RDN

Business Context and Reporting Period

Radian Group Inc. (Radian) is a credit enhancement company primarily focused on domestic first-lien residential mortgage insurance, with additional segments in financial guaranty and financial services. This Form 10-Q covers the quarterly period ended September 30, 2010. The company operates in a challenging environment characterized by high unemployment, declining home prices, and a prolonged housing market downturn, which has significantly impacted its loss experience, particularly in its mortgage insurance portfolio originated between 2005 and 2008.

Key Financial Metrics

Material Changes vs. Prior Period

• Net Income Volatility: The company reported a net income of $112.2 million for the quarter, a significant turnaround from a net loss of $70.5 million in the same period of 2009. This was primarily driven by a $229.8 million unrealized gain on the change in fair value of derivative instruments, largely due to the tightening of credit spreads on corporate CDOs and CMBS. Conversely, the nine-month period showed a net loss of $673.3 million, compared to $56.0 million in 2009, driven by a $372.8 million unrealized loss on derivatives and a substantial increase in the provision for losses.
• Provision for Losses: The provision for losses increased significantly to $1,323.4 million for the nine months ended September 30, 2010, compared to $864.4 million in the prior year. This increase was driven by higher default-to-claim rates, increased severity in pool insurance, and the breach of subordination levels in certain transactions, partially offset by a decrease in new default notices.
• Investment Portfolio Shift: Radian strategically repositioned its investment portfolio, selling significant portions of its fixed-maturity available-for-sale securities (including $1.1 billion in the third quarter) to improve statutory capital and liquidity. Proceeds were reinvested into trading securities, resulting in lower yields but higher liquidity.
• Capital Transactions: In May 2010, Radian completed a public offering of 50 million shares of common stock, raising approximately $526 million in net proceeds. Additionally, the company sold its remaining interest in Sherman Financial Group LLC in May 2010, recording a pre-tax gain of $34.8 million.

Guidance, Outlook, and Risks

• Outlook: Management expects total claims paid in 2010 to be approximately $1.6 billion and approximately $1.7 billion in 2011. The company anticipates that persistency rates will remain elevated due to market disruption. Radian is actively managing its risk-to-capital ratio, which stood at 17.2 to 1 for Radian Guaranty as of September 30, 2010, well below the 25 to 1 regulatory limit in many states.
• Liquidity: Radian Group holds approximately $478.6 million in unrestricted cash and marketable securities. The company has commenced a public offering of $350 million in Convertible Senior Notes due 2017 to fund working capital and potential debt repayments.
• Key Risks:
  • Rescissions and Denials: Elevated levels of rescissions and denials have reduced loss reserves by approximately $1.1 billion. However, an increasing number of lenders are challenging these actions, creating litigation risk that could force the company to reassume risk and reestablish reserves.
  • Regulatory Capital: Continued losses could push Radian Guaranty's risk-to-capital ratio toward the 25 to 1 limit, potentially restricting its ability to write new business unless capital is raised or regulatory relief is obtained.
  • IRS Examination: The IRS is examining tax returns for 2000–2007 regarding REMIC investments. Proposed adjustments could increase tax liability by approximately $128 million, though the company has made qualified deposits and disputes the findings.
  • Financial Guaranty Portfolio: Deterioration in the TruPs and CMBS portfolios remains a concern, with potential future claim payments expected to impact statutory capital.

Investor Verification Checklist

• Reserve Adequacy: Verify the assumptions used for the default-to-claim rate (39% as of Sep 30, 2010) and claim severity, particularly regarding the impact of potential litigation challenging rescissions and denials.
• Derivative Valuation: Review the sensitivity of the $530.7 million derivative liability to changes in Radian's own credit spread (CDS), which significantly impacts reported earnings through the non-performance risk adjustment.
• Capital Sufficiency: Monitor the risk-to-capital ratio of Radian Guaranty and the status of the Convertible Note Offering to ensure the company can maintain GSE eligibility and write new business.
• IRS Dispute Resolution: Track the status of the IRS examination and the potential impact of the $128 million proposed tax adjustment on future cash flows and deferred tax assets.
• Reinsurance Recoveries: Confirm the collectability of the $586.4 million in reinsurance recoverables, particularly from captive arrangements and Smart Home transactions.