank, be disadvantageous to such Bank. Each Bank will furnish to the Company a certificate setting forth in reasonable detail the basis and amount of each request by such Bank for compensation under paragraph (a) or (c) of this Section 5.01. Determinations and allocations by any Bank for purposes of this Section 5.01 of the effect of any Regulatory Change pursuant to paragraph (a) or (b) of this Section 5.01, or of the effect of capital maintained pursuant to paragraph (c) of this Section 5.01, on its costs or rate of return of maintaining Loans or its obligation to make Loans, or on amounts receivable by it in respect of Loans, and of the amounts required to compensate such Bank under this Section 5.01, shall be conclusive, provided that such -------- determinations and allocations are made on a reasonable basis and are not manifestly in error. 5.02 Limitation on Loans. Anything herein to the contrary ------------------- notwithstanding, if, on or prior to the determination of any Eurodollar Base Rate for any Interest Period: (a) the Administrative Agent determines, which determination shall be conclusive, that quotations of interest rates for the relevant Dollar deposits referred to in the definition of "Eurodollar Base Rate" in Section 1.01 hereof are not being provided in the relevant amounts or for the relevant maturities for purposes of determining rates of interest for Eurodollar Loans as provided herein; or Credit Agreement ---------------- -29- (b) if the Majority Banks in good faith determine, which determination shall otherwise be conclusive, and notify the Administrative Agent that the relevant rates of interest referred to in the definition of "Eurodollar Base Rate" in Section 1.01 hereof upon the basis of which the rate of interest for Eurodollar Loans for such Interest Period is to be determined are not likely adequately to cover the cost to such Banks of making or maintaining Eurodollar Loans for such Interest Period; then the Administrative Agent shall give the Company and each Bank prompt notice thereof and, so long as such condition remains in effect, the Banks shall be under no obligation to make additional Eurodollar Loans, to Continue Eurodollar Loans or to Convert Base Rate Loans into Eurodollar Loans and, on the last day(s) of the then current Interest Period(s) for the outstanding Term Loans, such Term Loans will bear interest at the Base Rate until such condition no longer remains in effect. 5.03 Illegality. Notwithstanding any other provision of this ---------- Agreement, in the event that it becomes unlawful for any Bank or its Applicable Lending Office to honor its obligation to make or maintain or Continue, or to Convert Base Rate Loans into, Eurodollar Loans hereunder, then such Bank shall promptly notify the Company thereof (with a copy to the Administrative Agent) and, in the case that it has become unlawful for such Bank to make Loans, such Bank's obligation to make or Continue, or to Convert Base Rate Loans into, Eurodollar Loans shall be suspended until such time as such Bank may again make or Continue, or to Convert Base Rate Loans into, Eurodollar Loans and, in the case that it has become unlawful for such Bank to maintain Loans, its outstanding Eurodollar Loans shall bear interest at the Base Rate from the date such Bank may specify to the Company with a copy to the Administrative Agent until it shall no longer be unlawful for such Bank to maintain its Eurodollar Loans hereunder. 5.04 Compensation. The Company shall pay to the Administrative Agent ------------ for account of each Bank, upon the request of such Bank through the Administrative Agent, such amount or amounts as shall be sufficient (in the reasonable opinion of such Bank) to compensate it for any loss, cost or expense that such Bank determines is attributable to: (a) any payment, mandatory or optional prepayment or Conversion of a Eurodollar Loan made by such Bank for any reason (including, without limitation, the acceleration of the Loans pursuant to Section 9 hereof) on a date other than the last day of an Interest Period for such Eurodollar Loan; Credit Agreement ---------------- -30- (b) any failure by the Company (whether by reason of the Company's election not to proceed or the failure of any of the conditions precedent specified in Section 6 hereof to be satisfied) to borrow a Eurodollar Loan from such Bank on the date for such borrowing specified in the relevant notice of borrowing given under Section 2.02 hereof. Without limiting the effect of the preceding sentence, such compensation shall include an amount equal to the excess (if any) of (i) the amount of interest that otherwise would have accrued on the principal amount so paid, prepaid or not borrowed, for the period from the date of such payment, prepayment, or failure to borrow, to the last day of the then current Interest Period for such Loan (or, in the case of a failure to borrow, the Interest Period for such Loan that would have commenced on the date specified for such borrowing) at the applicable rate of interest for such Loan provided for herein, less the Applicable Margin for such Loan, over (ii) the amount of interest that ---- otherwise would have accrued on such principal amount at a rate per annum equal to the interest component of the amount such Bank would have bid on the date of such payment, prepayment or failure to borrow in the London interbank market for Dollar deposits of leading banks in amounts comparable to such principal amount and with maturities comparable to such period (as reasonably determined by such Bank). 5.05 U.S. Taxes. ---------- (a) The Company agrees to pay to each Bank that is not a U.S. Person such additional amounts as are necessary in order that the net payment of any amount due to such non-U.S. Person hereunder after deduction for or withholding in respect of any U.S. Taxes imposed with respect to such payment (or in lieu thereof, payment of such U.S. Taxes by such non-U.S. Person), will not be less than the amount stated herein to be then due and payable, provided that the -------- foregoing obligation to pay such additional amounts shall not apply: (i) to any payment to a Bank hereunder unless such Bank is, on the date hereof (or on the date it becomes a Bank as provided in Section 11.06(b) hereof) and on the date of any change in the Applicable Lending Office of such Bank, either entitled to submit a Form 1001 (relating to such Bank and entitling it to a complete exemption from withholding on all interest to be received by it hereunder in respect of the Loans) or Form 4224 (relating to all interest to be received by such Bank hereunder in respect of the Loans), or (ii) to any U.S. Taxes imposed solely by reason of the failure by such non-U.S. Person to comply with applicable Credit Agreement ---------------- -31- certification, information, documentation or other reporting requirements if such compliance is required by statute or regulation of the United States of America as a precondition to relief or exemption from such U.S. Taxes. For the purposes of this Section 5.05(a), (w) "Form 1001" shall mean Form 1001 --------- (Ownership, Exemption, or Reduced Rate Certificate) of the Department of the Treasury of the United States of America, (x) "Form 4224" shall mean Form 4224 --------- (Exemption from Withholding of Tax on Income Effectively Connected with the Conduct of a Trade or Business in the United States) of the Department of the Treasury of the United States of America (or in relation to either such Form such successor and related forms as may from time to time be adopted by the relevant taxing authorities of the United States of America to document a claim to which such Form relates), (y) "U.S. Person" shall mean a citizen, national or ----------- resident of the United States of America, a corporation, partnership or other entity created or organized in or under any laws of the United States of America, or any estate or trust that is subject to Federal income taxation regardless of the source of its income and (z) "U.S. Taxes" shall mean any ---------- present or future tax, assessment or other charge or levy imposed by or on behalf of the United States of America or any taxing authority thereof or therein. (b) Within 30 days after paying any amount to the Administrative Agent or any Bank from which it is required by law to make any deduction or withholding, and within 30 days after it is required by law to remit such deduction or withholding to any relevant taxing or other authority, the Company shall deliver to the Administrative Agent for delivery to such non-U.S. Person evidence satisfactory to such Person of such deduction, withholding or payment (as the case may be). 5.06 Fair Allocation; Substitution of Banks. -------------------------------------- (a) Anything herein to the contrary notwithstanding, any determination by any Bank of any amounts payable by the Company under Section 5.01 shall be based upon a fair and equitable allocation by such Bank of the particular overall cost or loss among all its similarly situated borrowers relative to such Bank, and the Company shall not be obligated to compensate any Bank for any costs that would not have been incurred by such Bank but for its gross negligence or wilful misconduct. (b) Provided that no Default shall have occurred and be continuing, the Company may, at any time, replace any Bank that has requested compensation from the Company pursuant to Section 5.01 hereof or whose obligation to make additional Loans has been suspended pursuant to Section 5.03 hereof or that is Credit Agreement ---------------- -32- entitled to payment of additional amounts under Section 5.05 hereof (any such Bank being herein called an "Affected Bank"), by giving not less than ten ------------- Business Days' prior notice to the Administrative Agent (which shall promptly notify such Affected Bank and each other Bank), that it intends to replace such Affected Bank with one or more banks (including, but not limited to, any other Bank under this Agreement) selected by the Company and acceptable to the Administrative Agent (which shall not unreasonably withhold its consent). The method (whether by assignment or otherwise) of and documentation for such replacement shall be acceptable to the Affected Bank, the other Banks and the Administrative Agent (which shall not unreasonably withhold their consent and shall cooperate with the Company in effecting such replacement). Upon the effective date of any replacement under this Section 5.06 (and as a condition thereto), the Company shall, or shall cause the replacement bank(s) to, pay to the Affected Bank being replaced any amounts owing to such Affected Bank hereunder (including, without limitation, interest, commitment fees, compensation and additional amounts under this Section 5, in each case accrued to the effective date of such replacement), whereupon each replacement bank shall become a "Bank" for all purposes of this Agreement having a Commitment in the amount of such Affected Bank's Commitment assumed by it, and such Commitment of the Affected Bank being replaced shall be terminated upon such effective date and all of such Affected Bank's rights and obligations under this Agreement shall terminate (provided that the obligations of the Company under Sections 5.01, 5.04, 5.05 and 11.03 hereof to such Affected Bank shall survive such replacement as provided in Section 11.07 hereof). Section 6. Conditions Precedent. -------------------- 6.01 Initial Loan. The obligation of any Bank to make its initial ------------ Loan hereunder is subject to the receipt by the Administrative Agent of the following documents, each of which shall be satisfactory to the Administrative Agent (and to the extent specified below, to each Bank) in form and substance: (a) Corporate Documents. The following documents, each certified as ------------------- indicated below: (i) a copy of the charters, as amended and in effect, of the Company and of each Subsidiary certified as of a recent date by the Secretary of State of the State of its incorporation or by its Applicable Insurance Regulatory Authority, as the case may be, and a certificate from such respective State authorities dated as of a recent date as to the good standing of Credit Agreement ---------------- -33- and charter documents filed by the Company and by such Subsidiary; (ii) a certificate of the Secretary or an Assistant Secretary of the Company, dated the Closing Date and certifying (A) that attached thereto is a true and complete copy of the by-laws of the Company and of each Subsidiary as amended and in effect at all times from the date on which the resolutions referred to in clause (B) were adopted to and including the date of such certificate, (B) that attached thereto is a true and complete copy of resolutions duly adopted by the board of directors of the Company authorizing the execution, delivery and performance of the Basic Documents and the extensions of credit hereunder, and that such resolutions have not been modified, rescinded or amended and are in full force and effect, (C) that the charters of the Company and the Subsidiaries have not been amended since the date of the certification thereto furnished pursuant to subparagraph (i) above, and (D) as to the incumbency and specimen signature of each officer of the Company executing the Basic Documents and each other document to be delivered by the Company from time to time in connection therewith (and the Administrative Agent and each Bank may conclusively rely on such certificate until it receives notice in writing from the Company); and (iii) a certificate of another officer of the Company as to the incumbency and specimen signature of the Secretary or Assistant Secretary, as the case may be, of the Company. (b) Officer's Certificate. A certificate of a senior officer of the --------------------- Company, dated the Closing Date, to the effect set forth in the first sentence of Section 6.03 hereof. (c) Opinions of Counsel to the Company. Opinions, dated the Closing ---------------------------------- Date, of Alan S. Roseman, General Counsel of the Company, substantially in the form of Exhibit B-1 hereto and of Hogan & Hartson, special counsel to the Company, substantially in the form of Exhibit B-2 hereto, and in each case covering such other matters as the Administrative Agent or any Bank may reasonably request (and the Company hereby instructs each such counsel to deliver such opinions to the Banks and the Administrative Agent). (d) Opinion of Special New York Counsel to Chase. An opinion, dated -------------------------------------------- the Closing Date, of Milbank, Tweed, Hadley & Credit Agreement ---------------- -34- McCloy, special New York counsel to Chase, substantially in the form of Exhibit C hereto. (e) Notes. The Revolving Credit Notes, duly completed and executed. ----- (f) Tax Sharing Agreements. True, correct and complete copies of all ---------------------- tax sharing agreements (if any) to which the Company or any of its Subsidiaries is a party, which agreements must be in form and substance satisfactory to the Banks. (g) Capital Contribution Agreements. A true, correct and complete ------------------------------- copy of all agreements (if any) of the Company under which the Company is obligated to make capital contributions to any of its Insurance Subsidiaries, which agreements must be in form and substance satisfactory to the Banks. (h) Indenture. A true, correct and complete copy of the Indenture, --------- which shall be in form and substance satisfactory to the Banks. (i) Ratings. Evidence that the Rating of CRC by S&P shall be at least ------- AA+ and of Capital Mortgage shall be at least AA-. (j) Other Documents. Such other documents as the Administrative --------------- Agent or any Bank or special New York counsel to Chase may reasonably request. 6.02 Term Loans. ---------- The obligation of the Banks to make any Term Loans to the Company hereunder on the occasion of the borrowing of any Series of Term Loans is subject to the further condition precedent that the Company shall have delivered to the Administrative Agent the Term Loan Notes evidencing such Series of Term Loans. 6.03 Initial and Subsequent Loans. ---------------------------- The obligation of any Bank to make any Loan to the Company upon the occasion of any borrowing hereunder (including the initial borrowing) is subject to the further conditions precedent that, both immediately prior to the making of such Loan and also after giving effect thereto and to the intended use thereof: Credit Agreement ---------------- -35- (a) no Default shall have occurred and be continuing; and (b) the representations and warranties made by the Company in Section 7 hereof, and in each of the other Basic Documents, shall be true and complete on and as of the date of the making of such Loan with the same force and effect as if made on and as of such date (or, if any such representation or warranty is expressly stated to have been made as of a specific date, as of such specific date). Each notice of borrowing by the Company hereunder shall constitute a certification by the Company to the effect set forth in the preceding sentence (both as of the date of such notice and, unless the Company otherwise notifies the Administrative Agent prior to the date of such borrowing, as of the date of such borrowing). Section 7. Representations and Warranties. The Company represents ------------------------------ and warrants to the Administrative Agent and the Banks that: 7.01 Corporate Existence. Each of the Company and its Subsidiaries: ------------------- (a) is a corporation, partnership or other entity duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization; (b) has all requisite corporate or other power, and has all material governmental licenses, authorizations, consents and approvals, necessary to own its assets and carry on its business as now being or as proposed to be conducted; and (c) is qualified to do business and is in good standing in all jurisdictions in which the nature of the business conducted by it makes such qualification necessary and where failure so to qualify could, either individually or in the aggregate, have a Material Adverse Effect. 7.02 Financial Condition. ------------------- (a) The Company has heretofore furnished to each of the Banks consolidated and consolidating balance sheets of the Company and its Subsidiaries as at December 31, 1995 and the related consolidated and consolidating statements of income, shareholders' equity and cash flows of the Company and its Subsidiaries for the fiscal year ended on said date, with the opinion thereon (in the case of said consolidated balance sheet and statements) of Ernst & Young L.L.P, and the unaudited consolidated and consolidating balance sheets of the Company and its Subsidiaries as at March 31, 1996 and the related consolidated and consolidating statements of income, shareholders' equity and cash flows of the Company and its Credit Agreement ---------------- -36- Subsidiaries for the three-month period ended on such date. All such financial statements present fairly, in all material respects, the consolidated financial condition of the Company and its Subsidiaries, and (in the case of said consolidating financial statements) the respective unconsolidated financial condition of the Company and of each of its Subsidiaries, as at said dates and the consolidated results of their operations, and (in the case of said consolidating statements) the respective unconsolidated results of operations of the Company and of each of its Subsidiaries, for the fiscal year and three-month period ended on said dates (subject, in the case of such financial statements as at March 31, 1996, to normal year-end audit adjustments), all in accordance with generally accepted accounting principles and practices applied on a consistent basis. None of the Company nor any of its Subsidiaries has on the date hereof any material contingent liabilities, liabilities for taxes, unusual forward or long-term commitments or unrealized or anticipated losses from any unfavorable commitments, except as referred to or reflected or provided for in said financial statements (or in the notes thereto) as at said dates. Since December 31, 1995, there has been no material adverse change in the consolidated financial condition, operations or business of the Company and its Subsidiaries taken as a whole from that set forth in said financial statements as at said date. (b) The Company has heretofore furnished to each of the Banks the annual and quarterly Statutory Statements of each of its Insurance Subsidiaries for the fiscal year ended December 31, 1995 and for the quarterly fiscal period ended March 31, 1996 as filed with the Applicable Insurance Regulatory Authority. All such Statutory Statements present fairly, in all material respects, the financial condition of each Insurance Subsidiary, respectively, as at the respective dates thereof and its results of operations through fiscal year ended on December 31, 1995 and the quarterly fiscal period ended March 31, 1996, in accordance with statutory accounting practices prescribed or permitted by the Applicable Insurance Regulatory Authority. 7.03 Litigation. Except as disclosed in Schedule III hereto, there ---------- are no legal or arbitration proceedings, or any proceedings by or before any governmental or regulatory authority or agency, now pending or (to the knowledge of the Company) threatened against the Company or any of its Subsidiaries that, if adversely determined, could reasonably be expected, either individually or in the aggregate, to have a Material Adverse Effect. 7.04 No Breach. None of the execution and delivery of this Agreement --------- and the Notes and the other Basic Documents, the Credit Agreement ---------------- -37- consummation of the transactions herein and therein contemplated or compliance with the terms and provisions hereof and thereof will conflict with or result in a breach of, or require any consent under, the charter or by-laws of the Company, or any applicable law or regulation, or any order, writ, injunction or decree of any court or governmental authority or agency, or any agreement or instrument to which the Company or any of its Subsidiaries is a party or by which any of them or any of their Property is bound or to which any of them is subject, or constitute a default under any such agreement or instrument. 7.05 Action. The Company has all necessary corporate power, ------ authority and legal right to execute, deliver and perform its obligations under each of the Basic Documents; the execution, delivery and performance by the Company of each of the Basic Documents have been duly authorized by all necessary corporate action on its part (including, without limitation, any required shareholder approvals); and this Agreement has been duly and validly executed and delivered by the Company and constitutes, and each of the Notes and the other Basic Documents when executed and delivered (in the case of the Notes, for value) will constitute, the legal, valid and binding obligation of the Company, enforceable against the Company in accordance with its terms. 7.06 Approvals. No authorizations, approvals or consents of, and no --------- filings or registrations with, any governmental or regulatory authority or agency, or any securities exchange, are necessary for the execution, delivery or performance by the Company of the Basic Documents or for the legality, validity or enforceability hereof or thereof. 7.07 Margin Stock. Not more than 25% of the value (as determined by ------------ any reasonable method) of the Properties of the Company and its Subsidiaries (including, without limitation, common stock of the Company held in treasury) subject to the provisions of Section 8.05 or 8.06 hereof is represented by Margin Stock. 7.08 ERISA. Each Plan, and, to the knowledge of the Company, each ----- Multiemployer Plan, is in compliance in all material respects with, and has been administered in all material respects in compliance with, the applicable provisions of ERISA, the Code and any other Federal or State law, and no event or condition has occurred and is continuing as to which the Company would be under an obligation to furnish a report to the Banks under Section 8.01(g) hereof. 7.09 Taxes. The Company and its Subsidiaries are members of an ----- affiliated group of corporations filing Credit Agreement ---------------- -38- consolidated returns for Federal income tax purposes, of which the Company is the "common parent" (within the meaning of Section 1504 of the Code) of such group. The Company and its Subsidiaries have filed all Federal income tax returns and all other material tax returns that are required to be filed by them and have paid all taxes due pursuant to such returns or pursuant to any assessment received by the Company or any of its Subsidiaries. The charges, accruals and reserves on the books of the Company and its Subsidiaries in respect of taxes and other governmental charges are, in the opinion of the Company, adequate. The Company has not given or been requested to give a waiver of the statute of limitations relating to the payment of Federal, state, local and foreign taxes or other impositions. 7.10 Investment Company Act. Neither the Company nor any of its ---------------------- Subsidiaries is an "investment company", or a company "controlled" by an "investment company", within the meaning of the Investment Company Act of 1940, as amended. 7.11 Public Utility Holding Company Act. Neither the Company nor any ---------------------------------- of its Subsidiaries is a "holding company", or an "affiliate" of a "holding company" or a "subsidiary company" of a "holding company", within the meaning of the Public Utility Holding Company Act of 1935, as amended. 7.12 Material Agreements and Liens. ----------------------------- (a) Part A of Schedule I hereto is a complete and correct list, as of the date of this Agreement, of each credit agreement, loan agreement, indenture, securities purchase agreement, guarantee, letter of credit or other arrangement providing for or otherwise relating to any Indebtedness of the Company or any of its Subsidiaries the aggregate principal or face amount of which equals or exceeds (or may equal or exceed) $10,000,000, and the aggregate principal or face amount outstanding or that may become outstanding under each such arrangement is correctly described in Part A of said Schedule I. (b) Part B of Schedule I hereto is a complete and correct list, as of the date of this Agreement, of each Lien securing Indebtedness of any Person the aggregate principal or face amount of which equals or exceeds (or may equal or exceed) $10,000,000 and covering any Property of the Company or any of its Subsidiaries, and the aggregate Indebtedness secured (or which may be secured) by each such Lien and the Property covered by each such Lien is correctly described in Part B of said Schedule I. 7.13 Environmental Matters. There have been no environmental --------------------- investigations, studies, audits, tests, reviews or Credit Agreement ---------------- -39- other analyses conducted by or that are in the possession of the Company or any of its Subsidiaries in relation to any site or facility now or previously owned, operated or leased by the Company or any of its Subsidiaries which have not been made available to the Banks. 7.14 Capitalization. The authorized capital stock of the Company -------------- consists, on the date hereof, of (a) an aggregate of 75,000,000 shares of common stock, par value $0.01 per share, of which 15,728,480 shares were duly and validly issued and outstanding as at June 30, 1996 (and 189,700 shares of which were held in treasury), each of which shares is fully paid and nonassessable, and (b) an aggregate of 25,000,000 shares of preferred stock, par value $0.01 per share, none of which are outstanding or issued. As of the date hereof, except for the Company's compensation plans referred to in Note 15 to its consolidated financial statements referred to in Section 7.02(a) hereof and for the Company's Performance Share Plan (Effective July 1, 1996), (x) there are no outstanding Equity Rights with respect to the Company and (y) there are no outstanding obligations of the Company or any of its Subsidiaries to repurchase, redeem, or otherwise acquire any shares of capital stock of the Company nor are there any outstanding obligations of the Company or any of its Subsidiaries to make payments to any Person, such as "phantom stock" payments, where the amount thereof is calculated with reference to the fair market value or equity value of the Company or any of its Subsidiaries. 7.15 Subsidiaries, Etc. ------------------ (a) Set forth in Schedule II hereto is a complete and correct list, as of the date of this Agreement, of all of the Subsidiaries of the Company, together with, for each such Subsidiary, (i) the jurisdiction of organization of such Subsidiary, (ii) each Person holding ownership interests in such Subsidiary and (iii) the nature of the ownership interests held by each such Person and the percentage of ownership of such Subsidiary represented by such ownership interests. Except as disclosed in Schedule II hereto, as of the date of this Agreement (x) each of the Company and its Subsidiaries owns, free and clear of Liens, and has the unencumbered right to vote, all outstanding ownership interests in each Person shown to be held by it in Schedule II hereto, (y) all of the issued and outstanding capital stock of each such Person organized as a corporation is validly issued, fully paid and nonassessable and (z) there are no outstanding Equity Rights with respect to such Person. (b) None of the Subsidiaries of the Company is, on the date of this Agreement, subject to any indenture, agreement, Credit Agreement ---------------- -40- instrument or other arrangement of the type described in Section 8.18 hereof. 7.16 True and Complete Disclosure. The information, reports, ---------------------------- financial statements, exhibits and schedules furnished in writing by or on behalf of the Company or any of its Subsidiaries to the Administrative Agent or any Bank in connection with the negotiation, preparation or delivery of this Agreement and the other Basic Documents or included herein or therein or delivered pursuant hereto or thereto, when taken as a whole, do not, as of the date hereof, contain any untrue statement of material fact or omit to state any material fact necessary to make the statements herein or therein, in light of the circumstances under which they were made, not misleading. All written information furnished after the date hereof by the Company and its Subsidiaries to the Administrative Agent and the Banks in connection with this Agreement and the other Basic Documents and the transactions contemplated hereby and thereby will be true, complete and accurate in every material respect, or (in the case of projections) based on reasonable estimates, on the date as of which such information is stated or certified. To the Company's knowledge, there is no fact peculiar to the Company or any of its Subsidiaries (in contrast to information of a general economic or industry nature) that could reasonably be expected to have a Material Adverse Effect that has not been disclosed herein, in the other Basic Documents or in a report, financial statement, exhibit, schedule, disclosure letter or other writing furnished to the Banks for use in connection with the transactions contemplated hereby or thereby. Section 8. Covenants of the Company. The Company covenants and ------------------------ agrees with the Banks and the Administrative Agent that, so long as any Commitment or Loan is outstanding and until payment in full of all amounts payable by the Company hereunder: 8.01 Financial Statements; Information; Etc. The Company shall -------------------------------------- deliver to each of the Banks: (a) as soon as available and in any event within 60 days after the end of each quarterly fiscal period of each fiscal year of the Company, consolidated statements of income, shareholders' equity and cash flows of the Company and its Subsidiaries for such period and for the period from the beginning of the respective fiscal year to the end of such period, and the related consolidated balance sheet of the Company and its Subsidiaries as at the end of such period, setting forth in each case in comparative form the corresponding consolidated and consolidating figures for the corresponding period (except, in the case of the balance sheets, to the last day of) in the preceding fiscal year (it Credit Agreement ---------------- -41- being understood that delivery to the Banks of the Company's Report on Form 10-Q filed with the Securities and Exchange Commission shall satisfy the financial statement delivery requirements of this Section 8.01(a) so long as the financial information required to be contained in such Report is substantially the same as the financial information required under this Section 8.01(a)), accompanied by a certificate of a senior financial officer of the Company, which certificate shall state that said consolidated financial statements present fairly, in all material respects, the consolidated financial condition and results of operations of the Company and its Subsidiaries in accordance with generally accepted accounting principles, consistently applied, as at the end of, and for, such period (subject to normal year-end audit adjustments); (b) as soon as available and in any event within 100 days after the end of each fiscal year of the Company, consolidated statements of income, stockholders' equity and cash flows of the Company and its Subsidiaries for such fiscal year and the related consolidated balance sheet of the Company and its Subsidiaries as at the end of such fiscal year, setting forth in each case in comparative form the corresponding consolidated figures for the preceding fiscal year (it being understood that delivery to the Banks of the Company's Report on Form 10-K filed with the Securities and Exchange Commission shall satisfy the financial statement delivery requirements of this Section 8.01(b) so long as the financial information required to be contained in such Report is substantially the same as the financial information required under this Section 8.01(b)), and accompanied by an opinion thereon of independent certified public accountants of recognized national standing, which opinion shall state that said consolidated financial statements present fairly, in all material respects, the consolidated financial condition and results of operations of the Company and its Subsidiaries as at the end of, and for, such fiscal year in accordance with generally accepted accounting principles, and a certificate of such accountants addressed to the Banks stating that, in making the examination necessary for their opinion, nothing came to their attention that caused them to believe that the Company had failed to comply with any of its obligations under Sections 8.05 to 8.10 (inclusive) or that any Default specified in paragraph (b) or (e) to (j), inclusive, of Section 9 hereof had occurred, except as specifically stated; (c) within 5 days after filing with the Applicable Insurance Regulatory Authority and in any event within Credit Agreement ---------------- -42- 55 days after the end of each of the first three quarterly fiscal periods of each fiscal year of the Company the quarterly Statutory Statement of each Insurance Subsidiary for such fiscal period, together with a certificate of a senior financial officer of the Company stating that such Statutory Statement fairly presents, in all material respects, the financial condition of each Insurance Subsidiary, respectively, for such quarterly fiscal period in accordance with statutory accounting practices required or permitted by the Applicable Insurance Regulatory Authority. (d) within 5 days after filing with the Applicable Insurance Regulatory Authority and in any event within 55 days after the end of each fiscal year of the Company the annual Statutory Statement of each Insurance Subsidiary for such year, together with a certificate of a senior financial officer of the Company stating that such annual Statutory Statement fairly presents, in all material respects, the financial condition of each Insurance Subsidiary, respectively, for such fiscal year in accordance with statutory accounting practices required or permitted by the Applicable Insurance Regulatory Authority. (e) promptly upon their becoming available, copies of all registration statements (other than those on Form S-8) and regular periodic reports, if any, which the Company shall have filed with the Securities and Exchange Commission (or any governmental agency substituted therefor) or any national securities exchange; (f) promptly upon the mailing thereof to the shareholders of the Company generally, copies of all financial statements, reports and proxy statements so mailed; (g) as soon as possible, and in any event within ten days after the Company knows or has reason to believe that any of the events or conditions specified below with respect to any Plan or Multiemployer Plan has occurred or exists, a statement signed by a senior financial officer of the Company setting forth details respecting such event or condition and the action, if any, that the Company or its ERISA Affiliate proposes to take with respect thereto (and a copy of any report or notice required to be filed with or given to PBGC by the Company or an ERISA Affiliate with respect to such event or condition): (i) any reportable event, as defined in Section 4043(b) of ERISA and the regulations issued Credit Agreement ---------------- -43- thereunder, with respect to a Plan, as to which PBGC has not by regulation waived the requirement of Section 4043(a) of ERISA that it be notified within 30 days of the occurrence of such event (provided -------- that a failure to meet the minimum funding standard of Section 412 of the Code or Section 302 of ERISA, including, without limitation, the failure to make on or before its due date a required installment under Section 412(m) of the Code or Section 302(e) of ERISA, shall be a reportable event regardless of the issuance of any waivers in accordance with Section 412(d) of the Code); and any request for a waiver under Section 412(d) of the Code for any Plan; (ii) the distribution under Section 4041 of ERISA of a notice of intent to terminate any Plan or any action taken by the Company or an ERISA Affiliate to terminate any Plan; (iii) the institution by PBGC of proceedings under Section 4042 of ERISA for the termination of, or the appointment of a trustee to administer, any Plan, or the receipt by the Company or any ERISA Affiliate of a notice from a Multiemployer Plan that such action has been taken by PBGC with respect to such Multiemployer Plan; (iv) the complete or partial withdrawal from a Multiemployer Plan by the Company or any ERISA Affiliate that results in liability under Section 4201 or 4204 of ERISA (including the obligation to satisfy secondary liability as a result of a purchaser default) or the receipt by the Company or any ERISA Affiliate of notice from a Multiemployer Plan that it is in reorganization or insolvency pursuant to Section 4241 or 4245 of ERISA or that it intends to terminate or has terminated under Section 4041A of ERISA; (v) the institution of a proceeding by a fiduciary of any Multiemployer Plan against the Company or any ERISA Affiliate to enforce Section 515 of ERISA, which proceeding is not dismissed within 30 days; and (vi) the adoption of an amendment to any Plan that, pursuant to Section 401(a)(29) of the Code or Section 307 of ERISA, would result in the loss of tax-exempt status of the trust of which such Plan is a part if the Company or an ERISA Affiliate fails to timely provide security to the Plan in accordance with the provisions of said Sections; Credit Agreement ---------------- -44- (h) promptly after the Company knows or has reason to believe that any Default has occurred, a notice of such Default specifying that such notice is a "Notice of Default" and describing the same in reasonable detail and, together with such notice or as soon thereafter as possible, a description of the action that the Company has taken or proposes to take with respect thereto; and (i) from time to time such other information regarding the financial condition, operations, business or prospects of the Company or any of its Subsidiaries (including, without limitation, consolidating financial statements, any Plan or Multiemployer Plan and any reports or other information required to be filed under ERISA) as any Bank or the Administrative Agent may reasonably request. The Company will furnish to each Bank, at the time it furnishes each set of financial statements pursuant to paragraph (a) or (b) above, a certificate of a senior financial officer of the Company (i) to the effect that no Default has occurred and is continuing (or, if any Default has occurred and is continuing, describing the same in reasonable detail and describing the action that the Company has taken or proposes to take with respect thereto) and (ii) setting forth in reasonable detail the computations necessary to determine whether the Company is in compliance with Sections 8.05(vii), 8.06(h), 8.06(i), 8.07(f), 8.09, 8.10 and 8.12(a) hereof as of the end of the respective quarterly fiscal period or fiscal year. 8.02 Litigation. The Company will promptly give to each Bank notice ---------- of all legal or arbitration proceedings, and of all proceedings by or before any governmental or regulatory authority or agency, and any material development in respect of such legal or other proceedings, affecting the Company or any of its Subsidiaries, except proceedings which, if adversely determined, could not reasonably be expected either individually or in the aggregate, to have a Material Adverse Effect. 8.03 Existence, Etc. The Company will, and will cause each of its --------------- Subsidiaries to: (a) preserve and maintain its legal existence and all of its material rights, privileges, licenses and franchises (provided that nothing in this -------- Section 8.03 shall prohibit any transaction expressly permitted by Section 8.05 hereof); (b) comply with the requirements of all applicable laws, rules, regulations and orders of governmental or regulatory authorities if failure to comply with such requirements could reasonably be expected, either Credit Agreement ---------------- -45- individually or in the aggregate, to have a Material Adverse Effect; (c) pay and discharge all taxes, assessments and governmental charges or levies imposed on it or on its income or profits or on any of its Property prior to the date on which penalties attach thereto, except for any such tax, assessment, charge or levy the payment of which is being contested in good faith and by proper proceedings and against which adequate reserves are being maintained in accordance with GAAP; (d) maintain all of its Properties material to its business in reasonably adequate working order and condition, ordinary wear and tear excepted; (e) keep adequate records and books of account, in which complete entries will be made in accordance with generally accepted accounting principles consistently applied; and (f) permit representatives of any Bank or the Administrative Agent, during normal business hours, to examine, copy and make extracts from its books and records, to inspect any of its Properties, and to discuss its business and affairs with its officers, all to the extent reasonably requested by such Bank or the Administrative Agent (as the case may be). 8.04 Insurance. The Company will, and will cause each of its --------- Subsidiaries to, (a) keep insured by financially sound and reputable insurers all Property of a character usually insured by corporations engaged in the same or similar business similarly situated against loss or damage of the kinds and in the amounts customarily insured against by such corporations and carry such other insurance as is usually carried by such corporations and (b) furnish to each Bank, upon written request, full information as to the insurance carried. 8.05 Prohibition of Fundamental Changes. The Company will not, and ---------------------------------- will not permit any of its Subsidiaries to, wind up, liquidate or dissolve its affairs or enter into any transaction of merger or consolidation, or convey, sell, lease or otherwise dispose of (or agree to do any of the foregoing at any future time) all or any part of its Property, or purchase or otherwise acquire (in one or a series of related transactions) any part of the Property (other than purchases or other acquisitions of inventory, materials and equipment in the ordinary course of business) of any Person, or permit any of its Subsidiaries so to do any of the foregoing, except that (i) the Credit Agreement ---------------- -46- Company and its Subsidiaries may make sales of personal Property in the ordinary course of business, (ii) the Company and its Subsidiaries may, in the ordinary course of business, sell equipment which is uneconomic or obsolete, (iii) Capital Expenditures may be made to the extent permitted by Section 8.11 hereof, (iv) each of the Company and its Subsidiaries may in the ordinary course of business purchase, dispose of, transfer and otherwise manage Property in its investment portfolio, (v) the Company or any of its Subsidiaries may purchase or otherwise acquire all or any portion of the Property of any Person (other than the Company) or acquire such Person by merger so long as (x) no Default has occurred and is continuing or would occur after giving effect thereto, (y) such purchase, acquisition or merger shall not result in any downgrading of CRC's Rating assigned by Moody's or S&P from that in effect immediately prior to such purchase, acquisition or merger and (z) the Company shall deliver to the Administrative Agent such documents, certificates or other information as the Administrative Agent may reasonably request to establish that such purchase, acquisition or merger complied with the conditions contained in this clause (v), (vi) the Company or any Subsidiary may merge into another Person so long as (x) such merger is solely for the purpose of changing domicile, (y) in the case of the Company, the surviving Person assumes all obligations of the Company under the Basic Documents and (z) no Default has occurred and is continuing or would occur after giving effect thereto, (vii) the Company or any Subsidiary may take any action not otherwise permitted hereunder so long as no Default has occurred and is continuing to the extent such action is not in any manner materially adverse to the Company or the Banks, provided, that the Company may not merge or -------- consolidate with or into, or sell or otherwise transfer all or any substantial part of its Property to, any other Person if the consideration therefor is equal to or in excess of $75,000,000, and (viii) intercompany transactions shall be permitted in accordance with Section 8.13 hereof. 8.06 Limitation on Liens. The Company will not create, incur, assume ------------------- or suffer to exist any Lien upon any of its Property, whether now owned or hereafter acquired, except: (a) Liens in existence on the date hereof and listed in Part B of Schedule I hereto; (b) Liens imposed by any governmental authority for taxes, assessments or charges not yet due or which are being contested in good faith and by appropriate proceedings, unless the amount thereof is material with respect to it or its financial condition, if adequate reserves with respect thereto are maintained on the books of the Company in accordance with GAAP; Credit Agreement ---------------- -47- (c) carriers', warehousemen's, mechanics', materialmen's, repairmen's or other like Liens arising in the ordinary course of business which are not overdue for a period of more than 30 days or which are being contested in good faith and by appropriate proceedings and Liens securing judgments but only to the extent for an amount and for a period not resulting in an Event of Default under Section 9(h) hereof; (d) pledges or deposits under worker's compensation, unemployment insurance and other social security legislation; (e) deposits to secure the performance of bids, trade contracts (other than for borrowed money), leases, statutory obligations, surety and appeal bonds, performance bonds and other obligations of a like nature incurred in the ordinary course of business; (f) easements, rights-of-way, restrictions and other similar encumbrances incurred in the ordinary course of business and encumbrances consisting of zoning restrictions, easements, licenses, restrictions on the use of Property or minor imperfections in title thereto which, in the aggregate, are not material in amount, and which do not in any case materially detract from the value of the Property subject thereto or interfere with the ordinary conduct of the business of the Company; (g) Liens on any Property acquired by the Company after the date hereof from any Subsidiary of the Company, for consideration not in excess of the fair market value thereof, which Lien was not created in anticipation of such acquisition; (h) Liens upon real and/or tangible personal Property acquired after the date hereof (by purchase, construction or otherwise) by the Company, each of which Liens either existed on such Property before the time of its acquisition and was not created in anticipation thereof or was created solely for the purpose of securing Indebtedness incurred to finance, refinance, or refund the cost (including the cost of construction) of such Property; provided that (i) no such Lien shall extend to or cover any -------- Property of the Company or such Subsidiary other than the Property so acquired and improvements thereon and (ii) the principal amount of Indebtedness secured by any such Lien shall not exceed 80% of the fair market value (as determined) in good faith by a senior financial officer of the Company) of such Property at Credit Agreement ---------------- -48- the time it was acquired (by purchase, construction or otherwise); (i) additional Liens created after the date hereof so long as the Indebtedness secured thereby and incurred after the date hereof does not exceed $10,000,000 in the aggregate at any one time outstanding; and (j) any extension, renewal or replacement of the foregoing; provided -------- that the Liens permitted by this paragraph shall not extend to or cover any additional Indebtedness or Property (other than a substitution of like Property). 8.07 Indebtedness. The Company will not, and will not permit any of ------------ its Subsidiaries to, create, incur or suffer to exist any Indebtedness except: (a) Indebtedness to the Banks hereunder; (b) Indebtedness outstanding on the date hereof and, to the extent required under Section 7.12(a) hereof, listed in Part A of Schedule I hereto; (c) Indebtedness of the Company up to but not exceeding $25,000,000 in the aggregate principal amount at any one time outstanding under the Credit Agreement dated as of January 27, 1994, among the Company, the banks party thereto and Deutsche Bank AG, New York Branch, as agent, as the same may be modified or supplemented. (d) Indebtedness of any Wholly-Owned Subsidiary to the Company or to any other Wholly-Owned Subsidiary of the Company; (e) Indebtedness of the Company to any Subsidiary of the Company so long as such Indebtedness is subordinated in right of payment to the prior payment in full of the principal of and interest on and all other amounts owing to the Banks hereunder pursuant to documentation in form and substance satisfactory to the Majority Banks; (f) additional Indebtedness of the Company provided that on the date such Indebtedness is incurred and after giving effect thereto and to the concurrent retirement of any other Indebtedness of the Company, total consolidated Indebtedness of the Company and its Subsidiaries does not exceed 30% of Total Capitalization. Credit Agreement ---------------- -49- 8.08 Investments. The Company will not permit any of its Insurance ----------- Subsidiaries to make or permit to remain outstanding any Investments in its investment portfolio except: (a) Investments in securities meeting the requirements of clauses (i) and (ii) of paragraph (a)(6) of Section 270.2a-7 of the SEC ICA Regulations and in money market funds at least 95% of whose assets consist of First Tier Securities (as defined in paragraph (a)(6) of Section 270.2a-7 of the SEC ICA Regulations); provided that the Insurance Subsidiaries may make -------- Investments in short-term debt instruments (or in money market funds at least 95% of whose assets consist of short-term debt instruments) that are rated at least A-2 by S&P or P-2 by Moody's or a comparable rating category by any other NRSRO (as defined in paragraph (a)(10) of Section 270.2a-7 of the SEC ICA Regulations); (b) Investments constituting fixed income debt securities if, after giving effect to any such Investment: (i) the weighted average credit quality of the fixed income debt securities in the consolidated Investment portfolio of the Insurance Subsidiaries, as determined by the rating system of S&P, is [A] or higher; and (ii) the aggregate amount invested by the Insurance Subsidiaries in fixed income debt securities that are rated lower than BBB- by S&P or Baa3 by Moody's or BBB- by Fitch, or that are unrated, does not exceed 10% of the aggregate amount of the consolidated portfolio Investments of the Insurance Subsidiaries; and (c) equity Investments if, after giving effect to any such Investment, the aggregate amount of equity Investments of the Insurance Subsidiaries does not exceed 20% of the aggregate amount of the consolidated portfolio Investments of the Insurance Subsidiaries; provided that, the aggregate amount invested by the Insurance Subsidiaries in fixed income securities that are rated lower than BBB- by S&P or Baa3 by Moody's or BBB- by Fitch, or that are unrated, together with the aggregate amount of equity Investments, may not exceed 25% of the aggregate amount of the consolidated portfolio Investments of the Insurance Subsidiaries. 8.09 Restricted Payments. The Company will not declare or make any ------------------- Restricted Payment unless, on the date of Credit Agreement ---------------- -50- declaration and on the date of making such Restricted Payment (the "Computation ----------- Date"), and after giving effect thereto: - ---- (i) the aggregate amount of all Restricted Payments made during the period commencing on January 1, 1996 and ending on and including the Computation Date shall not exceed an amount equal to 25% of consolidated net income of the Company and its Subsidiaries for the period (treated as a single accounting period) commencing on January 1, 1995 and ending in the last day of the fiscal quarter of the Company ending on or most recently ended prior to the Computation Date; (ii) the Interest Expense for the most recently ended fiscal quarter for which the Company has or is required to have delivered financial statements to the Banks shall not exceed 3-1/3% of the statutory surplus of CRC as at the end of the most recent quarter for which statutory financial statements have been filed by CRC with the Maryland Insurance Commissioner; and (ii) no Default shall have occurred and be continuing. 8.10 Financial Covenants. ------------------- (a) Tangible Net Worth. The Company will not, on any date, permit ------------------ Tangible Net Worth to be less than $250,000,000. (b) Interest Coverage Ratio. The Company will not, at any date, ----------------------- permit the Interest Coverage Ratio for the period of the four consecutive fiscal quarters of the Company ending on, or most recently ended prior to, such date to be less than 2.5:1. 8.11 Lines of Business. The Company will not permit any of its ----------------- Insurance Subsidiaries to engage to any substantial extent in any line or lines of business activity other than the business of issuing financial guaranty insurance, credit insurance, mortgage insurance and residual value insurance (and reinsurance of the same) and similar or related products, unless such other line or lines of business or activity does not result in the downgrading of the Rating of CRC assigned by S&P. 8.12 Transactions with Affiliates. The Company will not, and will ---------------------------- not permit any of its Subsidiaries to, directly or indirectly: (a) make any Investment in any Affiliate of the Company; provided -------- that the Company and its Subsidiaries may Credit Agreement ---------------- -51- make advances and loans to its directors, officers and employees in an aggregate principal amount up to but not exceeding $5,000,000 at any one time outstanding; and provided that, any Insurance Subsidiary may, subject -------- to Section 8.08, make Investments in the ordinary course of its investment activities in securities of any Existing Institutional Holder. (b) transfer, sell, lease, assign or otherwise dispose of any Property to any Affiliate of the Company; (c) purchase or acquire Property from any Affiliate of the Company; or (d) enter into any other transaction directly or indirectly with or for the benefit of any Affiliate of the Company (including, without limitation, Guarantees and assumptions of obligations of any Affiliate of the Company); provided that the Company and its Subsidiaries may enter into transactions - -------- (other than Investments by the Company or any of its Subsidiaries in any Affiliate of the Company unless expressly permitted under clause (a) above) providing for the leasing of Property, the rendering or receipt of services or the purchase or sale of Property in the ordinary course of business if the monetary or business consideration arising therefrom would be substantially as advantageous to the Company and its Subsidiaries as the monetary or business consideration which would obtain in a comparable transaction with a Person not an Affiliate of the Company; and provided further that any Insurance Subsidiary -------- may issue or sell insurance policies, guarantees and other instruments for the benefit of any Affiliate of the Company in the ordinary course of the insurance business of such Insurance Subsidiary. 8.13 Use of Proceeds. The Company will use the proceeds of the Loans --------------- hereunder to refinance up to $16,000,000 aggregate principal amount of the Company's floating rate subordinated notes due August 20, 1996 and for general corporate purposes (in compliance with all applicable legal and regulatory requirements); provided that neither the Administrative Agent nor any Bank shall -------- have any responsibility as to the use of any of such proceeds. 8.14 Certain Obligations Respecting Subsidiaries. ------------------------------------------- (a) Subject to Section 8.05 hereof, the Company will, and will cause each of CRC, Capital Mortgage, Capital Mortgage Bermuda and Capital Credit to, take such action from time to time as shall be necessary to ensure that each of CRC and Capital Credit Agreement ---------------- -52- Mortgage, Capital Mortgage Bermuda and Capital Credit is a Wholly-Owned Subsidiary of the Company. (b) The Company will not permit any of CRC, Capital Mortgage, Capital Mortgage Bermuda and Capital Credit to issue any shares of stock of any class whatsoever to any Person (other than to the Company). 8.15 Modifications of Certain Documents. The Company will not ---------------------------------- consent to any modification, supplement or waiver of any of the provisions of the Indenture that would materially increase the obligations, or materially reduce the rights, of the Company or any of its Subsidiaries thereunder. 8.16 Ratings. The Company will not allow the Rating by S&P of CRC to ------- be less than AA+ (or to be withdrawn) at any time or the Rating of Capital Mortgage to be less than AA- (or to be withdrawn) at any time. 8.17. Dividends to or Investments in the Company by Subsidiaries. ---------------------------------------------------------- The Company will not, nor will it permit any of its Subsidiaries, to issue any securities or enter into any agreements (other than with or as required by applicable regulatory authorities) that will either (i) limit the ability of any of the Subsidiaries of the Company to declare or pay or set apart any funds for the payment of any dividend or make any distribution to or Investment in the Company or (ii) prevent such Subsidiary from paying to the Company the entire amount available to be paid as dividends or distributions by such Subsidiary; provided, that nothing herein shall be deemed to require any Subsidiary of the - -------- Company to pay any dividend to, or make any Investment in, the Company in excess of the amount necessary to enable the Company to make all payments required hereunder and under the Notes. Section 9. Events of Default. If one or more of the following events ----------------- (herein called "Events of Default") shall occur and be continuing: ----------------- (a) The Company shall: (i) default in the payment of any principal of any Loan when due (whether at stated maturity or upon mandatory or optional prepayment); or (ii) default in the payment of any interest on any Loan or any commitment fee hereunder when due and such default shall have continued unremedied for two or more Business Days; or (b) The Company or any of its Subsidiaries shall default in the payment when due of any principal of or interest on any of its Indebtedness aggregating $10,000,000 or more (other than (i) the Indebtedness referred to in Credit Agreement ---------------- -53- paragraph (a) above or (ii) Indebtedness under the $75,000,000 Credit Agreement dated as of January 24, 1994 among CRC, the banks party thereto and Deutsche Bank AG, New York Branch, as agent, as amended); or any event specified in any note, agreement, indenture or other document evidencing or relating to any such Indebtedness shall occur if the effect of such event is to cause, or (with the giving of any notice or the lapse of time or both) to permit the holder or holders of such Indebtedness (or a trustee or agent on behalf of such holder or holders) to cause, such Indebtedness to become due, or to be prepaid in full (whether by redemption, purchase, offer to purchase or otherwise), prior to its stated maturity or to have the interest rate thereon reset to a level so that securities evidencing such Indebtedness trade at a level specified in relation to the par value thereof; or (c) Any representation, warranty or certification made or deemed made herein or in any other Basic Document (or in any modification or supplement hereto or thereto) by the Company, or any certificate furnished to any Bank or the Administrative Agent pursuant to the provisions hereof or thereof, shall prove to have been false or misleading as of the time made, deemed made or furnished in any material respect; or (d) The Company shall default in the performance of any of its obligations under any of Sections 8.01(h), 8.05 to 8.10 (inclusive) and 8.12 to 8.17 (inclusive) hereof; or the Company shall default in the performance of any of its other obligations in this Agreement or any other Basic Document and such default shall continue unremedied for a period of 15 Business Days after notice thereof to the Company by the Administrative Agent or any Bank (through the Administrative Agent); or (e) The Company or any of its Material Subsidiaries shall admit in writing its inability to, or be generally unable to, pay its debts as such debts become due; or (f) The Company or any of its Material Subsidiaries shall (i) apply for or consent to the appointment of, or the taking of possession by, a receiver, custodian, trustee, examiner, rehabilitator, conservator or liquidator of itself or of all or a substantial part of its Property, (ii) make a general assignment for the benefit of its creditors, (iii) commence a voluntary case under the Bankruptcy Code, (iv) file a petition seeking to take advantage of any other law relating to bankruptcy, insolvency, reorganization, liquidation, dissolution, arrangement or winding-up, or Credit Agreement ---------------- -54- composition or readjustment of debts, (v) fail to controvert in a timely and appropriate manner, or acquiesce in writing to, any petition filed against it in an involuntary case under the Bankruptcy Code or (vi) take any corporate action for the purpose of effecting any of the foregoing; or (g) A proceeding or case shall be commenced, without the application or consent of the Company or any of its Material Subsidiaries, in any court of competent jurisdiction, seeking (i) its reorganization, rehabilitation, conservation, liquidation, dissolution, arrangement or winding-up, or the composition or readjustment of its debts, (ii) the appointment of a receiver, custodian, trustee, examiner, rehabilitator, conservator, liquidator or the like of the Company or such Subsidiary or of all or any substantial part of its Property, or (iii) similar relief in respect of the Company or such Subsidiary under any law relating to bankruptcy, insolvency, reorganization, rehabilitation, conservation, liquidation, winding-up, or composition or adjustment of debts, and such proceeding or case shall continue undismissed, or an order, judgment or decree approving or ordering any of the foregoing (other than an order for relief in an involuntary case under the Bankruptcy Code) shall be entered and continue unstayed and in effect, for a period of 60 or more days; or an order for relief against the Company or such Subsidiary shall be entered in an involuntary case under the Bankruptcy Code; or (h) A judgment or judgments for the payment of money in excess of $10,000,000 in the aggregate (exclusive of judgment amounts fully covered by insurance where the insurer has admitted liability in respect of such judgment) shall be rendered by one or more courts, administrative tribunals or other bodies having jurisdiction against the Company or any of its Subsidiaries and the same shall not be discharged (or provision shall not be made for such discharge), or a stay of execution thereof shall not be procured, within 60 days from the date of entry thereof and the Company or the relevant Subsidiary shall not, within said period of 60 days, or such longer period during which execution of the same shall have been stayed, appeal therefrom and cause the execution thereof to be stayed during such appeal; or (i) An event or condition specified in Section 8.01(g) hereof shall occur or exist with respect to any Plan or Multiemployer Plan and, as a result of such event or condition, together with all other such events or conditions, the Company or any ERISA Affiliate shall incur Credit Agreement ---------------- -55- or in the opinion of the Majority Banks shall be reasonably likely to incur a liability to a Plan, a Multiemployer Plan or PBGC (or any combination of the foregoing) which, in the determination of the Majority Banks, could have a Material Adverse Effect; or (j) A Change in Control shall occur; THEREUPON: (1) in the case of an Event of Default other than one referred to in paragraph (f) or (g) of this Section 9 with respect to the Company, the Administrative Agent may and, upon request of the Majority Banks, shall, by notice to the Company, terminate the Commitments and/or declare the principal amount then outstanding of, and the accrued interest on, the Loans and all other amounts payable by the Company hereunder and under the Notes (including, without limitation, any amounts payable under Section 5.04 hereof) to be forthwith due and payable, whereupon such amounts shall be immediately due and payable without presentment, demand, protest or other formalities of any kind, all of which are hereby expressly waived by the Company; and (2) in the case of the occurrence of an Event of Default referred to in paragraph (f) or (g) of this Section 9 with respect to the Company, the Commitments shall automatically be terminated and the principal amount then outstanding of, and the accrued interest on, the Loans and all other amounts payable by the Company hereunder and under the Notes (including, without limitation, any amounts payable under Section 5.04 hereof) shall automatically become immediately due and payable without presentment, demand, protest or other formalities of any kind, all of which are hereby expressly waived by the Company. Section 10. The Administrative Agent. ------------------------ 10.01 Appointment, Powers and Immunities. Each Bank hereby ---------------------------------- irrevocably (subject to Section 10.08 hereof) appoints and authorizes the Administrative Agent to act as its agent hereunder and under the other Basic Documents with such powers as are specifically delegated to the Administrative Agent by the terms of this Agreement and of the other Basic Documents, together with such other powers as are reasonably incidental thereto. The Administrative Agent (which term as used in this sentence and in Section 10.05 and the first sentence of Section 10.06 hereof shall include reference to its affiliates and its own and its affiliates' officers, directors, employees and agents): (a) shall have no duties or responsibilities except those expressly set forth in this Agreement and in the other Basic Documents, and shall not by reason of this Agreement or any other Basic Document be a trustee for any Bank; (b) shall not be responsible to the Banks for any recitals, statements, representations or warranties contained in this Agreement or in Credit Agreement ---------------- -56- any other Basic Document, or in any certificate or other document referred to or provided for in, or received by any of them under, this Agreement or any other Basic Document, or for the value, validity, effectiveness, genuineness, enforceability or sufficiency of this Agreement, any Note or any other Basic Document or any other document referred to or provided for herein or therein or for any failure by the Company or any other Person to perform any of its obligations hereunder or thereunder; (c) shall not be required to initiate or conduct any litigation or collection proceedings hereunder or under any other Basic Document; and (d) shall not be responsible for any action taken or omitted to be taken by it hereunder or under any other Basic Document or under any other document or instrument referred to or provided for herein or therein or in connection herewith or therewith, except for its own gross negligence or willful misconduct. The Administrative Agent may employ agents and attorneys-in-fact and shall not be responsible for the negligence or misconduct of any such agents or attorneys-in-fact selected by it in good faith. The Administrative Agent may deem and treat the payee of any Note as the holder thereof for all purposes hereof unless and until a notice of the assignment or transfer thereof shall have been filed with the Administrative Agent, together with the consent of the Company to such assignment or transfer (to the extent provided in Section 11.06(b) hereof). 10.02 Reliance by Administrative Agent. The Administrative Agent -------------------------------- shall be entitled to rely upon any certification, notice or other communication (including, without limitation, any thereof by telephone, telecopy, telex, telegram or cable) believed by it to be genuine and correct and to have been signed or sent by or on behalf of the proper Person or Persons, and upon advice and statements of legal counsel, independent accountants and other experts selected by the Administrative Agent. As to any matters not expressly provided for by this Agreement or any other Basic Document, the Administrative Agent shall in all cases be fully protected in acting, or in refraining from acting, hereunder or thereunder in accordance with instructions given by the Majority Banks or, if provided herein, in accordance with the instructions given by the Majority Banks or all of the Banks as is required in such circumstance, and such instructions of such Banks and any action taken or failure to act pursuant thereto shall be binding on all of the Banks. 10.03 Defaults. The Administrative Agent shall not be deemed to have -------- knowledge or notice of the occurrence of a Default unless the Administrative Agent has received notice from a Bank or the Company specifying such Default and stating that such notice is a "Notice of Default". In the event that the Administrative Agent receives such a notice of the occurrence of Credit Agreement ---------------- -57- a Default, the Administrative Agent shall give prompt notice thereof to the Banks (and shall give each Bank prompt notice of each such non-payment). The Administrative Agent shall (subject to Sections 10.01, 10.07 and 11.04 hereof) take such action with respect to such Default as shall be directed by the Majority Banks, provided that, unless and until the Administrative Agent shall -------- have received such directions, the Administrative Agent may (but shall not be obligated to) take such action, or refrain from taking such action, with respect to such Default as it shall deem advisable in the best interest of the Banks except to the extent that this Agreement expressly requires that such action be taken, or not be taken, only with the consent or upon the authorization of the Majority Banks or all of the Banks. 10.04 Rights as a Bank. With respect to its Commitments and the ---------------- Loans made by it, Chase (and any successor acting as Administrative Agent) in its capacity as a Bank hereunder shall have the same rights and powers hereunder as any other Bank and may exercise the same as though it were not acting as the Administrative Agent, and the term "Bank" or "Banks" shall, unless the context otherwise indicates, include the Administrative Agent in its individual capacity. Chase (and any successor acting as Administrative Agent) and its affiliates may (without having to account therefor to any Bank) accept deposits from, lend money to, make investments in and generally engage in any kind of banking, trust or other business with the Company (and any of its Subsidiaries or Affiliates) as if it were not acting as the Administrative Agent, and Chase and its affiliates may accept fees and other consideration from the Company for services in connection with this Agreement or otherwise without having to account for the same to the Banks. 10.05 Indemnification. The Banks agree to indemnify the --------------- Administrative Agent (to the extent not reimbursed under Section 11.03 hereof, but without limiting the obligations of the Company under said Section 11.03) ratably in accordance with the aggregate principal amount of the Loans held by the Banks (or, if no Loans are at the time outstanding, ratably in accordance with their respective Commitments), for any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind and nature whatsoever that may be imposed on, incurred by or asserted against the Administrative Agent (including by any Bank) arising out of or by reason of any investigation in or in any way relating to or arising out of this Agreement or any other Basic Document or any other documents contemplated by or referred to herein or therein or the transactions contemplated hereby or thereby (including, without limitation, the costs and expenses that the Company is obligated to pay under Section 11.03 hereof, but excluding, unless a Default has occurred and is continuing, Credit Agreement ---------------- -58- normal administrative costs and expenses incident to the performance of its agency duties hereunder) or the enforcement of any of the terms hereof or thereof or of any such other documents, provided that no Bank shall be liable -------- for any of the foregoing to the extent they arise from the gross negligence or willful misconduct of the party to be indemnified. 10.06 Non-Reliance on Administrative Agent and Other Banks. Each ---------------------------------------------------- Bank agrees that it has, independently and without reliance on the Administrative Agent or any other Bank, and based on such documents and information as it has deemed appropriate, made its own credit analysis of the Company and its Subsidiaries and decision to enter into this Agreement and that it will, independently and without reliance upon the Administrative Agent or any other Bank, and based on such documents and information as it shall deem appropriate at the time, continue to make its own analysis and decisions in taking or not taking action under this Agreement. The Administrative Agent shall not be required to keep itself informed as to the performance or observance by the Company of this Agreement or any of the other Basic Documents or any other document referred to or provided for herein or therein or to inspect the Properties or books of the Company or any of its Subsidiaries. Except for notices, reports and other documents and information expressly required to be furnished to the Banks by the Administrative Agent hereunder, the Administrative Agent shall not have any duty or responsibility to provide any Bank with any credit or other information concerning the affairs, financial condition or business of the Company or any of its Subsidiaries (or any of their affiliates) that may come into the possession of the Administrative Agent or any of its affiliates. 10.07 Failure to Act. Except for action expressly required of the -------------- Administrative Agent hereunder and under the other Basic Documents, the Administrative Agent shall in all cases be fully justified in failing or refusing to act hereunder and thereunder unless it shall receive further assurances to its satisfaction from the Banks of their indemnification obligations under Section 10.05 hereof against any and all liability and expense that may be incurred by it by reason of taking or continuing to take any such action. 10.08 Resignation or Removal of Administrative Agent. Subject to the ---------------------------------------------- appointment and acceptance of a successor Administrative Agent as provided below, the Administrative Agent may resign at any time by giving notice thereof to the Banks and the Company, and the Administrative Agent may be removed at any time with or without cause by the Majority Banks. Upon any such resignation or removal, the Majority Banks shall have the right to appoint a successor Administrative Agent. If no successor Credit Agreement ---------------- -59- Administrative Agent shall have been so appointed by the Majority Banks and shall have accepted such appointment within 30 days after the retiring Administrative Agent's giving of notice of resignation or the Majority Banks' removal of the retiring Administrative Agent, then the retiring Administrative Agent may, on behalf of the Banks, after consultation with the Company, appoint a successor Administrative Agent, that shall be a bank which has an office in New York, New York and which has a combined capital and surplus of at least $500,000,000. Upon the acceptance of any appointment as Administrative Agent hereunder by a successor Administrative Agent, such successor Administrative Agent shall thereupon succeed to and become vested with all the rights, powers, privileges and duties of the retiring Administrative Agent, and the retiring Administrative Agent shall be discharged from its duties and obligations hereunder. After any retiring Administrative Agent's resignation or removal hereunder as Administrative Agent, the provisions of this Section 10 shall continue in effect for its benefit in respect of any actions taken or omitted to be taken by it while it was acting as the Administrative Agent. 10.09 Arranger. The Arranger named on the cover page of this -------- Agreement is not a party thereto and shall not have any duties or responsibilities hereunder. Section 11. Miscellaneous. ------------- 11.01 Waiver. No failure on the part of the Administrative Agent or ------ any Bank to exercise and no delay in exercising, and no course of dealing with respect to, any right, power or privilege under this Agreement or any Note shall operate as a waiver thereof, nor shall any single or partial exercise of any right, power or privilege under this Agreement or any Note preclude any other or further exercise thereof or the exercise of any other right, power or privilege. The remedies provided herein are cumulative and not exclusive of any remedies provided by law. 11.02 Notices. All notices, requests and other communications ------- provided for herein and under the Pledge Agreement (including, without limitation, any modifications of, or waivers, requests or consents under, this Agreement) shall be given or made in writing (including, without limitation, by telecopy) delivered to the intended recipient at the "Address for Notices" specified below its name on the signature pages hereof); or, as to any party, at such other address as shall be designated by such party in a notice to each other party. Except as otherwise provided in this Agreement, all such communications shall be deemed to have been duly given when transmitted by telecopier or Credit Agreement ---------------- -60- personally delivered or, in the case of a mailed notice, upon receipt, in each case given or addressed as aforesaid. 11.03 Expenses, Etc. The Company agrees to pay or reimburse each of -------------- the Banks and the Administrative Agent for paying: (a) all reasonable out-of- pocket costs and expenses of the Administrative Agent (including, without limitation, the reasonable fees and expenses of Milbank, Tweed, Hadley & McCloy, special New York counsel to Chase), in connection with (i) the negotiation, preparation, execution and delivery of this Agreement and the other Basic Documents and the making of the Loans hereunder and (ii) any modification, supplement or waiver of any of the terms of this Agreement or any of the other Basic Documents; (b) all costs and expenses of the Banks and the Administrative Agent (including, without limitation, reasonable counsels' fees) in connection with (i) any Default and any enforcement or collection proceedings resulting therefrom or in connection with the negotiation of any restructuring or "work- out" (whether or not consummated) of the obligations of the Company hereunder or under any of the other Basic Documents and (ii) the enforcement of this Section 11.03; and (c) all transfer, stamp, documentary or other similar taxes, assessments or charges levied by any governmental or revenue authority in respect of this Agreement or any of the other Basic Documents or any other document referred to herein or therein and all costs, expenses, taxes, assessments and other charges incurred in connection with any filing, registration, recording or perfection of any security interest contemplated by any Basic Document or any other document referred to therein. The Company hereby agrees to indemnify the Administrative Agent and each Bank and their respective directors, officers, employees, attorneys and agents from, and hold each of them harmless against, any and all losses, liabilities, claims, damages or expenses incurred by any of them (other than liability of the Administrative Agent to any Bank) arising out of or by reason of any investigation or litigation or other proceedings (including any threatened investigation or litigation or other proceedings and whether or not the Administrative Agent or such Bank or other Person is a party thereto) relating to the extensions of credit hereunder or any actual or proposed use by the Company or any of its Subsidiaries of the proceeds of any of the extensions of credit hereunder, including, without limitation, the reasonable fees and disbursements of counsel incurred in connection with any such investigation or litigation or other proceedings (but excluding any such losses, liabilities, claims, damages or expenses incurred by reason of the gross negligence or willful misconduct of the Person to be indemnified). Credit Agreement ---------------- -61- 11.04 Amendments, Etc. Except as otherwise expressly provided in ---------------- this Agreement, any provision of this Agreement may be modified or supplemented only by an instrument in writing signed by the Company, the Administrative Agent and the Majority Banks, or by the Company and the Administrative Agent acting with the consent of the Majority Banks, and any provision of this Agreement may be waived by the Majority Banks or by the Administrative Agent acting with the consent of the Majority Banks; provided that: (a) no modification, supplement -------- or waiver shall, unless by an instrument signed by all of the Banks or by the Administrative Agent acting with the consent of all of the Banks (i) increase or extend the term of any of the Commitments, or extend the time or waive any requirement for the reduction or termination of any of the Commitments, (ii) extend any date fixed for the payment of principal of or interest on any Loan or any fee hereunder (other than any fee payable solely for account of the Administrative Agent), (iii) reduce the amount of any such payment of principal, (iv) reduce the rate at which interest is payable thereon or any fee is payable hereunder (other than any fee payable solely for account of the Administrative Agent), (v) reduce the obligations of the Company to prepay Loans, (vi) alter the terms of any of Sections 2.08, 4.02 or 4.07 hereof or this Section 11.04, (vii) modify the definition of the term "Majority Banks" or modify in any other manner the number or percentage of the Banks required to make any determinations or waive any rights hereunder or to modify any provision hereof, or (viii) waive any of the conditions precedent set forth in Section 6 hereof; and (b) any modification of any of the rights or obligations of the Administrative Agent hereunder shall require the consent of the Administrative Agent. 11.05 Successors and Assigns. This Agreement shall be binding upon ---------------------- and inure to the benefit of the parties hereto and their respective successors and permitted assigns. 11.06 Assignments and Participations. ------------------------------ (a) The Company may not assign any of its rights or obligations hereunder or under the Notes without the prior consent of all of the Banks and the Administrative Agent. (b) Each Bank may, at any time or from time to time, assign to one or more other Persons all or any portion of its Loans, its Notes, and its Commitment (but only with the consent of the Company and the Administrative Agent, which consent shall not be unreasonably withheld); provided that (i) no -------- such consent by the Company or the Administrative Agent shall be required in the case of any assignment to another Bank; (ii) any such partial assignment shall be in an amount at least equal to $5,000,000 or any integral multiple of $1,000,000 in excess thereof unless the Credit Agreement ---------------- -62- Company and the Administrative Agent shall otherwise agree; (iii) each such assignment by a Bank of its Revolving Credit Loans, Revolving Credit Note, Term Loans, Term Loan Notes or Commitment shall be made in such manner so that the same portion of its Revolving Credit Loans, Revolving Credit Note, Term Loans, Term Loan Notes and Commitment is assigned to the respective assignee; and (iv) upon each such assignment the assignor and assignee shall deliver to the Company and the Administrative Agent an Assignment and Acceptance substantially in the form of Exhibit E hereto. Upon execution and delivery by the assignor and the assignee to the Company and the Administrative Agent of such Assignment and Acceptance, and upon consent thereto by the Company and the Administrative Agent, to the extent required above, the assignee shall have, to the extent of such assignment (unless otherwise provided in such assignment with the consent of the Company and the Administrative Agent), the obligations, rights and benefits of a Bank hereunder holding the Commitment and Loans (or portions thereof) assigned to it (in addition to the Commitment and Loans, if any, theretofore held by such assignee) and the assigning Bank shall, to the extent of such assignment, be released from the Commitment (or portion thereof) so assigned. Upon each such assignment the assigning Bank shall pay the Administrative Agent an assignment fee of $3,000. (c) A Bank may, at any time or from time to time, sell or agree to sell to one or more other Persons a participation in all or any part of any Loans held by it, or in its Commitment, but no purchaser of a participation (a "Participant") shall, except as otherwise provided in Section 4.07(c) hereof, - ------------ have any rights or benefits under this Agreement or any Note or any other Basic Document (the Participant's rights against such Bank in respect of such participation to be those set forth in the agreements executed by such Bank in favor of the Participant). All amounts payable by the Company to any Bank under Section 5 hereof in respect of the Loans held by it, and its Commitment, shall be determined as if such Bank had not sold or agreed to sell any participations in such Loans and Commitment, and as if such Bank were funding each of such Loan and Commitment in the same way that it is funding the portion of such Loan and Commitment in which no participations have been sold. In no event shall a Bank that sells a participation agree with the Participant to take or refrain from taking any action hereunder or under any other Basic Document except that such Bank may agree with the Participant that it will not, without the consent of the Participant, agree to (i) increase or extend the term, or extend the time or waive any requirement for the reduction or termination, of such Bank's related Commitment, (ii) extend any date fixed for the payment of principal of or interest on the related Loan or Loans or any portion of any fee hereunder payable to the Participant, (iii) reduce the amount of any such payment Credit Agreement ---------------- -63- of principal, (iv) reduce the rate at which interest is payable thereon, or any fee hereunder payable to the Participant, to a level below the rate at which the Participant is entitled to receive such interest or fee, (v) increase the rights or reduce the obligations of the Company to prepay the related Loans or (vi) consent to any modification, supplement or waiver hereof or of any of the other Basic Documents to the extent that the same, under Section 10.09 or 11.04 hereof, requires the consent of each Bank. (d) In addition to the assignments and participations permitted by the foregoing provisions of this Section 11.06, any Bank may assign and pledge all or any portion of its Loans and its Notes to any Federal Reserve Bank as collateral security pursuant to Regulation A and any Operating Circular issued by such Federal Reserve Bank. No such assignment shall release the assigning Bank from its obligations hereunder. (e) A Bank may furnish any information concerning the Company or any of its Subsidiaries in the possession of such Bank from time to time to assignees and participants (including prospective assignees and participants), subject, however, to the provisions of Section 11.12(b) hereof. (f) Anything in this Section 11.06 to the contrary notwithstanding, neither the Company nor any of its Subsidiaries or Affiliates may acquire (whether by assignment, participation or otherwise), and no Bank shall assign or participate to the Company or any of its Subsidiaries or Affiliates, any interest in any Commitment or Loan without the prior consent of each Bank. 11.07 Survival. The obligations of the Company under Sections 5.01, -------- 5.04, 5.05 and 11.03 hereof and the obligations of the Banks under Section 10.05 hereof shall survive the repayment of the Loans and the termination of the Commitments. In addition, each representation and warranty made, or deemed to be made by a notice of any Loan, herein or pursuant hereto shall survive the making of such representation and warranty, and no Bank shall be deemed to have waived, by reason of making any Loan, any Default which may arise by reason of such representation or warranty proving to have been false or misleading, notwithstanding that such Bank or the Administrative Agent may have had notice or knowledge or reason to believe that such representation or warranty was false or misleading at the time such Loan was made. 11.08 Captions. The table of contents and captions and section -------- headings appearing herein are included solely for convenience of reference and are not intended to affect the interpretation of any provision of this Agreement. Credit Agreement ---------------- -64- 11.09 Counterparts. This Agreement may be executed in any number of ------------ counterparts, all of which taken together shall constitute one and the same instrument and any of the parties hereto may execute this Agreement by signing any such counterpart. 11.10 Governing Law; Submission to Jurisdiction. This Agreement and ----------------------------------------- the Notes shall be governed by, and construed in accordance with, the law of the State of New York. The Company hereby submits to the nonexclusive jurisdiction of the United States District Court for the Southern District of New York and of any New York State court sitting in New York County, and any appellate court therefrom, for the purposes of all legal proceedings arising out of or relating to this Agreement or the transactions contemplated hereby. The Company irrevocably waives, to the fullest extent permitted by applicable law, any objection which it may now or hereafter have to the laying of the venue of any such proceeding brought in such a court and any claim that any such proceeding brought in such a court has been brought in an inconvenient forum. 11.11 Waiver of Jury Trial. EACH OF THE COMPANY, THE ADMINISTRATIVE -------------------- AGENT AND THE BANKS HEREBY IRREVOCABLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, ANY AND ALL RIGHT TO TRIAL BY JURY IN ANY LEGAL PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY. 11.12 Treatment of Certain Information; Confidentiality. ------------------------------------------------- (a) The Company acknowledges that from time to time financial advisory, investment banking and other services may be offered or provided to the Company or one or more of its Subsidiaries (in connection with this Agreement or otherwise) by any Bank or by one or more Subsidiaries or Affiliates of such Bank and the Company hereby authorizes each Bank to share any information delivered to such Bank by the Company and its Subsidiaries pursuant to this Agreement, or in connection with the decision of such Bank to enter into this Agreement, to any such Subsidiary or Affiliate, it being understood that any such Subsidiary or Affiliate receiving such information shall be bound by the provisions of paragraph (b) below as if it were a Bank hereunder. (b) Each Bank and the Administrative Agent agrees (on behalf of itself and each of its affiliates, directors, officers, employees and representatives) to use reasonable precautions to keep confidential, in accordance with their customary procedures for handling confidential information of this nature and in Credit Agreement ---------------- -65- accordance with safe and sound banking practices, any non-public information supplied to it by the Company pursuant to this Agreement which is identified by the Company as being confidential at the time the same is delivered to the Banks or the Administrative Agent, provided that nothing herein shall limit the -------- disclosure of any such information (i) to the extent required by statute, rule, regulation or judicial process (with, unless prohibited by applicable law, prior notice thereof to the Company giving sufficient time, if practicable, to afford the Company an opportunity to seek a protective order), (ii) to counsel, auditors or accountants for any of the Banks or the Administrative Agent (so long as they are advised of the non-public nature of the information), (iii) to bank examiners, (iv) to the Administrative Agent or any other Bank (or to Chase Securities, Inc.), (v) in connection with any litigation to which any one or more of the Banks or the Administrative Agent is a party (with, except in the case of any litigation to which the Company or any of its Subsidiaries is also a party, or unless prohibited by applicable law, prior notice to the Company giving sufficient time, if practicable, to afford the Company an opportunity to seek a protective order), (vi) to a Subsidiary or Affiliate of such Bank as provided in paragraph (a) above or (vii) to any assignee or participant (or prospective assignee or participant) so long as such assignee or participant (or prospective assignee or participant) first executes and delivers to the respective Bank and the Company a Confidentiality Agreement substantially in the form of Exhibit D hereto; provided, further, that in no event shall any Bank or -------- ------- the Administrative Agent be obligated or required to return any materials furnished by the Company. The obligations of each Bank under this Section 11.12 shall supersede and replace the obligations of such Bank under the confidentiality letter in respect of this financing signed and delivered by such Bank to the Company prior to the date hereof. Credit Agreement ---------------- -66- IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and delivered as of the day and year first above written. CAPITAL RE CORPORATION By: /s/ David A. Buzen ------------------------- Name: David A. Buzen Title: EVP & CFO By: /s/ Howard S. Yaruss ------------------------- Name: Howard S. Yaruss Title: Vice President Address for Notices: 1325 Avenue of the Americas New York, New York 10019 Attention: Chief Financial Officer Telecopier No.: (212) 581-3268 Telephone No.: (212) 974-0100 Credit Agreement ---------------- -67- BANKS ----- Commitment THE CHASE MANHATTAN BANK - ---------- $25,000,000 By /s/ J. David Parker, Jr. --------------------------- Title: Vice President Lending Office for all Loans: The Chase Manhattan Bank 270 Park Avenue New York, New York 10017 Address for Notices: The Chase Manhattan Bank 1 Chase Manhattan Plaza 4th Floor New York, NY 10081 Attention: J. David Parker, Jr. Vice President Telecopier No.: (212) 552-3651 Telephone No.: (212) 552-7631 Credit Agreement ---------------- -68- THE CHASE MANHATTAN BANK as Administrative Agent By /s/ J. David Parker, Jr. ------------------------------ Title: Vice President Address for Notices to the Administrative Agent: The Chase Manhattan Bank 140 East 45th Street, 29th Floor New York, New York 10017 Attention: Agent Bank Services Telecopier No.: (212) 662-0122 Telephone No.: (212) 662-0004 With a copy to: The Chase Manhattan Bank 1 Chase Manhattan Plaza 4th Floor New York, NY 10081 Attention: J. David Parker, Jr. Vice President Telecopier No.: (212) 552-3651 Telephone No.: (212) 552-7631 Credit Agreement ---------------- -69- SCHEDULE I Material Agreements and Liens ----------------------------- [See Sections 7.12 and 8.07(b)] Part A - Material Agreements ------------------- Part B - Liens ----- None AMENDED AND RESTATED AGREEMENT CONCERNING FILING OF CONSOLIDATED FEDERAL INCOME TAX RETURNS In consideration of the mutual undertakings and agreements contained herein, it is agreed by and among the undersigned companies that: 1. Each company agrees to its inclusion in a consolidated federal income tax return for calendar year 1988 and succeeding taxable years during which it remains a member of the affiliated group and each company agrees to pay its proportionate share of the consolidated federal tax burden that would have been paid if said company had filed on a separate return basis. Under no circumstances shall the tax charged to each company under this Agreement be more than it would have paid if it had filed on a separate return basis. If tax losses or other tax benefits of one member of the group are utilized by another member of the group, it is agreed that reimbursement will be made under paragraph three (3) for such tax benefits utilized. 2. The amount of any payment of federal income taxes under this Agreement shall be calculated by Capital Re Corporation (the "Corporation"). The companies agree that the Corporation shall make any necessary adjustments to equalize the effect of the alternative minimum tax. 3. All intercompany balances will be settled by the necessary payments to and from the various companies at the same time as payments would have been made to the Internal Revenue Service if separate returns had been filed by all members of the affiliated group on the date the consolidated return is filed or within ten days after such date. If the amount paid by any company to the Corporation for federal income taxes under this Agreement is greater than the actual payment made by the Corporation to the Internal Revenue Service, then the difference shall be placed in escrow. Escrow assets may be released to the Corporation from the escrow account at such time as the permissible loss carryback has elapsed. Once a company is "paid" for its credits, it cannot use such credits in the calculation of its tax liability under the separate return basis. Any of the company's credits which are not used in the consolidated return and for which it has not been paid shall be retained by such company for possible future use. 4. This Agreement will terminate upon the occurrence of any of the following events: (a) the parties agree in writing to such termination, (b) the Corporation does not file a consolidated federal income tax return for any taxable year, or (c) as to any company, if membership of such company in the affiliated group or consolidated group ceases or is terminated for any reason whatsoever. 5. Notwithstanding the termination of this Agreement, its provisions will remain in effect with respect to any period of time for which the taxable income of any company was included in any consolidated federal income tax return of the Corporation. 6. Upon termination of this Agreement, all material including, but not limited to, returns, supporting schedules, workpapers, correspondence and other documents relating to the consolidated federal income tax returns shall be made available to any of the parties to this Agreement during regular business hours. 7. This Agreement shall become a binding agreement among the undersigned companies upon execution hereof by each and an entity hereafter becoming a member of the affiliated group shall become a participant in this Agreement simply by executing an appropriate instrument evidencing its wish to participate (provided that any necessary regulatory clearances shall have first been obtained). 8. This Agreement shall not be assignable by any party hereto, without the prior written consent of each of the other undersigned companies. 9. This Agreement may be executed in any number of counterparts each of which will be deemed an original, but all of which together shall constitute one of the same instrument. 10. As a condition precedent to any right of action hereunder, if any dispute shall arise between any two parties hereto with reference to the interpretation of this Agreement or their rights with respect to any transaction involved, such dispute, upon the written request of either party, shall be submitted to three arbitrators, one to be chosen by each party, and the third by the two arbitrators so chosen. If either party refuses or neglects to appoint an arbitrator within thirty (30) days after the receipt of written notice from the other party requesting it to do so, the requesting party may appoint two arbitrators. If the two arbitrators fail to agree in the selection of a third arbitrator within thirty (30) days of their appointment, each of them shall name two, of whom the other shall decline one and the decision shall be made by drawing lots. All arbitrators shall be active or retired disinterested officers of insurance or reinsurance companies not under the control of any party hereto. Except as may be otherwise provided herein, the arbitrators shall promulgate rules to interpret this Agreement based upon the Commercial Arbitration Rules of the American Arbitration Association. The arbitrators shall interpret this Agreement as an honorable engagement rather than as a legal obligation and will make their award with the view to effecting the general purpose and intent of this Agreement, rather than in accordance with the literal interpretation of this Agreement. The party requesting the arbitration shall submit its case to the arbitrators within forty-five (45) days of the appointment of the third arbitrator. The party responding to the request for arbitration shall submit its case to the arbitrators within forty-five (45) days of the receipt of the petitioner's case. A hearing shall be held within thirty (30) days after receipt of the parties cases in writing. The arbitrators shall render their decision within thirty (30) days after completion of the hearing. The decision in writing of any two arbitrators, when filed with the two disputing parties hereto, shall be final and binding on both parties. Judgment may be entered upon the final decision the arbitrators in any court having jurisdiction. Each disputing party shall bear the expense of its own arbitrator and shall jointly and equally bear with the other party the expense of the third arbitrator and arbitration. Said arbitration shall take place in New York City unless some other place is mutually agreed upon by the two disputing parties hereto. 11. This Agreement shall be interpreted in accordance with the laws of the State of New York. IN WITNESS WHEREOF, the undersigned companies as of the 13th day of Nov., 1995, have by their duly authorized officers executed this Agreement. ATTEST: CAPITAL RE CORPORATION /s/ (SIGNATURE APPEARS HERE) By: /s/ (SIGNATURE APPEARS HERE) - ----------------------------- ------------------------------- President SUBSIDIARIES - ------------ ATTEST: CAPITAL REINSURANCE CORPORATION /s/ (SIGNATURE APPEARS HERE) By: /s/ (SIGNATURE APPEARS HERE) - ----------------------------- ------------------------------- President ATTEST: CAPITAL RE CORPORATION /s/ (SIGNATURE APPEARS HERE) By: /s/ (SIGNATURE APPEARS HERE) - ----------------------------- ------------------------------- President ATTEST: CAPITAL CREDIT REINSURANCE COMPANY (BERMUDA) LTD. /s/ (SIGNATURE APPEARS HERE) By: /s/ (SIGNATURE APPEARS HERE) - ----------------------------- ------------------------------- President ATTEST: CAPITAL RE MANAGEMENT CORPORATION /s/ (SIGNATURE APPEARS HERE) By: /s/ (SIGNATURE APPEARS HERE) - ----------------------------- ------------------------------- President ATTEST: CAPITAL MORTGAGE REINSURANCE COMPANY /s/ (SIGNATURE APPEARS HERE) By: /s/ (SIGNATURE APPEARS HERE) - ----------------------------- ------------------------------- President ATTEST: CAPITAL TITLE REINSURANCE COMPANY /s/ (SIGNATURE APPEARS HERE) By: /s/ (SIGNATURE APPEARS HERE) - ----------------------------- ------------------------------- President -70- SCHEDULE II Capital Re Corporation Organization Chart Appears here -71- SCHEDULE III Litigation: None -72- EXHIBIT A-1 [Form of Revolving Credit Note] PROMISSORY NOTE $_______________ August __, 1996 New York, New York FOR VALUE RECEIVED, CAPITAL RE CORPORATION, a Delaware corporation (the "Company"), hereby promises to pay to __________________ (the "Payee"), for ------- ----- account of its Applicable Lending Office provided for by the Credit Agreement referred to below, at the principal office of The Chase Manhattan Bank in New York, New York, the principal sum of _______________ Dollars (or such lesser amount as shall equal the aggregate unpaid principal amount of the Revolving Credit Loans made by the Payee to the Company under the Credit Agreement), in lawful money of the United States of America and in immediately available funds, on the dates and in the principal amounts provided in the Credit Agreement, and to pay interest on the unpaid principal amount of each such Revolving Credit Loan, at such office, in like money and funds, for the period commencing on the date of such Revolving Credit Loan until such Revolving Credit Loan shall be paid in full, at the rates per annum and on the dates provided in the Credit Agreement. The date, amount, interest rate and duration of Interest Period of each Revolving Credit Loan made by the Payee to the Company, and each payment made on account of the principal thereof, shall be recorded by the Payee on its books and, prior to any transfer of this Note, endorsed by the Payee on the schedule attached hereto or any continuation thereof, provided that the failure -------- of the Payee to make any such recordation or endorsement shall not affect the obligations of the Company to make a payment when due of any amount owing under the Credit Agreement or hereunder in respect of the Revolving Credit Loans made by the Payee. This Note is one of the Revolving Credit Notes referred to in the Credit Agreement dated as of August 20, 1996 (as modified and supplemented and in effect from time to time, the "Credit Agreement") among the Company, the ---------------- Banks and The Chase Manhattan Bank, as Administrative Agent, and evidences Revolving Credit Loans made by the Payee thereunder. Terms used but not defined in this Note have the respective meanings assigned to them in the Credit Agreement. The Credit Agreement provides for the acceleration of the maturity of this Note upon the occurrence of certain events specified therein. Revolving Credit Note --------------------- -73- Except as permitted by Sections 11.06(b) and 11.06(d) of the Credit Agreement, this Note may not be assigned by the Payee to any other Person. This Note shall be governed by, and construed in accordance with, the law of the State of New York. CAPITAL RE CORPORATION By:____________________________ Name: Title: By:____________________________ Name: Title: Revolving Credit Note --------------------- -74- SCHEDULE OF REVOLVING CREDIT LOANS This Note evidences Revolving Credit Loans made, under the within- described Credit Agreement to the Company, on the dates, in the principal amounts, bearing interest at the rates and having Interest Periods (if applicable) of the durations set forth below, subject to the payments and prepayments of principal set forth below:
Prin- cipal Duration Unpaid Amount of Amount Prin- Date of Interest Interest Paid or cipal Notation Made Loan Rate Period Prepaid Amount Made by - ------- ---------- -------- ------- ------- ------- --------
Revolving Credit Note --------------------- -75- EXHIBIT A-2 [Form of Term Loan Note] PROMISSORY NOTE $_____________________ $____________, 199_ New York, New York FOR VALUE RECEIVED, CAPITAL RE CORPORATION, a Delaware corporation (the "Company"), hereby promises to pay to __________________ (the "Payee"), for ------- ----- account of its Applicable Lending Office provided for by the Credit Agreement referred to below, at the principal office of The Chase Manhattan Bank in New York, New York, the principal sum of _______________ Dollars, in lawful money of the United States of America and in immediately available funds, on the dates and in the principal amounts provided in the Credit Agreement, and to pay interest on the unpaid principal amount hereof, at such office, in like money and funds, for the period commencing on the date hereof until this Note shall be paid in full, at the rates per annum and on the dates provided in the Credit Agreement. This Note is one of the Term Loan Notes referred to in the Credit Agreement dated as of August 20, 1996 (as modified and supplemented and in effect from time to time, the "Credit Agreement") among the Company, the Banks ---------------- and The Chase Manhattan Bank, as Administrative Agent, and evidences a Term Loan made by the Payee thereunder. Terms used but not defined in this Note have the respective meanings assigned to them in the Credit Agreement. The Credit Agreement provides for the acceleration of the maturity of this Note upon the occurrence of certain events specified therein. Except as permitted by Sections 11.06(b) and 11.06(d) and of the Credit Agreement, this Note may not be assigned by the Payee to any other Person. Term Loan Note -------------- -76- This Note shall be governed by, and construed in accordance with, the law of the State of New York. CAPITAL RE CORPORATION By:____________________________ Name: Title: By:____________________________ Name: Title: Term Loan Note -------------- -77- EXHIBIT B-1 [Form of Opinion of General Counsel to the Company] August __, 1996 Each of the Banks party to the Credit Agreement referred to below The Chase Manhattan Bank, as Administrative Agent for said Banks 29th Floor 140 East 45th Street New York, New York 10017 Ladies and Gentlemen: I am the General Counsel of Capital Re Corporation, a corporation organized under the law of the State of Delaware (the "Company") and am ------- rendering this opinion in connection with the Credit Agreement dated as of August 20, 1996 (the "Credit Agreement") between the Company, the lenders party ---------------- thereto (the "Banks") and The Chase Manhattan Bank, in its capacity as ----- administrative agent for said Banks (the "Agent"), providing for, among other ----- things, extensions of credit to be made by the Banks to the Company in an aggregate principal or stated amount not exceeding $25,000,000. All capitalized terms used but not defined herein have the respective meanings given to such terms in the Credit Agreement. This opinion letter is delivered to you pursuant to Section 6.01(c) of the Credit Agreement. In rendering the opinions expressed below, I have examined the following agreements, instruments and other documents: (a) the Credit Agreement; (b) the Notes delivered on the date hereof (together with the Credit Agreement, the "Credit Documents"); ---------------- (c) such records of the Company and such other documents as I have deemed necessary as a basis for the opinions expressed below. -78- In my examination, I have assumed the genuineness of all signatures, the authenticity of all documents submitted to me as originals and the conformity with authentic original documents of all documents submitted to me as copies. When relevant facts were not independently established, I have relied upon certificates of governmental officials and appropriate representatives of the Company and upon representations made in or pursuant to the Credit Agreement. In rendering the opinions expressed below, I have assumed, with respect to the Credit Documents, that (except, to the extent expressly set forth in the opinions below, as to the Company): (i) the Credit Documents have been duly authorized by, have been duly executed and delivered by, and constitute legal, valid, binding and enforceable obligations of, all of the parties to the Credit Documents; (ii) all signatories to the Credit Documents have been duly authorized; and (iii) all of the parties to the Credit Documents are duly organized and validly existing and have the power and authority (corporate or other) to execute, deliver and perform the Credit Documents. Based upon and subject to the foregoing and subject also to the comments and qualifications set forth below, and having considered such questions of law as I have deemed necessary as a basis for the opinions expressed below, I am of the opinion that: 1. The Company is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. Each of the Company's Subsidiaries is a corporation, partnership or other entity duly organized, validly existing and in good standing under the laws of the jurisdiction listed opposite its name in Schedule II to the Credit Agreement. 2. The Company has all requisite corporate power, authority and legal right to execute, deliver and perform its obligations under each of the Credit Documents, and the execution, delivery and performance by the Company of each of the Credit Documents have been duly authorized by all necessary corporate action on its part (including, without limitation, any required shareholder approvals). 3. Each of the Credit Documents has been duly and validly executed and delivered by the Company. 4. The execution, delivery and performance by the Company of, and the consummation by the Company of the transactions contemplated by, the -79- Credit Documents do not and will not (a) violate any provision of the Amended and Restated Certificate of Incorporation or the Amended and Restated By-laws of the Company, (b) violate any provision of the General Corporation Law of the State of Delaware, (c) violate any applicable law, rule or regulation of the United States of America or the State of New York, (d) violate any order, writ, injunction or decree of any court or governmental authority or agency, or any agreement or any arbitral award applicable to the Company or any of its Subsidiaries or (e) result in a breach of, constitute a default under, require any consent under, or result in the acceleration or required prepayment of any Indebtedness pursuant to the terms of, any agreement or instrument to which the Company or any of its Subsidiaries is a party or by which any of them or any of their Property is bound or to which any of them is subject. 5. Except as disclosed in Schedule III to the Credit Agreement, I have no knowledge (after due inquiry) of any legal or arbitral proceedings, or any proceedings by or before any governmental or regulatory authority or agency, now pending or threatened against the Company or any of its Subsidiaries that, if adversely determined, could reasonably be expected to have a Material Adverse Effect. 6. No authorization, approval or consent of, and no filing or registration with, any governmental or regulatory authority or agent of the United States of America or the State of New York is necessary for the execution, delivery or performance by the Company of the Credit Documents, or for the legality, validity or enforceability thereof. The Company is not operating under any specific Federal or New York State regulatory framework under which the Company receives licenses or other authorizations or is making filings or registrations with regulatory authorities, other than tax filings, securities filings, corporate filings or New York insurance filings. The foregoing opinions are limited to matters involving the Federal laws of the United States of America, the General Corporation Law of the State of Delaware and the law of the State of New York, and I do not express any opinion as to the laws of any other jurisdiction. -80- At the request of my client, this opinion letter is provided to you by me in my capacity as General Counsel to the Company, and this opinion letter may not be relied upon by any Person for any purpose other than in connection with the transactions contemplated by the Credit Documents without, in each instance, my prior written consent. Very truly yours, Alan S. Roseman General Counsel -81- EXHIBIT B-2 [Form of Opinion of Special Counsel to the Company] August __, 1996 Each of the Banks listed on Schedule A hereto The Chase Manhattan Bank, as Administrative Agent for said Banks 140 East 45th Street, 29th Floor New York, New York 10017 Ladies and Gentlemen: This firm has acted as special counsel to Capital Re Corporation, a corporation organized under the law of the State of Delaware (the "Company"), in -------- connection with the Credit Agreement dated as of August 20, 1996 (the "Credit -------- Agreement") between the Company, the lenders party thereto (the "Banks") and The ------- Chase Manhattan Bank, in its capacity as administrative agent for said Banks (the "Agent"). All capitalized terms used but not defined herein have the ----- respective meanings given to such terms in the Credit Agreement. This opinion letter is delivered to you pursuant to Section 6.01(c) of the Credit Agreement in connection with the closing thereunder on the date hereof (the "Closing"). -------- For purposes of this opinion letter, we have examined the following documents: (a) Executed copy of the Credit Agreement. (b) Executed copy of the Notes delivered on the date hereof (together with the Credit Agreement, the "Credit Documents"). ---------------- (c) Certain resolutions of the Board of Directors of the Company adopted at a meeting held on August ___, 1996, as certified by the Secretary of the Company on the date hereof as being complete, accurate and in -82- effect, relating to, among other things, authorization of the Credit Documents and arrangements in connection therewith. (d) A certificate of the Chief Financial Officer of the Company, dated August ___, 1996, as to the incumbency and signatures of certain officers of the Company. (e) A certificate, dated as of the date hereof, of the Assistant Secretary of the Company as to certain facts relating to the Company. We have not, except as specifically identified above, made any independent review or investigation of factual or other matters, including the organization, existence, good standing, assets, business or affairs of the Company or any of its Subsidiaries. In our examination of the Credit Documents and the aforesaid certificates, records and documents, we have assumed the genuineness of all signatures (other than those on behalf of the Company on the Credit Documents), the legal capacity of all natural person, the accuracy and completeness of all documents submitted to us, the authenticity of all original documents and the conformity to authentic original documents of all documents submitted to us as copies (including telecopies). We also have assumed the accuracy, completeness and authenticity of the foregoing certifications of corporate officers and statements of fact, on which we are relying, and have made no independent investigations thereof. In rendering the following opinions, we have relied as to factual matters, without independent investigation, upon the representations, warranties and certifications made by the Company in or pursuant to the Credit Documents and upon the officers' certificates identified in Paragraphs (d) and (e) above. This opinion letter is given, and all statements herein are made in the context of the foregoing. For purposes of this opinion letter, we have assumed that (i) each party to the Credit Documents has all requisite power and authority under all applicable laws, regulations and governing documents to execute, deliver and perform its obligations under the Credit Documents, (ii) each such party has duly authorized, executed and delivered the Credit Documents to which it is a party, (iii) each party is validly existing and in good standing in all necessary jurisdictions, (iv) the Credit Documents to which the Agent and each other party to the Credit Documents (other than the Company) is a party constitute valid and binding obligations enforceable against each of them in accordance with their -83- respective terms, and (v) there has been no material mutual mistake of fact or misunderstanding or fraud, duress or undue influence, in connection with the negotiation, execution or delivery of the Credit Documents. This opinion letter is based as to matters of law solely on applicable provisions of (i) New York law customarily applicable between borrowers and creditors to transactions of the type contemplated by the Credit Documents (but not including any statutes, ordinances, administrative decisions, rules or regulations of any political subdivision of the State of New York) (hereinafter "New York Law"), (ii) the Investment Company Act of 1940, as amended, and (iii) the Public Utility Holding Company Act of 1935, as amended. We express no opinion as to any other laws, statutes, ordinances, rules or regulations (such as federal or state securities laws or regulations (other than the opinion expressed in paragraph (d) below as to the Investment Company Act of 1970, as amended), antitrust or unfair competition laws or regulations or tax laws or regulations, or New York insurance law). For purposes of the opinions set forth in Paragraphs (2) and (3), we have inquired of the Company whether the Company is, and we have received an officers' certificate from the Company to the effect that it is not, operating under any specific federal or New York state regulatory framework under which the Company receives licenses or other authorizations or is making filings or registrations with regulatory authorities, other than tax filings, securities filings, corporate filings or New York insurance filings. On the basis of this inquiry, and response, the opinions expressed in Paragraph (2) and (3) are limited to New York Laws). Based upon, subject to and limited by the foregoing, we are of the opinion that: 1. Each of the Credit Documents constitutes a legal, valid and binding obligation of the Company, enforceable against the Company in accordance with its terms, except as may be limited by bankruptcy, insolvency, reorganization, moratorium other laws affecting creditors' rights (including, without limitation, the effect of statutory and other law regarding fraudulent conveyances, fraudulent transfers and preferential transfers) and as may be limited by the exercise of judicial discretion and the applications of principles of equity, including, without limitation, requirements of good faith, fair dealing, conscionability and materiality (regardless of whether such agreements are considered in a proceeding in equity or at law). -84- 2. The execution, delivery and performance as of the date hereof by the Company of the Credit Documents do not violate New York Law. 3. No approval or consent of, or registration or filing with, any State of New York governmental agency is required to be obtained or made by the Company in connection with the execution, delivery and performance as of the date hereof by the Company of the Credit Documents. 4. Neither the Company nor any of its Subsidiaries is an "investment company", or a company "controlled" by an "investment company", within the meaning of the Investment Company Act of 1940, as amended. 5. Neither the Company nor any of its Subsidiaries is a "holding company", or an "affiliate" of a "holding company" or a "subsidiary company" of a "holding company", within the meaning of the Public Utility Holding Company Act of 1935, as amended. The opinion expressed in Paragraph (1) above shall be understood to mean only that if there is a default in performance of an obligation, (i) if a failure to pay or other damage can be shown and (ii) if the defaulting party can be brought into a court which will hear the case and apply the governing law, then subject to the availability of defenses and to the exceptions set forth in Paragraph (1) the court will provide a money damage (or perhaps injunctive or specific performance) remedy. We assume no obligation to advise you of any changes in the foregoing subsequent to the delivery of this opinion letter. This opinion letter has been prepared solely for your use in connection with the Closing under the Credit Documents on the date hereof, and should not be quoted in whole or in part or otherwise be referred to, nor be filed with or furnished to any governmental agency or other person or entity, without the prior written consent of this firm. Very truly yours, HOGAN & HARTSON, L.L.P. -85- HOGAN & HARTSON L.L.P. August 21, 1996 Page 5 SCHEDULE A THE CHASE MANHATTAN BANK -86- EXHIBIT C [Form of Opinion of Special New York Counsel to Chase] August __, 1996 Each of the Banks party to the Credit Agreement referred to below and The Chase Manhattan Bank, as Administrative Agent for said Banks 140 East 45th Street 29th Floor New York, New York 10017 Ladies and Gentlemen: We have acted as your special New York counsel in connection with the Credit Agreement dated as of August 20, 1996 (the "Credit Agreement") between ---------------- Capital Re Corporation (the "Company"), the Banks party thereto and The Chase ------- Manhattan Bank, as Administrative Agent for said Banks, providing for, among other things, extensions of credit to be made by the Banks to the Company in an aggregate principal or stated amount not exceeding $25,000,000. Terms defined in the Credit Agreement are used herein as defined therein. This opinion is being delivered pursuant to Section 6.01(d) of the Credit Agreement. In rendering the opinion expressed below, we have examined the following agreements, instruments and other documents: (a) the Credit Agreement; and (b) the Notes delivered on the date hereof (together with the Credit Agreement, the "Credit Documents"). ---------------- -87- In our examination, we have assumed the authenticity of all documents submitted to us as originals and the conformity with authentic original documents of all documents submitted to us as copies. In rendering the opinions expressed below, we have assumed, with respect to the Credit Documents, that: (i) the Credit Documents have been duly authorized by, have been duly executed and delivered by, and (except to the extent expressly set forth in the opinions below as to the Company) constitute legal, valid, binding and enforceable obligations of, all of the parties to the Credit Documents; (ii) all signatories to the Credit Documents have been duly authorized; and (iii) all of the parties to the Credit Documents are duly organized and validly existing and have the power and authority (corporate or other) to execute, deliver and perform the Credit Documents. Based upon and subject to the foregoing and subject also to the comments and qualifications set forth below, and having considered such questions of law as we have deemed necessary as a basis for the opinions expressed below, we are of the opinion that each of the Credit Documents constitutes the legal, valid and binding obligation of the Company, enforceable against the Company in accordance with its terms, except as may be limited by bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance or transfer or other similar laws relating to or affecting the rights of creditors generally and except as the enforceability of the Credit Documents is subject to the application of general principles of equity (regardless of whether considered in a proceeding in equity or at law), including, without limitation, (a) the possible unavailability of specific performance, injunctive relief or any other equitable remedy and (b) concepts of materiality, reasonableness, good faith and fair dealing. The foregoing opinions are subject to the following comments and qualifications: (A) The enforceability of Section 11.03 of the Credit Agreement may be limited by laws rendering unenforceable the release of a party from, or the indemnification of a party against, liability for its own wrongful or negligent acts under certain circumstances. -88- (B) The enforceability of provisions in the Credit Agreement to the effect that terms may not be waived or modified except in writing may be limited under certain circumstances. (C) We express no opinion as to (i) the effect of the laws of any jurisdiction in which any Bank is located (other than the State of New York) that limit the interest, fees or other charges such Bank may impose, (ii) Section 4.07(c) of the Credit Agreement, (iii) the second sentence of Section 11.10 of the Credit Agreement, insofar as such sentence relates to the subject matter jurisdiction of the United States District Court for the Southern District of New York to adjudicate any controversy related to the Credit Documents, and (iv) the waiver of inconvenient forum set forth in Section 11.10 of the Credit Agreement with respect to proceedings in the United States District Court for the Southern District of New York. The foregoing opinions are limited to matters involving the Federal laws of the United States of America and the law of the State of New York, and we do not express any opinion as to the laws of any other jurisdiction. This opinion letter is, pursuant to Section 6.01(d) of the Credit Agreement, provided to you by us in our capacity as your special New York counsel and may not be relied upon by any Person for any purpose other than in connection with the transactions contemplated by the Credit Documents without, in each instance, our prior written consent. Very truly yours, /s/ Milbank, Tweed, Hadley & McCloy ----------------------------------- CDP/___ -89- EXHIBIT D [Form of Confidentiality Agreement] CONFIDENTIALITY AGREEMENT [Date] [Insert Name and Address of Prospective Participant or Assignee] Re: Credit Agreement dated as of August 20, 1996 (the "Credit ------ Agreement"), among Capital Re Corporation (the "Company"), the --------- ------- lenders named therein and The Chase Manhattan Bank, as Administrative Agent. Ladies and Gentlemen: As a Bank party to the Credit Agreement, we have agreed with the Company pursuant to Section 11.12 of the Credit Agreement to use reasonable precautions to keep confidential, except as otherwise provided therein, all non- public information identified by the Company as being confidential at the time the same is delivered to us pursuant to the Credit Agreement. As provided in said Section 11.12, we are permitted to provide you, as a prospective [holder of a participation in the Loans (as defined in the Credit Agreement)][assignee Bank], with certain of such non-public information subject to the execution and delivery by you, prior to receiving such non-public information, of a Confidentiality Agreement in this form. Such information will not be made available to you until your execution and return to us of this Confidentiality Agreement. Accordingly, in consideration of the foregoing, you agree (on behalf of yourself and each of your affiliates, directors, officers, employees and representatives) that (A) such information will not be used by you except in connection with the proposed [participation][assignment] mentioned above and (B) you shall use reasonable precautions, in accordance with your customary procedures for handling confidential information and in accordance with safe and sound banking practices, to keep such information confidential, provided that -------- nothing herein shall limit the disclosure of any such information (i) to the extent required by statute, rule, regulation or judicial process (with, unless prohibited by applicable law, prior notice thereof to the Company giving sufficient time, if practicable, to afford the Company an opportunity to seek a protective order), (ii) to your counsel or to counsel for any of the Banks or the Administrative Confidentiality Agreement ------------------------- -90- Agent, (iii) to bank examiners, auditors or accountants, (iv) to the Administrative Agent or any other Bank (or to Chase Securities, Inc.), (v) in connection with any litigation to which you or any one or more of the Banks or the Administrative Agent are a party (with, except in the case of any litigation to which the Company or any of its Subsidiaries is also a party, or unless prohibited by applicable law, prior notice to the Company giving sufficient time, if practicable, to afford the Company an opportunity to seek a protective order), (vi) to a subsidiary or affiliate of yours as provided in Section 11.12(a) of the Credit Agreement or (vii) to any assignee or participant (or prospective assignee or participant) so long as such assignee or participant (or prospective assignee or participant) first executes and delivers to you a Confidentiality Agreement substantially in the form hereof; provided, further, -------- ------- that in no event shall you be obligated to return any materials furnished to you pursuant to this Confidentiality Agreement. Please indicate your agreement to the foregoing by signing as provided below the enclosed copy of this Confidentiality Agreement and returning the same to us. Very truly yours, [INSERT NAME OF BANK] By___________________________ Title: AGREED AS AFORESAID: [INSERT NAME OF PROSPECTIVE PARTICIPANT OR ASSIGNEE] By___________________________ Title: Confidentiality Agreement ------------------------- -91- EXHIBIT E [Form of Assignment and Acceptance] ASSIGNMENT AND ACCEPTANCE Reference is made to the Credit Agreement, dated as of August 20, 1996 (as modified and supplemented and in effect from time to time, the "Credit ------ Agreement"), among Capital Re Corporation, a Delaware Corporation (the - --------- "Company"), the lenders named therein, and The Chase Manhattan Bank, as ------- administrative agent for such lenders (in such capacity, the "Administrative -------------- Agent"). Terms defined in the Credit Agreement are used herein as defined - ----- therein. _________________ (the "Assignor") and _______________ (the -------- "Assignee") agree as follows: -------- 1. The Assignor hereby irrevocably sells and assigns to the Assignee without recourse to the Assignor, and the Assignee hereby irrevocably purchases and assumes from the Assignor without recourse to the Assignor, as of the Effective Date as set forth in Schedule 1 hereto (the "Effective Date"), an -------------- interest (the "Assigned Interest") in and to the Assignor's rights and ----------------- obligations under the Credit Agreement with respect to those credit facilities contained in the Credit Agreement as are set forth on Schedule 1 (individually, an "Assigned Facility"; collectively, the "Assigned Facilities"), in a principal ----------------- ------------------- amount and percentage for each Assigned Facility as set forth on Schedule 1. 2. The Assignor (i) makes no representation or warranty and assumes no responsibility with respect to any statements, warranties or representations made in or in connection with the Credit Agreement, any other Loan Document or any other instrument or document furnished pursuant thereto, or the execution, legality, validity, enforceability, genuineness, sufficiency or value of the Credit Agreement, any other Loan Document or any other instrument or document furnished pursuant thereto, other than that it has not created any adverse claim upon the interest being assigned by it hereunder and that such interest is free and clear of any such adverse claim; (ii) makes no representation or warranty and assumes no responsibility with respect to the financial condition of the Company, any of its Subsidiaries or any other obligation or the performance or observance by the Company, any of its Subsidiaries or any other obligor of any of their respective obligations under the Credit Agreement or any other Loan Document or any other instrument or document furnished pursuant hereto or thereto; and (iii) attaches the Note(s) held by it evidencing the Assigned Facilities and requests that the Administrative Agent exchange such Note(s) for a new Note or Notes payable to the Assignor (if the Assignor has Assignment and Acceptance ------------------------- -92- retained any interest in the Assigned Facility) and a new Note or Notes payable to the Assignee in the respective amounts which reflect the assignment being made hereby (and after giving effect to any other assignments which have become effective on the Effective Date). 3. The Assignee (i) represents and warrants that it is legally authorized to enter into this Assignment and Acceptance; (ii) confirms that it has received a copy of the Credit Agreement, together with copies of the financial statements referred to in Section 7.02 thereof, the financial statements delivered pursuant to Section 8.01 thereof, if any, and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into this Assignment and Acceptance; (iii) agrees that it will, independently and without reliance upon the Assignor, the Administrative Agent or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under the Credit Agreement, the other Loan Documents or any other instrument or document furnished pursuant hereto or thereto; (iv) appoints and authorizes the Administrative Agent to take such action as administrative agent on its behalf and to exercise such powers and discretion under the Credit Agreement, the other Loan Documents or any other instrument or document furnished pursuant hereto or thereto as are delegated to the Administrative Agent by the terms thereof, together with such powers as are incidental thereto; and (v) agrees that it will be bound by the provisions of the Credit Agreement and will perform in accordance with its terms all the obligations which by the terms of the Credit Agreement are required to be performed by it as a Lender including, if it is organized under the laws of a jurisdiction outside the United States of America, its obligation pursuant to Section 5.06 of the Credit Agreement to deliver the forms prescribed by the Internal Revenue Service of the United States certifying as to the Assignee's exemption from United States withholding taxes with respect to all payments to be made to the Assignee under the Credit Agreement, or such other documents as are necessary to indicate that all such payments are subject to such tax at a rate reduced by an applicable tax treaty. 4. Following the execution of this Assignment and Acceptance, it will be delivered to the Administrative Agent for acceptance by the Administrative Agent pursuant to Section 11.06 of the Credit Agreement, effective as of the Effective Date (which date shall not, unless otherwise agreed to by the Administrative Agent, be earlier than five Business Days after the date of such acceptance by the Administrative Agent). Assignment and Acceptance ------------------------- -93- 5. Upon such acceptance, from and after the Effective Date, the Administrative Agent shall make all payments in respect of the Assigned Interest (including payments of principal, interest, fees and other amounts) to the Assignee which accrue subsequent to the Effective Date. 6. From and after the Effective Date, (i) the Assignee shall be a party to the Credit Agreement and, to the extent provided in this Assignment and Acceptance, have the rights and obligations of a Lender thereunder and under the other Loan Documents and shall be bound by the provisions thereof and (ii) the Assignor shall, to the extent provided in this Assignment and Acceptance, relinquish its rights and be released from its obligations under the Credit Agreement except as provided in Section 11.07 of the Credit Agreement. 7. This Assignment and Acceptance shall be governed by and construed in accordance with the law of the State of New York. 8. This Assignment and Acceptance may be executed in any number of counterparts, all of which taken together shall constitute one and the same instrument and any of the parties hereto may execute this Assignment and Acceptance by signing any such counterpart. IN WITNESS WHEREOF, the parties hereto have caused this Assignment and Acceptance to be executed as of the date first above written by their respective duly authorized officers on Schedule 1 hereto. Assignment and Acceptance ------------------------- -94- Schedule 1 to Assignment and Acceptance relating to the Credit Agreement, dated as of August 20, 1996, among Capital Re Corporation (the "Company") ------- the lenders named therein and The Chase Manhattan Bank, as administrative agent for the Lenders (in such capacity, the "Administrative Agent") -------------------- Name of Assignor: Name of Assignee: Effective Date of Assignment: Credit Principal Percentage Facility Assigned Amount Assigned Assigned ----------------- --------------- -------- [ASSIGNEE] [ASSIGNOR] By:___________________________ By:__________________________ Title: Title: Consented to and Accepted: THE CHASE MANHATTAN BANK, as Administrative Agent By:__________________________ Name: Title: CAPITAL RE CORPORATION By:__________________________ Name: Title: -95- EX-10.39 3 CAPITAL RE CORPORATION PERFORMANCE SHARE PLAN EXHIBIT 10.39 CAPITAL RE CORPORATION PERFORMANCE SHARE PLAN (EFFECTIVE JULY 1, 1996) TABLE OF CONTENTS Page ----
I. GENERAL................................................... 1 1.1. Purpose.............................................. 1 1.2. Effective Date....................................... 1 II. DEFINITIONS.............................................. 1 III. ELIGIBILITY AND PARTICIPATION........................... 4 3.1. Eligibility.......................................... 4 3.2. Participation in Performance Share Awards............ 4 IV. PLAN DESIGN.............................................. 4 4.1. Eligibility Period................................... 4 4.2. Performance Period................................... 4 4.3. Performance Share Awards............................. 4 4.4. Performance Goals.................................... 5 4.5. Available Common Stock............................... 6 4.6. Adjustment to Shares................................. 6 4.7. Maximum Award........................................ 6 4.8. Committee Discretion to Adjust Awards................ 6 V. PAYMENT................................................... 7 5.1. Committee Determination of Common Stock Payable...... 7 5.2. Timing and Form of Payment........................... 7 5.3. Distribution upon Termination of Employment.......... 8 5.4. Beneficiary Designation.............................. 9 VI. ADMINISTRATION........................................... 9 6.1. Committee............................................ 9 6.2. General Rights, Powers, and Duties of Committee...... 9 6.3. Information to be Furnished to Committee............. 10 6.4. Responsibility and Indemnification................... 10 VII. AMENDMENT AND TERMINATION............................... 10 7.1. Amendment............................................ 10 7.2. Company's Right to Terminate......................... 10 VIII. MISCELLANEOUS.......................................... 10 8.1. No Implied Rights; Rights on Termination of Service.. 10 8.2. No Right to Company Assets........................... 11 8.3. No Employment Rights................................. 11 8.4. Other Benefits....................................... 11 8.5. Offset............................................... 11 8.6. Non-assignability.................................... 11 8.7. Notice............................................... 11 8.8. Governing Laws....................................... 12 8.9. Gender and Number.................................... 12 8.10. Severability........................................ 12
-i- I. GENERAL 1.1. PURPOSE. The purposes of the Plan are to retain officers and other key employees, to support the achievement of the Company's strategic business objectives, and to encourage increased ownership of Company stock by officers and other key employees by providing to such persons competitive long-term incentive opportunities that are linked to the profitability of the Company's business and increases in stockholder value. 1.2. EFFECTIVE DATE. The Plan shall become effective as of July 1, 1996, subject to its approval by the Company's stockholders. II. DEFINITIONS 2.1. "Beneficiary" means the person or persons so designated by a Participant pursuant to Section 5.4. 2.2. "Board of Directors" means the Board of Directors of the Company. 2.3 "Cause" means (i) the Participant has been found guilty by a court of having committed fraud or theft against the Company or having committed a felony and such conviction is affirmed on appeal or the time for appeal has expired; (ii) the Participant has been found guilty by a court of having committed a crime involving moral turpitude and such conviction is affirmed on appeal or the time for appeal has expired; (iii) in the reasonable judgment of the Board of Directors, the Participant has compromised trade secrets or other proprietary information of the Company; (iv) in the reasonable judgment of the Board of Directors, the Participant has willfully failed or refused to perform material assigned duties; or (v) in the reasonable judgment of the Board of Directors, the Participant has engaged in gross or willful misconduct that causes substantial and material harm to the business and operations of the Company or a subsidiary, the continuation of which will continue to substantially and materially harm the business and operations of the Company or a subsidiary in the future. 2.4. "Change in Control" means (i) any "person" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")), has become, after the date hereof, the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing forty percent (40%) or more of the combined voting power of the Company's then outstanding securities; (ii) during any two (2) year period, individuals who at the beginning of such period constitute the Board of Directors, including for this purpose any new director whose election (A) resulted from a vacancy on the Board of Directors caused by the mandatory retirement, death, or disability of a director and was approved by a vote of at least two-thirds (2/3rds) of the directors then still in office who were directors at the beginning of the period, or (B) was approved by the Participant affirmatively voting in his or her capacity as a stockholder, have ceased for any reason to constitute a majority thereof; (iii) notwithstanding clauses (i) or (v), the Company has consummated a merger or consolidation of the Company with or into another corporation, the -1- result of which is that the stockholders of the Company at the time of the execution of the agreement to merge or consolidate own less than eighty percent (80%) of the total equity of the corporation surviving or resulting from the merger or consolidation or of a corporation owning, directly or indirectly, one hundred percent (100%) of the total equity of such surviving or resulting corporation; or (iv) there has been a sale in one or a series of transactions of all or substantially all of the assets of the Company; (v) any person has commenced a tender or exchange offer, or entered into an agreement or received an option to acquire beneficial ownership of forty percent (40%) or more of the total number of voting shares of the Company, unless the Board of Directors has made a determination that such action does not constitute and will not constitute a change in the persons in control of the Company or (vi) there has been a change in control in the Company of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A promulgated under the Exchange Act other than in circumstances specifically covered by clauses (i) - (v) above. 2.5 "Code" means the Internal Revenue Code of 1986, as amended from time to time, and any successor thereto. 2.6. "Committee" means the committee referred to in Section 6.1. 2.7. "Common Stock" means common stock, par value $.01 per share, of the Company. 2.8. "Company" means Capital Re Corporation, a Delaware corporation. 2.9. "Covered Employee" means any Participant who is or may be a "covered employee," within the meaning of Section 162(m)(3) of the Code, in the year in which the payment of any shares of Common Stock in satisfaction of a Performance Share award will be taxable to such Participant. 2.10. "Disability" shall have the same meaning as under the Company- sponsored long-term disability plan under which the applicable Participant is then eligible to participate. 2.11. "Eligibility Period" means a period, as determined by the Committee pursuant to Section 4.1. 2.12. "Fair Market Value" means as of any given date the last reported sales price on such date of Common Stock on the New York Stock Exchange Composite Tape or, if not listed on such exchange, on any other national securities exchange on which such Common Stock is listed or on NASDAQ. If there is no regular public trading market for such Common Stock, the Fair Market Value of such Common Stock shall be determined by the Committee in good faith. 2.13. "Good Reason" shall mean (i) any proposed reduction in the Participant's base salary, provided that base salary may be reduced (and such reduction would not constitute "Good Reason") by up to 10% due to a reduction in compensation generally applicable to Participants; (ii) the Participant has his responsibilities or areas of supervision within the Company -2- substantially reduced (in the Participant's reasonable judgment); or (iii) a Change of Control has occurred within two years prior to the Participant's termination of employment. 2.14. "Non-Employee Director" means a member of the Board of Directors who qualifies as (i) a "non-employee director," as defined in Rule 16b-3, as promulgated by the Securities Exchange Commission under the Securities Exchange Act of 1934, or any successor definition adopted by the Securities Exchange Commission, and as (ii) an "outside director," as defined in Section 1.162- 27(e)(3) of the Treasury Regulations issued under Section 162(m) of the Code, or any successor definition adopted by the Department of the Treasury. 2.15. "Normal Retirement" means termination of employment after attainment of age 65. However, the Committee, within its discretion, may determine that a Participant who terminates employment prior to age 65 has terminated by virtue of Normal Retirement. 2.16. "Participant" means a person who is designated, pursuant to Article III, to be eligible to receive benefits under the Plan. 2.17. "Performance Goals" means the performance standards established by the Committee pursuant to Section 4.4. 2.18. "Performance Period" means a period of service, as determined pursuant to Section 4.2, over which the extent of achievement of established Performance Goals will be measured. For purposes of applying to Covered Employees the various rules of the performance-based compensation exemption under Section 162(m)(4)(C) of the Code and the Treasury Regulations issued thereunder, the Performance Period shall be the "period of service to which the Performance Goals relate" (as defined in Treasury Regulation Section 1.162-27(e) (2)). 2.19. "Performance Share" means an award, designated in terms of a share of Common Stock, granted pursuant to the Plan. 2.20. "Plan" means this Capital Re Corporation Performance Share Plan, as amended from time to time. 2.21. "Pro-rated" or "Pro-rata" means, for purposes of determining the amount of Common Stock payable to a Participant whose eligibility to participate in the Plan with respect to an Eligibility Period ceases prior to the end of such Eligibility Period for any of the reasons described in Section 3.2 or subsection (a), (b), (c) or (d) of Section 5.3, the percentage to be applied to the Common Stock that would have been payable at the end of the Performance Period to such Participant if he had been eligible to participate for the entire Eligibility Period. Such percentage shall equal the number of months (rounded to the nearest whole month) of the Eligibility Period during which the Participant was designated by the Committee as eligible to participate in the Plan divided by the number of months (rounded to the nearest whole month) in such Eligibility Period. A Participant who, pursuant to Section 3.2 but subject to the limitations of Section 4.3, is designated as eligible to participate in the Plan after the applicable Eligibility Period has commenced, shall, for purposes of this Section 2.21, be deemed to have been eligible as of the beginning of such Eligibility Period; provided, however, that the Committee -3- shall, in accordance with its authority under Section 4.8, have the discretion to reduce the Prorated Common Stock award that is otherwise payable to such Participant to account for such late commencement of participation. III. ELIGIBILITY AND PARTICIPATION 3.1. ELIGIBILITY. Participation in the Plan shall be limited to officers and other key employees of the Company or any of its subsidiaries or other affiliates who are designated to be eligible by the Committee. 3.2. PARTICIPATION IN PERFORMANCE SHARE AWARDS. The Committee will determine the persons who will participate for each Eligibility Period under the Plan. Subject to Section 4.3, after an Eligibility Period has commenced, persons may be designated as eligible to participate in the Plan with respect to such Eligibility Period. The award of Performance Shares with respect to a Performance Period contained in any Eligibility Period does not guarantee participation in subsequent Eligibility Periods. IV. PLAN DESIGN 4.1. ELIGIBILITY PERIOD. An Eligibility Period is a certain period of time, as determined by the Committee, over which eligibility to receive benefits under the Plan shall be measured. The initial Eligibility Period under the Plan shall begin on July 1, 1996 and terminate on December 31, 1999. The second Eligibility Period shall begin on January 1, 1998 and terminate on December 31, 2001. Subsequent Eligibility Periods under the Plans shall commence and terminate as determined by the Committee in its sole discretion. The Committee may esablish a separate Eligibility Period for persons determined to be eligible for participation after the commencement of any Eligibility Period. 4.2. PERFORMANCE PERIOD. Each Eligibility Period under the Plan shall include a Performance Period which shall be a specified period of service over which the achievement of applicable Performance Goals will be measured. The initial Performance Period under the Plan shall begin on July 1, 1996 and terminate on December 31, 1999. The second Performance Period shall begin on January 1, 1998 and terminate on December 31, 2001. Subsequent Performance Periods shall commence and terminate as determined by the Committee; provided that each such Performance Period shall commence coincident with or after the commencement of the corresponding Eligibility Period and shall terminate coincident with or prior to the termination of the corresponding Eligibility Period. Nothwithstanding the foregoing, in the event of a Change of Control, the Performance Period shall terminate. The Committee may also establish a separate Performance Period for persons determined to be eligible for participation after the commencement of any Peroformance Period. 4.3. PERFORMANCE SHARE AWARDS. On or about the commencement of each Eligibility Period under the Plan, the Committee shall establish the minimum and maximum Performance Shares that may be awarded to each Participant in the Plan for such Eligibility Period and the -4- basis for such awards. The Committee may also award Performance Shares to persons determined to be eligible for participation after the commencement of any Eligibility Period. Notwithstanding the foregoing, no Performance Shares shall be awarded to Covered Employees on or after the 90th day of the Performance Period contained within the applicable Eligibility Period or, if earlier, after 25% of such Performance Period has elapsed. Performance Shares must be awarded to Covered Employees at a time when the outcome of the Performance Goals established or to be established for the applicable Performance Period is substantially uncertain. The Performance Shares awarded to any Covered Employee and the terms and conditions applicable to such Performance Shares must be finalized in writing by the Committee on or prior to the applicable adjustment deadline described in the preceding sentences. Each award of Performance Shares under the Plan shall be evidenced by a written "Notice of Award," which shall be signed by an authorized officer of the Company and by the Participant and shall contain such terms and conditions as are approved by the Committee. Such terms and conditions need not be the same in all cases. 4.4. PERFORMANCE GOALS. (a) Performance Goals with respect to each Performance Period shall be established by the Committee. The Committee may in its discretion adjust the terms of such Performance Goals; provided that Performance Goals applied to Covered Employees ("Covered Employees' Performance Goals") shall not be adjusted on or after the 90th day of the applicable Performance Period or, if earlier, after 25% of the applicable Performance Period has elapsed. No Covered Employees' Performance Goals shall be adjusted at a time when the outcome of such Performance Goals is no longer substantially uncertain. Covered Employees' Performance Goals must be finalized in writing by the Committee on or prior to the applicable adjustment deadline described in the preceding sentences. (b) The Performance Goals set by the Committee shall be based on specified criteria as determined by the Committee, which shall specify the manner in which such Performance Goals shall be calculated. Covered Employees' Performance Goals shall be based on objective business criteria, which shall include one or more of the following: earnings per share, total shareholder return, operating earnings, growth in assets, return on equity, return on capital, market share, stock price, net income, cash flow, and retained earnings. Performance Goals also may be based upon the attainment of specified levels of performance of the Company under one or more of the measures described above relative to the performance of other corporations. (c) All of the provisions of this Section 4.4 are subject to the requirement that all Covered Employees' Performance Goals shall be objective performance goals satisfying the requirement for "performance-based compensation" within the meaning of Section 162(m)(4) of the Code and the Treasury Regulations issued thereunder. (d) In the event of a Change of Control, instead of the Performance Goals established pursuant to Sections 4.4(a) and (b) above, the sole Performance Goal for the Performance Period that ends with the Change of Control shall be stock price. If the Change of Control occurs during the first two years of the Performance Period and if the stock price of Company Common Stock -5- has increased by 100% as of the Change of Control, compared to the first day of the Performance Period, the Participant shall be awarded for the Performance Period the maximum Performance Shares that may be awarded to such Participant as established by the Committee for such period. If the Change of Control occurs after the end of the second year of the Performance Period and if the stock price of Company Common Stock has increased by 150% as of the Change of Control, compared to the first day of the Performance Period, the Participant shall be awarded for the Performance Period the maximum Performance Shares that may be awarded to such Participant as established by the Committee for such period. If the stock price of Company Common Stock has increased by less than 100% (during the first two years of the Performance Period) or 150% (after the end of the second year of the Performance Period) as the case may be, the Participant shall be awarded a pro-rated portion of the Performance Shares that would have otherwise been payable to the Participant based on the ratio that the stock price of Company Common Stock has increased as of the Change of Control from the first day of such Performance Period compared to whichever of the foregoing percentages is applicable. 4.5. AVAILABLE COMMON STOCK. The maximum number of shares of Common Stock which shall be available for distribution in satisfaction of awards under the Plan during its term shall not exceed 750,000, subject to adjustment as provided in Section 4.6. The shares of Common Stock available for issuance under the Plan may be authorized and unissued shares or treasury shares or may be purchased in the open market. 4.6. ADJUSTMENT TO SHARES. In the event of any merger, reorganization, consolidation, recapitalization, stock dividend, stock split, extraordinary distribution with respect to Common Stock or other change in corporate structure affecting such Common Stock, the Committee may make such substitution or adjustments in the aggregate number and kind of shares reserved for issuance under the Plan or in the number and kind of shares subject to outstanding Performance Share awards under the Plan. The Committee shall make such substitutions or adjustments as in its discretion it determines to be appropriate and equitable to prevent dilution or enlargement of rights hereunder; provided, however, that the number of shares of Common Stock subject to any Performance Share award shall always be a whole number. 4.7. MAXIMUM AWARD. The maximum number of shares of Common Stock that may be issued to any Covered Employee with respect to any Eligibility Period pursuant to any Performance Share award is 250,000 (subject to adjustment as provided in Section 4.6). This limit includes any portion or amount of Common Stock that is withheld for taxes (as described in Section 5.2). 4.8. COMMITTEE DISCRETION TO ADJUST AWARDS. At any time prior to the time the Committee determines, pursuant to Section 5.1, the amount of shares of Common Stock that are to be paid to any Participant in satisfaction of a Performance Share award hereunder, the Committee shall have the authority to modify, amend, or adjust the terms and conditions of such Performance Share award, the terms and conditions of the corresponding Performance Goals, and/or the amount of Common Stock payable, provided, however, such authority to modify, ----------------- amend or adjust the terms and conditions of such Performance Share award shall be exercised to reduce an award only in unusual circumstances not anticipated in the original design of the Plan. -6- However, the Committee shall have no authority to increase directly or indirectly or to otherwise adjust upwards the amount of Common Stock payable to a Covered Employee with respect to a particular Performance Share award or to take any other action to the extent that such action or the Committee's ability to take such action would cause any payment under the Plan to any Covered Employee to fail to qualify as "performance-based compensation" within the meaning of Code Section 162(m)(4) and the Treasury Regulations issued thereunder. V. PAYMENT 5.1. COMMITTEE DETERMINATION OF COMMON STOCK PAYABLE. After a Performance Period has ended, each Participant who has been awarded Performance Shares and satisfied the Performance Goals with respect to such Performance Period shall be entitled to receive a specified number of shares of Common Stock as determined by the Committee. The Committee shall determine the extent to which the Performance Goals set pursuant to Section 4.4 have been met, (as Pro-rated in accordance with Sections 2.18, 3.2, and/or 5.3, if applicable). With respect to Performance Shares awarded to Covered Employees, no payment of Common Stock shall be made hereunder prior to written certification by the Committee that the applicable Performance Goal or Goals have been satisfied to a particular extent for the Performance Period, and no Common Stock shall be payable unless a preestablished minimum level of achievement of the Performance Goals has been met. The date on which the Committee determines the number of shares of Common Stock payable to a Participant shall be the date on which such Participant will become the owner of such shares, regardless of when the underlying stock certificate or certificates are actually delivered to such Participant, and such Participant will enjoy all rights of ownership of such shares of Common Stock as of that date (the "Ownership Date"). 5.2. TIMING AND FORM OF PAYMENT. Shares of Common Stock payable to Participants pursuant to Section 5.1 shall be distributed as follows: (a) Fifty percent (50%) of the number of shares of Common Stock payable to a Participant shall be converted to a dollar amount based on the Fair Market Value of Common Stock on the last day of the Performance Period and, subject to Section 5.2(b) and Section 5.2(d), be distributable in a single, lump sum cash payment. (b) The Company shall have the right to deduct first from cash distributions hereunder any federal, state, or local taxes required by law to be withheld with respect to such distributions, and such additional amounts of withholding as are reasonably requested by the Participant. Accordingly, the amount of federal, state, and/or local taxes required, or agreed, to be withheld by the Company with respect to the dollar amount determined pursuant to subsection (a) above shall, for purposes of satisfying these withholding obligations, be deducted from the dollar amount of the cash payment and paid by the Company to the appropriate taxing authorities. If the entire cash distribution is insufficient to satisfy the withholding obligations, the Company shall have the right to deduct amounts from the Common Stock distributable to satisfy such withholding obligations. -7- (c) Fifty percent (50%) of the number of shares of Common Stock payable to a Participant shall, subject to Section 5.2(b) and Section 5.2(d), be paid to the Participant in shares of Common Stock as soon as practicable following the end of the Performance Period. (d) A Participant may elect by a written notice delivered to the Company, prior to the last day of the Performance Period, to have greater than fifty percent (50%) of the number of shares of Common Stock payable to a Participant for such Performance Period distributed to the Participant in shares of Common Stock, subject to the Participant's satisfaction of all withholding obligations with respect to such distribution by the Company withholding from the cash and/or shares of Common Stock distributable to the Participant or by the Participant paying to the Company any amount that the Company may reasonably determine to be necessary to satisfy such withholding obligations. 5.3. DISTRIBUTION UPON TERMINATION OF EMPLOYMENT. (a) Death. If a Participant in the Plan dies before the end of an Eligibility Period for which Performance Shares have been granted to him, such Participant's Beneficiary will be eligible for a Pro-rated portion of the Performance Shares that would have otherwise been payable to the Participant after the end of the applicable Performance Period. This distribution, if any is payable, will be made to the Beneficiary in the same form and at the same time that all other Participants under the Plan receive their distributions with respect to that Performance Period. (b) Disability. If a Participant in the Plan, upon becoming Disabled, terminates employment with the Company before the end of an Eligibility Period for which Performance Shares have been granted to him, the Participant will be eligible for a Pro-rated portion of the Performance Shares that would have otherwise been payable to him after the end of the applicable Performance Period. This distribution, if any is payable, will be made to the Participant in the same form and at the same time that all other Participants under the Plan receive their distributions with respect to that Performance Period. (c) Normal Retirement. If a Participant in the Plan terminates employment upon attaining Normal Retirement before the end of an Eligibility Period for which Performance Shares have been granted to him, the Participant will be eligible for a Pro-rated portion of the Performance Shares that would have otherwise been payable to him after the end of the applicable Performance Period. This distribution, if any is payable, will be made to the Participant in the same form and at the same time that all other Participants under the Plan receive their distributions with respect to that Performance Period. (d) Termination of Employment Without Cause. If (i) the Company terminates a Participant's employment other than for Cause or (ii) the Participant terminates the Participant's employment at the request of the Company, before the end of an Eligibility Period for which Performance Shares have been granted to him, the Participant will be eligible for the Performance Shares that would have otherwise been payable to him after the end of the applicable Performance Period. This distribution, if any is payable, will be made to the -8- Participant in the same form and at the same time that all other Participants under the Plan receive their distributions with respect to that Performance Period. (e) Termination of Employment for Good Reason. If the Participant terminates the Participant's employment for Good Reason, before the end of an Eligibility Period for which Performance Shares have been granted to him, the Participant will be eligible for a Pro-rated portion of the Performance Shares that would have otherwise been payable to him after the end of the applicable Performance Period. This distribution, if any is payable, will be made to the Participant in the same form and at the same time that all other Participants under the Plan receive their distributions with respect to that Performance Period. (f) Other Termination of Employment. If, before the end of an Eligibility Period for which Performance Shares have been granted to him, a Participant in the Plan incurs a termination of employment for any reason other than those specified in subsections (a)-(e) of this Section 5.3, whether voluntary or involuntary and a Change of Control has not occured, he shall forfeit all rights to receive any payment of Performance Shares with respect to such Eligibility Period. 5.4. BENEFICIARY DESIGNATION. A Participant may designate a Beneficiary who is to receive, upon his death, the distributions that otherwise would have been paid to him. All designations shall be in writing and shall be effective only if and when delivered to the [Vice President--Human Resources] of the Company during the lifetime of the Participant. If a Participant designates a Beneficiary without providing in the designation that the Beneficiary must be living at the time of each distribution, the designation shall vest in all of the distribution whether payable before or after the Beneficiary's death, and any distributions remaining upon the Beneficiary's death shall be made to the Beneficiary's estate. A Participant may from time to time during his lifetime change his Beneficiary by a written instrument delivered to the [Vice President--Human Resources] of the Company. In the event a Participant shall not designate a Beneficiary as aforesaid, or if for any reasons such designation shall be ineffective, in whole or in part, the distribution that otherwise would have been paid to such Participant shall be paid to his estate, and in such event the term "Beneficiary" shall include his estate. VI. ADMINISTRATION 6.1. COMMITTEE. The Plan shall be administered by the Compensation Committee of the Board of Directors, or such other Committee of the Board of Directors, composed exclusively of not less than two Non-Employee Directors, each of whom shall be appointed by and serve at the pleasure of the Board of Directors. The Committee may designate person(s) who are Company employees to oversee the day to day administration of the Plan. 6.2. GENERAL RIGHTS, POWERS, AND DUTIES OF COMMITTEE. The Committee shall be responsible for the management, operation, and administration of the Plan. Subject to the limitations contained in Section 4.8 and to the remaining terms -9- of the Plan, the Committee shall, in addition to those provided elsewhere in the Plan, have the following powers, rights, and duties: (a) To maintain records concerning the Plan sufficient to prepare reports, returns and other information required by the Plan or by law; (b) To direct the payment of benefits under the Plan, and to give such other directions and instructions as may be necessary for the proper administration of the Plan; and (c) To be responsible for the preparation, filing and disclosure on behalf of the Plan of such documents and reports as are required by any applicable federal or state law. The Committee shall also have the authority to adopt, alter, and repeal such administrative rules, guidelines, and practices governing the Plan as it shall, from time to time, deem advisable, to interpret the terms and provisions of the Plan and any award issued under the Plan (and any Notice of Award or other agreement relating thereto), and to otherwise supervise the administration of the Plan. Any determination made by the Committee pursuant to the provisions of the Plan with respect to any grants, payments, or other transactions under the Plan shall be made in the sole discretion of the Committee at the time of the grant, payment, or other transaction or, unless in contravention of any express term of the Plan, at any time thereafter. All decisions made by the Committee pursuant to the provisions of the Plan shall be final and binding on all persons, including the Company and Plan Participants. 6.3. INFORMATION TO BE FURNISHED TO COMMITTEE. Participants and their Beneficiaries shall furnish to the Committee such evidence, data, or information and execute such documents as the Committee requests. 6.4. RESPONSIBILITY AND INDEMNIFICATION. No member of the Committee or of the Board of Directors or any person who is designated to oversee the day to day administration of the Plan (as provided in Section 6.1) shall be liable to any person for any action taken or omitted in connection with the administration of this Plan unless attributable to his own fraud or willful misconduct; nor shall the Company be liable to any person for any such action unless attributable to fraud or willful misconduct on the part of a director, officer, or employee of the Company within the scope of his Company duties. Each member of the Committee shall be indemnified and held harmless by the Company for any liability arising out of the administration of the Plan, to the maximum extent permitted by law. VII. AMENDMENT AND TERMINATION 7.1. AMENDMENT. The Plan may be amended in whole or in part by the Company, by action of the Board of Directors, at any time. The Committee reserves the unilateral right to change any rule under the Plan if it deems such a change necessary to avoid the application of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), to the Plan. -10- No amendment shall be made without the approval of the Company's stockholders to the extent such approval is required by law or by agreement. 7.2. COMPANY'S RIGHT TO TERMINATE. The Company reserves the sole right to terminate the Plan, by action of the Board of Directors, at any time. VIII. MISCELLANEOUS 8.1. NO IMPLIED RIGHTS; RIGHTS ON TERMINATION OF SERVICE. Neither the establishment of the Plan nor any amendment thereof shall be construed as giving any Participant, Beneficiary, or any other person any legal or equitable right unless such right shall be specifically provided for in the Plan or conferred by specific action of the Committee in accordance with the terms and provisions of the Plan. Except as expressly provided in this Plan, the Company shall not be required or be liable to make any payment under the Plan. 8.2. NO RIGHT TO COMPANY ASSETS. Neither the Participant nor any other person shall acquire, by reason of the Plan, any right in or title to any assets, funds or property of the Company whatsoever including, without limiting the generality of the foregoing, any specific funds, assets, or other property which the Company, in its sole discretion, may set aside in anticipation of a liability hereunder. Any benefits which become payable hereunder shall be paid from the general assets of the Company. The Participant shall have only a contractual right to the amounts, if any, payable hereunder unsecured by any asset of the Company. Nothing contained in the Plan constitutes a guarantee by the Company that the assets of the Company shall be sufficient to pay any benefit to any person. 8.3. NO EMPLOYMENT RIGHTS. Nothing herein shall constitute a contract of employment or of continuing service or in any manner obligate the Company to continue the services of the Participant, shall obligate the Participant to continue in the service of the Company, or shall serve as a limitation of the right of the Company to discharge any of its employees, with or without cause. Nothing herein shall be construed as fixing or regulating the compensation payable to the Participant. 8.4. OTHER BENEFITS. No Common Stock paid under the Plan shall be considered compensation for purposes of computing benefits under any "employee benefit plan" (as defined in Section 3(3) of ERISA) of the Company nor affect any benefits or compensation under any other benefit or compensation plan of the Company now or subsequently in effect (except as provided to the contrary in such Company plan). 8.5. OFFSET. If, at the time payments are to be made hereunder, the Participant or the Beneficiary or both are indebted or obligated to the Company, then the payments under the Plan remaining to be made to the Participant or the Beneficiary or both may, at the discretion of the Company, be reduced by the amount of such indebtedness or obligation, provided, however, that an election by the Company not to reduce any such payment or payments shall not constitute a waiver of its claim for such indebtedness or obligation. -11- 8.6. NON-ASSIGNABILITY. Neither the Participant nor any other person shall have any voluntary or involuntary right to commute, sell, assign, pledge, anticipate, mortgage, or otherwise encumber, transfer, hypothecate, or convey in advance of actual receipt the amounts, if any payable hereunder or any part thereof, which are expressly declared to be unassignable and non-transferable. No part of the amounts payable prior to actual payment shall be subject to seizure or sequestration for the payment of any debts, judgments, alimony, or separate maintenance owed by the Participant or any other person, or be transferable by operation of law in the event of the Participant's or any other person's bankruptcy or insolvency. 8.7. NOTICE. Any notice required or permitted to be given under the Plan shall be sufficient if in writing and hand delivered, sent by registered or certified mail, or sent by facsimile to the Company at its principal office, directed to the attention of the Committee c/o the Chief Financial Officer of the Company. Such notice shall be deemed given as of the date of delivery or, if delivery is made by mail or facsimile, as of the date shown on the postmark, facsimile, or the receipt for registration or certification. 8.8. GOVERNING LAWS. The Plan and all awards made and actions taken under the Plan shall be governed and construed according to the laws of the State of Delaware. 8.9. GENDER AND NUMBER. Where appropriate, references in this Plan to the masculine shall include the feminine, and references to the singular shall include the plural. 8.10. SEVERABILITY. In the event any provision of the Plan shall be held legally invalid for any reasons, the illegality or invalidity shall not affect the remaining parts of the Plan, and the Plan shall be construed and enforced as if the illegal or invalid provision had not been included. -12- EX-11.01 4 STATEMENT RE: COMPUTATION OF EARNINGS Exhibit 11.01 CAPITAL RE CORPORATION AND SUBSIDIARIES EXHIBIT 11 STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS (Dollars in thousands except per share amounts)
Year Ended December 31, ------------------------------------------ 1996 1995 1994 ------------------------------------------ Earnings per common share (Primary and Fully Diluted) Average shares outstanding during the period 15,656 14,788 14,825 Net Income 56,524 45,527 39,806 Earnings per share amount $3.61 $3.08 $2.69 ========= ========= ========= Notes: The per share data for 1996, 1995 and 1994 does not include the net effect of dilutive stock options, since the dilution from the earnings per share amount is less than 3%.
EX-13.01 5 1996 ANNUAL REPORT Capital RE Corporation and Subsidiaries Financial Highlights
Year Ended December 31, ------------------------------------------------------------ (Dollars in thousands except per share amounts) 1996 1995 1994 1993 1992 - ------------------------------------------------------------------------------------------------------------ SUMMARY OF OPERATIONS Gross Premiums Written $129,818 $107,599 $94,851 $85,367 $79,283 Net Premiums Written 105,188 89,508 82,795 73,946 53,153 Net Premiums Earned 92,436 60,097 58,850 44,936 27,799 Net Investment Income 51,558 46,654 40,113 32,131 23,760 Net Realized Gains 1,471 53 1,780 881 5,487 Total Revenues 146,416 107,085 101,462 79,477 58,443 Net Income 56,524 45,527 39,806 36,354 30,153 - ------------------------------------------------------------------------------------------------------------ BALANCE SHEET Investment Portfolio 901,102 771,767 638,751 552,405 443,688 Total Assets 1,156,401 981,885 810,040 711,633 608,547 Net Deferred Premium Revenue 265,070 252,318 222,907 198,960 147,079 Stockholders' Equity 489,346 411,943 325,514 323,832 279,593 - ------------------------------------------------------------------------------------------------------------ PER SHARE DATA Earnings Per Share 3.61 3.08 2.69 2.43 2.16 Book Value Per Share 30.86 27.82 22.02 21.66 18.71 - ------------------------------------------------------------------------------------------------------------ STATUTORY SURPLUS AND RESERVES Unearned Premium Reserve 307,236 278,980 242,574 218,095 163,812 Contingency Reserve 123,363 89,685 63,591 43,459 34,472 Policyholders' Surplus 443,451 412,884 401,743 304,222 250,720 Total Policyholders'Surplus and Reserves 874,051 781,549 707,908 565,776 449,004 - -------------------------------------------------------------------------------------------------------------
2 Capital Re Corporation and Subsidiaries Audited Consolidated Financial Statements Year ended December 31, 1996
Contents Management's Discussion and Analysis ................................. 22 Report of Independent Auditors ....................................... 31 Consolidated Balance Sheets .......................................... 32 Consolidated Statements of Income .................................... 34 Consolidated Statements of Stockholders' Equity ...................... 35 Consolidated Statements of Cash Flows ................................ 36 Notes to Consolidated Financial Statements ........................... 37 Officers and Directors ............................................... 54 Shareholder Information .............................................. 55
21 Capital Re Corporation and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations General Capital Re Corporation (the "Corporation") was incorporated in the State of Delaware in December 1991, and is the successor by merger to a Maryland corporation incorporated in 1986. The Corporation is an insurance holding company and has six wholly-owned operating subsidiaries. Capital Reinsurance Company ("Capital Reinsurance"), domiciled in the state of Maryland, commenced operations in January 1988. Capital Reinsurance is engaged in the business of financial guaranty reinsurance, primarily the reinsurance of municipal and non- municipal bond insurance policies. Capital Mortgage Reinsurance Company ("Capital Mortgage"), a New York-domiciled company, commenced operations in February 1994. Capital Mortgage reinsures only residential mortgage guaranty insurance obligations. KRE Reinsurance Ltd. ("KRE"), (formerly Capital Mortgage Reinsurance Company (Bermuda) Ltd.), a Bermuda-domiciled company, commenced operations in March 1994. KRE is engaged in the business of reinsuring financial guaranty, mortgage guaranty and trade credit and other specialty insurance policies, both as a direct reinsurer of third party primary insurers and as a retrocessionaire of Capital Reinsurance, Capital Mortgage, and Capital Credit Reinsurance Company, Ltd. ("Capital Credit"). Capital Credit, also a Bermuda- domiciled insurance company, commenced operations in February 1990. Capital Credit reinsures trade credit and other specialty insurance lines concentrated in Western Europe and the United States and is a retrocessionaire of Capital Reinsurance and Capital Mortgage. Capital Title Reinsurance Company ("Capital Title"), a New York-domiciled insurance company, commenced operations in March 1996. Capital Title is engaged in the business of reinsuring title insurance policies. In November 1996, the Corporation acquired, through its newly formed United Kingdom holding company, Capital Re (UK) Holdings, 100% of the issued shares of Tower Street Holdings Limited (now known as RGB Holdings, Ltd.), the holding company for RGB Underwriting Agencies Ltd. ("RGB"). RGB is a managing agency and presently manages five syndicates operating in the Lloyd's of London insurance market. In connection with this acquisition, the Corporation established a corporate name at Lloyd's to support underwriting on the managed syndicates. The corporate name participates in a non-marine and a life syndicate. At December 31, 1996, the results of RGB and the corporate name at Lloyd's are consolidated in the Corporation's financial statements. The goodwill associated with this acquisition will be amortized over twenty years. In December 1996, the Corporation entered into a joint venture with GCR Holdings Limited to form a Bermuda-based insurer, Capital Global Underwriters Limited ("CGUL"), which will specialize in financial reinsurance, including financial guaranty, mortgage guaranty and finite risk reinsurance. The Corporation, through its subsidiary, KRE, owns a fifty percent interest in CGUL and controls 9.9% of its voting stock. The Corporation accounts for its investment in CGUL under the equity method. 22 Results of Operations Year Ended December 31, 1996, versus Year Ended December 31, 1995 Net income for the year ended December 31, 1996, increased 24.2% to $56.5 million from $45.5 million for the same period of 1995. On a per share basis, net income increased to $3.61 for the year ended December 31, 1996, from $3.08 for the same period of 1995, or 17.2%. In addition, net operating income (net income excluding realized gains and losses) increased 21.3% to $55.3 million for the year ended December 31, 1996, from $45.6 million for the same period in 1995. On a per share basis, net operating income increased to $3.53 for the year ended December 31, 1996, from $3.09 for the same period of 1995, or 14.2%. Growth in net premiums earned to $92.4 million from $60.1 million, or 53.7%, was the principal cause of the increase in net income. Growth in net premiums earned is a result of the Corporation's successful diversification into the mortgage, trade credit and other specialty reinsurance lines of business. Gross premiums written increased 20.6% to $129.8 million for the year ended December 31, 1996, from $107.6 million for the same period of 1995. This increase was primarily due to growth in the mortgage guaranty, trade credit and other specialty lines of business. In addition, Capital Title established its first reinsurance relationships in 1996, which contributed $1.8 million in premiums written for the year ended December 31, 1996. Non-municipal premiums written decreased to $10.9 million for the year ended December 31, 1996, from $17.2 million for the same period last year because of the positive impact on gross premiums written in the fourth quarter of 1995 of several large reinsurance transactions, which had upfront premium payments. The following table shows gross written premiums by line of business for the year ended December 31, 1996 and December 31, 1995.
Year ended Gross Premiums Written December 31, ---------------- (Dollars in millions) 1996 1995 - ---------------------------------------------------- Municipal $ 48.3 $ 44.2 Mortgage 53.7 39.1 Non-Municipal 10.9 17.2 Credit and Specialty 15.1 7.1 Title 1.8 0.0 - ---------------------------------------------------- $129.8 $107.6
Net premiums written increased by 17.5% to $105.2 million for the year ended December 31, 1996, from $89.5 million for the same period in 1995. This increase is commensurate with the increase in gross premiums written explained above. The following table shows net premiums written by line of business for the year ended December 31, 1996, and December 31, 1995.
Year ended Net Premiums Written December 31, ---------------- (Dollars in millions) 1996 1995 - ---------------------------------------------------- Municipal $ 36.7 $38.1 Mortgage 40.9 27.6 Non-Municipal 10.9 17.2 Credit and Specialty 14.9 6.6 Title 1.8 0.0 - ---------------------------------------------------- $105.2 $89.5
23 Capital Re Corporation and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations continued For the year ended December 31, 1996, net premiums earned increased 53.7% to $92.4 million from $60.1 million for the comparable 1995 period. This increase was primarily due to growth in net premiums earned in the mortgage, and credit and specialty reinsurance lines of business. For the year ended December 31, 1996, net refunded earned premium increased to $5.8 million from $0.8 million for the comparable period in 1995. Excluding the effects of net refunded earned premium, net premiums earned increased 46.2% to $86.7 million from $59.3 million for the year ended December 31, 1996 and 1995, respectively. A refunding extinguishes the Corporation's reinsurance liability for the refunded obligation and the Corporation then recognizes revenue equal to the remaining related deferred premium revenue. The following table shows net premiums earned by line of business for the year ended December 31, 1996 and December 31, 1995. For the year ended December 31, 1996 and 1995, ceded earned premium was $14.7 million and $8.0 million, respectively.
Year ended Net Premiums Earned December 31, ---------------- (Dollars in millions) 1996 1995 - ---------------------------------------------------- Municipal $27.5 $25.6 Mortgage 43.9 22.1 Non-Municipal 7.2 6.4 Credit and Specialty 12.2 6.0 Title 1.6 0.0 - ----------------------------------------------------- $92.4 $60.1
For the year ended December 31, 1996, net investment income increased 10.5% to $51.6 million from $46.7 million for the comparable period in 1995. Growth in investment income was primarily attributable to a larger investment portfolio caused by (i) an increase in invested assets from positive operating cash flows during the year ended December 31, 1996, and (ii) a public offering in the first quarter of 1996 of the Corporation's common stock which generated $25.9 million in net proceeds to the Corporation. In addition, the Corporation recognized net realized gains of $1.5 million for the year ended December 31, 1996, compared to net realized gains of $0.1 million for same period in 1995. Realized gains and losses are expected in connection with the Corporation's new emphasis on a total return investment strategy implemented during 1996. Loss and loss adjustment expenses increased to $9.5 million from $2.6 million for the year ended December 31, 1996 and 1995, respectively. Losses recorded in the year ended December 31, 1996, were primarily attributable to normal loss development in the mortgage guaranty and credit reinsurance lines of business which constitute an increasing portion of the Corporation's assumed book of business. Ceded losses for the year ended December 31, 1996 and 1995, were $6.5 million and $2.6 million, respectively. Total expenses, including loss and loss adjustment expenses, increased 47.4% to $69.3 million for the year ended December 31, 1996, from $47.0 million in the same period of 1995. This increase was primarily attributable to commissions associated with the increased level of premiums assumed, normal loss development from the 24 mortgage and credit lines of business and increased net profit commissions payable under certain of the Corporation's reinsurance contracts. In addition, the combined ratio increased to 61.7% for the year ended December 31, 1996, from 56.8% for the comparable 1995 period. This increase is an expected result of the Corporation's diversification strategy, which is producing more business from lines with relatively higher combined ratios than the financial guaranty reinsurance business. For the year ended December 31, 1996, the total tax provision increased to $20.6 million from $14.5 million for the same period in 1995. In addition, the effective tax rate increased to 26.7% in the third quarter of 1996, from 24.2% in the same period of 1995. This increase occurred in response to the Corporation's strategy of using a greater proportion of new cash flow to purchase taxable securities during 1996. Year Ended December 31, 1995 versus Year Ended December 31, 1994 Net income for the year ended December 31, 1995, increased 14.3% to $45.5 million from $39.8 million for the same period of 1994. On a per share basis, net income increased to $3.08 for the year ended December 31, 1995, from $2.69 for the same period of 1994, or 14.5%. Growth in net investment income to $46.7 million from $40.1 million, or 16.5%, and a decrease in profit commission expense to $0.9 million from $4.0 million, were the principal causes of the increase in net income. Gross premiums written increased 13.4% to $107.6 million for the year ended December 31, 1995, from $94.9 million for the same period of 1994. This increase was primarily due to an increase in gross premiums written from the Corporation's expansion of its mortgage guaranty reinsurance and credit reinsurance business lines. The following table shows gross written premiums by line of business for the year ended December 31, 1995, and December 31, 1994.
Year ended Gross Premiums Written December 31, ---------------- (Dollars in millions) 1996 1995 - ---------------------------------------------------- Municipal $ 44.2 $56.9 Mortgage 39.1 30.1 Non-Municipal 17.2 5.3 Credit 7.1 2.6 - ---------------------------------------------------- $107.6 $94.9
The decrease of $12.7 million of gross premiums written in the municipal bond reinsurance line of business was primarily due to a decline in new municipal bond issuance, a consequent decline in aggregate primary insurance premiums, and reduced reinsurance ceded in the municipal bond segment of the financial guaranty market. However, this decrease was offset by an increase of $12.0 million of gross premiums written in the non-municipal financial guaranty line of business. Net premiums written increased by 8.1% to $89.5 million for the year ended December 31, 1995, from $82.8 million for the same period in 1994. This increase followed from the causes described above for the increase in gross premiums written. The following table shows net premiums written by line of business for the year ended December 31, 1995, and December 31, 1994. 25 Capital Re Corporation and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations continued
Year ended Net Premiums Written December 31, ---------------- (Dollars in millions) 1996 1995 - ---------------------------------------------------- Municipal $38.1 $50.1 Mortgage 27.6 23.8 Non-Municipal 17.2 6.3 Credit 6.6 2.6 - ---------------------------------------------------- $89.5 $82.8
For the year ended December 31, 1995, net premiums earned increased 2.0% to $60.1 million from $58.9 million for the comparable 1994 period. This slight increase was primarily due to increases in net premiums earned in the mortgage, credit and non-municipal reinsurance lines of business, partially offset by a decline in net refunded earned premium. For the year ended December 31, 1995, net refunded earned premium decreased to $0.8 million from $9.2 million for the comparable period in 1994. Excluding the effects of net refunded earned premium, net premiums earned increased 19.3% to $59.3 million from $49.7 million for the year ended December 31, 1995 and 1994, respectively. A refunding extinguishes the Corporation's reinsurance liability for the refunded obligation and the Corporation then recognizes revenue equal to the remaining related deferred premium revenue. The following table shows net premiums earned by line of business for the year ended December 31, 1995, and December 31, 1994.
Year ended Net Premiums Written December 31, ----------------- (Dollars in millions) 1996 1995 - ---------------------------------------------------- Municipal $25.6 $34.5 Mortgage 22.1 16.8 Non-Municipal 6.4 5.3 Credit 6.0 2.3 - ---------------------------------------------------- $60.1 $58.9
For the year ended December 31, 1995, net investment income increased 16.5% to $46.7 million from $40.1 million for the comparable period in 1994. Growth in investment income was primarily attributable to an increase in invested assets from positive operating cash flows during the twelve months ended December 31, 1995. The Corporation recognized net realized gains of $0.1 million for the year ended December 31, 1995 compared to $1.8 million for the same period in 1994. The 1995 net realized gains included a write-down of $2.6 million on a planned amortization class interest-only collateralized mortgage obligation ("CMO") in accordance with the provisions of Emerging Issues Task Force ("EITF") Issue No. 93-18, which requires cash flows of volatile CMOs to be discounted to their fair value below amortized cost to the extent that any portion of this difference is considered to be other than temporary. Included in the 1994 net realized gains was a $1.0 million write-down on the same security. The carrying value of this security has been reduced to its currently expected discounted realizable amount. Loss and loss adjustment expenses increased to $2.6 million from $2.2 million for the year ended December 31, 1995 and 1994, respectively. Losses recorded in the year ended 1995 were primarily attributable to the mortgage guaranty and credit 26 reinsurance lines of business. This increase is reflective of the maturation of the books of business assumed in prior years and is consistent with the expected loss development pattern for these lines of business. Total expenses decreased 2.9% to $47.0 million for the year ended December 31, 1995, from $48.4 million in the same period of 1994. Also, the expense ratio decreased to 52.4% for the year ended December 31, 1995, from 58.2% for the comparable 1994 period. This decrease was due to lower profit commission expenses associated with favorable results under certain retrocessional agreements. For the year ended December 31, 1995, the total tax provision increased to $14.5 million from $13.3 million for the same period in 1994. However, the effective tax rate decreased to 24.2% for the year ended December 31, 1995, from 25.0%. This decrease occurred in response to the Corporation's strategy of using a greater proportion of new cash flow to purchase tax-exempt securities during 1995. Liquidity and Capital Resources The Corporation relies on dividends from Capital Reinsurance for funds used in its operations. The major sources of liquidity for Capital Reinsurance are funds generated from reinsurance premiums, net investment income and maturing investments. Capital Reinsurance is domiciled in the state of Maryland, and under Maryland insurance law, the amount of the surplus of Capital Reinsurance available for distribution as dividends is subject to certain statutory restrictions. The amount available for distribution from Capital Reinsurance during 1996 with notice to, but without prior approval of, the Maryland Insurance Commissioner was limited to 10% of Capital Reinsurance's policyholders' surplus as of December 31, 1995, or approximately $32.9 million. For the year ended December 31, 1996, Capital Reinsurance paid $17.5 million in dividends to the Corporation. Credit Re Corporation relies on dividends from its wholly owned subsidiary, Capital Credit, for funds which it provides the Corporation. Capital Credit's major sources of liquidity are also funds generated from reinsurance premiums, net investment income and maturing investments. Capital Credit is a Bermuda- domiciled insurer whose distributions are governed by Bermuda law. Under Bermuda law and the by-laws of Capital Credit, dividends may be paid out of the profits of the company (defined as accumulated realized profits less accumulated realized losses). Distributions to shareholders may also be paid out of Capital Credit's surplus limited by requirements that such company must at all times (i) maintain the minimum share capital required under Bermuda Law, and (ii) have relevant assets in an amount equal to or greater than 75% of relevant liabilities, all as defined under Bermuda Law. Since its organization, Capital Credit has not declared nor paid any dividends. Capital Mortgage and Capital Title are subject to the dividend restrictions imposed under New York Insurance Law. Accordingly, dividends may only be declared and distributed out of earned surplus (as defined under New York Insurance Law). Additionally, no dividend may be declared or distributed in an amount which, together with all dividends declared or distributed by Capital Mortgage during the preceding twelve months, exceeds the lesser of 10% of the company's surplus to policyholders as shown by its last Annual Statutory Statement on file with the New York 27 Capital Re Corporation and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations continued Insurance Department, or 100% of adjusted net investment income (as defined under New York Insurance Law) during such period, unless, upon prior application, the Superintendent of Insurance approves a greater dividend distribution based upon his finding that Capital Mortgage will retain sufficient surplus to support its obligations and writings. KRE's dividends and distributions to its sole shareholder, Capital Mortgage, are governed by Bermuda law, and are subject to the same restrictions as those described in the preceding paragraph for Capital Credit. To date, Capital Mortgage, KRE and Capital Title have not declared or paid any dividends. In January 1994, the Corporation formed and capitalized, through the purchase of common shares, Capital Re LLC. Capital Re LLC exists solely for the purpose of issuing preferred and common shares and lending the proceeds of such issuance to the Corporation to fund its business operations. In January 1994, Capital Re LLC issued $75.0 million of Company obligated mandatorily redeemable preferred securities, the proceeds of which were loaned to the Corporation. The Corporation has, among other undertakings, unconditionally guaranteed all legally declared and unpaid dividends of Capital Re LLC. The Company obligated mandatorily redeemable preferred securities were issued at $25 par value per share and pay monthly dividends at a rate of 7.65% per annum. Also in January 1994, Capital Reinsurance and Capital Credit invested an aggregate of $120.0 million to capitalize Capital Mortgage. Of the total original contribution of $120.0 million, Capital Reinsurance invested $94.8 million and Capital Credit invested $25.2 million. On February 12, 1996, the Corporation completed a public offering of approximately 3.5 million shares of common stock. Of the 3.5 million shares, an institutional shareholder sold 2.6 million shares and the Corporation sold 853,120 shares in the public offering generating net proceeds to the Corporation of approximately $25.9 million of which $21.5 million was used to complete the $25 million capitalization of Capital Title. The remaining $4.4 million was used for Corporation expenses associated with the public offering and general corporate purposes. The Corporation received no proceeds from the institutional shareholder's sale of shares. During 1996, the Corporation paid three quarterly common stock dividends at a rate of $0.06 per share. In December of 1996, the Corporation's Board of Directors authorized an increase of the quarterly common stock dividend rate to $0.07 per share, or $0.28 annually. For the year ended December 31, 1996, common dividends were declared and paid in the amount of $3.9 million or $0.25 per share. Cash flows from operations for the year ended December 31, 1996 and 1995, consisting of reinsurance premiums collected net of expenses, investment income and income taxes, were $95.9 million and $73.7 million, respectively. The Corporation believes that current levels of cash flow from operations provide the Corporation with sufficient liquidity to meet its operating needs. The Corporation's non-operating cash outflows are primarily dedicated to (i) fixed- income investment activity, (ii) the payment of dividends on its common shares, (iii) payments of interest on long-term debt and (iv) the payment of its loan obligations to Capital Re LLC. 28 At December 31, 1996, cash and investments approximated $916.4 million, an increase of $140.1 million, or 18.0%, from $776.3 million at December 31, 1995. In managing its investment portfolio, the Corporation places a high priority on quality and liquidity. As of December 31, 1996, the entire investment portfolio was invested in highly-rated fixed income securities. At December 31, 1996, approximately $200.8 million or 22.3% of the Corporation's investment portfolio was comprised of mortgage-backed securities ("MBS"). Of the MBS portfolio, approximately $142.8 million or 71.1% is backed by agencies or entities sponsored by the U.S. government as to the full amount of principal and interest. As of December 31, 1996, the entire MBS portfolio was invested in triple A rated securities. Prepayment risk is an inherent risk of holding MBS. However, the degree of prepayment risk is particular to the type of MBS held. The Corporation limits its exposure to prepayments by purchasing less volatile types of MBS. As of December 31, 1996, $52.2 million or approximately 26.0% of the MBS portfolio was invested in collateralized mortgage obligations ("CMOs") which are characterized as planned amortization class CMOs ("PACs"). PACs are securities whose cash flows are designed to remain constant over a variety of mortgage prepayment environments. Other classes in the CMO security are structured to accept the volatility of mortgage prepayment changes, thereby insulating the PAC class. Of the remaining MBS portfolio, $148.6 million, or 74.0%, was invested in mortgage- backed pass-throughs or sequential CMOs. Pass-throughs are securities in which the monthly cash flows of principal and interest (both scheduled and prepayments) generated by the underlying mortgages are distributed on a pro-rata basis to the holders of securities. A sequential MBS is structured to divide the CMO security into sequentially ordered classes. Receipt of principal payments within classes is contingent on the retirement of all previously paying classes. Generally, interest payments are made currently on all classes. While these securities are more sensitive to prepayment risk than PACs, they are not considered highly volatile securities. While the Corporation may consider investing in any tranche of a sequential MBS, the individual security's characteristics (duration, relative value, underlying collateral, etc.) along with aggregate portfolio risk management determine which tranche of sequential MBS will be purchased. At December 31, 1996, the Corporation had no securities such as interest-only securities, principal-only securities, or MBS purchased at a substantial premium to par that have the potential for loss of a significant portion of the original investment due to changes in the prepayment rate of the underlying loans supporting the security. On January 31, 1997, the Corporation extended its existing agreement with Deutsche Bank AG for the provision of a $25.0 million liquidity facility (the "DB Liquidity Facility") which is available for general corporate purposes. The DB Liquidity Facility was extended for one year and is scheduled to expire on January 26, 1998. The Corporation has not borrowed under the DB Liquidity Facility. Capital Reinsurance also entered into an agreement on January 31, 1994 with Deutsche Bank AG for a credit facility of up to $75.0 million specifically designed to provide rating agency qualified capital to further support Capital Reinsurance's claims-paying resources. This agreement expires January 27, 2004. 29 Capital Re Corporation and Subsidiaries Management's Discussion and Analyses of Financial Condition and Results of Operations continued In addition, on August 20, 1996, the Corporation entered into a credit agreement with Chase Manhattan Bank for the provision of a $25.0 million credit facility (the "Chase Facility") which is available for general corporate purposes. Furthermore, on August 26, 1996, the Corporation utilized $16.0 million of the Chase Facility for purposes of paying subordinated notes which came due. Interest on the bank note issued under the Chase Facility is payable quarterly based upon the Corporation's chosen interest rate option under the terms of the Chase Facility. In November of 1996, the Corporation utilized the remaining $9 million of the Chase Facility for purposes of acquiring RGB. 30 Report of Independent Auditors Board of Directors and Stockholders Capital Re Corporation We have audited the accompanying consolidated balance sheets of Capital Re Corporation and Subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Capital Re Corporation and Subsidiaries at December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. January 21, 1997 31 Capital Re Corporation and Subsidiaries Consolidated Balance Sheets
December 31, ---------------------------------- (Dollars in thousands except share amounts) 1996 1995 - ----------------------------------------------------------------------------------------------------- Assets Fixed maturity securities available for sale, at market (amortized cost: $800,137 in 1996 and $652,966 in 1995) $ 825,678 $687,657 Short-term investments, at cost, which approximates market 75,424 84,110 - ----------------------------------------------------------------------------------------------------- Total investments 901,102 771,767 Cash 15,285 4,537 Accrued investment income 12,287 9,481 Deferred acquisition costs 111,364 102,353 Prepaid reinsurance premiums 72,034 62,133 Reinsurance recoverable on ceded losses 1,833 2,524 Funds held under reinsurance contracts 3,861 3,832 Premiums receivable 5,794 17,907 Property and equipment, at cost (net of accumulated depreciation and amortization of $1,502 in 1996 and $1,014 in 1995) 2,291 1,702 Goodwill 13,567 -- Investment in CGUL 10,000 -- Other assets 6,983 5,649 - ----------------------------------------------------------------------------------------------------- Total assets $1,156,401 $981,885 =====================================================================================================
See accompanying notes to consolidated financial statements. 32
December 31, ----------------------------------- (Dollars in thousands except share amounts) 1996 1995 - ------------------------------------------------------------------------------------------------------ Liabilities Deferred premium revenue $ 337,104 $314,451 Reserve for losses and loss adjustment expenses 19,902 12,783 Profit commission liability 13,329 8,806 Ceded balances payable 50 8,000 Bank note payable 25,000 -- Subordinated notes payable -- 16,000 Long-term debt 74,782 74,744 Deferred federal income taxes payable 58,474 50,187 Other liabilities 20,665 9,971 Liability for securities purchased 42,749 -- - ------------------------------------------------------------------------------------------------------ Total liabilities 592,055 494,942 - ------------------------------------------------------------------------------------------------------ Company obligated mandatorily redeemable preferred securities of Capital Re LLC 75,000 75,000 - ------------------------------------------------------------------------------------------------------ Stockholders' equity Preferred stock--$.01 par value per share: 25,000,000 shares authorized; no shares issued or outstanding -- -- Common stock--$.01 par value per share: 75,000,000 shares authorized; 15,856,762 and 14,805,055 shares issued and outstanding in 1996 and 1995 160 150 Additional paid-in capital 222,525 191,654 Retained earnings 253,807 201,228 Treasury stock--189,700 and 182,700 shares in 1996 and 1995, respectively (3,870) (3,638) Net unrealized gain on fixed maturity securities available for sale 16,602 22,549 Net unrealized gain on foreign currency translation 122 -- - ------------------------------------------------------------------------------------------------------ Total stockholders' equity 489,346 411,943 - ------------------------------------------------------------------------------------------------------ Total liabilities, preferred securities of Capital Re LLC and stockholders' equity $1,156,401 $981,885 ======================================================================================================
33 Capital Re Corporation and Subsidiaries Consolidated Statements of Income
Year ended December 31, ---------------------------------------- (Dollars in thousands except per share amounts) 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------ Revenues Gross written premiums $129,818 $107,599 $ 94,851 Ceded premiums (24,630) (18,091) (12,056) - ------------------------------------------------------------------------------------------------------------ Net written premiums 105,188 89,508 82,795 Increase in deferred premium revenue (12,752) (29,411) (23,945) - ------------------------------------------------------------------------------------------------------------ Earned premiums 92,436 60,097 58,850 Net investment income 51,558 46,654 40,113 Net realized gains 1,471 53 1,780 Other income 951 281 719 - ------------------------------------------------------------------------------------------------------------ Total revenues 146,416 107,085 101,462 - ------------------------------------------------------------------------------------------------------------ Expenses Losses and loss adjustment expenses 9,483 2,637 2,167 Acquisition costs 39,725 32,607 34,099 Increase in deferred acquisition costs (9,011) (11,705) (12,628) Profit commission expense 6,008 902 4,009 Other operating expenses 10,796 9,710 8,787 Foreign exchange gains (losses) (377) 228 -- Interest expense 6,895 6,893 6,539 Minority interest in Capital Re LLC 5,738 5,738 5,387 - ------------------------------------------------------------------------------------------------------------ Total expenses 69,257 47,010 48,360 - ------------------------------------------------------------------------------------------------------------ Income before provision for federal income taxes 77,159 60,075 53,102 Provision for federal income taxes: Current 9,146 9,175 6,976 Deferred 11,489 5,373 6,320 - ------------------------------------------------------------------------------------------------------------ Total provision for federal income taxes 20,635 14,548 13,296 - ------------------------------------------------------------------------------------------------------------ Net income $ 56,524 $ 45,527 $ 39,806 ============================================================================================================ Per share data Weighted average common shares outstanding 15,656 14,788 14,825 Net income per share of common stock $ 3.61 $ 3.08 $ 2.69 Cash dividend per common share $ 0.25 $ 0.21 $ 0.20 - ------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 34 Capital Re Corporation and Subsidiaries Consolidated Statements of Stockholders' Equity
Year ended December 31, ------------------------------------- (Dollars in thousands except per share amounts) 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------ Common stock Balance at beginning of period 150 150 149 Common stock issued 8 -- 1 Exercise of stock options, including tax benefit 2 -- -- - ------------------------------------------------------------------------------------------------------------ Balance at end of period 160 150 150 - ------------------------------------------------------------------------------------------------------------ Additional paid-in capital Balance at beginning of period 191,654 191,214 190,902 Issuance of common stock 25,485 440 312 Exercise of stock options, including tax benefit 5,386 -- -- - ------------------------------------------------------------------------------------------------------------ Balance at end of period 222,525 191,654 191,214 - ------------------------------------------------------------------------------------------------------------ Retained earnings Balance at beginning of period 201,228 158,806 121,959 Net Income 56,524 45,527 39,806 Dividend (3,945) (3,015) (2,959) - ------------------------------------------------------------------------------------------------------------ Balance at end of period 253,807 201,228 158,806 - ------------------------------------------------------------------------------------------------------------ Treasury stock Balance at beginning of period (3,638) (3,638) -- Purchase of treasury stock at cost (232) -- (3,638) - ------------------------------------------------------------------------------------------------------------ Balance at end of period (3,870) (3,638) (3,638) - ------------------------------------------------------------------------------------------------------------ Foreign exchange translation Balance at beginning of period 0 (20) (10) Foreign exchange translation 122 20 (10) - ------------------------------------------------------------------------------------------------------------ Balance at end of period 122 0 (20) - ------------------------------------------------------------------------------------------------------------ Net unrealized gain (loss) on fixed maturity securities available for sale Balance at beginning of period 22,549 (20,998) 10,832 Fixed maturities available for sale adjustments (5,947) 43,547 (31,830) - ------------------------------------------------------------------------------------------------------------ Balance at end of period 16,602 22,549 (20,998) - ------------------------------------------------------------------------------------------------------------ Total stockholders' equity 489,346 411,943 325,514 ============================================================================================================
35 Capital Re Corporation and Subsidiaries Consolidated Statements of Cash Flows
Year ended December 31, ---------------------------------------- (Dollars in thousands) 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------ Net income $ 56,524 $ 45,527 $ 39,806 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of discount on long-term debt 38 38 38 Net amortization of investment security discounts 293 1,573 2,099 Provision for deferred federal income taxes 11,489 5,351 6,320 Acquisition costs deferred (39,725) (32,607) (34,099) Amortization of deferred acquisition costs 30,714 20,902 21,471 Change in accrued investment income (2,806) 462 (2,547) Change in premiums receivable 2,467 (13,864) (1,657) Change in deferred premium revenue, net 12,752 29,411 23,947 Change in reserve for losses and loss adjustment expenses, net 7,810 2,557 5,926 Change in funds held under reinsurance contracts -- 16 6,194 Net realized gains on investments (1,471) (53) (1,780) Change in ceded balances payable (7,950) 8,000 -- Other 25,795 6,371 2,518 - ------------------------------------------------------------------------------------------------------------ Net cash provided by operating activities 95,930 73,684 68,236 - ------------------------------------------------------------------------------------------------------------ Investing activities Fixed maturity securities available-for-sale: Purchases (741,415) (226,955) (202,516) Sales 589,143 165,775 53,437 Maturities 6,280 7,100 36,170 Fixed maturity securities held-to-maturity: Purchases -- -- (11,573) Maturities -- 6,028 14,782 Purchases of short-term investments, net 8,686 (21,649) (23,774) Investment in subsidiaries (25,791) (304) (273) Other investing activities 42,211 -- -- - ------------------------------------------------------------------------------------------------------------ Net cash used in investing activities (120,886) (70,005) (133,747) - ------------------------------------------------------------------------------------------------------------ Financing activities Net proceeds from sale of preferred shares of subsidiary -- -- 72,753 Net proceeds from sale of stock 25,493 440 313 Net proceeds from exercise of stock options 5,388 -- -- Net proceeds from issuance of notes payable 9,000 -- -- Purchase of treasury stock, at cost (232) -- (3,638) Dividends paid (3,945) (3,105) (2,959) - ------------------------------------------------------------------------------------------------------------ Net cash (used in) provided by financing activities 35,704 (2,665) 66,469 - ------------------------------------------------------------------------------------------------------------ Increase in cash 10,748 1,014 958 Cash at beginning of year 4,537 3,523 2,565 - ------------------------------------------------------------------------------------------------------------ Cash at end of year $ 15,285 $ 4,537 $ 3,523 ============================================================================================================
See accompanying notes to consolidated financial statements. 36 Capital Re Corporation and Subsidiaries Notes to Consolidated Financial Statements December 31, 1996 1. Business and Organization Capital Re Corporation (the "Corporation") was incorporated in the State of Delaware in December 1991, and is the successor by merger to a Maryland corporation incorporated in 1986. The Corporation is an insurance holding company and has six wholly-owned operating subsidiaries. Capital Reinsurance Company ("Capital Reinsurance"), domiciled in the state of Maryland, commenced operations in January 1988. Capital Reinsurance is principally engaged in the business of financial guaranty reinsurance, which includes the reinsurance of municipal and non-municipal bond reinsurance policies. Capital Mortgage Reinsurance Company ("Capital Mortgage"), a New York-domiciled company, commenced operations in February 1994. Capital Mortgage reinsures only residential mortgage guaranty insurance obligations originating principally in the United States and the United Kingdom. KRE Reinsurance Ltd. ("KRE"), (formerly Capital Mortgage Reinsurance Company (Bermuda) Ltd.) a Bermuda- domiciled company, commenced operations in March 1994. KRE is engaged in the business of reinsuring financial guaranty, mortgage guaranty and trade credit and other specialty insurance policies, both as a direct reinsurer of third party primary insurers and as a retrocessionaire of Capital Reinsurance, Capital Mortgage and Capital Credit Reinsurance Company, Ltd. ("Capital Credit"). Capital Credit, also a Bermuda-domiciled insurance company, commenced operations in February 1990. Capital Credit reinsures trade credit and other specialty insurance lines, concentrated in Western Europe and the United States and is a retrocessionaire of Capital Reinsurance and Capital Mortgage. Capital Title Reinsurance Company ("Capital Title"), a New York-domiciled insurance company, commenced operations in March 1996. Capital Title is engaged in the business of reinsuring title insurance policies. In November 1996, the Corporation, through its newly formed United Kingdom holding company, Capital Re (UK) Holdings, acquired 100% of the issued shares of Tower Street Holdings Limited (now known as RGB Holdings, Ltd.), the holding company for RGB Underwriting Agencies Ltd. ("RGB"). RGB is a managing agency and presently manages five syndicates operating in the Lloyd's of London insurance market. In connection with this acquisition, the Corporation established a corporate name at Lloyd's to support underwriting on the managed syndicates. The corporate name participates in a non marine and a life syndicate. At December 31, 1996, the results of RGB and the corporate name at Lloyd's are consolidated in the Corporation's financial statements. The goodwill associated with this acquisition will be amortized over twenty years. Also in December 1996, the Corporation entered into a joint venture with GCR Holdings Limited to form a Bermuda-based insurer, Capital Global Underwriters Limited ("CGUL"), which will specialize in financial reinsurance, including financial guaranty, mortgage guaranty and finite risk reinsurance. The Corporation, through its subsidiary, KRE, owns a fifty percent interest in CGUL and controls 9.9% of its voting stock. The Corporation accounts for its investment in CGUL under the equity method. 2. Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements include the accounts and operations of the Corporation and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported 37 Capital Re Corporation and Subsidiaries Notes to Consolidated Financial Statements continued 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 period. Actual results could differ from those estimates. The 1995 and 1994 financial statements have been reclassified to conform with the 1996 presentation. Significant accounting policies are as follows: Investments in Securities The Corporation accounts for its investments in fixed maturity securities in accordance with FASB Statement No. 115 ("SFAS 115"), "Accounting for Certain Investments in Debt and Equity Securities." Management determines the appropriate classification of securities at the time of purchase. At December 31, 1996 and 1995, investments in fixed maturity securities were designated as available-for-sale. The Corporation invests in mortgage-backed securities, including collateralized mortgage obligations. The Corporation recognizes income for these securities using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. When actual prepayments differ significantly from anticipated prepayments, the effective yield is recalculated to reflect actual payments to date and anticipated future payments. The net investment in the security is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the security. That adjustment is included in net investment income. Short-term investments are carried at cost, which approximates market value. Realized gains and losses on sale or maturity of investments and declines in value judged to be other-than- temporary are determined by specific identification and included in net realized gains. The amortized cost of fixed maturity securities is adjusted for amortization of premiums and accretion of discounts. That amortization or accretion is included in net investment income. Premium Revenue Recognition Financial Guaranty: Generally, financial guaranty reinsurance premiums which include municipal and non-municipal transactions are paid entirely at contract inception. For purposes of earnings recognition, premiums are allocated to each year in the term of the guaranty and are earned pro-rata over the period of risk. Accordingly, the deferred premium revenue represents the portion of premiums written that is applicable to the unexpired risk of reinsured bonds and notes. Mortgage Guaranty: Mortgage guaranty reinsurance premiums are collected on both a single premium basis and annual payment basis. All premiums written are initially deferred as deferred premium revenue and earned pro-rata over the policy term. Premiums paid in lump sum on policies covering more than one year are amortized over the policy life in accordance with the expiration of risk. Premiums paid annually are earned on a monthly pro-rata basis over the annual period. Trade Credit: Trade credit reinsurance contracts are typically issued on an annual basis with premiums payable quarterly or semi-annually. Premiums are earned pro-rata over the covered period under the terms of each contract. Title Insurance: Title reinsurance premiums are generally paid up front. Premiums are earned as written. Deferred Acquisition Costs Acquisition costs include only those expenses that relate to, and vary with, premium production, including commissions, brokerage and costs of underwriting and marketing personnel. Acquisition costs are deferred and amortized over the period in which the related premiums are 38 earned. Ceding commission income on premiums ceded to other reinsurers reduces acquisition costs. Anticipated losses, loss adjustment expenses and the remaining costs of servicing the reinsured issues are considered in determining the recoverability of acquisition costs. Losses and Loss Adjustment Expenses Financial Guaranty: Financial guaranty reserves for losses and loss adjustment expenses are equal to the present value of the expected loss on any reinsured risks having, in management's judgment, a probable payment default. At December 31, 1996 and 1995, reserves for losses and loss adjustment expenses were discounted approximately $0.4 million using an average rate of 6.0% in 1996 and 6.75% in 1995. Mortgage Guaranty: For the mortgage guaranty business, reserves are established for reported insurance losses and loss adjustment expenses based on the receipt of notices of default from ceding companies. Reserves are also established for estimated losses incurred on notices of default not yet reported to ceding companies. Reserves for ultimate losses are established by management using estimated claim rates and claim amounts. Trade Credit: For the trade credit reinsurance business, loss reserves are established according to management's loss expectations which are based on historical loss development patterns experienced by the ceding companies on similar business as well as management's view of current macroeconomic conditions in the countries in which the policies apply. Title Insurance: For title reinsurance business, reserves are established for reported insurance losses and loss adjustment expenses based upon receipt of notices of a claim from the ceding companies. As of December 31, 1996, there were no title insurance losses ceded to the Corporation. Contingent Commissions Under the terms of certain of the Corporation's reinsurance contracts, the Corporation is obligated to pay the ceding company a contingent commission based upon a specified percentage of the net underwriting profits. As of December 31, 1996 and 1995, the Corporation's liability for the present value of expected future payments is shown on the balance sheet under the caption "Profit commission liability." Stock Based Compensation The Corporation grants stock options to certain employees for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Corporation accounts for stock option grants in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees," and, accordingly, recognizes no compensation expense for the stock option grants. Income Taxes In accordance with FASB Statement No. 109, "Accounting for Income Taxes," deferred federal income taxes are provided on the temporary difference between the tax basis of an asset or liability and its reported amount in the financial statements that will result in deductible or taxable amounts in future years when the reported amount of the asset or liability is recovered or settled. Such temporary differences relate principally to premium revenue recognition, deferred acquisition costs, and contingency reserve. The Internal Revenue Code permits companies writing financial guaranty insurance and mortgage guaranty insurance to deduct from taxable income amounts added to the statutory contingency reserve, subject to certain limitations. The amounts deducted must be included in taxable income in the tenth or twentieth year following the year of deduction dependent on the type of business, or in the event that incurred losses exceed certain statutorily established levels and the contingency reserve is released to cover such excess losses. 39 Capital Re Corporation and Subsidiaries Notes to Consolidated Financial Statements continued However, the tax benefits obtained from such deductions must be invested in noninterest-bearing U.S. Government tax and loss bonds. The Corporation records purchases of tax and loss bonds as payments of federal income taxes. Earnings Per Share Net income per share of common stock is computed by dividing net income by the weighted average number of shares of common stock outstanding during each year. The effect of outstanding stock options in 1996, 1995 and 1994 was not dilutive in the computation of earnings per share. 3. Statutory Accounting Practices The financial statements are prepared on the basis of GAAP, which differs in certain respects from accounting practices prescribed or permitted by the Maryland Insurance Administration and the Insurance Department of the State of New York (the insurance departments in the states of domicile of Capital Reinsurance and Capital Mortgage and Capital Title, respectively), as well as the statutory requirements of the Minister of Finance of the Island of Bermuda (place of domicile of Capital Credit and KRE). Statutory accounting practices for the Corporation's insurance subsidiaries differ from GAAP as follows: Acquisition costs are charged to current operations as incurred rather than as related premiums are earned; A contingency reserve is computed on the basis of statutory requirements regardless of when loss contingencies actually exist; A title statutory premium reserve is established based upon assumed exposure regardless of when loss contingencies actually exist; Federal income taxes are only provided on taxable income for which income taxes are currently payable, while under GAAP, deferred income taxes are provided with respect to temporary differences. Purchases of tax and loss bonds are reflected as admitted assets, while under GAAP they are recorded as federal income tax payments; Financial guaranty premiums are earned in direct proportion to the payment of debt service rather than pro-rata over the period of risk; Investments in fixed maturity securities are reported at amortized cost or market value based on the National Association of Insurance Commissioners ("NAIC") rating; under GAAP, these fixed maturity investments are carried in accordance with SFAS 115 (see Note 2). Certain assets designated as "non-admitted assets" are charged directly to statutory capital and surplus, but are reflected as assets under GAAP. Holding company guarantees (approved by Bermuda's Minister of Finance) issued for the benefit of Capital Credit and KRE under which the holding company is obligated under certain circumstances to invest additional capital in each company are admitted assets and included as part of statutory capital and surplus. The following is a reconciliation of the Corporation's consolidated GAAP net income and stockholders' equity to the corresponding consolidated statutory amounts for its insurance subsidiaries: 40
Year ended December 31, ------------------------------------- (Dollars in thousands) 1996 1995 1994 - ---------------------------------------------------------------------------------------------------------------- Consolidated GAAP net income $ 56,524 $ 45,527 $ 39,806 Premium revenue recognition (14,851) (6,995) (532) Deferred acquisition costs (9,011) (11,705) (12,628) Deferral of income taxes 11,489 5,373 6,320 Tax and loss bonds 4,848 4,116 1,964 Interest expense and minority interest in Capital Re LLC 12,633 12,631 11,925 Other, including non-insurance subsidiaries (4,091) (3,160) (3,768) - ---------------------------------------------------------------------------------------------------------------- Consolidated statutory net income $ 57,541 $ 45,787 $ 43,087 ================================================================================================================ Year ended December 31, ------------------------------- (Dollars in thousands) 1996 1995 - ---------------------------------------------------------------------------------------------------------------- GAAP stockholders' equity $ 489,346 $ 411,943 Premium revenue recognition (42,166) (26,662) Deferred acquisition costs (111,364) (102,353) Profit commission (8,067) (86) Unrealized (gain) loss on fixed maturity securities available for sale (25,541) (34,691) Deferral of income taxes 58,474 50,187 Tax and loss bonds 17,157 12,309 Contingency reserve (123,363) (89,685) Long-term debt and Company obligated mandatorily redeemable preferred securities of Capital Re LLC 174,782 165,744 Parental guarantee 30,000 30,000 Goodwill (13,567) -- Other, including noninsurance subsidiaries (2,240) (3,822) - ---------------------------------------------------------------------------------------------------------------- Consolidated statutory policyholders' surplus $ 443,451 $ 412,884 ================================================================================================================
41 Capital Re Corporation and Subsidiaries Notes to Consolidated Financial Statements continued 4. Insurance in Force--Financial Guaranty and Mortgage Guaranty Financial Guaranty: At December 31, 1996, the Corporation's reinsured financial guaranty portfolio included the reinsured portfolios of Capital Reinsurance, Capital Credit and KRE, net of eliminations and was broadly diversified by bond type, geographic location and maturity schedule, with no single risk representing more than 1.9% of the Corporation's net par in force. The Corporation limits its exposure to losses from reinsured financial guarantees by underwriting primarily investment grade obligations and retroceding a portion of its risks to other insurance companies. Net financial guaranty par in force was approximately $39.4 billion at December 31, 1996. The composition at December 31, 1996, by type of issue and the range of final maturities, was as follows:
Range Net Par of Final (Dollars in billions) in Force Maturities - ------------------------------------------------------------------------------------------------- Type of Issue Tax-backed $11.7 1-40 years Utility 11.1 1-40 years Non-municipal 5.3 1-35 years Health care 5.2 1-40 years Special revenue 4.7 1-40 years Housing 1.0 1-40 years U.S. Government 0.4 1-40 years - ------------------------------------------------------------------------------------------------- $39.4 =================================================================================================
The reinsured portfolio contained exposures in each of the 50 states. Net par in force at December 31, 1996, by state, was as follows:
Net Par (Dollars in billions) in Force - ------------------------------------------------------------------------------------------------- California $ 4.4 New York 4.2 Florida 2.6 Texas 2.0 Pennsylvania 1.9 Others (each less than 4%) 24.3 - ------------------------------------------------------------------------------------------------- $39.4 =================================================================================================
42 Mortgage Guaranty: At December 31, 1996, the Corporation's net mortgage guaranty insurance in force (representing the current principal balance of all mortgage loans that are currently reinsured) and direct primary net risk in force was approximately $8.0 billion and $2.3 billion, respectively. California represents the Corporation's largest U.S. risk concentration at approximately 22%, however, its total U.S. distribution of mortgage guaranty risk in force parallels that of the U.S. primary mortgage insurance industry. 5. Investments in Securities The following summarizes the Corporation's aggregate investment portfolio at December 31, 1996:
Gross Gross Amortized Unrealized Unrealized Estimated (Dollars in thousands) Cost Gains Losses Fair Value - ----------------------------------------------------------------------------------------------------------------- Fixed maturity securities available for sale: U.S. Treasury securities and obligations of U.S. government agencies $ 75,960 $ 1,525 $ (428) $ 77,057 Obligations of states and political subdivisions 398,006 21,058 (98) 418,966 Corporate securities 115,013 751 (231) 115,533 Mortgage-backed securities 197,928 3,147 (313) 200,762 Emerging markets 13,230 136 (6) 13,360 - ----------------------------------------------------------------------------------------------------------------- Total available-for-sale 800,137 26,617 (1,076) 825,678 Short-term investments 75,424 -- -- 75,424 - ----------------------------------------------------------------------------------------------------------------- Total investments $875,561 $26,617 $(1,076) $901,102 =================================================================================================================
The following summarizes the Corporation's aggregate investment portfolio at December 31, 1995:
Gross Gross Amortized Unrealized Unrealized Estimated (Dollars in thousands) Cost Gains Losses Fair Value - ---------------------------------------------------------------------------------------------------------------- Fixed maturity securities available for sale: U.S. Treasury securities and obligations of U.S. government agencies $ 30,219 $ 1,615 $ -- $ 31,834 Obligations of states and political subdivisions 332,229 26,871 (126) 358,974 Corporate securities 134,130 1,977 (126) 135,981 Mortgage-backed securities 156,388 4,778 (298) 160,868 - ---------------------------------------------------------------------------------------------------------------- Total available-for-sale 652,966 35,241 (550) 687,657 Short-term investments 84,110 -- -- 84,110 - ---------------------------------------------------------------------------------------------------------------- Total investments $737,076 $35,241 $(550) $771,767 ================================================================================================================
43 Capital Re Corporation and Subsidiaries Notes to Consolidated Financial Statements continued The amortized cost and estimated fair value of fixed maturity securities available-for-sale at December 31, 1996, by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Amortized (Dollars in thousands) Cost Fair Value - ----------------------------------------------------------------------------------------------------------- Maturity: Due in 1997-2001 $ 89,923 $ 90,581 Due in 2002-2006 85,694 87,058 Due after 2006 426,592 447,277 Mortgage-backed securities 197,928 200,762 - ----------------------------------------------------------------------------------------------------------- Total $800,137 $825,678 ===========================================================================================================
In 1996, the Corporation realized gross gains and losses of $8.5 million and ($7.0) million, respectively. In 1995, the Corporation realized gross gains and losses of $3.5 million and ($3.4) million, respectively. Included in gross losses in 1995 were ($2.6) million for other than temporary declines in value. In 1994, the Corporation realized gross gains and losses of $3.2 million and ($1.4) million, respec tively. Included in gross losses in 1994 were ($1.1) million for other than temporary declines in value. Approximately 22.3% of the Corporation's total investment portfolio of $901.1 million at December 31, 1996 is comprised of mortgage-backed securities ("MBS"), including collateralized mortgage obligations. Of the securities in the MBS portfolio, approximately 71.1% are backed by agencies or entities sponsored by the U.S. government. As of December 31, 1996, the weighted average credit quality of the Corporation's entire investment portfolio was triple A. Net investment income is derived from the following sources:
Year ended December 31, -------------------------------------- (Dollars in thousands) 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------- Income from fixed maturity securities $46,207 $42,730 $38,458 Income from short-term investments 6,351 4,406 2,156 - ------------------------------------------------------------------------------------------------------------- Total investment income 52,558 47,136 40,614 Less investment expenses (1,000) (482) (501) - ------------------------------------------------------------------------------------------------------------- Net investment income $51,558 $46,654 $40,113 =============================================================================================================
44 Under agreements with its cedants and in accordance with statutory requirements, certain of the Corporation's subsidiaries maintain fixed maturity securities in trust accounts for the benefit of reinsured companies and for the protection of policyholders in states in which they are not licensed. The carrying amount of such restricted balances amounted to approximately $31.9 million and $30.5 million at December 31, 1996 and 1995, respectively. Additionally, at December 31, 1996 and 1995, $3.7 million and $5.1 million, respectively, was on deposit with state insurance departments to satisfy regulatory requirements. 6. Reserves for Unpaid Losses and Loss Adjustment Expenses The following table provides a reconciliation of the beginning and ending reserve balances for unpaid losses and loss adjustment expenses ("LAE").
Year ended December 31, -------------------------------------- (Dollars in thousands) 1996 1995 1994 - ---------------------------------------------------------------------------------------------------------------- Reserve for losses and LAE, net of related reinsurance recoverables, at beginning of year $10,245 $7,702 $1,776 Add: Provision for unpaid losses and LAE for claims occurring in the current year, net of reinsurance 8,370 1,660 1,296 Increase in estimated losses and LAE for claims occurring in prior years, net of reinsurance 1,113 977 871 - ---------------------------------------------------------------------------------------------------------------- Incurred losses during the current year, net of reinsurance 9,483 2,637 2,167 - ---------------------------------------------------------------------------------------------------------------- Deduct: Losses and LAE payments (net of recoverables) for claims occurring in the current year 10 (474) (32) Losses and LAE payments (net of recoverables) for claims occurring in the prior year 1,959 568 (3,727) - ---------------------------------------------------------------------------------------------------------------- 1,969 94 (3,759) - ---------------------------------------------------------------------------------------------------------------- Reserve for unpaid losses and LAE, net of related reinsurance recoverables, at end of year 17,759 10,245 7,702 Unrealized foreign exchange loss on reserve revaluation 310 14 -- Reinsurance recoverables on unpaid losses and LAE, at end of year 1,833 2,524 1,310 - ---------------------------------------------------------------------------------------------------------------- Reserve for unpaid losses and LAE, gross of reinsurance recoverables on unpaid losses at end of year $19,902 $12,783 $9,012 ================================================================================================================
45 Capital Re Corporation and Subsidiaries Notes to Consolidated Financial Statements continued Incurred losses in 1996 and 1995 were principally from the mortgage guaranty and trade credit reinsurance lines of business. Incurred losses in 1994 were caused primarily by increases in reserves estimated for mortgage guaranty losses. The increases for 1996, 1995 and 1994 are consistent with the expected loss development patterns for the mortgage guaranty and trade credit lines of business. 7. Debt and Liquidity Facility Debt consists of:
Year ended December 31, -------------------------------- (Dollars in thousands) 1996 1995 - ---------------------------------------------------------------------------------------------------------------- 7.75% Debentures due 2002, net of unamortized discount of $0.2 million in 1996 and $0.3 million in 1995 ("Debentures") $74,782 $74,744 Subordinated Notes due August 1996 -- 16,000 Bank note payable 25,000 -- - ---------------------------------------------------------------------------------------------------------------- Total $99,782 $90,744 ================================================================================================================
The Debentures include certain covenants none of which significantly restrict the Corporation's operating activities or dividend paying ability. During 1996, the Corporation entered into a $25.0 million credit facility with Chase Manhattan Bank, expiring August 20, 1997. Interest on the facility is payable semi-annually at a rate equal to the then London Interbank offered rate plus 40 basis points. The Corpo-ration utilized $16.0 million, of this $25.0 million facility to retire the subordinated notes and the remaining $9.0 million of the credit facility for purposes of acquiring Tower Street Holdings. On January 31, 1997, the Corporation renewed an agreement with Deutsche Bank AG for the provision of a $25.0 million liquidity facility which will be available for general corporate purposes expiring January 26, 1998. Capital Reinsurance also renewed an agreement on January 31, 1997 with Deutsche Bank AG for a credit facility of up to $75.0 million specifically designed to provide rating agency qualified capital to further support Capital Reinsurance's claims-paying resources. This agreement expires January 27, 2004. During 1996, 1995 and 1994, the Corporation paid total interest of approximately $6.9 million, $6.9 million and $6.5 million, respectively. 8. Income Taxes The Corporation and its subsidiaries file a consolidated federal income tax return. The Corporation's effective federal corporate tax rate for 1996, 1995 and 1994 was 26.7%, 24.2% and 25.0%, respectively. A reconciliation from the tax provision calculated at the federal statutory rate of 35% in 1996, 1995 and 1994, to the total tax is as follows: 46
Year ended December 31, -------------------------------------- (Dollars in thousands) 1996 1995 1994 - ---------------------------------------------------------------------------------------------------------------- Tax provision at statutory rate $27,006 $21,026 $18,586 Tax-exempt interest (6,710) (5,940) (5,594) Other, net 339 (538) 304 - ---------------------------------------------------------------------------------------------------------------- Total federal income tax provision $20,635 $14,548 $13,296 ================================================================================================================
The liability for deferred federal income taxes reflects the tax effect of the following temporary differences:
Year ended December 31, -------------------------------- (Dollars in thousands) 1996 1995 - ---------------------------------------------------------------------------------------------------------------- Deferral of acquisition costs $ 39,033 $ 35,824 Contingency reserve 30,670 22,186 Deferred premium revenue 3,198 (1,031) Other than temporary declines in value of investments -- (2,293) Unrealized gain on fixed maturity securities available for sale 8,940 12,142 Other 430 499 - ---------------------------------------------------------------------------------------------------------------- Effects of temporary differences 82,271 67,327 Credit for alternative minimum tax carryforwards (6,640) (4,831) Tax and loss bonds (17,157) (12,309) - ---------------------------------------------------------------------------------------------------------------- Liability for deferred federal income taxes $ 58,474 $ 50,187 ================================================================================================================
Income taxes paid during 1996, 1995 and 1994 were approximately $7.9 million, $8.7 million and $6.2 million, respectively. 9. Reinsurance Ceded To limit its exposure on assumed risks, the Corporation enters into certain proportional and nonproportional retrocessional agreements that cede a portion of risks underwritten to other insurance companies. In the event that any or all of the reinsurers were unable to meet their obligations, the Corporation would be liable for such defaulted amounts. For the years ended December 31, 1996, 1995 and 1994, ceded earned premiums were $14.7 million, $8.0 million and $11.5 million, respectively. Ceded losses for the same periods were $6.5 million, $2.6 million and $3.7 million, respectively. During 1993, Capital Reinsurance entered into a multi-year nonproportional reinsurance contract which provides for aggregate loss protection of $80.0 million in exchange for $19.5 million of premium. Additional premiums may become payable dependent upon the level of losses incurred. During 1993, Capital Credit entered into similar multi-year reinsurance contracts which provide for aggregate loss protection of $34.0 million in exchange for $4.3 million in premiums. Additional premiums may also become payable dependent upon the level of losses incurred. 47 Capital Re Corporation and Subsidiaries Notes to Consolidated Financial Statements continued During 1994, Capital Reinsurance entered into a portfolio excess of loss reinsurance contract which provides $100.0 million aggregate loss protection on specified municipal obligations in excess of $82.0 million of losses. Capital Mortgage entered into a similar portfolio excess of loss reinsurance contract which provides $30.0 million aggregate loss protection in excess of a specified loss ratio covering all reinsured obligations. Premiums due on both contracts are not dependent upon the level of losses incurred. During 1995, Capital Mortgage entered into an assumption agreement whereby it provides excess of loss reinsurance on an existing portfolio of mortgage pool insurance. In connection with this assumed transaction, Capital Mortgage is required to cede a portion of the risks, thereby reducing its total net retention. Total ceded premiums under the contract were approximately $21.6 million. Total expected assumed premiums of $56.0 million are payable in seven annual installments of $8.0 million. Contingent commissions will be payable on the assumed reinsurance and receivable on the ceded reinsurance, dependent upon the level of losses incurred under the contract. 10. Fair Values of Financial Instruments The following methods and assumptions were used by the Corporation in estimating its fair value disclosure for financial instruments. These determinations were made based on available market information and appropriate valuation methodologies. Considerable judgment is required to interpret market data to develop the estimates and therefore, they may not necessarily be indicative of the amount the Corporation could realize in a current market exchange. Cash and Short-term Investments The carrying amount reported in the balance sheet for these instruments approximates fair value. Fixed Maturity Securities The fair value for fixed maturity securities shown in Note 5 is based on quoted market prices. Deferred Premium Revenue The fair value of the Corporation's deferred premium revenue is based on entering into a cession of the entire portfolio with third party reinsurers under market conditions. This figure was determined by using the statutory basis unearned premium reserve, net of deferred acquisition costs, and the present value of the estimated future cash flow stream from installment premiums. At December 31, 1996, the fair value of the Corporation's net deferred premium revenue was estimated to be $272.0 million. Reserve for Losses and Loss Adjustment Expenses, Net of Reinsurance Recoverable on Ceded Losses The carrying amount is composed of the present value of the expected cash flows for case basis claims. Accordingly, the carrying amount is deemed the best estimate of fair value as of December 31, 1996. Debt The fair value of the Corporation's $75.0 million of outstanding Debentures is determined based on the projected cash flows discounted by the sum of the seven-year U.S. treasury yield at December 31, 1996, and the appropriate credit spread for similar debt instruments. At Decem-ber 31, 1996, the fair value of the Corporation's Debentures was estimated to be $77.2 million. 48 The carrying amount of the Corporation's bank notes payable of $25.0 million approximates fair value due to their floating interest rate provision. Preferred Securities of Capital Re LLC The fair value of the Corporation's $75.0 million Company obligated mandatorily redeemable preferred securities of Capital Re LLC at December 31, 1996, was $72.4 million based on the closing price per share on the New York Stock Exchange at that date. 11. Dividends Under Maryland's insurance law, the amount of surplus available for distribution as dividends is subject to certain statutory provisions, which generally prohibit the payment of dividends in any twelve-month period without prior approval of the Maryland Commissioner of Insurance in an amount exceeding 10% of statutory capital and surplus at the preceding December 31. The amount available for distribution from Capital Reinsurance during 1996 with notice to, but without prior approval of, the Maryland Commissioner of Insurance under the Maryland insurance law was approximately $32.9 million. During 1996, Capital Reinsurance paid dividends in the amount of $17.5 million to the Corporation. Credit Re has never paid a dividend to the Corporation. Were it to pay dividends to the Corporation, it would rely on dividends from its wholly-owned subsidiary, Capital Credit. Capital Credit's and KRE's dividend distributions are governed by Bermuda law. Under Bermuda law and the By-Laws of Capital Credit and KRE, dividends may be paid out of the profits of Capital Credit and KRE (defined as accumulated realized profits less accumulated realized losses). Distributions to shareholders may also be paid out of Capital Credit's and KRE's surplus limited by requirements that Capital Credit and KRE must at all times (i) maintain the minimum share capital required under Bermuda law and (ii) have relevant assets in an amount equal to or greater than 75% of relevant liabilities, all as defined under Bermuda law. Since their organization, Capital Credit and KRE have not declared or paid any dividends. Under New York Insurance Law, neither Capital Mortgage nor Capital Title may pay any dividend to shareholders which, together with all dividends declared or distributed by it during the preceding twelve months, exceeds the lesser of 10% of its surplus to policyholders as shown by its last statement on file with the superintendent, or 100% of adjusted net investment income during such period unless specifically allowed by the superintendent. To date, Capital Mortgage and Capital Title have not declared or paid any dividends. The maximum dividend payable during 1996 is approximately $6.1 million. 12. Commitments At December 31, 1996, future minimum rental payments under the terms of the Corporation's noncancellable operating leases for office space are $1.2 million for the year 1997, $0.8 million for the years 1998, 1999, 2000 and 2001, and $6.5 million in the aggregate thereafter. These future minimum rental payments totaling $10.9 million have not been reduced by minimum sublease rentals of $0.8 million due in the future under noncancellable subleases. These payments are subject to escalations in building operating costs and real estate taxes. Total rent expense amounted to approximately $0.9 million in each of the years 1996, 1995 and 1994. 49 Capital Re Corporation and Subsidiaries Notes to Consolidated Financial Statements continued 13. Capital Re LLC In January 1994, the Corporation formed and capitalized Capital Re LLC, a limited liability company organized under the laws of the Turks and Caicos Islands. Additionally, in January 1994, Capital Re LLC issued $75,000,000, 7.65% of cumulative monthly income preferred shares, the proceeds of which were loaned to the Corporation. The preferred shares were issued at $25 par value per share and are shown on the balance sheet under the caption "Company obligated mandatorily redeemable preferred securities of Capital Re LLC." The Corporation guarantees the payment of the monthly dividend as well as any amounts upon liquidation or redemption which cannot occur prior to January 31, 1999, at the Corporation's discretion. Capital Re LLC exists solely for the purpose of issuing preferred and common shares and lending the proceeds to the Corporation to fund its business operations. The total amount paid to preferred shareholders for the years ended 1996 and 1995 was approximately $5.7 million and is shown on the income statement under the caption "Minority interest in Capital Re LLC." 14. Compensation Plans Prior to its initial public offering, the Corporation had a stock incentive plan wherein eligible employees were granted shares of restricted common stock. Shares awarded under the Plan amounted to 696,000 at December 31, 1991. For these awards, the difference between the price paid by the employees and the market value of the award at the date of grant, if any, was recorded as deferred compensation and was amortized ratably over the four-year vesting period. Upon completion of the initial public offering in 1992, these shares became vested and all restrictions lapsed. To enable recipients of awards under the stock incentive plan to meet tax obligations which may have resulted from such awards, the Corporation agreed to make loans to recipients, payable upon ultimate disposition of their shares or three years after their termination of employment. As of December 31, 1996 and 1995, total loans outstanding under all officer loan programs were approximately $1.74 million and $1.78 million, respectively, at the end of the year, and are included under the caption "Other assets." On April 15, 1992, the Corporation adopted the 1992 Stock Option Plan (the "Option Plan"). The Option Plan enables key employees to benefit from appreciation in the price of the common stock of the Corporation. The Option Plan provides for grants of incentive stock options ("ISO"), which are intended to qualify under Section 422 of the Internal Revenue Code and of options which are intended not to so qualify ("NQSO"). ISO's and NQSO's may be granted at a price not less than 100% of the fair market value as determined on the date granted. ISO's and NQSO's awarded are exercisable in four equal yearly installments commencing one year after the date of grant and expire ten years from the date of grant. According to the terms of the Option Plan, the aggregate number of shares subject to option awards shall not exceed 1,450,000. Also, all options granted have 10 year terms and vest 25% per annum over the term of continued employment. In 1993, the Corporation also adopted a stock option plan (the "Director's Plan") for the benefit of its outside directors. The terms of the plan are similar to those of the employee plan except that options become fully vested at the time of grant. According to the terms of the Director's Plan, the aggregate number of shares subject to option award shall not exceed 30,000. The Corporation has elected to follow Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" (APB 25) and 50 related interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation," requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Corporation's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Pro forma information regarding net income and earnings per share is required by State-ment 123, and has been determined as if the Corporation had accounted for its employee stock options under the fair value method of that statement. The fair value for these options was estimated at the date of grant using a Black- Schole's option pricing model with the following weighted-average assumptions for 1996 and 1995, respectively: risk-free interest rates of 5.42% and 7.36% dividend yields of 0.80% and 0.88%; volatility factors of the expected market price of the Corporation's common stock of 19.10 and 29.94; and an expected life of the options of 7 years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Corporation's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' expected lives. The Corporation's pro forma information follows (in thousands, except for per share information):
(Dollars in thousands) 1996 1995 - ---------------------------------------------------------------------------------------------------------------- Pro forma net income $56,030 $45,273 Pro forma earnings per common share $ 3.58 $ 3.06 - ---------------------------------------------------------------------------------------------------------------- A summary of the Corporation's stock option activity, and related information for the years ended December 31 follows: 1996 1995 ----------------------- ----------------------- Weighted- Weighted- Average Average Exercise Exercise Options Price Options Price - ---------------------------------------------------------------------------------------------------------------- Outstanding, beginning of year 908,000 $20.77 686,400 $19.56 Granted 277,500 31.49 248,400 23.99 Exercised (205,587) 19.69 (22,575) 19.51 Forfeited (11,313) 26.50 (4,225) 19.62 - ---------------------------------------------------------------------------------------------------------------- Outstanding, end of year 968,600 $24.01 908,000 $20.77 ================================================================================================================ Exercisable, end of year 422,447 $20.25 395,150 $19.63 - ----------------------------------------------------------------------------------------------------------------
51 Capital Re Corporation and Subsidiaries Notes to Consolidated Financial Statements continued
(Dollars in thousands) 1996 1995 - ---------------------------------------------------------------------------------------------------------------- Weighted-average fair value of options granted during the year $10.92 $11.03 - ----------------------------------------------------------------------------------------------------------------
Exercise prices for options outstanding as of December 31, 1996, ranged from $19.50 to $39.88. The weighted-average remaining contractual life of those options is approximately 7.5 years. In 1996, the Corporation adopted a performance share plan for the benefit of senior executives of the Corporation. The plan is intended to align senior management with the interest of the shareholders. To achieve this objective, the plan ties awards granted under the plan with earning per share growth and with total shareholder return and share price. These shares will be awarded at December 31, 1999. The Corporation recognized $1.0 million in deferred compensation expense for the year ended December 31, 1996. The Corporation maintains a savings incentive plan which is qualified under Section 401 of the Internal Revenue Code. The savings incentive plan is available to all full-time employees with a minimum of six months of service. Eligible participants may contribute 9% of their base salary subject to a maximum of $9,500 for 1996. Contributions are matched by the Corporation at a rate of 100%, up to 6% of the participants' contribution subject to certain limitations and vest at a rate of 25% per year starting with the second year of service. The Corporation contributed approximately $0.3 million, $0.2 million, and $0.1 million in 1996, 1995 and 1994, respectively. The Corporation also maintains a profit sharing plan which is available to all full-time employees with a minimum of six months of service. Annual contributions to the plan are at the discretion of the Board of Directors. The plan contains a qualified portion and a nonqualified portion. Total expense incurred under the plan amounted to approximately $0.03 million in 1996 and 1995, and $0.5 million in 1994. The Corporation does not provide health care or life insurance benefits to retirees. 15. Major Customers The Corporation derives the majority of its gross written premiums from a small number of primary insurers. The primary insurers which accounted for 10% or more of gross written premiums are as follows:
Year ended December 31, ------------------------------------- 1996 1995 1994 - ------------------------------------------------------------------------------------------------- Primary Insurer CMAC 15.9% 11.5% * MBIA 14.9 17.8 19.4 FGIC 11.9 * 26.0 PMI 10.7 10.5 18.8 AMBAC * 12.1 * FSA * 14.9 11.4 - ------------------------------------------------------------------------------------------------- * Less than 10%
52 This customer concentration results from the small number of primary insurance companies which are dedicated to writing financial guaranty and mortgage guaranty insurance. The loss of a major customer would have the effect of reducing the Corporation's gross written premiums. However, on a year-to-year basis the Corporation is not particularly vulnerable to the loss of any of its major customers because prior to the end of each calendar year, its reinsurance treaty agreements are renewed for the following year and are generally not cancelable until the following year-end. Further, because written premium are earned over many years, net income would not be materially impacted in any single year. 16. Quarterly Financial Summary (Unaudited)
1st 2nd 3rd 4th (Dollars in thousands except per share amounts) Quarter Quarter Quarter Quarter Year - ---------------------------------------------------------------------------------------------------------------- 1996 Gross written premiums $34,255 $30,957 $43,220 $21,386 $129,818 Net written premiums 18,060 26,902 40,500 19,726 105,188 Earned premiums 20,104 22,322 22,005 28,005 92,436 Net investment income and net realized gains 12,191 11,781 12,781 16,276 53,029 Income before provision for federal income tax 17,193 18,207 18,808 22,951 77,159 Net income 12,767 13,285 13,955 16,517 56,524 Net income per common share $ 0.84 $ 0.85 $ 0.88 $ 1.04 $ 3.61 - ---------------------------------------------------------------------------------------------------------------- 1995 Gross written premiums $24,189 $21,202 $23,977 $38,231 $107,599 Net written premiums 21,748 19,302 20,789 27,669 89,508 Earned premiums 13,929 16,584 13,322 16,262 60,097 Net investment income and net realized gains 11,530 11,493 11,546 12,138 46,707 Income before provision for federal income tax 14,350 15,004 15,099 15,622 60,075 Net income 11,077 11,264 11,353 11,833 45,527 Net income per common share $ 0.75 $ 0.76 $ 0.77 $ 0.80 $ 3.08 - ---------------------------------------------------------------------------------------------------------------- 1994 Gross written premiums $33,344 $23,743 $22,003 $15,761 $ 94,851 Net written premiums 20,732 24,439 21,128 16,496 82,795 Earned premiums 16,999 17,015 12,144 12,692 58,850 Net investment income and net realized gains 10,390 9,913 10,540 11,050 41,893 Income before provision for federal income tax 14,130 14,282 12,810 11,880 53,102 Net income 10,407 10,549 9,583 9,267 39,806 Net income per common share $ 0.70 $ 0.71 $ 0.65 $ 0.63 $ 2.69 - ----------------------------------------------------------------------------------------------------------------
53 Capital Re Corporation and Subsidiaries Officers and Directors Executive Officers of Capital Re Corporation Michael E. Satz Chairman, President and Chief Executive Officer Executive Vice Presidents David A. Buzen Laurence C. D. Donnelly Jerome F. Jurschak Senior Vice Presidents Stephen Donnarumma Susan L. Hooker Alan S. Roseman Joseph W. Swain - -------------------------------------------------------------------------------- RGB Underwriting Agencies Ltd. Peter Brotherton Alan D. Satterford Active Underwriter Active Underwriter - -------------------------------------------------------------------------------- Board of Directors of Capital Re Corporation Michael E. Satz/(3)/ Chairman, President and Chief Executive Officer Harrison W. Conrad, Jr./(2,3)/ Richard L. Huber/(1)/ Vice Chairman, Strategy and Finance Aetna Life & Casualty Co. Steven D. Kesler/(2,3)/ President Constellation Investments, Inc. Steven H. Newman/(2,3)/ Chairman and President Underwriters Re Group, Inc. Philip H. Robinson/(1)/ Edwin L. Russell/(2)/ President and Chief Executive Officer Minnesota Power & Light Company Dan R. Skowronski, Esq./(1)/ General Counsel Constellation Holdings, Inc. Barbara D. Stewart/(1,2)/ President Stewart Economics, Inc. Jeffrey F. Stuermer/(1,3)/ Manager of Taxes Minnesota Power & Light Company Board Committees: 1. Audit Committee 2. Compensation Committee 3. Investment Committee 54 Capital Re Corporation and Subsidiaries Shareholder Information Corporate Headquarters Capital Re Corporation 1325 Avenue of the Americas New York, New York 10019 Telephone: 212-974-0100 Fax: 212-581-3268 Annual Meeting The annual meeting of shareholders of Capital Re Corporation will be held on May 21, 1997, at 10:00 a.m. at The Equitable, 787 Seventh Avenue, 49th Floor, New York, New York 10019. Form 10-K A copy of the Corporation's annual report on Form-10K to the Securities and Exchange Commission is available on request, and without charge, by writing to the Director of Communications, Capital Re Corporation, 1325 Avenue of the Americas, New York, New York 10019. Transfer Agent, Registrar and Dividend Disbursing Agent ChaseMellon Financial Shareholder Services 85 Challenger Road Overpeck Center Ridgefield Park, New Jersey 07660 1-800-526-0801 Shareholder Information For further shareholder information, please contact: Capital Re Corporation Director of Communications 1325 Avenue of the Americas New York, New York 10019 212-974-0100 Investor Relations Contacts David A. Buzen Executive Vice President Chief Financial Officer 212-974-0100 Catherine C. Bailey Director of Communications 212-974-0100
Market Price Dividends --------------------------------- COMMON STOCK DATA Paid Per share High Low Close - --------------------------------------------------------------------------- 1996 1st Quarter $0.06 $36 $28 7/8 $36 2nd Quarter $0.06 $38 $32 5/8 $36 3/4 3rd Quarter $0.06 $39 3/8 $33 1/4 $38 4th Quarter $0.07 $46 5/8 $38 3/8 $46 5/8 - --------------------------------------------------------------------------- 1995 1st Quarter $0.05 $27 1/8 $22 $23 1/8 2nd Quarter $0.05 $36 1/4 $22 5/8 $26 3rd Quarter $0.05 $30 $25 1/2 $30 4th Quarter $0.06 $31 5/8 $28 $30 3/4 - ---------------------------------------------------------------------------
Capital Re Corporation 1325 Avenue of the Americas New York, New York 10019 Telephone: 212-974-0100 Fax: 212-581-3268 Capital Reinsurance Company 1325 Avenue of the Americas New York, New York 10019 Telephone: 212-974-0100 Fax: 212-581-3268 Capital Mortgage Reinsurance Company 1325 Avenue of the Americas New York, New York 10019 Telephone: 212-974-3703 Fax: 212-262-9391 KRE Reinsurance Ltd. P. O. Box HM 1022 Clarendon House Church Street West Hamilton HM DX, Bermuda Telephone: 809-292-4402 Capital Credit Reinsurance Company, Ltd. P. O. Box HM 1022 Clarendon House Church Street West Hamilton HM DX, Bermuda Telephone: 809-292-4402 Capital Title Reinsurance Company 1325 Avenue of the Americas New York, New York 10019 Telephone: 212-974-0100 Fax: 212-581-3268 RGB Underwriting Agencies, Ltd. 2 Minster Court Mincing Lane London EC3 7FX Telephone: 0171-283-0802 Fax: 0171-929-3413 Design: Donovan and Green Still-Life Photography: Reven T. C. Wurman Portrait Photography: Bard Martin Printing: Tanagraphics EX-22.01 6 SUBSIDIARIES OF REGISTRANT Exhibit 22.01 SUBSIDIARIES OF REGISTRANT Capital Re Corporation, a Delaware insurance holding company; Credit Re Corporation, a Maryland corporation; Capital Re LLC, a Turks and Caicos limited life company; Capital Reinsurance Company, a Maryland domiciled insurance company; Capital Credit Reinsurance Company Ltd., a Bermuda domiciled insurance company; Capital Mortgage Reinsurance Company, a New York domiciled insurance company; Capital Title Reinsurance Company, a New York domiciled insurance company; KRE Reinsurance Ltd., a Bermuda domiciled insurance company Capital Re Management Corporation, a New York reinsurance intermediary Capital Re (UK) Holdings CRC Capital, Ltd., a corporation established under the Laws of England RGB Holdings, Ltd., a corporation established under the Laws of England RGB Underwriting Services, Ltd., a corporation established under the Laws of England RGB Underwriting Agencies, Ltd., a corporation established under the Laws of England Capital Global Managers, Ltd., a Bermuda domiciled managing general agency Capital Global Underwriters, Ltd., a Bermuda domiciled insurance company EX-24.01 7 CONSENT OF ERNST & YOUNG LLP Exhibit 24.01 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report (Form 10-K) of Capital Re Corporation of our report dated January 21, 1997, included in the 1996 Annual Report to Stockholders of Capital Re Corporation. Our audits also included the financial statement schedules of Capital Re Corporation listed in Item 14(a). These schedules are the responsibility of the Corporation's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-47723) pertaining to the Capital Re Corporation 1992 Stock Option Plan and in the Registration Statement (Form S-8 No. 33-73122) pertaining to the Capital Re Corporation Directors' Stock Option Plan of our report dated January 21, 1997, with respect to the consolidated financial statements incorporated herein by reference, and our report included in the preceding paragraph with respect to the financial statement schedules included in this Annual Report (Form 10-K) of Capital Re Corporation. /s/ Ernst & Young LLP New York, New York March 25, 1997 EX-25.01 8 POWER OF ATTORNEY Exhibit 25.01 CAPITAL RE CORPORATION POWER OF ATTORNEY ----------------- KNOW ALL MEN BY THESE PRESENTS, that each of the Officers and Directors of Capital Re Corporation, 1325 Avenue of the Americas, New York, New York 10019 whose signature appears below constitutes and appoints Michael E. Satz and Alan S. Roseman, and each of them individually, as his true and lawful attorneys-in- fact and agents as of March 31, 1997, with full power of substitution and resubstitution, for him and his name, place and stead in any and all capacities, to sign the Annual Report on Form 10-K of Capital Re Corporation and any and all amendments to such Annual Report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, granting unto said attorney's-in-fact and agents, full power and authority to perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or their substitutes, may lawfully do or cause to be done by virtue thereof. ____________________ President, Chief Executive March 31, 1997 Michael E. Satz Officer and Chairman of the Board ____________________ Executive Vice President March 31, 1997 David A. Buzen and Chief Financial Officer ____________________ Director March 31, 1997 Edwin Russell ____________________ Director March 31, 1997 Jeffery F. Stuermer ____________________ Director March 31, 1997 Dan Skowronski ____________________ Director March 31, 1997 Steven H. Newman ____________________ Director March 31, 1997 Steven D. Kesler ____________________ Director March 31, 1997 Richard L. Huber ____________________ Director March 31, 1997 Philip Robinson ____________________ Director March 31, 1997 Harrison Conrad ____________________ Director March 31, 1997 Barbara Stewart EX-27 9 FINANCIAL DATA SCHEDULE
7 1,000 12-MOS DEC-31-1996 DEC-31-1996 901,102 0 0 0 0 0 901,102 15,285 691,415 111,364 1,156,401 19,902 337,104 0 0 99,782 75,000 0 160 489,186 1,156,401 92,436 51,558 1,471 951 9,483 30,714 10,796 77,159 20,635 56,524 0 0 0 56,524 3.61 3.61 10,245 8,370 1,113 10 1,959 17,759 0 *NOT APPLICABLE FOR MORTGAGE GUARANTY AND SPECIALTY REINSURER
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