Radian Group Inc. -- Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2009

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number 1-11356

 

 

Radian Group Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   23-2691170

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

1601 Market Street, Philadelphia, PA   19103
(Address of principal executive offices)   (Zip Code)

(215) 231-1000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

 

Large accelerated filer  ¨   Accelerated filer  x       Non-accelerated filer  ¨   Smaller reporting company  ¨
    (Do not check if a smaller reporting company)  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 82,612,170 shares of common stock, $0.001 par value per share, outstanding on August 3, 2009.

 

 

 


Table of Contents

Radian Group Inc.

INDEX

 

         Page
Number

Forward-Looking Statements—Safe Harbor Provisions

  1

PART I—FINANCIAL INFORMATION

 

Item 1.

  

Financial Statements (Unaudited)

 
  

Condensed Consolidated Balance Sheets

  3
  

Condensed Consolidated Statements of Operations

  4
  

Condensed Consolidated Statements of Changes in Common Stockholders’ Equity

  5
  

Condensed Consolidated Statements of Cash Flows

  6
  

Notes to Unaudited Condensed Consolidated Financial Statements

  7

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  45

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

  96

Item 4.

  

Controls and Procedures

  98

PART II—OTHER INFORMATION

 

Item 1.

  

Legal Proceedings

  100

Item 1A.

  

Risk Factors

  101

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

  103

Item 4.

  

Submission of Matters to a Vote of Security Holders

  103

Item 5.

  

Other Information

  104

Item 6.

  

Exhibits

  105

SIGNATURES

  106

EXHIBIT INDEX

  107


Table of Contents

Forward-Looking Statements—Safe Harbor Provisions

All statements in this report that address events, developments or results that we expect or anticipate may occur in the future are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934 and the U.S. Private Securities Litigation Reform Act of 1995. In most cases, forward-looking statements may be identified by words such as “anticipate,” “may,” “should,” “expect,” “intend,” “plan,” “goal,” “contemplate,” “believe,” “estimate,” “predict,” “project,” “potential,” “continue,” or the negative or other variations on these words and other similar expressions. These statements, which include, without limitation, projections regarding our future performance and financial condition are made on the basis of management’s current views and assumptions with respect to future events. Any forward-looking statement is not a guarantee of future performance and actual results could differ materially from those contained in the forward-looking information. The forward-looking statements, as well as our prospects as a whole, are subject to risks and uncertainties, including the following:

 

   

changes in general financial and political conditions, such as a deepening of the existing national economic recession, further decreases in housing demand, mortgage originations or housing values (in particular, further deterioration in the housing, mortgage and related credit markets, which would harm our future consolidated results of operations and could cause losses for our businesses to be worse than expected), a further reduction in the liquidity in the capital markets and further contraction of credit markets, further increases in unemployment rates, changes or volatility in interest rates or consumer confidence, changes in credit spreads, changes in the way investors perceive the strength of private mortgage insurers or financial guaranty providers, investor concern over the credit quality and specific risks faced by the particular businesses, municipalities or pools of assets covered by our insurance;

 

   

catastrophic events or further economic changes in geographic regions where our mortgage insurance or financial guaranty insurance in force is more concentrated;

 

   

our ability to successfully execute upon our internally sourced capital plan for our mortgage insurance business (which depends, in part, on the performance of our financial guaranty portfolio), and if necessary, to obtain additional capital to support new business writings in our mortgage insurance business and the long-term liquidity needs of our holding company (including significant payment obligations in 2010 and 2011) and to protect our credit ratings and the financial strength ratings of Radian Guaranty Inc., our principal mortgage insurance subsidiary, from further downgrades;

 

   

a further decrease in the volume of home mortgage originations due to reduced liquidity in the lending market, tighter underwriting standards and the ongoing deterioration in housing markets throughout the U.S.;

 

   

our ability to maintain adequate risk-to-capital ratios and surplus requirements in our mortgage insurance business in light of ongoing losses in this business and in our financial guaranty portfolio, which, in the absence of new capital, may depend on our ability to execute strategies for which regulatory and other approvals are required and may not be obtained;

 

   

our ability to continue to effectively mitigate our mortgage insurance losses, which mitigation efforts recently have resulted in increased levels of rescissions and denials that may not be sustainable and could lead to an increased risk of litigation;

 

   

the concentration of our mortgage insurance business among a relatively small number of large customers;

 

   

disruption in the servicing of mortgages covered by our insurance policies;

 

   

the aging of our mortgage insurance portfolio and changes in severity or frequency of losses associated with certain of our products that are riskier than traditional mortgage insurance or financial guaranty insurance policies;

 

   

the performance of our insured portfolio of higher risk loans, such as Alternative-A (“Alt-A”) and subprime loans, and of adjustable rate products, such as adjustable rate mortgages and interest-only mortgages, which have resulted in increased losses and are expected to result in further losses;

 

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changes in persistency rates of our mortgage insurance policies;

 

   

an increase in the risk profile of our existing mortgage insurance portfolio due to mortgage refinancing in the current housing market;

 

   

further downgrades or threatened downgrades of, or other ratings actions with respect to, our credit ratings or the ratings assigned by the major rating agencies to any of our rated insurance subsidiaries at any time (in particular, the credit rating of Radian Group Inc. and the financial strength ratings assigned to Radian Guaranty Inc.);

 

   

heightened competition for our mortgage insurance business from others such as the Federal Housing Administration and the Veterans’ Administration or other private mortgage insurers (in particular those that have been assigned higher ratings from the major rating agencies);

 

   

changes in the charters or business practices of Federal National Mortgage Association (“Fannie Mae”) and Freddie Mac, the largest purchasers of mortgage loans that we insure, and our ability to remain an eligible provider to both Freddie Mac and Fannie Mae;

 

   

the application of existing federal or state consumer, lending, insurance, securities and other applicable laws and regulations, or changes in these laws and regulations or the way they are interpreted; including, without limitation: (i) the outcome of existing investigations or the possibility of private lawsuits or other formal investigations by state insurance departments and state attorneys general alleging that services offered by the mortgage insurance industry, such as captive reinsurance, pool insurance and contract underwriting, are violative of the Real Estate Settlement Procedures Act and/or similar state regulations or (ii) legislative and regulatory changes affecting demand for private mortgage insurance, limiting or restricting our use of (or requirements for) additional capital, the products we may offer, the form in which we may execute the credit protection we provide or the aggregate notional amount of any product we may offer for any one transaction or in the aggregate;

 

   

the possibility that we may fail to estimate accurately the likelihood, magnitude and timing of losses in connection with establishing loss reserves for our mortgage insurance or financial guaranty businesses or premium deficiencies for our mortgage insurance businesses, or to estimate accurately the fair value amounts of derivative contracts in our mortgage insurance and financial guaranty businesses in determining gains and losses on these contracts;

 

   

the ability of our primary insurance customers in our financial guaranty reinsurance business to provide appropriate surveillance and to mitigate losses adequately with respect to our assumed insurance portfolio; and the significant concentration of our financial guaranty reinsurance business in customers under common control;

 

   

volatility in our earnings caused by changes in the fair value of our derivative instruments and our need to reevaluate the premium deficiency in our mortgage insurance business on a quarterly basis;

 

   

changes in accounting guidance from the SEC or the Financial Accounting Standards Board;

 

   

legal and other limitations on amounts we may receive from our subsidiaries as dividends or through our tax and expense-sharing arrangements with our subsidiaries; and

 

   

our investment in Sherman Financial Group LLC, which could be negatively affected in the current credit environment if Sherman is unable to maintain sufficient sources of funding for its business activities or remain in compliance with its credit facilities.

For more information regarding these risks and uncertainties as well as certain additional risks that we face, you should refer to the Risk Factors detailed in Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2008 and in Item 1A of Part II in this Quarterly Report on Form 10-Q. We caution you not to place undue reliance on these forward-looking statements, which are current only as of the date on which we filed this report. We do not intend to, and we disclaim any duty or obligation to, update or revise any forward-looking statements made in this report to reflect new information or future events or for any other reason.

 

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PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements. (Unaudited)

Radian Group Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

 

(In thousands, except share and per share amounts)    June 30
2009
    December 31
2008
 

ASSETS

    

Investments

    

Fixed maturities held to maturity—at amortized cost (fair value $31,308 and $37,486)

   $ 30,225      $ 36,628   

Fixed maturities available for sale—at fair value (amortized cost $2,371,366 and $3,899,487)

     2,158,523        3,647,269   

Trading securities—at fair value (amortized cost $2,460,768 and $670,835)

     2,474,923        654,699   

Equity securities available for sale—at fair value (cost $217,585 and $212,620)

     175,570        165,099   

Hybrid securities—at fair value (amortized cost $469,239 and $499,929)

     450,016        426,640   

Short-term investments

     1,082,016        1,029,285   

Other invested assets (cost $23,256 and $21,388)

     23,406        21,933   
                

Total investments

     6,394,679        5,981,553   

Cash

     64,554        79,048   

Investment in affiliates

     108,767        99,712   

Deferred policy acquisition costs

     208,882        160,526   

Prepaid federal income taxes

     —          248,828   

Accrued investment income

     48,112        61,722   

Accounts and notes receivable (less allowance of $68,537 and $61,168)

     243,785        90,158   

Property and equipment, at cost (less accumulated depreciation of $87,835 and $84,911)

     15,760        18,178   

Derivative assets

     179,837        179,515   

Deferred income taxes, net

     368,281        446,102   

Reinsurance recoverables

     570,245        492,359   

Other assets

     252,600        258,418   
                

Total assets

   $ 8,455,502      $ 8,116,119   
                

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Unearned premiums

   $ 1,120,359      $ 916,724   

Reserve for losses and loss adjustment expenses (“LAE”)

     3,304,236        3,224,542   

Reserve for premium deficiency

     40,861        86,861   

Long-term debt and other borrowings

     856,848        857,802   

Variable interest entity debt—at fair value

     283,242        160,035   

Derivative liabilities

     379,270        519,260   

Accounts payable and accrued expenses

     404,432        320,185   
                

Total liabilities

     6,389,248        6,085,409   
                

Commitments and Contingencies (Note 15)

    

Stockholders’ equity

    

Common stock: par value $.001 per share; 325,000,000 shares authorized; 99,460,173 and 98,223,210 shares issued at June 30, 2009 and December 31, 2008, respectively; 82,252,266 and 81,034,883 shares outstanding at June 30, 2009 and December 31, 2008, respectively

     99        98   

Treasury stock, at cost: 17,207,907 and 17,188,327 shares at June 30, 2009 and December 31, 2008, respectively

     (889,142     (888,057

Additional paid-in capital

     1,358,440        1,350,704   

Retained earnings

     1,764,878        1,766,946   

Accumulated other comprehensive loss, net

     (168,021     (198,981
                

Total stockholders’ equity

     2,066,254        2,030,710   
                

Total liabilities and stockholders’ equity

   $ 8,455,502      $ 8,116,119   
                

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Radian Group Inc.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

 

     Three Months Ended
June 30
    Six Months Ended
June 30
 
(In thousands, except per share amounts)    2009     2008     2009     2008  

Revenues:

        

Premiums written—insurance:

        

Direct

   $ 193,854      $ 248,660      $ 392,223      $ 511,266   

Assumed

     8,127        13,043        3,198        37,314   

Ceded

     (40,080     (39,058     (76,764     (81,629
                                

Net premiums written

     161,901        222,645        318,657        466,951   

Decrease in unearned premiums

     31,728        26,492        86,187        24,107   
                                

Net premiums earned—insurance

     193,629        249,137        404,844        491,058   

Net investment income

     53,251        65,128        109,534        131,107   

Change in fair value of derivative instruments

     272,318        56,226        (12,098     764,035   

Net gains (losses) on other financial instruments

     54,384        14,801        79,264        (26,040

Total other-than-temporary impairment losses

     (46     (23,052     (680     (37,095

Losses recognized in other comprehensive income (loss)

     —          —          —          —     
                                

Net impairment losses recognized in earnings

     (46     (23,052     (680     (37,095

Other income

     3,888        3,221        8,020        6,835   
                                

Total revenues

     577,424        365,461        588,884        1,329,900   
                                

Expenses:

        

Provision for losses

     132,750        458,879        459,504        1,041,590   

Provision for premium deficiency

     2,184        369,807        (46,000     387,897   

Policy acquisition costs

     25,967        75,952        39,921        99,858   

Other operating expenses

     55,635        63,849        107,237        118,990   

Interest expense

     12,295        13,832        24,594        26,325   
                                

Total expenses

     228,831        982,319        585,256        1,674,660   
                                

Equity in net income of affiliates

     5,110        15,704        15,662        28,230   
                                

Pretax income (loss)

     353,703        (601,154     19,290        (316,530

Income tax provision (benefit)

     121,828        (208,630     4,852        (119,644
                                

Net income (loss)

   $ 231,875      $ (392,524   $ 14,438      $ (196,886
                                

Basic net income (loss) per share

   $ 2.85      $ (4.91   $ 0.18      $ (2.46
                                

Diluted net income (loss) per share

   $ 2.82      $ (4.91   $ 0.18      $ (2.46
                                

Weighted-average number of common shares outstanding—basic

     81,396        79,967        81,400        79,960   
                                

Weighted-average number of common and common equivalent shares outstanding—diluted

     82,240        79,967        82,236        79,960   
                                

Dividends per share

   $ 0.0025      $ 0.02      $ 0.0050      $ 0.04   
                                

See accompanying notes to unaudited condensed consolidated financial statements

 

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Radian Group Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN COMMON STOCKHOLDERS’ EQUITY (UNAUDITED)

 

                        Accumulated Other
Comprehensive Income (Loss)
       
(In thousands)   Common
Stock
  Treasury
Stock
    Additional
Paid-in
Capital
  Retained
Earnings
    Foreign Currency
Translation
Adjustment
  Unrealized
Holding Gains
(Losses)
    Other     Total  

BALANCE, JANUARY 1, 2008

  $ 98   $ (889,478   $ 1,331,790   $ 2,181,191      $ 12,142   $ 86,619      $ (1,626   $ 2,720,736   

Comprehensive loss:

               

Net loss

    —       —          —       (196,886     —       —          —          (196,886

Unrealized foreign currency translation adjustment, net of tax of $2,225

    —       —          —       —          4,133     —          —          4,133   

Unrealized holding losses arising during period, net of tax benefit of $51,383

    —       —          —       —          —       (95,425     —          —     

Less: Reclassification adjustment for net losses included in net loss, net of tax benefit of $11,260

    —       —          —       —          —       20,190        —          —     
                     

Net unrealized loss on investments, net of tax benefit of $40,123

    —       —          —       —          —       (74,515     —          (74,515
                     

Comprehensive loss

    —       —          —       —          —       —          —          (267,268

Repurchases of common stock under incentive plans

    —       (574     856     —          —       —          —          282   

Issuance of restricted stock

    —       —          78     —          —       —          —          78   

Amortization of restricted stock

    —       —          3,788     —          —       —          —          3,788   

Stock-based compensation expense

    —       —          1,550     —          —       —          —          1,550   

Dividends declared

    —       —          —       (3,259     —       —          —          (3,259
                                                         

BALANCE, JUNE 30, 2008

  $ 98   $ (890,052   $ 1,338,062   $ 1,981,046      $ 16,275   $ 12,104      $ (1,626   $ 2,455,907   
                                                         

BALANCE prior to implementation effects JANUARY 1, 2009

  $ 98   $ (888,057   $ 1,350,704   $ 1,766,946      $ 13,966   $ (196,480   $ (16,467   $ 2,030,710   

Cumulative effect of adoption of SFAS No. 163 (see Note 1)

    —       —          —       (37,587     —       —          —          (37,587
                                                         

BALANCE, JANUARY 1, 2009, as adjusted

  $ 98   $ (888,057   $ 1,350,704   $ 1,729,359      $ 13,966   $ (196,480   $ (16,467   $ 1,993,123   

Cumulative effect of adoption of FSP FAS 115-2/124-2 (see Note 1)

    —       —          —       21,490        —       (21,490     —          ––   

Comprehensive income:

               

Net income

    —       —          —       14,438        —       —          —          14,438   

Unrealized foreign currency translation adjustment, net of tax of $1,193

    —       —          —       —          2,215     —          —          2,215   

Unrealized holding gains arising during the period, net of tax of $41,338

    —       —          —       —          —       76,772        —          ––   

Less: Reclassification adjustment for net gains included in net income, net of tax of $14,300

    —       —          —       —          —       (26,558     —          ––   
                     

Net unrealized gain on investments, net of tax of $27,038

    —       —          —       —          —       50,214        —          50,214   
                     

Comprehensive income

    —       —          —       —          —       —          —          66,867   

Repurchases of common stock under incentive plans

    —       (1,085     1,085     —          —       —          —          ––   

Issuance of stock under benefit plans

    1     —          1,848     —          —       —          —          1,849   

Amortization of restricted stock

    —       —          2,234     —          —       —          —          2,234   

Stock-based compensation expense

    —       —          2,569     —          —       —          —          2,569   

Dividends declared

    —       —          —       (409     —       —          —          (409

Net actuarial loss

    —       —          —       —          —       —          21        21   
                                                         

BALANCE, JUNE 30, 2009

  $ 99   $ (889,142   $ 1,358,440   $ 1,764,878      $ 16,181   $ (167,756   $ (16,446   $ 2,066,254   
                                                         

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Radian Group Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

     Six Months Ended
June 30
 
(In thousands)    2009     2008  

Cash flows used in operating activities

   $ (1,581,401   $ (185,245
                

Cash flows from investing activities:

    

Proceeds from sales of fixed-maturity investments available for sale

     1,683,501        193,536   

Proceeds from sales of equity securities available for sale

     3,256        5,792   

Proceeds from sales of hybrid securities

     105,857        205,206   

Proceeds from redemptions of fixed-maturity investments available for sale

     240,733        93,094   

Proceeds from redemptions of fixed-maturity investments held to maturity

     6,890        7,481   

Proceeds from redemptions of hybrid securities

     9,304        29,347   

Purchases of fixed-maturity investments available for sale

     (308,994     (340,218

Purchases of equity securities available for sale

     (8,701     (85,289

Purchases of hybrid securities

     (117,733     (242,954

(Purchases) sales of short-term investments, net

     (45,889     263,492   

Purchases of other invested assets, net

     (1,473     (1,249

Purchases of property and equipment, net

     (910     (3,283
                

Net cash provided by investing activities

     1,565,841        124,955   
                

Cash flows from financing activities:

    

Dividends paid

     (409     (3,259

Proceeds from termination of interest rate swap

     —          12,800   
                

Net cash (used in) provided by financing activities

     (409     9,541   
                

Effect of exchange rate changes on cash

     1,475        (1,710

Decrease in cash

     (14,494     (52,459

Cash, beginning of period

     79,048        200,787   
                

Cash, end of period

   $ 64,554      $ 148,328   
                

Supplemental disclosures of cash flow information:

    

Income taxes received

   $ (339,719   $ (227,753
                

Interest paid

   $ 25,999      $ 28,428   
                

Supplemental disclosures of non-cash items:

    

Stock-based compensation, net of tax

   $ 4,224      $ 5,173   
                

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Radian Group Inc

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. Condensed Consolidated Financial Statements—Basis of Presentation

Our condensed consolidated financial statements include the accounts of Radian Group Inc. and its subsidiaries. We refer to Radian Group Inc. together with its consolidated subsidiaries as “Radian,” “we,” “us” or “our,” unless the context requires otherwise. We generally refer to Radian Group Inc. alone, without its consolidated subsidiaries, as “Radian Group.”

Our condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of all wholly-owned subsidiaries. We have condensed or omitted certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with GAAP pursuant to the instructions of Article 10 of Regulation S-X of the Securities and Exchange Commission’s (“SEC”) rules and regulations.

The financial information presented for interim periods is unaudited; however, such information reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the financial position, results of operations, and cash flows for the interim periods. These interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2008. 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. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. While the amounts included in our condensed consolidated financial statements include our best estimates and assumptions, actual results may vary.

Basic net income per share is based on the weighted-average number of common shares outstanding, while diluted net income per share is based on the weighted-average number of common shares outstanding and common share equivalents that would be issuable upon the exercise of stock options and other stock-based compensation. For the three and six months ended June 30, 2009, 3,780,500 shares of our common stock issued under our stock-based compensations plans were not included in the calculation of diluted net income per share because they were anti-dilutive. As a result of our net loss for the three and six months ended June 30, 2008, 4,371,633 shares of our common stock issued under our stock-based compensation plans were not included in the calculation of diluted net loss per share because they were anti-dilutive.

We adopted Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurement” (“SFAS No. 157”) effective January 1, 2008 with respect to financial assets and liabilities measured at fair value. SFAS No. 157 (i) defines fair value, (ii) establishes a framework for measuring fair value in accordance with GAAP, and (iii) expands disclosure requirements about fair value measurements. SFAS No. 157 is effective for all financial statements issued for fiscal years beginning after November 15, 2007 on a prospective basis. There was no cumulative impact on retained earnings as a result of the adoption. In accordance with Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”) SFAS No. 157-2, “Effective Date of FASB Statement No. 157” we elected to defer the effective date of SFAS No. 157 for non-financial assets and non-financial liabilities until January 1, 2009. The adoption of SFAS No. 157 with respect to non-financial assets and non-financial liabilities effective January 1, 2009 did not have a significant impact on our condensed consolidated financial statements.

 

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Table of Contents

Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

We adopted FSP Emerging Issues Task Force (“EITF”) 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” effective January 1, 2009. This FSP requires companies to consider unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents as participating securities, which shall be included in the calculation of basic and diluted earnings per share. Our restricted stock awards meet the definition of participating securities. The adoption of this EITF did not have a material impact on our condensed consolidated financial statements.

We adopted SFAS No. 161, “Disclosures About Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133” (“SFAS No. 161”) effective January 1, 2009. SFAS No. 161 requires increased qualitative, quantitative and credit-risk disclosures including: (a) how and why an entity is using a derivative instrument or hedging activity; (b) how the entity is accounting for its derivative instruments and hedged items under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”); and (c) how the instruments affect the entity’s financial position, financial performance and cash flows. SFAS No. 161 also amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments” (“SFAS No. 107”) to clarify that derivative instruments are subject to SFAS No. 107’s concentration-of-credit-risk disclosures. See Notes 3, 4 and 5 for further information.

We adopted SFAS No. 163, “Accounting for Financial Guarantee Insurance Contracts, an interpretation of FASB Statement No. 60” (“SFAS No. 163”) effective January 1, 2009. SFAS No. 163 clarifies how SFAS No. 60, “Accounting and Reporting by Insurance Enterprises” (“SFAS No. 60”) applies to financial guarantee insurance contracts, including the recognition and measurement to be used to account for premium revenue and claim liabilities. The scope of SFAS No. 163 is limited to financial guarantee insurance (and reinsurance) contracts issued by insurance enterprises included within the scope of SFAS No. 60. SFAS No. 163 does not apply to financial guarantee insurance contracts accounted for as derivative contracts under SFAS No. 133. As a result of the implementation of SFAS No. 163, we recognized the cumulative effect of adoption as a reduction in retained earnings of $37.6 million, after tax, effective January 1, 2009. See Note 10, “Financial Guaranty Insurance Contracts” for further information.

We adopted FSP FAS 107-1 and Accounting Principles Board (“APB”) 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“APB 28-1”) effective April 1, 2009. This FSP amends SFAS No. 107 to require disclosures about the fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP also amends APB Opinion No. 28, “Interim Financial Reporting,” to require fair value disclosures to be included in summarized financial information at interim reporting periods. See Note 4, “Fair Value of Financial Instruments” for further information.

We adopted FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP FAS 115-2”) effective April 1, 2009. This FSP amends the other-than-temporary impairment guidance in GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. The adoption of this FSP resulted in a $21.5 million increase in retained earnings and a corresponding decrease in accumulated other comprehensive income, net upon adoption. See Note 6, “Investments” for further information.

We adopted FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP FAS 157-4”) effective April 1, 2009. This FSP provides additional guidance for estimating fair value in accordance with SFAS No. 157, when the volume and level of activity for the asset or liability have significantly decreased. This FSP also includes guidance on identifying circumstances that indicate a transaction is not “orderly.” The adoption of this FSP did not have a significant impact on our condensed consolidated financial statements.

 

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Table of Contents

Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

2. Segment Reporting

We have three reportable segments: Mortgage Insurance, Financial Guaranty and Financial Services. We allocate corporate income and expenses to our mortgage insurance and financial guaranty segments based on either an allocated percentage of time spent or internally allocated capital. We evaluate operating segment performance based principally on net income. Summarized financial information concerning our operating segments, as of and for the year-to-date periods indicated, are as follows:

 

     Three Months Ended
June 30
    Six Months Ended
June 30
 

Mortgage Insurance (In thousands)

   2009     2008     2009     2008  

Net premiums written—insurance

   $ 154,919      $ 199,030      $ 316,878      $ 410,281   
                                

Net premiums earned—insurance

   $ 170,047      $ 205,096      $ 347,930      $ 409,361   

Net investment income

     32,298        38,941        63,643        77,786   

Change in fair value of derivative instruments

     (6,557     25,173        (35,133     96,942   

Net gains (losses) on other financial instruments

     12,590        18,155        25,500        (11,404

Net impairment losses recognized in earnings

     (46     (7,711     (680     (14,885

Other income

     3,748        2,999        7,566        6,490   
                                

Total revenues

     212,080        282,653        408,826        564,290   
                                

Provision for losses

     142,802        449,296        464,486        1,020,304   

Provision for premium deficiency

     2,184        369,807        (46,000     387,897   

Policy acquisition costs

     7,921        63,686        13,660        77,146   

Other operating expenses

     35,590        48,703        71,284        82,873   

Interest expense

     2,619        7,332        8,313        14,422   
                                

Total expenses

     191,116        938,824        511,743        1,582,642   
                                

Equity in net income of affiliates

     —          —          —          —     
                                

Pretax income (loss)

     20,964        (656,171     (102,917     (1,018,352

Income tax provision (benefit)

     7,948        (221,988     (27,136     (357,713
                                

Net income (loss)

   $ 13,016      $ (434,183   $ (75,781   $ (660,639
                                

Cash and investments

   $ 3,919,403      $ 4,054,264       

Deferred policy acquisition costs

     28,674        11,554       

Total assets

     5,073,729        5,037,309       

Unearned premiums

     304,336        359,080       

Reserve for losses and loss adjustment expenses

     3,122,444        2,120,577       

Derivative liabilities

     23,086        308,543       

 

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Table of Contents

Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

     Three Months Ended
June 30
    Six Months Ended
June 30
 

Financial Guaranty (In thousands)

   2009     2008     2009     2008  

Net premiums written—insurance

   $ 6,982      $ 23,615      $ 1,779      $ 56,670   
                                

Net premiums earned—insurance

   $ 23,582      $ 44,041      $ 56,914      $ 81,697   

Net investment income

     20,951        26,187        45,889        53,307   

Change in fair value of derivative instruments

     278,875        31,053        23,035        667,093   

Net gains (losses) on other financial instruments

     41,794        (3,393     53,764        (14,673

Net impairment losses recognized in earnings

     —          (15,341     —          (22,210

Other income

     66        58        219        179   
                                

Total revenues

     365,268        82,605        179,821        765,393   
                                

Provision for losses

     (10,052     9,583        (4,982     21,286   

Provision for premium deficiency

     —          —          —          —     

Policy acquisition costs

     18,046        12,266        26,261        22,712   

Other operating expenses

     19,909        15,019        35,742        35,757   

Interest expense

     9,676        6,500        16,281        11,654   
                                

Total expenses

     37,579        43,368        73,302        91,409   
                                

Equity in net income of affiliates

     —          —          —          —     
                                

Pretax income

     327,689        39,237        106,519        673,984   

Income tax provision

     112,019        6,768        26,249        225,987   
                                

Net income

   $ 215,670      $ 32,469      $ 80,270      $ 447,997   
                                

Cash and investments

   $ 2,539,830      $ 2,481,133       

Deferred policy acquisition costs

     180,208        173,211       

Total assets

     3,259,249        3,166,316       

Unearned premiums

     816,023        688,984       

Reserve for losses and loss adjustment expenses

     181,792        167,165       

Derivative liabilities

     356,184        348,883       

 

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Table of Contents

Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

     Three Months Ended
June 30
   Six Months Ended
June 30

Financial Services (In thousands)

   2009    2008    2009    2008

Net premiums written—insurance

   $ —      $ —      $ —      $ —  
                           

Net premiums earned—insurance

   $ —      $ —      $ —      $ —  

Net investment income

     2      —        2      14

Change in fair value of derivative instruments

     —        —        —        —  

Net gains on other financial instruments

     —        39      —        37

Net impairment losses recognized in earnings

     —        —        —        —  

Other income

     74      164      235      166
                           

Total revenues

     76      203      237      217
                           

Provision for losses

     —        —        —        —  

Provision for premium deficiency

     —        —        —        —  

Policy acquisition costs

     —        —        —        —  

Other operating expenses

     136      127      211      360

Interest expense

     —        —        —        249
                           

Total expenses

     136      127      211      609
                           

Equity in net income of affiliates

     5,110      15,704      15,662      28,230
                           

Pretax income

     5,050      15,780      15,688      27,838

Income tax provision

     1,861      6,590      5,739      12,082
                           

Net income

   $ 3,189    $ 9,190    $ 9,949    $ 15,756
                           

Cash and investments

   $ —      $ —        

Deferred policy acquisition costs

     —        —        

Total assets

     122,524      205,792      

Unearned premiums

     —        —        

Reserve for losses and loss adjustment expenses

     —        —        

Derivative liabilities

     —        —        

A reconciliation of segment net income (loss) to consolidated net income (loss) is as follows:

 

     Three Months Ended
June 30
    Six Months Ended
June 30
 

Consolidated (In thousands)

   2009    2008     2009     2008  

Net income (loss):

         

Mortgage Insurance

   $ 13,016    $ (434,183   $ (75,781   $ (660,639

Financial Guaranty

     215,670      32,469        80,270        447,997   

Financial Services

     3,189      9,190        9,949        15,756   
                               

Total

   $ 231,875    $ (392,524   $ 14,438      $ (196,886
                               

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

3. Derivative Instruments and Hedging Activities

A summary of our derivative assets and liabilities, as of and for the periods indicated, is as follows. Certain contracts are in an asset position because the net present value of the contractual premium exceeds the net present value of our estimate of the expected future premiums that a financial guarantor of similar credit quality to us would charge to provide the same credit protection assuming a transfer of our obligation to such financial guarantor as of the measurement date.

 

Balance Sheets (In millions)

   June 30
2009
    December 31
2008
 

Derivative assets:

    

Financial Guaranty credit derivative assets

   $ 19.4      $ 22.8   

Net interest margin securities (“NIMS”) assets

     10.4        5.8   

Put options on Money Market committed preferred custodial trust securities (“CPS”)

     150.0        150.0   

Mortgage Insurance domestic and international credit default swaps (“CDS”) assets

     —          0.9   
                

Total derivative assets

     179.8        179.5   
                

Derivative liabilities:

    

Financial Guaranty credit derivative liabilities

     356.2        357.4   

NIMS liabilities (1)

     —          84.3   

Mortgage Insurance domestic and international CDS liabilities

     23.1        77.6   
                

Total derivative liabilities

     379.3        519.3   
                

Total derivative liabilities, net

   $ (199.5   $ (339.8
                

 

(1) All NIMS trusts required consolidation at June 30, 2009, resulting in the fair value being reported as variable interest entity (“VIE”) debt and derivative assets. The fair value of the VIE debt was $283.2 million and $160.0 million at June 30, 2009 and December 31, 2008, respectively.

Amounts set forth in the table above represent gross unrealized gains and gross unrealized losses on derivative assets and liabilities. The notional value of our derivative contracts at June 30, 2009 and December 31, 2008 was $50.3 billion and $51.8 billion, respectively.

The components of the gain (loss) included in change in fair value of derivative instruments are as follows:

 

     Three Months Ended
June 30
    Six Months Ended
June 30
 

Statements of Operations (In millions)

       2009             2008             2009             2008      

Net premiums earned—derivatives

   $ 14.5      $ 20.9      $ 29.2      $ 46.1   

Financial Guaranty credit derivative liabilities

     265.8        (13.1     (2.0     567.8   

NIMS

     (5.2     58.5        (9.5     155.0   

Mortgage Insurance domestic and international CDS

     (0.1     (38.9     (21.5     (71.2

Put options on CPS

     (0.9     30.6        (1.8     72.0   

Other

     (1.8     (1.8     (6.5     (5.7
                                

Change in fair value of derivative instruments

   $ 272.3      $ 56.2      $ (12.1   $ 764.0   
                                

 

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Table of Contents

Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

The application of SFAS No. 133, as amended, results in volatility from period to period in gains and losses as reported on our condensed consolidated statements of operations. Generally, these gains and losses result from changes in corporate credit or asset-backed spreads and changes in the creditworthiness of underlying corporate entities or the credit performance of the assets underlying an asset-backed security. Any incurred gains or losses on our financial guaranty contracts that are accounted for as derivatives are recognized as a change in the fair value of derivative instruments. Beginning in the first quarter of 2008, as required by the provisions of SFAS No. 157, we also incorporated our own non-performance risk into our fair valuation methodology. Our fair value estimates may result in significant volatility in our financial position or results of operations for future periods.

The following table shows selected information about our derivative contracts:

 

Product

   June 30 2009  
   Number of
Contracts
    Par/Notional
Exposure
    Total Net Asset/
(Liability)
 
     (In millions)  

Put options on CPS

   3      $ 150.0      $ 150.0   

NIMS related (1)

   —   (2)      —   (2)      10.4   

Corporate collateralized debt obligations (“CDOs”)

   101        37,467.5        (170.5

Non-Corporate CDOs and other derivative transactions:

      

Trust Preferred Securities (“TruPs”) on a first-to-pay basis

   18        2,166.0        (6.7

CDO of commercial mortgage-backed securities (“CMBS”)

   4        1,831.0        (37.2

CDO of asset-backed securities (“ABS”)

   2        621.3        (93.2

Other:

      

Structured finance (3)

   19        1,507.5        (11.4

Public finance

   28        1,579.5        (0.8
                      

Total Other

   47        3,087.0        (12.2
                      

Total Non-Corporate CDOs and other derivative transactions

   71        7,705.3        (149.3

Assumed financial guaranty credit derivatives:

      

Structured finance

   311        1,466.5        (14.8

Public finance

   16        308.2        (2.2
                      

Total Assumed

   327        1,774.7        (17.0

Mortgage Insurance international CDS

   2        3,247.2        (23.1
                      

Grand Total

   504      $ 50,344.7      $ (199.5
                      

 

(1) This represents NIMS VIE derivative assets and NIMS bonds purchased.
(2) NIMS related derivative assets represent assets associated with the consolidation of NIMS and does not represent additional exposure, as would be the case in a financial guaranty contract.
(3) Includes $166.8 million of TruPs in a second-to-pay position.

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

4. Fair Value of Financial Instruments

The following is a list of those assets and liabilities that are measured at fair value by hierarchy level as of June 30, 2009:

 

(In millions)

Assets and Liabilities at Fair Value

   Level I    Level II    Level III    Total    Investments
Not Carried
at Fair Value
    Total
Investments

Investment Portfolio:

  

U.S. government and agency securities

   $ —      $ 526.6    $ —      $ 526.6    $ —        $ 526.6

Municipal and state securities

     —        1,570.3      —        1,570.3      —          1,570.3

Money market instruments

     1,058.8      —        —        1,058.8      —          1,058.8

Corporate bonds

     —        1,080.1      —        1,080.1      —          1,080.1

Asset-backed securities

     —        1,316.7      7.1      1,323.8      —          1,323.8

Foreign government securities

     —        81.2      —        81.2      —          81.2

Hybrid securities

     —        449.6      0.4      450.0      —          450.0

Equity securities

     120.4      107.8      1.5      229.7      —          229.7

Other investments

     —        —        4.1      4.1      —          4.1
                                

Other investments not carried at fair value

                 70.1 (1)      70.1
                          

Total Investments

     1,179.2      5,132.3      13.1      6,324.6    $ 70.1      $ 6,394.7
                                          

Derivative Assets

     —        —        179.8      179.8     
                                

Total Assets at Fair Value

   $ 1,179.2    $ 5,132.3    $ 192.9    $ 6,504.4     
                                

Derivative Liabilities

   $ —      $ —      $ 379.3    $ 379.3     

VIE debt (2)

     —        —        283.2      283.2     
                                

Total Liabilities at Fair Value

   $ —      $ —      $ 662.5    $ 662.5     
                                

 

(1) Comprised of fixed-maturities held to maturity ($30.2 million carried at cost), short-term investments ($16.5 million), and other invested assets ($23.4 million) accounted for as equity-method investments and not measured at fair value.
(2) Represents consolidated debt issued by the NIMS VIE that required consolidation upon our becoming the primary beneficiary of the VIE.

 

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Table of Contents

Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

The following is a list of assets and liabilities that are measured at fair value by hierarchy level as of December 31, 2008:

 

(In millions)

Assets and Liabilities at Fair Value

  Level I   Level II   Level III   Total   Investments
Not Carried
at Fair Value
    Total
Investments

Investment Portfolio:

 

U.S. government and agency securities

  $ —     $ 159.8   $ —     $ 159.8   $ —        $ 159.8

Municipal and state securities

    —       3,607.0     —       3,607.0     —          3,607.0

Money market instruments

    836.7     —       —       836.7     —          836.7

Corporate bonds

    —       176.8     —       176.8     —          176.8

Asset-backed securities

    —       308.4     —       308.4     —          308.4

Foreign government securities

    —       64.9     —       64.9     —          64.9

Hybrid securities

    —       422.1     4.5     426.6     —          426.6

Equity securities

    117.3     72.5     0.8     190.6     —          190.6

Other investments

    —       1.4     5.1     6.5     —          6.5
                           

Other investments not carried at fair value

            204.2 (1)      204.2
                     

Total Investments

    954.0     4,812.9     10.4     5,777.3   $ 204.2      $ 5,981.5
                                     

Derivative Assets

    —       —       179.5     179.5    
                           

Total Assets at Fair Value

  $ 954.0   $ 4,812.9   $ 189.9   $ 5,956.8    
                           

Derivative Liabilities

  $ —     $ —     $ 519.3   $ 519.3    

VIE debt (2)

    —       —       160.0     160.0    
                           

Total Liabilities at Fair Value

  $ —     $ —     $ 679.3   $ 679.3    
                           

 

(1) Comprised of fixed-maturities held to maturity ($36.6 million carried at cost), short-term investments ($145.7 million), and other invested assets ($21.9 million) accounted for as equity-method investments and not measured at fair value.
(2) Represents consolidated debt issued by the NIMS VIE that required consolidation upon our becoming the primary beneficiary of the VIE.

The following table is a rollforward of Level III assets and liabilities measured at fair value for the quarter ended June 30, 2009:

 

(In millions)   Beginning
Balance at
April 1
2009
    Realized and Unrealized
Gains (Losses) Recorded
in Earnings
    Purchases, Sales,
Issuances &
Settlements
    Transfers Into
(Out of) Level III (1)
    Ending
Balance at
June 30
2009
 

Investments:

         

Asset-backed securities

  $ —        $ 0.1      $ 7.0      $ —        $ 7.1   

Hybrid securities

    0.4        —          —          —          0.4   

Equity Securities.

    1.4        0.2        —          (0.1     1.5   

Other investments

    4.4        —          (0.3     —          4.1   
                                       

Total Level III Investments

  $ 6.2      $ 0.3      $ 6.7      $ (0.1   $ 13.1   
                                       

Derivative liabilities, net

  $ (571.6   $ 276.4 (2)    $ 95.7      $ —        $ (199.5

NIMS VIE debt

    (206.5     (33.2     (43.5 )(3)      —          (283.2
                                       

Total Level III liabilities, net

  $ (778.1   $ 243.2      $ 52.2      $ —        $ (482.7
                                       

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

 

(1) Transfers are assumed to be made at the end of the period.
(2) All related to gains on derivatives still held at June 30, 2009.
(3) This amount primarily represents derivative liabilities transferred to VIE debt related to NIMS trusts that we were required to consolidate during the period.

The following is a rollforward of Level III assets and liabilities measured at fair value for the six months ended June 30, 2009:

 

(In millions)   Beginning
Balance at
January 1
2009
    Realized and Unrealized
Gains (Losses) Recorded
in Earnings
    Purchases, Sales,
Issuances &
Settlements
    Transfers Into
(Out of) Level III (1)
  Ending
Balance at
June 30
2009
 

Investments:

         

Asset-backed securities

  $ —        $ 0.1      $ 7.0      $ —     $ 7.1   

Hybrid securities

    4.5        4.8        (9.3     0.4     0.4   

Equity securities

    0.8        0.5        —          0.2     1.5   

Other investments

    5.1        0.1        (1.1     —       4.1   
                                     

Total Level III Investments

  $ 10.4      $ 5.5      $ (3.4   $ 0.6   $ 13.1   
                                     

Derivative liabilities, net

  $ (339.8   $ (3.6 )(2)    $ 143.9      $ —     $ (199.5

NIMS VIE debt

    (160.0     (27.0     (96.2 )(3)      —       (283.2
                                     

Total Level III liabilities, net

  $ (499.8   $ (30.6   $ 47.7      $ —     $ (482.7
                                     

 

(1) Transfers are assumed to be made at the end of the period.
(2) Of this amount, $9.9 million relates to losses on derivatives no longer held at June 30, 2009, and $6.3 million relates to gains on derivatives still held at June 30, 2009.
(3) This amount primarily represents derivative liabilities transferred to VIE debt related to NIMS trusts that we were required to consolidate during the period.

At June 30, 2009, our total Level III assets approximated 3.2% of total assets measured at fair value and our total Level III liabilities accounted for 100% of total liabilities measured at fair value. Realized and unrealized gains and losses on Level III assets and liabilities in the rollforward represent gains and losses for the periods in which they were classified as Level III.

The following table is a rollforward of Level III assets and liabilities measured at fair value for the quarter ended June 30, 2008:

 

(In millions)   Beginning
Balance at
April 1
2008
    Realized and Unrealized
Gains (Losses) Recorded
in Earnings
    Purchases, Sales,
Issuances &
Settlements
    Transfers Into
(Out of) Level III (1)
  Ending
Balance at
June 30
2008
 

Investments:

         

Corporate bonds

  $ —        $ —        $ —        $ 0.3   $ 0.3   

Hybrid securities

    —          —          1.0        —       1.0   

Equity securities

    0.1        —          —          0.9     1.0   

Other investments

    9.3        (1.9     0.7        —       8.1   
                                     

Total Level III Investments

  $ 9.4      $ (1.9   $ 1.7      $ 1.2   $ 10.4   
                                     

Derivative liabilities, net

  $ (470.7   $ 49.5      $ 14.8      $ —     $ (406.4

NIMS VIE debt

    (100.2     29.5        (15.0     —       (85.7
                                     

Total Level III liabilities, net

  $ (570.9   $ 79.0      $ (0.2   $ —     $ (492.1
                                     

 

(1) Transfers are assumed to be made at the end of the period.

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

The following table is a rollforward of Level III assets and liabilities measured at fair value for the six months ended June 30, 2008:

 

(In millions)   Beginning
Balance at
January 1
2008
    Unearned
Premiums
Reclass
January 1
2008 (1)
    Realized and
Unrealized
Gains
(Losses)
Recorded in
Earnings
    Purchases, Sales,
Issuances &
Settlements
    Transfers Into
(Out of)
Level III (2)
    Ending
Balance at
June 30
2008
 

Investments:

           

Corporate bonds

  $ —        $ —        $ —        $ —        $ 0.3      $ 0.3   

Hybrid securities

    6.7        —          —          1.0        (6.7     1.0   

Equity securities

    0.1        —          —          —          0.9        1.0   

Other investments

    12.1        —          (5.3     1.3        —          8.1   
                                               

Total Level II Investments

  $ 18.9        —        $ (5.3   $ 2.3      $ (5.5   $ 10.4   
                                               

Derivative liabilities, net

  $ (1,262.5   $ (23.3   $ 761.1      $ 118.3      $ —        $ (406.4

NIMS VIE debt

    —          —          29.5        (115.2     —          (85.7
                                               

Total Level III liabilities, net

  $ (1,262.5   $ (23.3   $ 790.6      $ 3.1      $ —        $ (492.1
                                               

 

(1) These unearned premiums were reclassified after adoption of an agreement with member companies of the Association of Financial Guaranty Investors (“AFGI”) in consultation with the staffs of the Office of the Chief Accountant and the Division of Corporate Finance of the SEC. This reclassification was implemented in order to increase comparability of our financial guaranty companies with derivative contracts.
(2) Transfers are assumed to be made at the end of the period.

The following table quantifies the impact of our non-performance risk on our derivative assets, derivative liabilities and NIMS VIE debt (in aggregate by type) presented in our condensed consolidated balance sheets. Our five-year CDS spread is representative of the market’s view of our non-performance risk; the CDS spread used in the valuation of these specific assets or liabilities is typically based on the remaining term of the instrument.

 

     January 1
2008
   June 30
2008
   December 31
2008
   June 30
2009

Radian Group five-year CDS spread

   628    2,530    2,466    1,598

(in basis points)

           

 

Product (In millions)

   Cumulative
Unrealized Gain
at December 31 2008
   Cumulative
Unrealized Gain
at June 30 2009

Corporate CDOs

   $ 4,197.1    $ 1,917.1

Non-Corporate CDOs

     948.7      830.3

NIMS and other

     440.0      266.0
             

Total

   $ 5,585.8    $ 3,013.4
             

The unrealized gain attributable to the market’s perception of our non-performance risk decreased by $2.6 billion during the first half of 2009, as presented in the table above. This decrease was primarily the result of the tightening of our CDS spread, which decreased by 868 basis points during the six months ended June 30, 2009.

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

VIE Debt-NIMS

NIMS VIE debt represents the consolidated NIMS trust obligations that we were required to consolidate in accordance with FASB Interpretation (“FIN”) 46R, “Consolidation of Variable Interest Entities (revised)—an interpretation of Accounting Research Bulletin (“ARB”) No. 51” (“FIN 46R”) as of June 30, 2009 and December 31, 2008. In 2008, we elected in accordance with SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”) to record at fair value the consolidated NIMS VIE debt. The VIE debt recorded represents our obligation to pay the NIMS guaranteed cash flows expected to be paid to the NIMS bondholders. At June 30, 2009, all NIMS trust obligations that we have guaranteed have been consolidated. The face value of our consolidated liability was $443.1 million and includes $24.8 million that has been issued by the consolidated trusts which is not guaranteed by us.

Other Fair Value Disclosure

On our condensed consolidated balance sheets, we disclose the carrying value and fair value of assets and liabilities which are reported at fair value. The carrying value and estimated fair value of other selected assets and liabilities that are not carried at fair value on our condensed consolidated balance sheets are as follows:

 

     June 30 2009    December 31 2008
(In millions)    Carrying
Amount
   Estimated
Fair Value
   Carrying
Amount
   Estimated
Fair Value

Assets:

           

Fixed-maturities held to maturity

   $ 30.2    $ 31.3    $ 36.6    $ 37.5

Short-term investments (carried at cost)

     16.5      16.5      145.7      145.7

Other invested assets.

     23.4      23.3      21.9      21.4

Liabilities:

           

Long-term debt and other borrowings

     856.8      423.8      857.8      410.6

Non-derivative financial guaranty liabilities

     653.3      807.3      800.3      756.9

Fixed-Maturity Held to Maturity—The fair values of fixed-maturity securities are obtained from independent pricing services that use observed market transactions, including broker-dealer quotes and actual trade activity as a basis for valuation.

Short-Term Investments Carried at Cost—The fair value of short-term investments carried at cost is estimated using market quotes or actual fair value estimates.

Other Invested Assets––The fair value of other invested assets is based on the present value of the estimated net future cash flows. The carrying value of equity-method investment and cost-method investments approximates fair value.

Long-Term Debt and Other Borrowings—The fair value is estimated based on the quoted market prices for the same or similar issue or on the current rates offered to us for debt of the same remaining maturities.

Non-Derivative Financial Guaranty Liabilities—We estimate the fair value of these non-derivative financial guarantees in accordance with SFAS No. 157 in a hypothetical market where market participants include other monoline mortgage and financial guaranty insurers with similar credit quality to us, assuming that the net liability related to these insurance contracts could be transferred to these other mortgage and financial guaranty insurance and reinsurance companies.

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

This fair value estimate of non-derivative financial guarantees includes direct and assumed contracts written, and is based on the difference between the present value of (1) the expected future contractual premiums and (2) the fair premium amount to provide the same credit protection assuming a transfer of our obligation to such guarantor as of the measurement date.

The key variables considered in estimating fair value include par amounts outstanding (including future periods for the estimation of future installment premiums), expected term, unearned premiums, expected losses and our CDS spread. Estimates of future installment premiums received are based on contractual premium rates.

With respect to the fair premium amount, SFAS No. 157 requires that the non-performance risk of a financial liability be included in the estimation of fair value. Accordingly, the fair premium amount for financial guarantee insurance contracts includes consideration of our credit quality as represented by our CDS spread.

Our ability to accurately estimate the fair value of our non-derivative financial guarantees is limited. There are no observable market data points as a result of the current disruption in the credit markets and we have experienced recent rating agency actions. These factors have significantly limited the amount of new financial guaranty business we have written recently. We believe that in the absence of a principal market, our estimate of fair value described above in a hypothetical market provides the most relevant information with respect to fair value estimates given the information currently available to us. Due to the volume and geographic diversification of our financial guaranty exposures, in the future we may need to consider other key variables that may influence the fair value estimate. Variables not currently incorporated in our current fair value estimate of non-derivative financial guarantees include the credit spreads of the underlying insured obligations, the underlying ratings of those insured obligations and assumptions about current financial guarantee premium levels relative to the underlying insured obligations’ credit spreads.

The carrying value of our non-derivative financial guaranty liabilities consists of unearned premiums, premiums receivable, deferred policy acquisition costs, and reserve for losses and LAE as reported on our condensed consolidated balance sheets.

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

5. Special Purpose Entities (“SPEs”)

The following is a summary of the financial impact on our condensed consolidated balance sheet, our condensed consolidated statement of operations and our condensed consolidated statement of cash flows as of and for the six months ended June 30, 2009, as it relates to VIEs in which we have a significant variable interest and qualified special purpose entities (“QSPEs”) sponsored by us:

 

     Significant Interests in VIEs     Sponsored QSPE  
(In millions)    NIMS     Financial Guaranty
Insurance and
Credit Derivatives
    CPS     International
CDS
    Smart Home  

Balance Sheet:

          

Reinsurance recoverables

   $ —        $ —        $ —        $ —        $ 96.3 (1) 

Derivative assets

     10.4        —          150.0        —          —     

Unearned premiums

     —          10.7        —          —          —     

Reserves for losses and LAE

     —          5.4        —          —          —     

Derivative liabilities

     —          —          —          23.1        —     

VIE consolidated debt

     283.2        —          —          —          —     

Other comprehensive income (loss) (“OCI”)

     —          —          —          (0.2     —     

Statement of Operations:

          

Change in fair value of derivative instruments—gain (loss)

     (8.5     —          (1.8     (10.3     —     

Provision for losses

     —          8.2        —          —          5.2 (2) 

Net gain on other financial instruments

     (25.5     —          —          —          —     

Net premiums earned

     0.5        1.9        —          0.4        (5.6

Cash Inflow (Outflow) Impact:

          

Net (payments) receipts related to credit derivatives

     (17.3 )(3)      —          (1.8     0.4        —     

Net receipts related to VIE consolidated debt

     0.4        —          —          —          —     

Premiums received (paid)

     —          1.7        —          —          (5.6

Losses paid.

     —          (6.1     —          —          —     

 

(1) Represents ceded loss reserves recorded as reinsurance loss recoverables.
(2) Represents ceded provision for losses.
(3) Represents the amount paid for interest and the amount paid for the purchase of NIMS bonds we insure, offset by premiums received.

For all VIEs in which we have a variable interest, we perform an evaluation to determine whether we are the primary beneficiary. In making this determination, we first qualitatively assess whether we have a sufficiently large variable interest in the VIE to be a potential primary beneficiary. In instances where it is not clear who the primary beneficiary is, we perform an analysis of the present value of expected losses to determine whether we would absorb more than 50% of those losses. Other than our NIMS transactions, we are not the primary beneficiary of any VIE as determined by our qualitative and quantitative analyses.

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

NIMS

As of June 30, 2009, the amount included in derivative assets and VIE debt related to the NIMS trusts was $10.4 million and $283.2 million, respectively. As of December 31, 2008, the amount included in derivative assets and VIE debt related to the NIMS trusts was $5.8 million and $160.0 million, respectively. We consolidate the assets and liabilities associated with these VIEs when we gain control over the trust assets and liabilities as a result of our contractual provisions. The consolidated NIMS assets are treated as derivatives in accordance with SFAS No. 133, and recorded at fair value. The consolidated NIMS VIE debt is recorded at fair value as allowed by SFAS No. 159.

As a risk mitigation initiative, we have purchased, at a discount to par, some of our insured NIMS bonds. The NIMS purchased are accounted for as derivative assets and are recorded at fair value in accordance with SFAS No. 133. Upon purchase, and prior to consolidation, our liability representing the unrealized loss associated with the purchased NIMS is eliminated. The difference between the amount we pay for the NIMS and the sum of the fair value of the NIMS and the eliminated liability represents the net impact to earnings. The overall impact to our consolidated results of operations as a result of these purchases has been immaterial.

The following is summary information related to all NIMS trusts as of the dates indicated:

 

     June 30, 2009    December 31, 2008

(In millions)

VIE Assets

   Total
NIMS
Trust
Assets
   Maximum
Principal
Exposure (1)
   Average
Rating of
Collateral
at Inception
   Total
NIMS
Trust
Assets
   Maximum
Principal
Exposure
   Average
Rating of
Collateral
at Inception

NIMS

   $ 539.8    $ 418.3    BBB to BB    $ 556.6    $ 438.3    BBB to BB

 

(1) Represents maximum exposure related to derivative liabilities and consolidated VIE assets and liabilities.

There was $418.3 million of risk in force associated with NIMS at June 30, 2009 comprised of 30 transactions. The average expiration of our existing NIMS transactions is approximately three years. At June 30, 2009, all of the NIMS transactions required consolidation in our condensed consolidated balance sheets.

Financial Guaranty Insurance and Credit Derivatives

The following table sets forth our financial guaranty total assets and maximum exposure to loss associated with VIEs in which we held significant variable interests:

 

     June 30 2009    December 31 2008
(In millions)    Total
Assets
   Maximum
Exposure
   Total
Assets
   Maximum
Exposure

Asset-Backed Obligations

   $ 2,106.1    $ 331.3    $ 2,349.6    $ 371.8

Other Structured Finance

     6,031.9      434.9      8,736.9      544.0
                           

Total

   $ 8,138.0    $ 766.2    $ 11,086.5    $ 915.8
                           

Put Options

In September 2003, our principal financial guaranty subsidiary, Radian Asset Assurance Inc. (“Radian Asset Assurance”), completed a transaction for $150 million of CPS, pursuant to which it entered into a series of three perpetual put options on its own preferred stock to Radian Asset Securities Inc. (“Radian Asset Securities”), our

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

wholly-owned subsidiary. Radian Asset Securities in turn entered into a series of three perpetual put options on its own preferred stock (on substantially identical terms to the Radian Asset Assurance preferred stock). The counterparties to the Radian Asset Securities put options are three trusts. The trusts were created as a vehicle for providing capital support to Radian Asset Assurance by allowing Radian Asset Assurance to obtain immediate access to additional capital at its sole discretion at any time through the exercise of one or more of the put options and the corresponding exercise of one or more corresponding Radian Asset Securities put options. Our put options are perpetual in nature, allowing us to put or call our preferred stock solely at our discretion and call our preferred stock subsequent to its issuance. Specifically, there is no limit to the number of times that Radian Asset Assurance (and, correspondingly, Radian Asset Securities) may put its preferred stock to Radian Asset Securities (and, correspondingly, from the custodial trusts), fully redeem its preferred stock from Radian Asset Securities (and, correspondingly, from the custodial trusts), and put it back to Radian Asset Securities (and, correspondingly, the custodial trusts).

If the Radian Asset Assurance put options were exercised, Radian Asset Securities, through the Radian Asset Assurance preferred stock thereby acquired, and investors, through their equity investment in the Radian Asset Securities preferred stock, would have rights to the assets of Radian Asset Assurance as an equity investor in Radian Asset Assurance. Such rights would be subordinate to policyholders’ claims, as well as to claims of general unsecured creditors of Radian Asset Assurance, but senior to any claim of Radian Guaranty Inc. (“Radian Guaranty”), as the owner of the common stock of Radian Asset Assurance. If all the Radian Asset Assurance put options were exercised, Radian Asset Assurance would receive up to $150 million in return for the issuance of its own perpetual preferred stock, the proceeds of which could be used for any purpose, including the payment of claims. Dividend payments on the preferred stock will be cumulative only if Radian Asset Assurance pays dividends on its common stock.

We performed an analysis of these trusts and determined that these trusts are significant variable interest entities which are evaluated under FIN 46R. Since we are not considered to be the primary beneficiary of these trusts under the FIN 46R framework, we do not consolidate these trusts; therefore, there is no impact to our consolidated balance sheets, statements of operations, statements in changes in common stockholders’ equity or statements of cash flows. The aggregate fair value of the put options is classified as a derivative asset, and changes in the fair value of the put options are classified as a change in fair value of derivative instruments.

International CDS

We provide credit enhancement in the form of credit default swaps in the international markets and have one international CDS transaction involving a VIE in which we have a significant interest. At June 30, 2009, total exposure to this international CDS transaction was $3.1 billion and our total derivative liability was $23.1 million. At December 31, 2008, our total exposure to this international CDS transaction was $3.2 billion and our total derivative liability was $14.2 million.

Sponsored QSPE—Smart Home

We have completed four Smart Home reinsurance transactions, with the last of these transactions closing in May 2006. Details of these transactions (aggregated) as of the initial closing of each transaction and as of June 30, 2009 are as follows:

 

     Initial    As of
June 30 2009

Pool of mortgages (par value)

   $ 14.7 billion    $ 4.8 billion

Risk in force (par value)

   $ 3.9 billion    $ 1.2 billion

Notes sold to investors/risk ceded (principal amount)

   $ 718.6 million    $ 557.6 million

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

6. Investments

Our investment portfolio consisted of the following at June 30, 2009 and December 31, 2008:

 

     Cost/Amortized
Cost
   Fair
Value
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
     (In thousands)

June 30, 2009:

           

Fixed-maturities held to maturity:

           

Bonds and notes:

           

State and municipal obligations

   $ 30,225    $ 31,308    $ 1,138    $ 55
                           
   $ 30,225    $ 31,308    $ 1,138    $ 55
                           

Fixed-maturities available for sale:

           

Bonds and notes:

           

U.S. government securities

   $ 81,351    $ 85,127    $ 3,776    $ —  

U.S. government-sponsored enterprises

     34,247      34,882      635      —  

State and municipal obligations

     1,692,527      1,481,445      12,101      223,183

Corporate

     173,266      170,761      4,006      6,511

Other securities available for sale:

           

Asset-backed securities

     297,181      293,776      5,381      8,786

Private placements

     14,719      13,718      360      1,361

Foreign governments

     78,075      78,814      1,444      705
                           
   $ 2,371,366    $ 2,158,523    $ 27,703    $ 240,546
                           

Short-term investments

   $ 1,081,948    $ 1,082,016    $ 101    $ 33
                           

Equity securities available for sale

   $ 217,585    $ 175,570    $ 1,867    $ 43,882
                           

Trading securities

   $ 2,460,768    $ 2,474,923    $ 37,217    $ 23,062
                           

Hybrid securities

   $ 469,239    $ 450,016    $ 17,511    $ 36,734
                           

Other invested assets

   $ 23,256    $ 23,406    $ 150    $ —  
                           

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

     Cost/Amortized
Cost
   Fair
Value
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
     (In thousands)

December 31, 2008:

           

Fixed-maturities held to maturity:

           

Bonds and notes:

           

State and municipal obligations

   $ 36,628    $ 37,486    $ 1,293    $ 435
                           
   $ 36,628    $ 37,486    $ 1,293    $ 435
                           

Fixed-maturities available for sale:

           

Bonds and notes:

           

U.S. government securities

   $ 81,636    $ 93,206    $ 11,739    $ 169

U.S. government-sponsored enterprises

     20,089      21,636      1,547      —  

State and municipal obligations

     3,235,053      2,977,919      54,768      311,902

Corporate

     176,085      169,510      2,974      9,549

Other securities available for sale:

           

Asset-backed securities

     310,269      307,150      8,416      11,535

Private placements

     13,652      12,992      522      1,182

Foreign governments

     62,703      64,856      2,216      63
                           
   $ 3,899,487    $ 3,647,269    $ 82,182    $ 334,400
                           

Short-term investments

   $ 1,029,167    $ 1,029,285    $ 118    $ —  
                           

Equity securities available for sale

   $ 212,620    $ 165,099    $ 1,011    $ 48,532
                           

Trading securities

   $ 670,835    $ 654,699    $ 7,118    $ 23,254
                           

Hybrid securities

   $ 499,929    $ 426,640    $ 7,530    $ 80,819
                           

Other invested assets

   $ 21,388    $ 21,933    $ 545    $ —  
                           

 

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Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

The following table shows the gross unrealized losses and fair value of our investments (in thousands), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.

 

     Less Than 12 Months    12 Months or Greater    Total

Description of Securities

   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
     (In thousands)

June 30, 2009:

                 

State and municipal obligations

   $ 172,797    $ 50,484    $ 1,082,526    $ 172,754    $ 1,255,323    $ 223,238

Corporate bonds and notes

     38,247      2,282      37,042      4,260      75,289      6,542

Asset-backed securities

     8,130      445      48,742      8,341      56,872      8,786

Private placements

     3,554      379      4,971      982      8,525      1,361

Foreign governments

     37,764      702      9,250      5      47,014      707

Equity securities

     124,368      34,169      37,553      9,713      161,921      43,882
                                         

Total

   $ 384,860    $ 88,461    $ 1,220,084    $ 196,055    $ 1,604,944    $ 284,516
                                         
     Less Than 12 Months    12 Months or Greater    Total

Description of Securities

   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
     (In thousands)

December 31, 2008

                 

U.S. government securities

   $ 6,981    $ 169    $ —      $ —      $ 6,981    $ 169

State and municipal obligations

     847,638      88,372      838,786      223,965      1,686,424      312,337

Corporate bonds and notes

     73,259      6,532      15,551      3,017      88,810      9,549

Asset-backed securities

     40,691      4,210      43,923      7,325      84,614      11,535

Private placements

     7,516      1,028      1,143      154      8,659      1,182

Foreign governments

     6,083      39      10,285      24      16,368      63

Equity securities

     150,584      48,532      —        —        150,584      48,532
                                         

Total

   $ 1,132,752    $ 148,882    $ 909,688    $ 234,485    $ 2,042,440    $ 383,367
                                         

The contractual maturity of securities in an unrealized loss position at June 30, 2009 was as follows:

 

(In thousands)    Fair Value    Amortized
Cost
   Unrealized
Losses

2009

   $ 12,272    $ 12,305    $ 33

2010—2013

     52,495      54,058      1,563

2014—2018

     78,084      81,877      3,793

2019 and later

     1,300,172      1,535,417      235,245

Equity securities

     161,921      205,803      43,882
                    

Total

   $ 1,604,944    $ 1,889,460    $ 284,516
                    

Effective with the adoption of FSP FAS 115-2 and FAS 124-2 on April 1, 2009, we analyzed our debt securities for impairment under the new FSP. In accordance with this new guidance, if an entity intends to sell or if it is more likely than not that it will be required to sell an impaired security prior to recovery of its amortized

 

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Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

cost basis, the security is other-than-temporarily impaired and the full amount of the impairment is recognized as a loss in the statement of operations. Otherwise, losses on securities which are other-than-temporarily impaired are separated into: (i) the portion of loss which represents the credit loss; and (ii) the portion which is due to other factors. The credit loss portion is recognized as a loss in the statement of operations while the loss due to other factors is recognized in other comprehensive income (loss), net of taxes and related amortization. The credit loss is determined to exist if the present value of cash flows expected to be collected from the security is less than the cost basis of the security. The present value of cash flows is determined using the original yield of the security. For securities held as of April 1, 2009 that have previously been other-than-temporarily impaired, a pre-tax transition adjustment of $33.1 million was booked to reclassify these impairments from retained earnings to other comprehensive income.

The following table provides a rollforward of the amount related to credit losses recognized in earnings for which a portion of an other-than-temporary impairment (“OTTI”) was recognized in OCI for the second quarter of 2009 (in thousands):

 

     Three Months Ended
June 30 2009

Debt securities credit losses, beginning balance at April 1, 2009

   $ 868

Additions:

  

Credit losses on previously impaired securities

     —  

Credit losses for which an OTTI was not previously recognized

     —  

Credit losses for which an OTTI was previously recognized

     —  

Reductions:

  

Credit losses on securities

     —  

Increases in expected cash flows on previously impaired securities

     —  

For securities sold during the period

     —  
      

Debt securities credit losses, ending balance at June 30, 2009

   $ 868
      

At June 30, 2009, we did not have the intent to sell any debt securities in an unrealized loss position, and determined that it is more likely than not that we will not be required to sell the securities before recovery of their cost basis.

In evaluating whether a decline in value is other-than-temporary, we consider several factors, including, but not limited to, the following:

 

   

the extent and the duration of the decline in value;

 

   

the reasons for the decline in value (credit event, interest related or market fluctuations);

 

   

the financial position and access to capital of the issuer, including the current and future impact of any specific events;

 

   

our intent to sell the security, or whether it is more likely than not that we will be required to sell it before recovery; and

 

   

the financial condition of and near term prospects of the issuer.

 

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Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

A debt security impairment is deemed other-than-temporary if:

 

   

we either intend to sell the security, or it is more likely than not that we will be required to sell the security before expected recovery of amortized cost; or

 

   

we will be unable to collect cash flows sufficient to recover the amortized cost basis of the security.

Impairments due to deterioration in credit that result in a conclusion that the present value of cash flows expected to be collected will not be sufficient to recover the amortized cost basis of the security are considered other-than-temporary. Other declines in fair value (for example, due to interest rate changes, sector credit rating changes or company-specific rating changes) that result in a conclusion that the present value of cash flows expected to be collected will not be sufficient to recover the amortized cost basis of the security may also result in a conclusion that an other-than-temporary impairment has occurred. To the extent we determine that a security is deemed to be other-than-temporarily impaired, an impairment loss is recognized.

We have securities that have been in an unrealized loss position for 12 months or more that we did not consider to be other-than-temporarily impaired due to the qualitative factors explained below.

State and municipal obligations

The unrealized losses of 12 months or greater duration as of June 30, 2009 on our investments in tax-exempt state and municipal securities were caused primarily by interest rate movement. Certain securities, mainly those insured by monoline insurance companies, experienced credit spread widening during 2008 and 2009 as a result of the deterioration in the financial condition of those monolines. Because as of June 30, 2009, we did not intend to sell these investments, nor did we believe we will more likely than not be required to sell before recovery of our amortized cost basis, which may be maturity, we did not consider these investments to be other-than-temporarily impaired at June 30, 2009.

Corporate bonds and notes

The unrealized losses of 12 months or greater duration as of June 30, 2009 on the majority of the securities in this category were caused by market interest rate movement. Certain securities, mainly those issued by financial firms with exposure to subprime residential mortgages, experienced spread widening during 2008 and 2009. Because as of June 30, 2009, we did not intend to sell these investments, nor did we believe we will more likely than not be required to sell before recovery of our amortized cost basis, which may be maturity, we did not consider these investments to be other-than-temporarily impaired at June 30, 2009.

Asset-backed securities

The unrealized losses of 12 months or greater duration as of June 30, 2009 on the securities in this category were caused by market interest rate movement. The ABS in our investments are primarily AAA rated senior tranche positions, collateralized by pools of credit card, auto loan and equipment lease receivables. The ratings of these investments are supported by credit enhancements which include financial guarantor insurance, subordination, over-collateralization and reserve accounts. Most of our ABS investments have retained AAA ratings. Because as of June 30, 2009, we did not intend to sell these investments, nor did we believe we will more likely than not be required to sell before recovery of our amortized cost basis, we did not consider the investment in these securities to be other-than-temporarily impaired at June 30, 2009.

 

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Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

Private placements

The unrealized losses of 12 months or greater duration as of June 30, 2009 on the majority of the securities in this category were caused by market interest rate movement. Because we did not intend to sell these investments, nor did we believe we will more likely than not be required to sell before recovery of our amortized cost basis, we did not consider the investment in these securities to be other-than-temporarily impaired at June 30, 2009.

Foreign governments

The unrealized losses of 12 months or greater duration as of June 30, 2009 on the majority of the securities in this category were caused by market interest rate movement. We believe that credit quality did not impact security pricing due to the relative high quality of the holdings (i.e., the majority of the securities were highly-rated governments and government agencies or corporate issues with minimum ratings of single-A). Because as of June 30, 2009, we did not intend to sell these investments, nor did we believe we will more likely than not be required to sell before recovery of our amortized cost basis, we did not consider these investments to be other-than-temporarily impaired at June 30, 2009.

For all investment categories, unrealized losses of less than 12 months in duration were generally attributable to interest rate or equity market indices movements. In addition, certain securities experienced spread widening due to issuers’ exposure to subprime residential mortgages. All securities were evaluated in accordance with our impairment recognition policy covering various time and price decline scenarios. Because as of June 30, 2009, we did not intend to sell these investments, nor did we believe we will more likely than not be required to sell before recovery of our amortized cost basis, we did not consider the investment in these securities to be other-than-temporarily impaired at June 30, 2009.

7. Investment in Affiliates

We own a 28.7% interest in Sherman Financial Group LLC (“Sherman”) and a 46% interest in Credit-Based Asset Servicing and Securitization LLC (“C-BASS”), each of which are credit-based consumer asset businesses. As a consequence of the complete write-off of our investment in C-BASS in 2007, we have no continuing interest of value in C-BASS. All of C-BASS’s business is currently in run-off and we anticipate that all future cash flows of C-BASS will be used to service the outstanding debt. The likelihood that we will recoup any of our investment is extremely remote. Accordingly, we believe that the likelihood that our investment in C-BASS will have anything more than a negligible impact on our financial position, results of operations or cash flows at any time in the future is extremely remote.

The following table shows the components of our investment in affiliates balance:

 

(In thousands)    June 30
2009
   December 31
2008

Sherman

   $ 108,719    $ 99,656

Other

     48      56
             

Total

   $ 108,767    $ 99,712
             

 

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Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

     Three Months Ended
June 30
    Six Months Ended
June 30
 
(In thousands)    2009    2008     2009     2008  

Investment in Affiliates-Selected Information:

         

Sherman

         

Balance, beginning of period

   $ 103,236    $ 116,929      $ 99,656      $ 104,315   

Share of net income for period

     5,110      15,704        15,662        28,230   

Dividends received

     —        19,499        6,441        19,499   

Other comprehensive income

     373      (490     (158     (402
                               

Balance, end of period

   $ 108,719    $ 112,644      $ 108,719      $ 112,644   
                               

Portfolio Information:

         

Sherman

         

Total assets

   $ 2,103,158    $ 2,432,122       

Total liabilities

     1,696,471      1,960,667       

Summary Income Statement:

         

Sherman

         

Income

         

Revenues from receivable portfolios—net of amortization

   $ 311,446    $ 382,783      $ 653,714      $ 772,487   

Other revenues

     389      5,381        5,842        12,972   

Derivative mark-to-market

     8,614      10,210        8,927        4,883   
                               

Total revenues

     320,449      398,374        668,483        790,342   
                               

Expenses

         

Operating and servicing expenses

     129,483      177,882        278,090        370,372   

Provision for loan losses

     95,606      105,571        208,848        209,311   

Interest

     28,263      25,230        53,367        48,812   

Other

     32,627      11,938        53,705        20,147   
                               

Total expenses

     285,979      320,621        594,010        648,642   
                               

Net income

   $ 34,470    $ 77,753      $ 74,473      $ 141,700   
                               

8. Reserve for losses and LAE—Mortgage Insurance

The following table reconciles our mortgage insurance segment’s beginning and ending reserves for losses and LAE for the three and six months ended June 30, 2009:

 

(In thousands)    Three Months Ended
June 30 2009
   Six Months Ended
June 30 2009

Mortgage Insurance

     

Balance at beginning of period

   $ 3,116,553    $ 2,989,994

Less Reinsurance recoverables

     536,777      491,836
             

Balance at beginning of period, net

     2,579,776      2,498,158

Add total losses and LAE incurred in respect of default notices reported and unreported

     142,802      464,486

Deduct total losses and LAE paid

     167,685      407,751
             

Balance at end of period, net

     2,554,893      2,554,893

Add Reinsurance recoverables

     567,551      567,551
             

Balance at end of period

   $ 3,122,444    $ 3,122,444
             

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

We have protected against some of the losses that may occur related to riskier products, including non-prime products, by reinsuring our exposure through transactions (referred to as “Smart Home”) that effectively transfer risk to investors in the capital markets. Smart Home ceded losses recoverable were $96.3 million at June 30, 2009. In addition to Smart Home, we transfer a portion of our primary mortgage insurance risk to captive reinsurance companies affiliated with our lender-customers. Ceded losses recoverable related to captive transactions were $471.3 million at June 30, 2009. The change in reinsurance recoverables on Smart Home and captive transactions is reflected in our provision for losses.

While we have experienced an increase in outstanding delinquencies in the quarter, the effect of this increase on reserves for losses and LAE was substantially offset by an increase in expected insurance rescissions and claim denials on insured loans. Our loss mitigation efforts to review more claims have resulted in higher rescissions and denials than we have experienced in the past, which is reflected in our estimate of reserves for losses and LAE at June 30, 2009. Our default to claim rate decreased from 46% at December 31, 2008 to 37% at June 30, 2009, primarily as a result of our estimate of expected rescissions and denials. The increase in rescissions and denials may lead to an increased risk of litigation by the lenders and policyholders challenging our right to rescind coverage or deny claims. Such challenges may be made several years after we have rescinded insurance or denied a claim. Although we believe that our rescissions and denials are valid under our policies, if we are not successful in defending the rescissions and denials in any potential legal action, we may need to reassume the risk on, and reestablish loss reserves for, those loans.

We considered the sensitivity of mortgage insurance loss reserve estimates at June 30, 2009 by assessing the potential changes resulting from a parallel shift in severity and default to claim rate. For example, assuming all other factors remain constant, for every one percentage point change in claim severity (28% of unpaid principal balance at June 30, 2009), we estimated that our loss reserves would change by approximately $121 million at June 30, 2009. For every one percentage point change in our default to claim rate (37% at June 30, 2009, including our assumptions related to rescissions and denials), we estimated a $90 million change in our loss reserves at June 30, 2009.

9. Reserve for Premium Deficiency

We perform a quarterly evaluation of our expected profitability for our existing mortgage insurance portfolio, by business line, over the remaining life of the portfolio. A premium deficiency reserve (“PDR”) is established when the present value of expected losses and expenses for a particular product line exceeds the present value of expected future premiums and existing reserves for that product line. We consider first- and second-lien products separate lines of business as each product is managed separately, priced differently and has a different customer base.

As of June 30, 2009, the net present value of expected losses and expenses on our first-lien business was $3.8 billion, offset by the present value of expected premiums of $2.4 billion and already established reserves (net of reinsurance recoverables) of $2.5 billion. Because the combination of the net present value of expected premiums and already established reserves (net of reinsurance recoverables) exceeds the net present value of expected losses and expenses, a first-lien PDR was not required as of June 30, 2009. Expected losses are based on an assumed paid claim rate of approximately 12% on our total primary first-lien mortgage insurance portfolio, including 8% on prime, 32% on subprime and 23% on Alternative-A (“Alt-A”). While deterioration in the macroeconomic environment has resulted in an increase in expected losses, new business originated during the second half of 2008 and first half of 2009 is expected to be profitable, which has contributed to the overall expected net profitability of our first-lien portfolio. In addition, an increase in expected rescissions and denials on

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

insured loans as part of our loss mitigation efforts is expected to offset the impact of expected defaults and claims to some extent.

Numerous factors affect our ultimate paid claim rates, including home price depreciation, unemployment, the impact of our loss mitigation efforts and interest rates, as well as potential benefits associated with recently announced lender and governmental initiatives to modify loans and ultimately reduce foreclosures. To assess the need for a PDR on our first-lien mortgage insurance portfolio, we develop loss projections based on modeled loan defaults in our current risk in force. This projection is based on recent trends in default experience, severity, and rates of delinquent loans moving to claim (such default to claim rates are net of our estimates of rescissions and denials), as well as recent trends in prepayment speeds. As of June 30, 2009, our modeled loan default projections assume that recent observed default rates will increase through the end of 2009, will remain stable through the middle of 2010, and will gradually return to normal historical levels over the subsequent two years. If our modeled loan default projections were stressed such that recent observed increases in defaults were to continue until the end of 2010, remain stable through the middle of 2012, and gradually return to normal historical levels over the subsequent three years, we estimate that the combination of the net present value of expected premiums and already established reserves (net of reinsurance recoverables) would exceed the net present value of expected losses and expenses by approximately $0.6 billion; therefore, no PDR would be required in this scenario.

During 2009, our second-lien PDR decreased by approximately $46.0 million to $40.9 million as a result of the transfer of premium deficiency reserves to loss reserves, offset by a slight increase in expected future losses. The net present value of expected losses and expenses on our second-lien business at June 30, 2009 was $146.5 million, partially offset by the net present value of expected premiums of $13.3 million and already established reserves of $99.0 million.

The following table reconciles our mortgage insurance segment’s beginning and ending second-lien PDR for the three and six months ended June 30, 2009 (in thousands):

 

Second-lien PDR:

   Three Months Ended
June 30 2009
    Six Months Ended
June 30 2009
 

Balance at beginning of period

   $ 38,677      $ 86,861   

Incurred losses recognized in loss reserves

     (4,458     (65,997

Premiums recognized in earned premiums

     2,150        3,385   

Changes in underlying assumptions

     7,154        20,260   

Accretion of discount and other

     (2,662     (3,648
                

Balance at end of period

   $ 40,861      $ 40,861   
                

10. Financial Guaranty Insurance Contracts

In January 2009, we adopted SFAS No. 163 for all non-derivative financial guaranty insurance policies. SFAS No. 163 requires that an insurance enterprise recognize a claim liability prior to an event of default (insured event) when there is evidence that credit deterioration has occurred in an insured financial obligation, and when the present value of the expected claim loss will exceed the unearned premium revenue. The expected claim loss is based on the probability-weighted present value of expected net cash outflows to be paid under the policy. In measuring the claim liability, we develop the present value of expected net cash outflows by using our own assumptions about the likelihood of all possible outcomes, based on information currently available. We determine the existence of payment defaults on directly insured policies based on periodic reporting from the

 

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Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

insured party, indenture trustee or servicer, or based on our surveillance efforts. The expected cash outflows are discounted using the risk-free rate at the time the claim liability is initially recognized. Our assumptions about the likelihood of outcomes, expected cash outflows and the appropriate risk-free rate are updated each reporting period. For assumed policies, we rely on information provided by the primary insurer as confirmed by us, as well as our specific knowledge of the credit, for determining expected loss.

SFAS No. 163 requires that an insurance enterprise record the initial unearned premium liability on installment policies equal to the present value of the premiums due or expected to be collected over either the period of the policy or the expected period of risk. In determining the present value of premiums due, we use a discount rate that reflects the risk-free rate as of the implementation date of SFAS No. 163. Under SFAS No. 163, premiums paid in full at inception are recorded as unearned premiums. Consequently, unearned premiums, premiums receivable and deferred acquisition costs increased by $263.5 million, $161.4 million and $62.3 million, respectively, and retained earnings decreased by $28.8 million, net of tax upon the implementation of SFAS No. 163.

In addition, SFAS No. 163 requires the recognition of the remaining unearned premium revenue when bonds issued are redeemed or otherwise retired (a “refunding”) that results in the extinguishment of the financial guaranty policies insuring such bonds. A refunding that is effected through the deposit of cash or permitted securities into an irrevocable trust for repayment when permitted under the applicable bond indenture (a “legal defeasance”) does not qualify for immediate revenue recognition since the defeased obligation legally remains outstanding and covered by our insurance. Consequently, $3.6 billion of net par outstanding on defeased refundings was reversed upon the implementation of SFAS No. 163. As a result, unearned premiums and deferred acquisition costs increased by $29.3 million and $3.7 million, respectively, and retained earnings decreased by $17.0 million, net of tax.

The risk management function in our financial guaranty business is responsible for the identification, analysis, measurement and surveillance of credit, market, legal and operational risk associated with our financial guaranty insurance contracts. Risk management, working with our legal group, is also primarily responsible for claims prevention and loss mitigation strategies. This discipline is applied at the point of origination of a transaction and during the ongoing monitoring and surveillance of each exposure in the portfolio.

There are both performing and non-performing credits in our financial guaranty portfolio. Performing credits generally have investment-grade internal ratings. However, claim liabilities could be established for performing credits if the expected losses on the credit exceed the unearned premium revenue for the contract based on the present value of the expected net cash outflows. When our risk management department concludes that a directly insured transaction should no longer be considered performing, it is placed in one of three designated categories for deteriorating credits: Special Mention, Intensified Surveillance or Case Reserve. Assumed exposures in financial guaranty’s reinsurance portfolio are generally placed in one of these categories if the primary insurer for such transaction downgrades it to an equivalent watch list classification. However, if our financial guaranty risk management group disagrees with the risk rating assigned by the ceding company, we may assign our own risk rating rather than using the risk rating assigned by the ceding company.

Our risk management department uses internal ratings in monitoring our insured transactions. We determine our internal ratings for a transaction by utilizing all relevant information available to us, including: periodic reports supplied by the issuer, trustee or servicer for the transaction; publicly available information regarding the issuer, the transaction, 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,

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

public or private ratings assigned to our insured transactions or to other obligations that have substantially similar risk characteristics to our transactions without the benefit of financial guaranty or similar credit insurance. When we deem it appropriate, we also utilize nationally recognized rating agency models and methodologies 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 rating agency opinion and analysis. When our analyses 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 rating agency.

Our rating scale is comparable to the rating scales utilized by the nationally recognized rating agencies (Standard & Poor’s Rating Service (“S&P”) and Moody’s Investor Service (“Moody’s”)), meaning that an obligation with an internal rating comparable to that of the rating agencies (e.g. AAA internally versus AAA by S&P or Aaa by Moody’s) has approximately the equivalent credit quality indicated by such a rating. Our internal ratings estimates are subject to revision at any time and may differ from the credit ratings ultimately assigned by the rating agencies.

The initial impact of the adoption of SFAS No. 163 on January 1, 2009, on our condensed consolidated financial statements is shown in the table below (in millions):

 

Increase in unearned premiums

   $ (292.8

Increase in premiums receivable

     161.4   

Increase in deferred policy acquisition costs

     66.0   

Decrease in reserves for losses and LAE

     8.2   

Decrease in deferred income taxes, net

     20.2   

Increase in premium taxes payable

     (0.6
        

Decrease in retained earnings, net of taxes

   $ (37.6
        

The following table includes additional information as of June 30, 2009 regarding our financial guaranty claim liabilities segregated by the surveillance categories described above:

Surveillance Categories

 

($ in millions)

  Performing   Special
Mention
  Intensified
Surveillance
  Case
Reserve
  Total

Number of policies

    70     195     103     75     443

Remaining weighted-average contract period (in years)

    20     18     26     28     22

Insured contractual payments outstanding:

         

Principal

  $ 610.5   $ 1,301.6   $ 1,039.0   $ 543.2   $ 3,494.3

Interest

    435.9     526.1     855.0     407.1     2,224.1
                             

Total

  $ 1,046.4   $ 1,827.7   $ 1,894.0   $ 950.3   $ 5,718.4
                             

Gross claim liability

  $ 27.8   $ 16.7   $ 136.5   $ 146.4   $ 327.4

Less:

         

Gross potential recoveries

    16.3     6.7     35.1     51.9     110.0

Discount, net

    2.2     2.7     17.2     2.3     24.4
                             

Net claim liability

  $ 9.3   $ 7.3   $ 84.2   $ 92.2   $ 193.0
                             

Unearned premium revenue

  $ 7.8   $ 32.0   $ 30.8   $ —     $ 70.6
                             

Claim liability reported in the balance sheet

  $ 4.4   $ 1.9   $ 73.0   $ 92.2   $ 171.5
                             

Reinsurance recoverables

  $ ––   $ —     $ —     $ —     $ —  
                             

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

Included in accounts and notes receivable and unearned premiums on our condensed consolidated balance sheets are the present value of premiums receivable and unearned premiums that are received on an installment basis. The premiums receivable is net of commissions on assumed reinsurance business. The present value of the premiums receivable and unearned premiums as of January 1, 2009 and June 30, 2009 are as follows (in millions):

 

     January 1
2009
   June 30
2009

Premiums receivable

   $ 161.4    $ 154.0

Unearned premiums

     223.3      201.0

These premiums receivable and unearned premium amounts include those associated with the Ambac policies that were commuted in July 2009. See Note 16 for further information.

The accretion of these balances is included in premiums written and premiums earned for premiums receivable and policy acquisition costs for commissions on our condensed consolidated statement of operations. The amount of the accretion included in premiums written, premiums earned and policy acquisition costs for the three and six months ended June 30, 2009 is as follows (in millions):

 

     Three Months
Ended

June 30 2009
   Six Months
Ended

June 30 2009

Premiums written

   $ 1.2    $ 2.5

Premiums earned

     1.2      2.5

Policy acquisition costs

     0.4      0.7

The weighted-average risk-free rate used to discount the premiums receivable and premiums to be collected was 2.45% at June 30, 2009.

The following table shows the nominal (non-discounted) premiums net of commissions that are expected to be collected (without giving effect to the Ambac Commutation described below) on financial guaranty contracts with installment premiums included in premiums receivable as of June 30, 2009 (in millions):

 

     

Future
Expected
Premium
Payments

Third Quarter 2009

   $ 4.4

Fourth Quarter 2009

     4.4
      

Total 2009

     8.8

2010

     16.6

2011

     12.4

2012

     10.0

2013

     11.5
      

2009-2013

     59.3

2014-2018

     44.7

2019-2023

     31.3

2024-2028

     25.0

After 2028

     39.0
      

Total

   $ 199.3
      

 

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Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

The following table shows the rollforward of the net present value of premiums receivable as of June 30, 2009 (in millions):

 

     Premiums
Receivable
 

Balance at beginning of period

   $ 161.4   

Payments received

     (10.2

Accretion

     1.8   

Adjustments to installment premiums

     (0.1

Foreign exchange revaluation

     1.1   
        

Balance at end of period

   $ 154.0   
        

Premiums earned were affected by the following for the three and six months ended June 30, 2009 (in millions):

 

     Three Months
Ended
June 30 2009
    Six Months
Ended
June 30 2009
 

Refundings

   $ 10.5      $ 23.5   

Recaptures/Commutations (1)

     (15.0     (15.0

Unearned premium acceleration upon establishment of case reserves

     0.6        5.8   

Foreign exchange revaluation, gross of commissions

     2.4        1.1   

Adjustments to installment premiums, gross of commissions

     6.9        3.2   
                

Total adjustment to premiums earned

   $ 5.4      $ 18.6   
                

 

(1) Primarily Ambac Commutation.

 

The following table shows the expected contractual premium revenue from our existing financial guaranty portfolio, assuming no prepayments or refunding of any financial guaranty obligations and without giving effect to the Ambac Commutation (See Note 16 for further information), as of June 30, 2009:

 

(In millions)    Ending Net
Unearned
Premiums
   Unearned
Premium
Amortization
   Accretion    Total
Premium
Earnings

Third Quarter 2009

   $ 799.5    $ 16.5    $ 1.3    $ 17.8

Fourth Quarter 2009

     783.5      16.0      1.2      17.2
                           

Total 2009

     783.5      32.5      2.5      35.0

2010

     722.8      60.7      4.7      65.4

2011

     666.2      56.6      4.4      61.0

2012

     612.6      53.6      4.2      57.8

2013

     561.9      50.7      3.9      54.6
                           

2009 – 2013

     561.9      254.1      19.7      273.8

2014 – 2018

     347.2      214.7      16.0      230.7

2019 – 2023

     196.7      150.5      11.5      162.0

2024 – 2028

     97.4      99.3      7.8      107.1

After 2028

     —        97.4      8.0      105.4
                           

Total

   $ —      $ 816.0    $ 63.0    $ 879.0
                           

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

The following table shows the significant components of the change in our financial guaranty claim liability as of June 30, 2009 (in millions):

 

     Three Months
Ended

June 30 2009
    Six Months
Ended
June 30 2009
 

Claim liability, beginning of period

   $ 203.6      $ 211.5   
                

Incurred losses and LAE:

    

Increase in gross claim liability

     49.9        100.7   

Adjustment to net claim liability for Ambac Commutation

     (38.6     (38.6

Increase in gross potential recoveries

     (11.2     (40.9

Increase in discount

     (4.9     (19.8

Increase in unearned premiums

     (3.6     (3.0
                

Incurred losses and LAE

     (8.4     (1.6

Paid losses and LAE

     (23.7     (38.4
                

Claim liability, end of period

   $ 171.5      $ 171.5   
                

Components of incurred losses and LAE:

    

Claim liability established in current period

   $ 15.6      $ 35.5   

Changes in existing claim liabilities

     (24.0     (37.1
                

Total incurred losses and LAE

   $ (8.4   $ (1.6
                

Weighted-Average Risk-Free Rates (used for discounting gross claim liability and gross potential recoveries):

 

January 1, 2009

   2.53

March 31, 2009

   3.25

June 30, 2009

   4.07

 

(In millions)    Three Months
Ended
June 30 2009
    Six Months
Ended
June 30 2009
 

Components of increase in discount:

    

Increase in discount related to claim liabilities established in current period

   $ (7.8   $ (11.2

Decrease (increase) in discount related to existing claim liabilities

     2.9        (8.6
                

Total increase in discount

   $ (4.9   $ (19.8
                

On July 20, 2009, Radian Asset Assurance entered into a commutation and release agreement with Ambac Assurance Corporation and Ambac Assurance UK Limited (collectively, “Ambac”). Under this agreement, on July 24, 2009, Radian Asset Assurance paid a $100 million settlement payment to Ambac to commute $9.8 billion of Radian Asset Assurance net par outstanding assumed from Ambac (the “Ambac Commutation”). The risk commuted under this agreement represents 99.7% of Radian Asset Assurance’s reinsured portfolio with Ambac, 26.2% of Radian Asset Assurance’s total reinsurance portfolio and 9.8% of Radian Asset Assurance’s total insured portfolio, in each case as of June 30, 2009. The Ambac Commutation also reduced Radian Asset Assurance’s financial guaranty exposure to mortgage-backed securities (“MBS”) by 41.9%.

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

We have adjusted certain estimates in our June 30, 2009 financial statements as a result of this commutation. The impact on our financial statements at June 30, 2009 related to the Ambac Commutation is as follows:

 

Statement of Operations

      
(In millions)       

Increase (decrease) in:

  

Net premiums earned

   $ (15.3

Policy acquisition costs

     8.9   

Provision for losses

     (38.6
        

Pre-tax income

   $ 14.4   
        

The decrease in our reserve for losses and LAE at June 30, 2009 is primarily related to the decrease in expected claim payments on policies that have been commuted to Ambac.

 

11. Comprehensive Income (Loss)

Our total comprehensive income (loss), as calculated per SFAS No. 130, “Reporting Comprehensive Income” (“SFAS No. 130”) was as follows (in thousands):

 

     Three Months Ended
June 30
    Six Months Ended
June 30
 
     2009    2008     2009    2008  

Net income (loss), as reported

   $ 231,875    $ (392,524   $ 14,438    $ (196,886

Other comprehensive income (loss) (net of tax)

          

Net unrealized gains (losses) on investments

     22,919      (17,285     50,214      (74,515

Unrealized foreign currency translation adjustment

     6,146      (1,820     2,215      4,133   
                              

Comprehensive income (loss)

   $ 260,940    $ (411,629   $ 66,867    $ (267,268
                              

 

12. Income Taxes

We provide for income taxes in accordance with the provisions of SFAS No. 109, “Accounting for Income Taxes” (“SFAS No. 109”). As required under SFAS No. 109, our deferred tax assets and liabilities are recognized under the balance sheet method which recognizes the future tax effect of temporary differences between the amounts recorded in our condensed consolidated financial statements and the tax bases of these amounts. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the periods in which the deferred tax asset or liability is expected to be realized or settled.

Given the uncertainty of the impact of gains and losses on our financial instruments on our pre-tax loss projected for the full year, which directly affects our ability to project an effective tax rate for the full year, we book our income tax expense based on the actual results of operations as of June 30, 2009.

For federal income tax purposes, we have approximately $471.5 million of net operating loss carryforwards as of June 30, 2009. To the extent not utilized, approximately $303.5 million and $168.0 million of the net operating loss carryforwards will expire during tax years 2028 and 2029, respectively.

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

As of June 30, 2009, we have a net deferred tax asset (“DTA”) in the amount of $368.3 million. We believe that it is more likely than not that these assets will be realized. As such, no valuation allowance was established. The following factors were considered in reaching this conclusion:

 

   

Approximately $119.7 million of the net DTA relates to mark-to-market losses on our financial guaranty derivative instruments, which we expect will result in very limited or no claim payments. We have the ability and intent to hold these instruments until maturity and believe that the associated DTA will reverse over time as credit spreads relating to these instruments improve and their duration approaches maturity.

 

   

Approximately $84.1 million of the net DTA relates to available for sale securities in our fixed-maturity investment portfolio for which we have recorded unrealized losses as a separate component of other comprehensive income. We have the ability and intent to hold these securities to recovery or maturity.

 

   

We believe that a viable tax planning strategy exists for moving from tax-exempt investments to taxable investments and that such a plan will provide for higher yielding securities with fully taxable interest which would provide a significant source of future taxable income. While we have already reduced the level of tax-exempt investments within our investment portfolio, this strategy would be fully committed to and implemented, if necessary, and could generate a sufficient amount of additional taxable income over the loss carryforward period allowed under the Internal Revenue Code (“IRC”) to recover our remaining DTA balance.

The need for a valuation allowance will continue to be reviewed on a quarterly basis and no assurances can be made with regard to whether a valuation allowance will be needed in the future.

 

13. Recent Accounting Pronouncements

In May 2009, the FASB issued Statement No. 165, “Subsequent Events” (“SFAS No. 165”). SFAS No. 165 establishes principles and requirements for subsequent events. In particular, it sets forth (i) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and (iii) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. SFAS No. 165 is effective for all financial statements issued for interim and annual periods ending after June 15, 2009. We adopted SFAS No. 165 effective June 30, 2009.

In June 2009, the FASB issued Statement No. 166, “Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140” (“SFAS No. 166”). SFAS No. 166 improves the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement in transferred financial assets. Specifically, this statement removes the concept of a qualifying special purpose entity from Statement 140 and removes the exception from applying FIN 46. Enhanced disclosures are required to provide financial statement users with greater transparency about transfers of financial assets and a transferor’s continuing involvement with transferred financial assets. SFAS No. 166 is effective as of the beginning of the first annual reporting period beginning after November 15, 2009. Management is currently evaluating the impact that may result from the adoption of SFAS No. 166.

In June 2009, the FASB issued Statement No. 167, “Amendments to FASB Interpretation No. 46R” (“SFAS No. 167”). SFAS No. 167 carries forward the scope of FIN 46R, with the addition of entities previously

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

considered QSPEs. It also amends certain guidance in FIN 46R for determining whether an entity is a VIE. Application of this revised guidance may change an enterprise’s assessment of which entities with which it is involved are VIEs. Ongoing reassessment of whether an enterprise is the primary beneficiary of a VIE is required, and the quantitative approach previously required for determining the primary beneficiary of a VIE is eliminated. The quantitative approach was based on determining which enterprise absorbs the majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both. SFAS No. 167 requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a VIE. This analysis identifies the primary beneficiary of a VIE as the enterprise that has both (i) the power to direct the activities of a VIE that most significantly impacts the entity’s economic performance and (ii) the obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE. SFAS No. 167 is effective as of the beginning of the first annual reporting period beginning after November 15, 2009. Management is currently evaluating the impact that may result from the adoption of SFAS No. 167.

In June 2009, the FASB issued Statement No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles—a replacement of FASB Statement No. 162.” The FASB Accounting Standards Codification, or the “Codification,” will become the single source of authoritative United States accounting and reporting standards applicable for all non-governmental entities, with the exception of the SEC and its staff. The Codification, which changes the referencing of financial standards, is effective for interim or annual financial periods ending after September 15, 2009. Therefore, in the third quarter of 2009, all references made to GAAP will use the new Codification numbering system prescribed by the FASB. As the Codification is not intended to change or alter existing GAAP, it is not expected to have any impact on our consolidated financial position or results of operations.

 

14. Selected Financial Information of Registrant—Radian Group Inc.

The following is selected financial information for Radian Group:

 

(In thousands)    June 30
2009
   December 31
2008

Investment in subsidiaries, at equity in net assets

   $ 3,147,689    $ 3,112,028

Total assets

     3,401,527      3,226,687

Long-term debt and other borrowings

     856,848      857,802

Total liabilities

     1,335,273      1,195,977

Total stockholders’ equity

     2,066,254      2,030,710

Total liabilities and stockholders’ equity

     3,401,527      3,226,687

 

15. Commitments and Contingencies

As previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2008, in August and September 2007, two purported stockholder class action lawsuits, Cortese v. Radian Group Inc. and Maslar v. Radian Group Inc., were filed against Radian Group and individual defendants in the U.S. District Court for the Eastern District of Pennsylvania. The complaints, which are substantially similar, allege that we were aware of and failed to disclose the actual financial condition of C-BASS prior to our declaration of a material impairment to our investment in C-BASS. On January 30, 2008, the court ordered that the cases be consolidated into In re Radian Securities Litigation. On April 16, 2008, a consolidated and amended complaint was filed, adding one additional defendant. On June 6, 2008, we filed a motion to dismiss this case, which was granted on April 9, 2009. On April 22, 2009, plaintiffs filed a motion seeking an extension of time within which

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

to move to amend their complaint, which was granted by the court on May 11, 2009. Plaintiffs filed their amended class action complaint on July 10, 2009. As was the case with the initial complaint, we do not believe that the allegations in the amended complaint have any merit, and we intend to defend against this action vigorously.

In April 2008, a purported class action lawsuit was filed against Radian Group, the Compensation and Human Resources Committee of our board of directors and individual defendants in the U.S. District Court for the Eastern District of Pennsylvania. The complaint alleges violations of the Employee Retirement Income Securities Act as it relates to our Savings Incentive Plan. The named plaintiff is a former employee of ours. On July 25, 2008, we filed a motion to dismiss this case. On July 16, 2009, the court granted our motion to dismiss, dismissing the complaint without prejudice.

As previously disclosed, on June 26, 2008, we filed a complaint for declaratory judgment in the United States District Court for the Eastern District of Pennsylvania, naming IndyMac, Deutsche Bank National Trust Company, Financial Guaranty Insurance Company (“FGIC”), Ambac Assurance Corporation (“Ambac”) and MBIA Insurance Corporation (“MBIA”) as defendants. The suit involves three of our pool policies covering second-lien mortgages, entered into in late 2006 and early 2007 with respect to loans originated by IndyMac. We are in a second loss position behind IndyMac and in front of three defendant financial guaranty companies. We are alleging that the representations and warranties made to us to induce us to issue the policies were materially false, and that as a result, the policies should be void. The total amount of our claim liability for all three pool policies is approximately $77 million. We have established loss reserves equal to the total amount of our exposure to these transactions. After being stayed for several months as a result of the Federal Deposit Insurance Corporation (“FDIC”)’s seizure of IndyMac, this action resumed in April 2009, at which time the defendants filed motions to dismiss the action.

Also in June 2008, IndyMac filed a suit against us in California State Court in Los Angeles on the same policies, alleging that we have wrongfully denied claims or rescinded coverage on the underlying loans. This action was subsequently dismissed without prejudice.

In March 2009, FGIC, Ambac, and MBIA served us with demands to arbitrate certain issues relating to the same three pool policies that are the subject of our declaratory judgment complaint. In July 2009, the court declined to dismiss our declaratory judgment action, but stayed the action to permit the arbitrations to proceed first. Also in July 2009, we reached a confidential settlement in principle with Ambac and Deutsche Bank with respect to one of the disputed pool policies, which policy represents approximately $27 million of the approximately $77 million in total claim liability. We anticipate the settlement will be finalized in August 2009, resolving the declaratory judgment action as it pertains to Ambac and permitting the arbitration commenced by Ambac to be dismissed with prejudice. We do no expect this settlement to have a significant impact on our condensed consolidated financial statements.

In addition to the above litigation, we are involved in litigation that has arisen in the normal course of our business. We are contesting the allegations in each such pending action and believe, based on current knowledge and after consultation with counsel, that the outcome of such litigation will not have a material adverse effect on our consolidated financial position and results of operations.

In October 2007, we received a letter from the staff of the Chicago Regional Office of the SEC stating that the staff is conducting an investigation involving Radian Group and requesting production of certain documents. The staff has also requested that certain of our employees provide voluntary testimony in this matter. We believe

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

that the investigation generally relates to the previously proposed merger with Mortgage Guaranty Insurance Corporation (“MGIC”) and Radian Group’s investment in C-BASS. We are cooperating with the requests of the SEC. The SEC staff has informed us that this investigation should not be construed as an indication by the SEC or its staff that any violation of the securities laws has occurred, or as a reflection upon any person, entity or security.

Securities regulations became effective in 2005 that impose enhanced disclosure requirements on issuers of asset-backed (including mortgage-backed) securities. To allow our customers to comply with these regulations, we typically are required, depending on the amount of credit enhancement we are providing, to provide (1) audited financial statements for the insurance subsidiary participating in the transaction or (2) a full and unconditional holding-company-level guarantee for our insurance subsidiaries’ obligations in such transactions. To date, Radian Group has guaranteed two structured transactions for Radian Guaranty involving approximately $240.1 million of remaining credit exposure.

Under our change of control agreements with our executive officers, upon a change of control of Radian Group or Radian Asset Assurance, as the case may be, we are required to fund an irrevocable rabbi trust to the extent of our obligations under these agreements. The total maximum amount that we would be required to place in trust is approximately $19.1 million as of June 30, 2009. In addition, in the event of a change of control under our existing cash-based incentive plans, we would be required to pay approximately $10.9 million as of June 30, 2009.

As part of the non-investment-grade allocation component of our investment program, we have committed to invest $55.0 million in alternative investments ($18.9 million of unfunded commitments at June 30, 2009) that are primarily private equity securities. These commitments have capital calls over a period of at least the next six years, and certain fixed expiration dates or other termination clauses.

We also utilize letters of credit to back assumed reinsurance contracts, medical insurance policies and an excise tax-exemption certificate used for ceded premiums from our domestic operations to our international operations. These letters of credit are with various financial institutions, have terms of one year and will automatically renew unless we specify otherwise. The letters of credit outstanding at June 30, 2009 and December 31, 2008 were $3.9 million and $4.7 million, respectively.

Our mortgage insurance business utilizes its underwriting skills to provide an outsourced underwriting service to our customers known as contract underwriting. We give recourse to our customers on loans we underwrite for compliance. Typically, we agree that if we make a material error in underwriting a loan, we will provide a remedy to the customer, by purchasing or placing additional mortgage insurance coverage on the loan, or by indemnifying the customer against loss. In the second quarter of 2009, we processed requests for remedies on less than 1% of the loans underwritten. We paid losses for sales and remedies during the second quarter of 2009 of approximately $2.5 million. Providing these remedies means we assume some credit risk and interest rate risk if an error is found during the limited remedy period in the agreements governing our provision of contract underwriting services. At June 30, 2009, our reserve for such obligations was $13.2 million. We closely monitor this risk and negotiate our underwriting fee structure and recourse agreements on a client-by-client basis. We also routinely audit the performance of our contract underwriters to ensure that customers receive quality underwriting services.

As a result of S&P’s downgrades of our financial guaranty insurance subsidiaries in June and August 2008, $65.9 billion of our financial guaranty net par outstanding as of June 30, 2009 remains subject to recapture or

 

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Radian Group Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

 

termination at the option of our reinsurance customers (after giving effect to the Ambac Commutation), our credit derivative counterparties or other insured parties. All of our unaffiliated reinsurance customers have the right to recapture business previously ceded to us under their reinsurance agreements with us. As of June 30, 2009, after giving effect to the Ambac Commutation, up to $27.7 billion of our total net assumed par outstanding was subject to recapture. Assuming all of this business were recaptured as of June 30, 2009, Radian Asset Assurance statutory surplus would have increased by approximately $148.7 million.

The counterparty to one of our synthetic CDO transactions, with an aggregate net par outstanding of $26.5 million as of June 30, 2009, has the right to terminate this transaction with settlement on a mark-to-market basis, subject to a maximum payment amount as of June 30, 2009 of $14.0 million.

As of June 30, 2009, the counterparties to 141 of our financial guaranty transactions currently have the right to terminate these transactions without our having an obligation to settle the transaction on a mark-to-market basis. If all of these counterparties had terminated these transactions as of June 30, 2009, our net par outstanding would have been reduced by $38.2 billion, with a corresponding decrease in unearned premium reserves of $12.2 million (of which only $1.1 million would be required to be refunded to counterparties) and a decrease in the present value of expected future installment premiums of $162.9 million. In addition, net unrealized losses of $257.1 million would also have been reversed.

Following the June 2008 downgrades of our financial guaranty insurance subsidiaries, in July 2008, we initiated a plan to reduce our financial guaranty workforce. In order to maintain a portion of the workforce needed to effectively manage our existing business, we have put into place retention and severance agreements for all remaining personnel at an estimated cost of $27.3 million, of which $11.4 million was incurred in 2008 and $15.1 million is expected to be incurred in 2009. The remaining expense will be incurred in 2010 through 2012.

 

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