Business Context and Reporting Period
Radian Group Inc. (Radian) is a credit enhancement company with primary strategic focus on domestic first-lien residential mortgage insurance. The company operates through three segments: Mortgage Insurance, Financial Guaranty, and Financial Services. This Form 10-Q covers the quarterly period ended June 30, 2009. The company is an accelerated filer and is not a shell company. As of August 3, 2009, there were 82,612,170 shares of common stock outstanding.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2009 | Six Months Ended June 30, 2009 | Three Months Ended June 30, 2008 | Six Months Ended June 30, 2008 |
|---|---|---|---|---|
| Net Income (Loss) | $231.9 million | $14.4 million | $(392.5) million | $(196.9) million |
| Diluted EPS | $2.82 | $0.18 | $(4.91) | $(2.46) |
| Total Revenues | $577.4 million | $588.9 million | $365.5 million | $1,329.9 million |
| Net Premiums Earned | $193.6 million | $404.8 million | $249.1 million | $491.1 million |
| Provision for Losses | $132.8 million | $459.5 million | $458.9 million | $1,041.6 million |
| Change in Fair Value of Derivatives | $272.3 million (Gain) | $(12.1) million (Loss) | $56.2 million (Gain) | $764.0 million (Gain) |
| Total Assets | $8,455.5 million | — | — | — |
| Total Liabilities | $6,389.2 million | — | — | — |
| Stockholders' Equity | $2,066.3 million | — | — | — |
| Cash and Cash Equivalents | $64.6 million | — | — | — |
Material Changes vs. Prior Period
- Net Income Turnaround: The company reported a net income of $231.9 million for the quarter ended June 30, 2009, compared to a net loss of $392.5 million in the same period of 2008. This improvement was primarily driven by a $272.3 million gain from the change in fair value of derivative instruments and a significant reduction in the mortgage insurance provision for losses.
- Derivative Valuation: The gain in derivatives was largely due to the tightening of Radian's credit default swap (CDS) spread (from 2,466 basis points at Dec 31, 2008, to 1,598 basis points at June 30, 2009) and tightening credit spreads on insured CDOs. This offset the reduction in cumulative unrealized gains related to non-performance risk.
- Loss Provisions: The provision for losses decreased by 71.1% in the quarter and 55.9% year-to-date compared to 2008. This reduction was driven by increased insurance rescissions and claim denials, which lowered the default-to-claim rate estimate.
- Premium Deficiency: Unlike the prior year, no provision for first-lien premium deficiency was recorded in 2009. The second-lien premium deficiency reserve decreased by $46.0 million year-to-date.
- Premiums Written: Net premiums written decreased 27.3% in the quarter and 31.8% year-to-date, reflecting an industry-wide decline in mortgage originations and the company's decision to discontinue writing new financial guaranty business.
Guidance, Outlook, and Risks
- Ambac Commutation: On July 20, 2009, Radian entered into a commutation agreement with Ambac Assurance Corporation. Radian paid $100 million to commute $9.8 billion of net par outstanding assumed from Ambac. This transaction reduced Radian's financial guaranty exposure to mortgage-backed securities by 41.9% and is expected to positively impact statutory surplus.
- Liquidity and Capital: Radian Group held approximately $480 million in unrestricted cash and marketable securities at June 30, 2009. The company expects to fund short-term liquidity needs through existing cash, tax-sharing arrangements, and potential dividends from affiliates. Long-term needs include debt repayments due in 2011 and tax-sharing payments due in 2010.
- Key Risks:
- Rescissions and Denials: The company relies on high levels of rescissions and denials to mitigate losses. If these levels decline or are challenged in litigation, loss reserves could increase materially.
- Capital Constraints: Ongoing losses in the mortgage insurance business have increased the risk-to-capital ratio. If this ratio reaches 25:1, state regulators may restrict new business writing.
- Derivative Volatility: Earnings remain highly sensitive to changes in credit spreads and the company's own CDS spread. A widening of the CDS spread could result in significant unrealized losses.
- Recession Impact: Further deterioration in the housing market, rising unemployment, or a deepening recession could worsen loss performance in both mortgage insurance and financial guaranty portfolios.
Investor Verification Checklist
- Derivative Gains Sustainability: Verify the sustainability of the $272.3 million derivative gain, which is heavily influenced by the company's own credit spread tightening rather than underlying asset performance.
- Rescission Rates: Monitor the actual rate of insurance rescissions and claim denials. A decline in these rates would significantly increase the provision for losses.
- Ambac Commutation Impact: Confirm the finalization of the Ambac settlement and its precise impact on the third-quarter financial statements and statutory surplus.
- Capital Adequacy: Track the risk-to-capital ratio of Radian Guaranty. If it approaches the 25:1 regulatory limit, the company's ability to write new business could be severely restricted.
- Second-Lien Exposure: Review the remaining exposure and reserve adequacy for the second-lien mortgage portfolio, which continues to carry a premium deficiency reserve.