RADIAN GROUP INC quarterly report, Q2 FY2011

Radian Group Inc. — Q2 2011 Form 10-Q

Reporting period: Three and six months ended June 30, 2011. Unaudited consolidated results. Radian provides mortgage insurance, principally U.S. first-lien residential coverage, and is running off its financial guaranty portfolio; it stopped writing new financial guaranty business in 2008.

Financial performance and position

Metric	Q2 2011	Q2 2010	Six months 2011	Six months 2010
Total revenue	$472.0 million	$(245.8) million	$1,075.2 million	$(118.0) million
Net income (loss)	$137.1 million	$(475.1) million	$240.1 million	$(785.4) million
Diluted EPS	$1.03	$(4.31)	$1.80	$(8.15)
Net premiums earned—insurance	$188.9 million	$203.4 million	$392.0 million	$401.7 million
Provision for losses	$263.6 million	$435.2 million	$690.9 million	$979.0 million

Reported earnings benefited substantially from fair-value gains on financial guaranty derivatives: $188.7 million in Q2 and $432.6 million in the first half, versus losses of $524.6 million and $602.6 million in the comparable 2010 periods. Management attributed much of the gains to widening Radian credit spreads and the resulting reduction in the recorded fair-value liability; these gains do not necessarily indicate lower expected ultimate claims.
Mortgage insurance remained loss-making: net losses were $97.6 million in Q2 and $333.6 million for the first half. Financial guaranty reported net income of $234.7 million and $573.7 million, respectively, primarily reflecting fair-value movements.
Operating cash flow was negative $608.9 million for the first half, versus negative $460.7 million in 2010, mainly due to increased claims paid. Investing activities provided $770.4 million; financing activities used $160.7 million. Ending consolidated cash was $21.1 million.
At June 30, total assets were $6.93 billion, total liabilities $5.80 billion, and stockholders’ equity $1.13 billion, up from $859.8 million at year-end 2010. Long-term debt was $811.3 million, down from $964.8 million; the $160 million 7.75% debentures were repaid at maturity in June.
Holding-company unrestricted cash and liquid investments were $680.2 million, including $150 million held in CPS trust accounts. This is distinct from consolidated cash. Radian expected to use more cash than it generated from operations over the next 12 months.

Material changes and operating trends

Mortgage insurance primary default rate fell to 15.2% from 16.5% at December 31, 2010; primary default inventory declined to 111,434 loans from 125,470. However, defaults remained elevated, particularly in 2005–2008 vintages, and aged delinquencies increased expected claim costs.
Mortgage insurance claims paid were $512.6 million in Q2 and $877.8 million in the first half. Management expected 2011 claims paid of approximately $1.7 billion and believed Q2 might represent a quarterly peak, with claims expected to decline slowly thereafter.
First-half new mortgage insurance written was $4.9 billion, up from $4.6 billion; Q2 volume was $2.3 billion versus $2.7 billion. Nearly all first-half primary new business was prime. Management changed underwriting guidelines and rates and expanded its jumbo program to compete with the FHA.
Mortgage insurance loss reserves declined to $3.27 billion from $3.52 billion at year-end. The weighted-average default-to-claim assumption increased to 43% from 40%; management cited aging defaults and uncertainty over rescissions and claim denials. Estimated rescissions and denials reduced reserves by about $655 million at June 30, compared with $922 million at year-end.
No first-lien premium deficiency reserve was required, but the second-lien reserve remained $6.3 million. Management’s first-lien premium-excess estimate fell to $1.22 billion from $1.55 billion at year-end and was sensitive to default and claim assumptions.
Financial guaranty net par outstanding declined to $74.7 billion from $78.8 billion at year-end. About $54.6 billion, or 73.1% of the segment’s total, remained subject to counterparty recapture or termination rights. The segment’s portfolio remained concentrated in structured finance, including $37.8 billion of CDO exposure.
Radian Guaranty’s statutory policyholders’ surplus declined to about $1.0 billion from $1.3 billion at year-end; its risk-to-capital ratio rose to 19.8:1 from 16.8:1. The filing identifies 25:1 as a level that could trigger restrictions on new business. A second excess-of-loss reinsurance agreement transferred approximately $2 billion of risk in force to Radian Insurance in Q2.

Outlook, risks, and unusual items

Management cited housing-market weakness, high unemployment, low home-price appreciation, servicing and foreclosure delays, and reduced mortgage originations as significant uncertainties. The filing provides no earnings guidance; it does provide the approximately $1.7 billion 2011 claims-paid estimate noted above.
Radian’s quarterly earnings are exposed to substantial fair-value volatility. At June 30, fair-value liabilities included $313.7 million of derivative liabilities and $393.7 million of VIE debt. The filing states that all fair-value liabilities measured at fair value were Level III, relying on significant unobservable inputs. The company’s five-year CDS spread widened to 968 basis points from 465 at year-end, affecting reported fair values.
Mortgage insurance reserves depend on estimates of default-to-claim rates, claim severity, cures, and rescissions or denials. Each one-percentage-point change in the overall default-to-claim estimate was estimated to change reserves by about $69 million; a one-point change in primary claim severity by about $96 million.
Potential challenges to rescissions and denials could require Radian to reinstate coverage, increase reserves, or pay claims. The filing describes litigation involving American Home Mortgage Servicing and a new August 2011 action against Quicken Loans. A separate dispute over three pool policies was settled for approximately $44 million against about $77 million of claim liability; the related actions were dismissed in July.
Other significant exposures include a distressed CDO of ABS for which Radian expects substantial principal claims, Jefferson County sewer bonds and TruPs CDOs. Potential liquidity claims on seven TruPs bonds covered $828 million of net par. Financial guaranty reinsurance recapture could also concentrate remaining risks.
Radian disclosed a $77 million expected October 2011 payment to Radian Guaranty under its tax-sharing agreement. Its $1.7 billion federal NOL carryforwards and deferred tax assets are subject to realization risk; a valuation allowance of approximately $769.7 million was recorded at June 30.
After quarter-end, S&P downgraded the U.S. sovereign rating on August 5, 2011. Management said the impact was uncertain and could further pressure financial markets and insured exposures. Moody’s outlooks for several Radian entities were positive, while S&P outlooks were negative.

Important facts for investors to verify

Whether mortgage insurance reserve assumptions remain adequate as default inventory ages and rescission challenges or reinstatements evolve.
Actual 2011 claims paid versus management’s approximately $1.7 billion estimate, and whether the Q2 peak expectation is borne out.
Radian Guaranty’s statutory capital and risk-to-capital ratio, including its ability to remain eligible with the GSEs and continue writing business.
Holding-company liquidity after tax-sharing payments, debt service, and potential capital support; also the availability and constraints on subsidiary cash and dividends.
The durability of reported earnings apart from derivative and VIE fair-value movements, especially gains related to Radian’s own credit spread.
Developments in major financial guaranty exposures, counterparty termination or recapture activity, litigation, and Dodd-Frank rulemaking that could affect collateral needs or mortgage insurance demand.