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RDN > SEC Filings for RDN > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for RADIAN GROUP INC



Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following analysis should be read in conjunction with our unaudited condensed consolidated financial statements and the notes thereto included in this report and our audited financial statements, notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Form 10-K for the fiscal year ended December 31, 2011, as amended by the Company's Annual Reports on Form 10-K/A for the fiscal year ended December 31, 2011, as filed with the SEC on March 2, 2012 and November 6, 2012 (as amended, the "2011 Form 10-K"), for a more complete understanding of our financial position and results of operations. In addition, investors should review the "Forward Looking Statements-Safe Harbor Provisions" above and the "Risk Factors" detailed in Item 1A of Part I of our 2011 Form 10-K, and in Item 1A of Part II of our Quarterly Reports on Form 10Q filed in 2012, for a discussion of those risks and uncertainties that have the potential to affect our business, financial condition, results of operations, cash flows or prospects in a material and adverse manner. The results of operations for interim periods are not necessarily indicative of results to be expected for the full year or for any other period.

Business Summary
We are a credit enhancement company with a primary strategic focus on domestic, first-lien residential mortgage insurance. Our business segments are mortgage insurance and financial guaranty.
Mortgage Insurance
Our mortgage insurance segment provides credit-related insurance coverage, principally through private mortgage insurance, and risk management services to mortgage lending institutions. We provide these products and services mainly through our wholly-owned subsidiary, Radian Guaranty Inc. ("Radian Guaranty"). Private mortgage insurance protects mortgage lenders from all or a portion of default-related losses on residential mortgage loans made to home buyers who generally make downpayments of less than 20% of the home's purchase price. Private mortgage insurance also facilitates the sale of these mortgage loans in the secondary mortgage market, most of which are sold to Freddie Mac and Federal National Mortgage Association ("Fannie Mae"). We refer to Freddie Mac and Fannie Mae together as "Government Sponsored Enterprises" or "GSEs." Traditional Mortgage Insurance. Our mortgage insurance segment offers primary mortgage insurance coverage on residential first-lien mortgages ("first-liens"). At September 30, 2012, primary insurance on first-liens comprised approximately 94.2% of our total risk in force ("RIF"). Prior to 2009, we also wrote pool insurance, which at September 30, 2012, comprised approximately 5.3% of our total RIF.
Non-Traditional Mortgage Credit Enhancement. In addition to first-lien mortgage insurance, in the past, we provided other forms of credit enhancement on residential mortgage assets. These products included mortgage insurance on second-lien mortgages ("second-liens"), credit enhancement on net interest margin securities ("NIMS"), and primary mortgage insurance on international mortgages (collectively, we refer to the risk associated with these transactions as "non-traditional"). We stopped writing non-traditional business in 2007, other than a small amount of international mortgage insurance, which we discontinued writing in 2008. Our non-traditional RIF was $167 million as of September 30, 2012, representing 0.5% of our total RIF.
In the second quarter of 2012, Radian Guaranty entered into a quota share reinsurance agreement with a third-party reinsurance provider (the "Initial Quota Share Reinsurance Transaction"). Through the Initial Quota Share Reinsurance Transaction, Radian Guaranty agreed to cede 20% of its new insurance written ("NIW") beginning with the business written in the fourth quarter of 2011. As of September 30, 2012, the amount ceded pursuant to this transaction was $1.4 billion of Radian Guaranty's RIF. The amount of risk that ultimately may be ceded is limited to $1.6 billion. At a 25 to 1 risk-to-capital ratio, the equivalent initial capital benefit associated with ceding this amount of risk will be $62.5 million. Radian Guaranty has the ability, at its option, to commute two-thirds of the reinsurance ceded as part of this transaction on December 31, 2014.
In the fourth quarter of 2012, Radian Guaranty and the same third-party reinsurance provider agreed to the terms of a second quota share reinsurance agreement (the "Second Quota Share Reinsurance Transaction") that provide for incremental ceded risk of $750 million initially, and the parties have the ability to mutually increase the amount of ceded risk up to a maximum of $2 billion. See Note 7 of Notes to Unaudited Condensed Consolidated Financial Statements for more information.

Financial Guaranty
Our financial guaranty segment has provided direct insurance and reinsurance on credit-based risks through Radian Asset Assurance Inc. ("Radian Asset Assurance"), a wholly-owned subsidiary of Radian Guaranty. Financial guaranty insurance typically provides an unconditional and irrevocable guaranty to the holder of a financial obligation of full and timely payment of principal and interest when due. Financial guaranty insurance may be issued at the inception of an insured obligation or may be issued for the benefit of a holder of an obligation in the secondary market.
We have provided financial guaranty credit protection through the issuance of a financial guaranty insurance policy, by insuring the obligations under a credit default swap ("CDS"), or through the reinsurance of both types of obligations. Both a financial guaranty insurance policy and a CDS provide the purchaser of such credit protection with a guaranty of the timely payment of interest and scheduled principal when due on a covered financial obligation, and in the case of most of our financial guaranty CDSs, credit protection for amounts in excess of specified levels of losses. These forms of credit enhancement each require similar underwriting and surveillance of the insured risks. We historically have offered the following financial guaranty products:
Public Finance-Insurance of public finance obligations, including tax-exempt and taxable indebtedness of states, counties, cities, special service districts, other political subdivisions, enterprises such as public and private higher education institutions and healthcare facilities and infrastructure, project finance and private finance initiative assets in sectors such as airports, education, healthcare and other infrastructure projects;

Structured Finance-Insurance of structured finance obligations, including collateralized debt obligations ("CDOs") and asset-backed securities ("ABS"), consisting of funded and non-funded (referred to herein as "synthetic") executions that are payable from or tied to the performance of a specific pool of assets or covered reference entities. Examples of the pools of assets that collateralize or underlie structured finance obligations include corporate loans, bonds or other borrowed money, residential and commercial mortgage loans, trust preferred securities ("TruPs"), diversified payment rights ("DPRs"), a variety of consumer loans, equipment receivables, real and personal property leases, or a combination of asset classes or securities backed by one or more of these pools of assets;

Reinsurance-Reinsurance of domestic and international public finance obligations, including those issued by sovereign and sub-sovereign entities, and structured finance obligations.

We determine the ratings for a transaction by utilizing relevant information available to us, which includes: periodic reports supplied by the issuer, trustee or servicer for the transaction; publicly available information regarding the issuer, the transaction structure, the underlying collateral or asset class of the transaction and/or collateral; communications with the issuer, trustee, collateral manager and servicer for the transaction; and when available, public or private ratings assigned to our insured and reinsured transactions or to other obligations that have substantially similar risk characteristics to our transactions without the benefit of financial guaranty or similar credit insurance. In addition, for our assumed reinsurance transactions, we also utilize information provided by the primary insurer, including the ratings assigned to the transaction by such insurer. We also utilize models and methodologies from the nationally recognized statistical ratings organizations (the "NRSROs") to assist in such analysis. We use this information to develop an independent judgment regarding the risk and loss characteristics for our insured transactions. If public or private ratings have been used, our risk management analysts express a view regarding the opinion and analysis of the NRSROs. When our analysis of the transaction results in a materially different view of the risk and loss characteristics of an insured transaction, we will assign a different internal rating than that assigned by the NRSROs. Our internal ratings estimates are subject to revision periodically and may differ from the credit ratings assigned by the NRSROs for the same obligation. Unless otherwise indicated in our discussion of credit performance of our financial guaranty portfolio, the ratings we have stated have been developed internally.

The following table describes the ratings scale we utilize for our internal ratings:

Internal Rating (1)       Rating is Assigned When our Analysis Indicates:
                    the obligor's capacity to meet its financial commitment on
        AAA         the obligation is extremely strong and it is subject to the
                    lowest level of credit risk
                    the obligor's capacity to meet its financial commitment on
        AA          the obligation is very strong, and it is subject to very low
                    credit risk
                    the obligor's capacity to meet its financial commitment on
                    the obligation is strong, but it is somewhat more
         A          susceptible to adverse changes in circumstances or economic
                    conditions than higher rated obligations, and it is subject
                    to low credit risk
                    the obligor's capacity to meet its financial commitment on
                    the obligation is adequate, but adverse changes in
        BBB         circumstances or economic conditions are more likely to lead
                    to a weakened capacity of the obligor to meet its financial
                    commitment on the obligation and it is subject to moderate
                    credit risk
                    the obligation faces significant ongoing uncertainties or
                    exposure to adverse business, financial or economic
        BB          conditions, which could lead to the obligor's inadequate
                    capacity to meet its financial commitment on the obligation
                    and it is subject to substantial credit risk
                    adverse business, financial or economic conditions will
                    likely impair the obligor's capacity or willingness to meet
         B          its financial commitment on the obligation even though the
                    obligor currently has the capacity to meet its financial
                    commitments on the obligation, and it is subject to high
                    credit risk
                    the obligation is currently vulnerable to nonpayment, and is
                    dependent upon favorable business, financial and economic
        CCC         conditions for the obligor to meet its financial commitment
                    on the obligation, and it is subject to very high credit
                    the obligation is currently highly vulnerable to nonpayment,
                    and absent favorable business, financial and economic
        CC          conditions, the obligor is highly likely not to have the
                    financial capacity to meet its financial commitment on the
                    obligation, and is subject to extremely high credit risk
                    the obligation is currently extremely vulnerable to
         C          nonpayment and payment default is imminent, but the
                    obligation has not yet experienced a payment default
         D          there is currently a payment default on the obligation


(1) Our internal ratings may be modified by the addition of a "+" or "-" to show the relative standing within a letter category.

When we refer to an obligation as "BIG" or "below investment grade," it means we believe the obligation has significant speculative characteristics and is subject to at least substantial credit risk. Such obligations are rated BB, B, CCC, CC, C or D.
Since 2008, we have significantly reduced our financial guaranty operations and have reduced our financial guaranty exposures through commutations in order to mitigate uncertainty, maximize the ultimate capital available for our mortgage insurance business and accelerate our access to that capital.
In January 2012, Radian Asset Assurance entered into a three-part transaction (the "Assured Transaction") with subsidiaries of Assured Guaranty Ltd. (collectively "Assured") that included the following:
the commutation of $13.8 billion of financial guaranty net par outstanding that was reinsured by Radian Asset Assurance (the "Assured Commutation");

the cession of $1.8 billion of public finance business to Assured (the "Assured Cession"); and

the sale of Municipal and Infrastructure Assurance Corporation (the "FG Insurance Shell"), a New York domiciled financial guaranty insurance company with licenses to conduct business in 37 states and the District of Columbia. The sale of the FG Insurance Shell was completed in the second quarter of 2012.

This three-part transaction with Assured reduced our financial guaranty net par outstanding by 22.5% and provided a statutory capital benefit to Radian Asset Assurance and Radian Guaranty of $100.7 million as of September 30, 2012. This transaction is consistent with our strategic objective of accelerating the reduction of our financial guaranty net par outstanding and strengthening the statutory capital positions of Radian Asset Assurance and Radian Guaranty. See "Results of Operations-Financial Guaranty-Quarter and Nine Months Ended September 30, 2012 Compared to Quarter and Nine Months Ended September 30, 2011" below for further information.
In the second quarter of 2012, Radian Asset Assurance entered into a commutation with one of its derivative counterparties (the "Counterparty") to commute Radian Asset Assurance's: (1) only remaining CDO of ABS exposure which was related to a directly insured tranche of an extremely distressed CDO of ABS transaction (the "CDO of ABS Transaction"), for which we had expected to pay claims on substantially all of the $450.2 million in net par outstanding; and (2) credit protection through CDS on six directly insured TruPs CDO transactions, representing $699.0 million of net par outstanding at the time of the commutation (the "Terminated TruPs CDOs"). In consideration for these commutations, Radian Asset Assurance paid $210.0 million (the "Commutation Amount"), a significant portion of which (the "LPV Initial Capital") has been deposited with a limited purpose vehicle (an "LPV") to cover the Counterparty's potential future losses on the TruPs bonds underlying the Terminated TruPs CDOs (the "Terminated TruPs Bonds"). The commutations described in this paragraph are referred to herein as the "Commutation Transactions." As part of the Commutation Transactions, the LPV entered into a credit default swap (the "Residual CDS") with the Counterparty to provide for payments to the Counterparty for future losses relating to the Terminated TruPs Bonds. The LPV Initial Capital, together with investment earnings (collectively, the "LPV Capital"), represent the only funds available to pay the Counterparty for amounts due under the Residual CDS. The Residual CDS terminates concurrently with the Terminated TruPs Bonds for which we had provided credit protection and provides for payment to the Counterparty substantially in accordance with the terms of our original CDS protection for the Terminated TruPs Bonds. In addition, pursuant to an agreement with the Counterparty, if any LPV Capital amount is remaining following the maturity of the Residual CDS, Radian Asset Assurance is entitled to these remaining funds.
All of the transactions commuted pursuant to the Commutation Transactions were rated BIG at the time of the transaction with $1.0 billion net par outstanding of the commuted transactions rated B or below. In the aggregate, the transactions commuted pursuant to the Commutation Transactions represented approximately 51% of our financial guaranty segment's aggregate net par outstanding rated B or below at the time of the transaction. See "Results of Operations-Financial Guaranty-Quarter and Nine Months Ended September 30, 2012 Compared to Quarter and Nine Months Ended September 30, 2011" below for further information.
Financial Guaranty Exposure Subject to Recapture or Termination. Approximately $26.3 billion of our total net par outstanding as of September 30, 2012 (representing 67.4% of our financial guaranty segment's total net par outstanding), was subject to recapture by our primary insurance customers or termination in the case of our financial guaranty credit derivative counterparties. Of such amount, $20.0 billion was subject to termination by our financial guaranty credit derivative counterparties, while the remaining $6.3 billion was subject to recapture at the option of our primary reinsurance customers. During the first nine months of 2012, five CDS counterparties in our financial guaranty business exercised their termination rights with respect to 24 corporate CDOs that we insured and an additional counterparty exercised its termination right with respect to one CDS of an investor-owned utility bond that we insured (collectively, the "2012 CDO Terminations"), which further reduced our financial guaranty net par outstanding by $10.2 billion in the aggregate. In addition, in October 2012, three of these counterparties and one additional CDS counterparty terminated an additional 11 corporate CDOs and a foreign infrastructure CDS that we insured with an aggregate of $4.4 billion net par outstanding. There was no material impact on our financial statements as a result of these terminations.

On June 28, 2012, one of our primary reinsurance customers, Financial Guaranty Insurance Company ("FGIC") was placed into rehabilitation by the New York Department of Financial Services ("NYDFS"). As of September 30, 2012, we had reinsured an aggregate of $826.9 million in net par outstanding from FGIC. On November 9, 2012, Radian Asset Assurance entered into an agreement (the "Agreement") with FGIC which, if consummated, would commute all of this remaining reinsurance exposure (the "Commutation"), which represented 13% of Radian Asset Assurance's total reinsurance portfolio as of September 30, 2012. The portfolio to be commuted includes $196 million of Radian Asset Assurance's $225 million in net par outstanding as of September 30, 2012, related to Jefferson County, Alabama sewer warrants. See "Results of Operations-Financial Guaranty-Quarter and Nine Months Ended September 30, 2012 Compared to Quarter and Nine Months Ended September 30, 2011-Financial Guaranty Exposure Information" for additional information regarding the Jefferson County, Alabama sewer warrants. Because of the rehabilitation proceeding for FGIC pursuant to Article 74 of the New York Insurance Law that is currently pending before the Supreme Court of the State of New York (the "Court"), the effectuation of the Commutation is subject to approval by the Court of the Agreement and certain related matters. Such approval is within the Court's sole discretion, and no assurance can be given that the Court will grant such approval or when it will be granted. If the Court grants such approval, Radian Asset Assurance will be required to make a commutation payment to FGIC in the approximate amount of $52.4 million once that approval becomes final in accordance with the Agreement, and the Commutation will become effective upon FGIC's receipt of such payment. The amount of this payment was determined primarily based on existing loss reserves and unearned premium reserves, and therefore is not expected to have a material impact on our consolidated financial statements or Radian Asset Assurance's statutory capital position.
In addition, as of September 30, 2012, we had $89.9 million of second-to-pay exposure to FGIC (or 4.0% of our aggregate second-to-pay exposure), pursuant to which we are obligated to pay claims to the extent that both the underlying obligation defaults and FGIC (or its rehabilitator) fails to pay all or a portion of such claims.
Overview of Business Results
As a seller of credit protection, our results are subject to macroeconomic conditions and specific events that impact the origination environment and credit performance of our underlying insured assets. Despite recent signs of improvement in the United States ("U.S.") housing market, the overall market and related credit markets remain weak compared to historical standards, with limited mortgage originations, modest improvement in home prices in certain markets after a prolonged period of significant home price depreciation, mortgage servicing and foreclosure delays, and ongoing deterioration in the credit performance of mortgage and other assets originated prior to 2009. These factors, together with current macroeconomic trends such as limited economic growth, the lack of meaningful liquidity in some sectors of the capital markets, and continued high unemployment, have had, and we believe will continue to have, a significant negative impact on the operating environment and results of operations for each of our businesses. Because of these factors, there is uncertainty regarding our ultimate loss performance. Mortgage Insurance
Defaults. Our first-lien primary default rate at September 30, 2012, was 12.6%, compared to 15.2% at December 31, 2011. Our primary default inventory comprised 94,831 loans at September 30, 2012, compared to 98,450 loans and 110,861 loans at June 30, 2012 and December 31, 2011, respectively. The reduction in our default inventory is the result of the total number of defaulted loans: (1) that have cured ("cures"); (2) for which claim payments have been made; and (3) that have resulted in insurance rescissions and claim denials, collectively exceeding the total number of new defaults on insured loans. Despite this positive trend, our overall primary default rates continue to remain elevated compared to historical levels due to continued high unemployment and weakness in the U.S. housing and mortgage credit markets. We believe that a return to sustained profitability in our mortgage insurance business is dependent upon both a further reduction in the number of new defaults and an increase in the number of cures, particularly with respect to loans that have been in default for more than twelve months. We are experiencing improved operating results in our mortgage insurance business in 2012 compared to 2011, and although we expect an operating loss for our mortgage insurance business in 2012, based on our current projections, which are subject to significant risks and uncertainties, we expect to achieve marginal operating profitability in our mortgage insurance business in 2013. We are projecting a 20%-25% total decrease in new primary defaults in 2012 compared to 2011, which compares to an 18% decrease in new primary defaults in 2011 compared to 2010. During the third quarter and first nine months of 2012, new primary defaults decreased 23% and 21%, respectively, compared to the same periods of 2011.

Notwithstanding these decreases, defaults have remained at elevated levels across all of our mortgage insurance product lines, including our insured portfolio of prime, first-lien mortgages. Overall, the underlying trend of high defaults continues to be driven primarily by the poor performance of our 2005 through 2008 books of business. In addition, a slowdown in mortgage foreclosures driven by servicing delays and the effect of prolonged modification programs for delinquent loans, has contributed to the sustained high level of our default inventory. This slowdown has resulted in more defaults remaining unresolved for a longer period of time than has historically been the case.
Provision for Losses. Our mortgage insurance provision for losses for the third quarter and first nine months of 2012 was $171.8 million and $614.6 million, respectively, and consisted primarily of reserves established on new defaults. Primary new defaults, which have been the main driver for incurred losses in 2012, were down by 23% for the third quarter of 2012, compared to the third quarter of 2011. The default rate in our mortgage insurance business is subject to seasonality. Historically, our mortgage insurance business experiences a fourth quarter seasonal increase in defaults and a first quarter seasonal decline in defaults. Consistent with this, we are expecting the negative impact of seasonality on both new defaults and cures to result in significantly higher incurred losses for the fourth quarter of 2012.

Our mortgage insurance reserve for losses continues to be favorably affected by our loss management efforts. Our loss reserve estimate incorporates our recent experience with respect to the elevated number of claims that we are denying due to the policyholder's failure to submit sufficient documentation to perfect a claim submission and to the number of insurance certificates that we are rescinding due to fraud, underwriter negligence and other factors, as well as our expectations of the number of previously rescinded or denied policies that we expect to reinstate. Our current level of rescissions and denials remains elevated compared to historical levels, which we believe reflects the larger concentration of poorly underwritten loans (primarily originated during 2005 through 2008) that are in our default inventory, as well as our extensive efforts to examine substantially all claims for potential rescissions or denials. We expect the level of rescissions and denials to continue to remain elevated compared to historical levels as long as our 2005 through 2008 insurance policies comprise a significant percentage of our default inventory. In addition, as part of our claims review process, we assess whether defaulted loans were serviced appropriately in accordance with our insurance policies and servicing guidelines. To the extent a servicer has failed to satisfy its servicing obligations, our policies provide that we may curtail the claim payment for such default, and in some circumstances, cancel coverage or deny the claim. In 2012, claim curtailments due to servicer noncompliance with our insurance policies and servicing guidelines have increased both in frequency and in size, which has contributed to a reduction in the severity of our claim payments during this period. While we cannot give assurance regarding the extent or level at which such claim curtailments will continue, we expect this trend to continue for the immediate future in light of well publicized issues in the . . .

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