Business Context and Reporting Period
Company: Radian Group Inc.
Filing Type: Form 10-Q (Unaudited)
Period Ended: September 30, 2007
Business Overview: Radian operates three primary segments: Mortgage Insurance, Financial Guaranty, and Financial Services. The Mortgage Insurance segment provides private mortgage insurance and risk management services. The Financial Guaranty segment insures public finance and structured finance obligations. The Financial Services segment consists of equity interests in Credit-Based Asset Servicing and Securitization (C-BASS) and Sherman Financial Group.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended Sep 30, 2007 | Nine Months Ended Sep 30, 2007 | Nine Months Ended Sep 30, 2006 |
|---|---|---|---|
| Net Premiums Written | $330,075 | $875,265 | $833,285 |
| Net Premiums Earned | $273,402 | $777,421 | $766,927 |
| Net Investment Income | $64,959 | $188,605 | $174,123 |
| Net Gains on Securities | $14,840 | $54,279 | $29,587 |
| Change in Fair Value of Derivatives | $(643,942) | $(733,273) | $(7,031) |
| Gain on Sale of Affiliates | $181,734 | $181,734 | $0 |
| Provision for Losses | $330,504 | $611,508 | $284,889 |
| Provision for Second-Lien Premium Deficiency | $155,176 | $155,176 | $0 |
| Equity in Net (Loss) Income of Affiliates | $(448,924) | $(376,645) | $186,248 |
| Net (Loss) Income | $(703,864) | $(569,314) | $423,802 |
| Diluted EPS | $(8.82) | $(7.16) | $5.12 |
Balance Sheet Highlights (in thousands)
- Total Assets: $8,214,860 (Sep 30, 2007) vs. $7,928,671 (Dec 31, 2006)
- Total Investments: $6,512,997
- Derivative Liabilities, Net: $675,432 (Sep 30, 2007) vs. $0 (Dec 31, 2006)
- Reserve for Losses and LAE: $1,094,704
- Long-Term Debt: $948,010
- Total Stockholders' Equity: $3,447,492
Material Changes vs. Prior Period
- Net Loss vs. Net Income: The company reported a net loss of $703.9 million for the quarter and $569.3 million for the nine months ended September 30, 2007, compared to net income of $112.0 million and $423.8 million in the corresponding 2006 periods.
- Derivative Valuation: A significant driver of the loss was a $643.9 million decrease in the fair value of derivative instruments for the quarter, primarily due to a $366.7 million mark-to-market loss on Net Interest Margin Securities (NIMS) and a $255.6 million loss on financial guaranty collateralized debt obligations (CDOs).
- Investment in Affiliates (C-BASS): The Financial Services segment recorded a $448.9 million equity loss for the quarter due to the impairment of the investment in C-BASS. The company recognized its share of C-BASS losses ($441 million) and wrote off the remaining carrying value of the equity investment ($27 million).
- Second-Lien Premium Deficiency: A new $155.2 million provision was recorded in the third quarter for a premium deficiency reserve on the second-lien mortgage insurance business, as expected future losses exceeded expected future premiums.
- Gain on Sale of Sherman: The company recorded a $181.7 million gain on the sale of a portion of its interest in Sherman Financial Group, partially offsetting the losses.
- Loss Reserves: The provision for losses increased significantly to $330.5 million for the quarter, driven by deteriorating credit performance in the mortgage insurance portfolio, particularly in Alt-A and subprime segments.
Guidance, Outlook, and Risks
Management Commentary and Outlook
- Mortgage Insurance: Management expects incurred losses from the traditional mortgage insurance portfolio to be 90-100% of earned premiums in 2007, 80-100% in 2008, and 60-70% in 2009, before returning to a normalized ratio of ~50% in 2010. A "stress-case" scenario involving a 20% decline in home prices in vulnerable markets could increase cumulative loss ratios by 30-35%.
- NIMS: The company ceased writing new NIMS business in Q2 2007. A mark-to-market reserve of approximately $432 million exists for the NIMS portfolio, with the majority of claims expected to be paid starting in 2010.
- Second-Lien: The second-lien book is expected to be paid down by 2010. Projected future losses are approximately $324 million, against which $100 million in premiums are expected to be earned.
- Merger Termination: The proposed merger with MGIC Investment Corporation was terminated on September 4, 2007, due to challenging market conditions.
Risks and Contingencies
- Credit Rating Downgrades: Moody's placed ratings under review for possible downgrade. Fitch downgraded Radian Group and mortgage insurance subsidiaries to A- and AA- respectively with negative outlooks. S&P affirmed ratings with a negative outlook. Downgrades could restrict access to the flow channel of business and increase borrowing costs.
- C-BASS Liquidity: C-BASS faced severe liquidity stress due to margin calls. While a sale of its Litton Loan Servicing assets was agreed upon, the closing is uncertain. A full or partial impairment of the $50 million demand note held by Radian may be required in Q4 2007.
- IRS Examination: The IRS is examining tax years 2000-2005 regarding REMIC investments. Radian anticipates a potential payment on account of approximately $84 million in Q4 2007 or Q1 2008.
- Legal Proceedings: Two stockholder class action lawsuits were filed in August/September 2007 alleging failure to disclose the financial condition of C-BASS. An SEC investigation regarding the merger and C-BASS investment is also underway.
- Internal Control Weakness: Management identified a material weakness in internal controls over financial reporting due to turnover in key accounting positions (Controller and Assistant Controller).
Key Facts for Investor Verification
- C-BASS Impairment Status: Verify the final determination of the impairment on the $50 million demand note to C-BASS and the status of the Litton Loan Servicing sale.
- Loss Reserve Adequacy: Assess the sensitivity of the $1.09 billion loss reserve to further declines in home prices, particularly in California, Florida, and the Midwest.
- Derivative Valuation Methodology: Review the refined mark-to-market methodology for NIMS and financial guaranty CDOs, as these are significant drivers of current volatility.
- Rating Agency Actions: Monitor the outcome of Moody's review and S&P's negative outlook, as a downgrade below specific thresholds could trigger recapture rights or loss of GSE business.
- Liquidity Position: Confirm the company's ability to meet the anticipated $84 million IRS payment and ongoing claim obligations without further dilution or asset sales.