Business Context and Reporting Period
Company: Radian Group Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2009
Business Overview: Radian is a credit enhancement company with three primary segments: Mortgage Insurance (domestic first-lien residential), Financial Guaranty (direct insurance and reinsurance on credit-based risks), and Financial Services (equity interest in Sherman Financial Group LLC). The company is operating in a challenging environment characterized by a prolonged downturn in housing and credit markets, leading to increased defaults and claims.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2009 | Nine Months Ended Sep 30, 2009 | Nine Months Ended Sep 30, 2008 |
|---|---|---|---|
| Net Premiums Earned | $209.5 million | $614.3 million | $740.8 million |
| Net Investment Income | $54.0 million | $163.6 million | $196.3 million |
| Change in Fair Value of Derivatives | ($30.9 million) loss | ($43.0 million) loss | $928.8 million gain |
| Provision for Losses | $404.9 million | $864.4 million | $1,586.5 million |
| Net (Loss) Income | ($70.5 million) | ($56.0 million) | ($160.2 million) |
| Diluted EPS | ($0.86) | ($0.69) | ($2.01) |
| Total Assets | $8.36 billion | N/A | |
| Total Liabilities | $6.22 billion | ||
| Stockholders' Equity | $2.14 billion | N/A | |
| Cash and Cash Equivalents | $44.2 million |
Material Changes vs. Prior Period
- Net Loss Improvement: The net loss for the nine months ended September 30, 2009, decreased significantly to $56.0 million from $160.2 million in the prior year period. This improvement was driven by a substantial reduction in the provision for losses and net gains on other financial instruments, partially offset by a decrease in the change in fair value of derivative instruments.
- Derivative Volatility: The change in fair value of derivative instruments shifted from a $928.8 million gain in the prior year to a $43.0 million loss in the current period. This reversal is primarily due to the tightening of the company's credit default swap (CDS) spread, which reduced the cumulative unrealized gain attributable to the market's perception of the company's non-performance risk by approximately $2.6 billion.
- Loss Provisions: The provision for losses decreased by 45.5% year-over-year for the nine-month period. This reduction is attributed to increased insurance rescissions and claim denials, as well as recoveries from the termination of certain captive reinsurance transactions.
- Premium Deficiency: The reserve for premium deficiency decreased by $77.6 million for the nine months ended September 30, 2009, primarily related to the second-lien mortgage insurance business. No premium deficiency reserve was required for the first-lien portfolio as of September 30, 2009.
Guidance, Outlook, and Risks
- Outlook: Management expects defaults on first-lien mortgages to continue to increase throughout the remainder of 2009. Claims paid are expected to rise as foreclosure moratoriums expire. The company anticipates limited, if any, dividends from its affiliate Sherman Financial Group for the remainder of 2009.
- Liquidity Needs: Radian Group faces significant liquidity demands, including approximately $192 million in long-term debt principal due in June 2011 and potential tax-sharing payments to subsidiaries of up to $253 million in October 2010. The company is exploring capital raising options, including debt or equity offerings, and the potential purchase of Custodial Trust Securities (CPS) to improve liquidity.
- Key Risks:
- Capital Adequacy: Radian Guaranty's risk-to-capital ratio increased to 16.1:1. Without additional capital or relief, this ratio could reach the 25:1 regulatory limit in some states, potentially restricting new business writing.
- Financial Guaranty Portfolio: Continued deterioration in the Direct TruPs CDO portfolio and a specific CDO of ABS transaction ($468.3 million exposure) poses significant risk. An interest shortfall event occurred in October 2009 on a Direct TruPs CDO.
- Rescissions and Denials: While increased rescissions have mitigated losses, there is a risk that these levels may not be sustained or that legal challenges from lenders could force the company to reassume risk.
- Rating Actions: S&P placed the company's mortgage insurance subsidiaries on CreditWatch with negative implications in October 2009. Further downgrades could impact GSE eligibility and capital costs.
Investor Verification Checklist
- Capital Plan Execution: Verify the company's ability to raise capital or secure capital relief to maintain risk-to-capital ratios below regulatory limits (25:1) in key states.
- Derivative Valuation Sensitivity: Assess the impact of further tightening in the company's CDS spread on derivative liabilities and reported earnings, given the $2.6 billion reduction in unrealized gains already recorded.
- Loss Reserve Adequacy: Monitor the sustainability of high rescission and denial rates and the potential for litigation that could require the reassumption of risk.
- Financial Guaranty Exposure: Review the status of the $468.3 million CDO of ABS transaction and the Direct TruPs CDO portfolio for potential claim payments and their impact on statutory surplus.
- Liquidity Coverage: Confirm the company's strategy for meeting the $192 million debt obligation due in June 2011 and the potential $253 million tax-sharing payment due in October 2010.