Business Context and Reporting Period
Company: Radian Group Inc.
Filing Type: Form 10-Q (Unaudited)
Period Ended: March 31, 2009
Business Overview: Radian is a credit enhancement company with three primary segments: Mortgage Insurance (domestic first-lien residential), Financial Guaranty (public and structured finance), and Financial Services (equity interest in Sherman Financial Group). The company operates in a severe downturn in the U.S. housing and credit markets, characterized by declining home prices, rising defaults, and reduced liquidity.
Key Financial Metrics
| Metric (in thousands) | Q1 2009 | Q1 2008 |
|---|---|---|
| Net Premiums Written | $156,756 | $244,306 |
| Net Premiums Earned | $211,215 | $241,921 |
| Net Investment Income | $56,283 | $65,979 |
| Change in Fair Value of Derivatives | $(284,416) | $707,809 |
| Provision for Losses | $326,754 | $582,711 |
| Provision for Premium Deficiency | $(48,184) | $18,090 |
| Net (Loss) Income | $(217,437) | $195,638 |
| Diluted EPS | $(2.69) | $2.44 |
| Total Assets | $8,703,610 | $8,116,119 |
| Total Liabilities | $6,902,704 | $6,085,409 |
| Stockholders' Equity | $1,800,906 | $2,030,710 |
| Cash and Cash Equivalents | $77,444 | $181,038 |
Material Changes vs. Prior Period
- Net Loss vs. Net Income: The company reported a net loss of $217.4 million in Q1 2009, a reversal from a net income of $195.6 million in Q1 2008. This swing was primarily driven by a $992 million swing in the "Change in fair value of derivative instruments" line item.
- Derivative Valuation: The Q1 2009 loss includes a $284.4 million unrealized loss on derivatives, compared to a $707.8 million gain in Q1 2008. This volatility is largely attributed to the tightening of Radian's own credit default swap (CDS) spread (improving credit perception) which, under SFAS No. 157, reduced the fair value of derivative liabilities, creating a loss. Conversely, Q1 2008 saw a widening spread that created a gain.
- Provision for Losses: The provision for losses decreased by 43.9% to $326.8 million. This reduction was driven by an increase in claim rescissions and denials due to heightened loss mitigation efforts, partially offset by a 9.7% increase in first-lien defaults.
- Premium Deficiency: The company recorded a benefit of $48.2 million related to a reduction in the second-lien premium deficiency reserve, compared to an expense of $18.1 million in the prior year.
- Premium Volume: Net premiums written declined 35.8% due to an industry-wide drop in mortgage originations and the cessation of new financial guaranty business in late 2008.
Guidance, Outlook, and Risks
- Outlook: Management expects new first-lien defaults to continue increasing throughout 2009. Total mortgage insurance claims paid are projected to be between $1.2 billion and $1.4 billion for the full year 2009.
- Capital Plan: The company is executing an internally sourced capital plan to support its mortgage insurance business. It expects Radian Asset Assurance (Financial Guaranty) to pay approximately $100 million in ordinary dividends to Radian Guaranty in 2009 as the portfolio matures.
- Liquidity: Radian Group holds approximately $367.2 million in unrestricted cash and marketable securities. However, the company anticipates limited or no dividends from its affiliate, Sherman Financial Group, for the remainder of 2009 due to credit market disruptions.
- Key Risks:
- Credit Deterioration: Continued decline in housing values and rising unemployment could worsen loss severity and frequency.
- Derivative Volatility: Earnings remain highly sensitive to changes in the company's own CDS spread and credit spreads on underlying collateral.
- Regulatory and Ratings: Recent downgrades by Moody's and S&P (to CCC/B3 and Ba3/BB- respectively) limit the ability to write new business and may trigger recapture clauses on $77.1 billion of net par outstanding in the financial guaranty segment.
- Legal Proceedings: Ongoing SEC investigation regarding the MGIC merger and C-BASS investment; class action lawsuits regarding C-BASS disclosure; and litigation with IndyMac and other guarantors regarding second-lien policies.
Investor Verification Checklist
- Derivative Valuation Methodology: Verify the assumptions used to calculate the fair value of derivatives, specifically the impact of the company's own non-performance risk (CDS spread) on reported earnings.
- Loss Reserve Adequacy: Assess the sensitivity of loss reserves to changes in claim severity and default-to-claim rates, particularly for the 2005-2008 vintage books of business.
- Reinsurance Recoveries: Confirm the collectability of $536.8 million in ceded losses recoverable from "Smart Home" and captive reinsurance arrangements.
- Financial Guaranty Recaptures: Monitor the potential impact of counterparties exercising recapture rights on $38.4 billion of assumed par outstanding following rating downgrades.
- Liquidity Constraints: Review the ability to fund the $110 million tax-sharing payment due to subsidiaries by October 2009 and the potential $300 million payment due in 2010.