The following analysis of our financial condition and results of operations
should be read in conjunction with our Consolidated Financial Statements and
Notes thereto included in Item 8 and the Risk Factors detailed in Item 1A of
Part I of this report.
Business Summary
Overview
We are a credit enhancement company with a primary strategic focus on domestic,
first-lien residential mortgage insurance. Our business segments are mortgage
insurance and financial guaranty. Through our financial guaranty segment, we
maintain a sizable financial guaranty insured portfolio, consisting of public
finance and structured finance risks. Prior to January 1, 2011, we also had a
third segment-financial services.
Mortgage Insurance
Our mortgage insurance segment provides credit-related insurance coverage,
principally through private mortgage insurance, and risk management services to
mortgage lending institutions. We have provided these products and services
mainly through our wholly-owned subsidiary, Radian Guaranty Inc., and its
wholly-owned subsidiaries Radian Mortgage Assurance Inc. (formerly Amerin
Guaranty Corporation), and Radian Insurance Inc. (which we refer to as "Radian
Guaranty," "Radian Mortgage Assurance," and "Radian Insurance," respectively).
Private mortgage insurance protects the holders of our insurance from all or a
portion of default-related losses on residential mortgage loans made generally
to home buyers who make down payments of less than 20% of the home's purchase
price. Private mortgage insurance also facilitates the sale of these mortgage
loans in the secondary mortgage market, most of which are sold to Freddie Mac
and Federal National Mortgage Association ("Fannie Mae"). We refer to Freddie
Mac and Fannie Mae together as "Government Sponsored Enterprises" or "GSEs."
Traditional Mortgage Insurance. Our mortgage insurance segment offers primary
mortgage insurance coverage on residential first-lien mortgages ("first-lien").
At December 31, 2011, primary insurance on first-liens made up approximately
93.7% of our total first-lien insurance risk in force ("RIF"). Prior to 2009, we
also wrote pool insurance, which comprised approximately 6.3% of our total
first-lien insurance RIF at December 31, 2011.
Non-Traditional Mortgage Credit Enhancement. In addition to traditional
mortgage insurance, in the past, we provided other forms of credit enhancement
on residential mortgage assets. These products included mortgage insurance on
second-lien mortgages ("second-lien"), credit enhancement on net interest margin
securities ("NIMS"), credit default swaps ("CDSs") on domestic and international
mortgages and primary mortgage insurance on international mortgages
(collectively, we refer to the risk associated with these transactions as
"non-traditional"). We stopped writing non-traditional business in 2007, other
than a small amount of international mortgage insurance, which we discontinued
writing in 2008. As of December 31, 2011, the aggregate remaining RIF on such
non-traditional mortgage credit enhancement was approximately $214 million,
which accounted for less than 1% of our total risk in force.
Financial Guaranty
Our financial guaranty segment has provided direct insurance and reinsurance on
credit-based risks through Radian Asset Assurance Inc. ("Radian Asset
Assurance"), a wholly-owned subsidiary of Radian Guaranty. Financial guaranty
insurance typically provides an unconditional and irrevocable guaranty to the
holder of a financial obligation of full and timely payment of principal and
interest when due. Financial guaranty insurance may be issued at the inception
of an insured obligation or may be issued for the benefit of a holder of an
obligation in the secondary market.
We have provided financial guaranty credit protection through the issuance of a
financial guaranty insurance policy, by insuring the obligations under a CDS or
through the reinsurance of such obligations. Both a financial guaranty insurance
policy and a CDS provide the purchaser of such credit protection with a guaranty
of the timely payment of interest and scheduled principal when due on a covered
financial obligation, and in the case of most of our financial guaranty CDSs,
credit protection for amounts in excess of specified levels of losses. These
forms of credit enhancement each require similar underwriting and surveillance.
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In 2008, in light of difficult market conditions and the downgrade of the
financial strength ratings of our financial guaranty insurance subsidiaries, we
discontinued writing any new financial guaranty business, other than as
necessary to commute, restructure, hedge or otherwise mitigate losses or reduce
exposure in our existing portfolio. Since 2008, we have significantly reduced
our financial guaranty operations and have reduced our financial guaranty
exposures through commutations in order to mitigate uncertainty, maximize the
ultimate capital available for our mortgage insurance business and accelerate
our access to that capital.
In January 2012, Radian Asset Assurance entered into a three-part transaction
(the "Assured Transaction") with subsidiaries of Assured Guaranty Ltd.
(collectively "Assured") that included the following:
• the commutation of $13.8 billion of financial guaranty net par outstanding
that was reinsured by Radian Asset Assurance (the "Assured Commutation");
• the ceding of $1.8 billion of direct public finance business to assured
(the "Assured Cession"); and
• an agreement to sell to Assured Municipal and Infrastructure Assurance
Corporation (the "FG Insurance Shell"), a New York domiciled financial
guaranty insurance company with licenses to conduct business in 37 states
and the District of Columbia. Radian Asset Assurance acquired the FG
Insurance Shell in June 2011 in order to pursue potential strategic
alternatives in the public finance market. We expect to complete the sale
of the FG Insurance Shell in the first quarter of 2012, subject to
regulatory approval.
This three-part transaction with Assured reduced our financial guaranty net par
outstanding by approximately 22.5% and is expected to provide a statutory
capital benefit to Radian Asset Assurance of approximately $100 million in the
first quarter of 2012. Because Radian Asset Assurance is a wholly-owned
subsidiary of Radian Guaranty, this transaction will also provide a statutory
capital benefit of $100 million to Radian Guaranty. This transaction is
consistent with our strategic objectives of accelerating the reduction of our
financial guaranty net par outstanding and strengthening the statutory capital
positions of Radian Asset Assurance and Radian Guaranty. Following the Assured
Transaction, on February 22, 2012, Radian Asset Assurance agreed to terminate
its arrangement with the National League of Cities ("NLC") to explore the
formation of a new public finance mutual bond insurance company.
The following table provides the expected impact on our consolidated financial
statements in the first quarter of 2012 for the Assured Transaction. While we
expect a statutory capital benefit as a result of this transaction as discussed
above, under GAAP this transaction will result in a reduction in net income, and
therefore, a reduction in retained earnings.
Statement of Operations
(In millions)
Decrease in premiums written $ (119.8 )
Decrease in net premiums earned $ (22.2 )
Increase in change in fair value of derivative instruments-gain 0.1
Increase in policy acquisition costs
(15.7 )
Gain on sale of affiliate 9.0
Decrease in pre-tax income $ (28.8 )
Balance Sheet
(In millions)
Decrease in:
Cash $ 92.3
Deferred policy acquisition costs 26.2
Accounts and notes receivable 1.1
Derivative assets 0.6
Unearned premiums 71.6
Derivative liabilities 0.9
Increase in other assets 19.0
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Financial Guaranty Exposure Subject to Recapture or Termination. Approximately
$52.9 billion of our total net par outstanding as of December 31, 2011,
(representing 76.4% of our financial guaranty segment's total net par
outstanding) was subject to recapture or termination at the option of our
primary reinsurance customers and financial guaranty credit derivative
counterparties. In February 2012, three of our CDS counterparties exercised
their termination rights with respect to 14 corporate collateralized debt
obligations ("CDOs") that we insured (the "February 2012 CDO Terminations"). The
February 2012 CDO Terminations reduced our net par outstanding by $5.8 billion.
After giving effect to the Assured Transaction and the February 2012 CDO
Terminations, approximately $33.3 billion of our total net par outstanding
remains subject to recapture or termination at the option of our primary
reinsurance customers and financial guaranty credit derivative counterparties.
Financial Services
Prior to January 1, 2011, we also had a third segment-financial services. Our
financial services segment consisted mainly of our ownership interest in
Credit-Based Asset Servicing and Securitization LLC ("C-BASS"), which was a
credit-based consumer asset business. We wrote off our entire investment in
C-BASS in 2007. C-BASS filed for Chapter 11 bankruptcy protection on November
12, 2010, and was subsequently liquidated. Our equity interest in C-BASS, and a
related note receivable from C-BASS that had also been previously written off,
were extinguished pursuant to the Plan of Liquidation that was confirmed on
April 25, 2011.
On May 3, 2010, Radian Guaranty sold to Sherman Financial Group LLC ("Sherman"),
a consumer asset and servicing firm specializing in charged-off and bankruptcy
plan consumer assets, all of its remaining 28.7% equity interest in Sherman for
approximately $172.0 million in cash, pursuant to a Securities Purchase
Agreement (the "Sherman Purchase Agreement") dated as of May 3, 2010, between
Radian Guaranty and Sherman. As a result of the sale, in the second quarter of
2010, we recorded a pre-tax gain of approximately $34.8 million, net of
transaction related expenses of $1.3 million, and a pre-tax decrease in
accumulated comprehensive income of $29.7 million.
Overview of Business Results
As a seller of credit protection, our results are subject to macroeconomic
conditions and specific events that impact the origination environment and
credit performance of our underlying insured assets. The ongoing weakness in the
United States ("U.S.") housing and related credit markets, characterized by a
decrease in mortgage originations, decline in home prices, mortgage servicing
and foreclosure delays, and ongoing deterioration in the credit performance of
mortgage and other assets originated prior to 2009, together with current
macroeconomic factors such as limited economic growth, the lack of meaningful
liquidity in some sectors of the capital markets, and continued high
unemployment, have had, and we believe will continue to have, a significant
negative impact on the operating environment and results of operations for each
of our businesses. Because of these factors, there is a great deal of
uncertainty regarding our future performance. See Note 1 of Notes to
Consolidated Financial Statements.
Our businesses have been significantly impacted by, and our future success may
depend upon, legislative and regulatory developments impacting the housing
finance industry. The GSEs are the primary beneficiaries of the majority of our
mortgage insurance policies, and the Federal Housing Authority ("FHA") remains
our primary competitor outside of the private mortgage insurance industry.
Federal and state efforts to support homeowners and the housing market,
including through the U.S. Department of the Treasury's Homeowner Affordability
and Stability Plan ("HASP"), have had a positive impact on our business in
recent periods. Various regulatory agencies are now in the process of developing
new rules under the Dodd-Frank Wall Street Reform and Consumer Protection Act
(the "Dodd-Frank Act") that are expected to have a significant impact on the
housing finance industry, and the U.S. Congress is engaged in planning for the
reform of the housing finance market, including the future roles of the GSEs.
See "Risk Factors-Because most of the mortgage loans that we insure are sold to
Freddie Mac and Fannie Mae, changes in their charters or business practices
could significantly impact our mortgage insurance business", "The Dodd-Frank
Wall Street Reform and Consumer Protection Act may have a material effect on our
mortgage insurance and financial guaranty businesses" and "A decrease in the
volume of home mortgage originations could result in fewer opportunities for us
to write new insurance business" in Part I, Item 1A of this Annual Report on
Form 10-K.
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Mortgage Insurance
• Defaults. Our first-lien primary default rate at December 31, 2011, was
15.2%, compared to 16.5% at December 31, 2010. Our primary default
inventory comprised 110,861 loans at December 31, 2011, compared to
125,470 loans at December 31, 2010, representing an 11.6% decrease. Our
primary default inventory declined slightly in January 2012. The reduction
in our defaulted inventory has been the result of the total number of
defaulted loans that have cured ("cures"), claim payments on defaulted
loans, and insurance rescissions and claim denials collectively exceeding
the total number of new defaults on insured loans. Despite this positive
trend, our overall primary default rates continue to remain elevated
compared to historical levels due to continued high unemployment and
weakness in the U.S. housing and mortgage credit markets. In addition,
this positive trend slowed in the second half of 2011 as the number of new
defaults has remained elevated, while cures on existing defaults have been
consistently low. We believe that a return to sustained profitability in
our mortgage insurance business is dependent upon both a further reduction
in the number of new defaults and an increase in the number of cures,
particularly coming from our older delinquent loans. Based on our
projections, which are subject to significant risks and uncertainties, we
expect continued improvement in the operating results of our mortgage
insurance business in 2012 and to achieve marginal operating profitability
in our mortgage insurance business in 2013. For 2012, we are projecting a
15% decrease in new defaults compared to 2011, which compares to an 18%
decrease in 2011 and a 30% decrease in 2010.
Defaults have remained at elevated levels across all of our mortgage insurance
product lines, including our insured portfolio of prime, first-lien mortgages.
Overall, the underlying trend of high defaults continues to be driven primarily
by the poor performance of our 2005 through 2008 books of business. In addition,
a slowdown in mortgage foreclosures, driven by foreclosure moratoriums,
servicing delays and the effect of prolonged modification programs for
delinquent loans, has contributed to the sustained high level of our default
inventory. This slowdown has resulted in more defaults remaining unresolved for
a longer period of time than has historically been the case.
• Provision for Losses. Our mortgage insurance provision for losses for 2011
was $1,293.9 million, and was primarily related to reserves established on
new defaults. Our results for 2011 were also negatively impacted by
increases in our incurred but not recorded ("IBNR") reserve estimate,
which includes our estimate for the amount of reserves we will need to
reinstate on loans that were previously rescinded and claims that were previously denied. In addition, our provision for losses has been affected
by an increase in the weighted average rate at which defaulted loans are
expected to move to claim (the "default to claim rate"), due to a greater
than anticipated impact from the aging of underlying defaulted loans. With
continuing declines in home values, persistently high unemployment and
delays by servicers in either modifying loans or foreclosing on
properties, the time it has taken to cure or otherwise resolve a
delinquent loan has been prolonged. Consequently, in recent years, our default inventory has experienced an increase in its weighted average age,
and because we apply higher estimated default to claim rates on our older
delinquent loans, this has resulted in higher reserves. Although the
weighted average age of our defaulted portfolio continued to increase
throughout 2011, the pace of this increase slowed in the second half of
2011. Our assumed aggregate weighted average default to claim rate (which
incorporates the expected impact of rescissions and denials) was
approximately 43% and 40% for the years ending December 31, 2011 and 2010,
respectively. For 2012, we anticipate that the aggregate weighted average
default to claim rate will be similar to that assumed in 2011.
Our mortgage insurance reserve for losses continues to be favorably affected by
our loss management efforts. Our loss reserve estimate incorporates our recent
experience with respect to the number of claims that we are denying and the
number of insurance certificates that we are rescinding due to fraud,
underwriter negligence or other factors, including the impact of our recent
experience regarding reinstatements of previously rescinded policies and denied
claims. Our current level of rescissions and denials remains elevated compared
to historical levels, which we believe reflects the larger concentration of
poorly underwritten loans (primarily originated during 2005 through 2008) that
are in our default inventory, as well as our extensive efforts to examine all
claims for potential rescissions or denials. We expect the level of rescissions
and denials to continue to remain elevated compared to historical levels as long
as our 2005 through 2008 insurance policies comprise the majority of our default
inventory.
• Claims Paid. Total mortgage insurance claims paid in 2011 were $1.5
billion and include $90.5 million related to the termination of certain
structured mortgage insurance transactions. As discussed above,
foreclosure backlogs, servicer delays and loan modification programs have
reduced the number of defaults going to claim. Claims paid in 2011 were
also affected by our internal claims payment process. Beginning in 2011,
we increased the number of claims that were subject to review for
potential violations of our insurance policies. We currently expect total
claims paid for 2012 to be approximately $1.3 billion.
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• New Insurance Written. We wrote $15.5 billion of new mortgage insurance in
2011, compared to $11.6 billion of insurance written in 2010. The increase
in 2011 compared to 2010 is mainly attributable to an increase in the
penetration rate of private mortgage insurance in the overall insured
mortgage market, as well as an increase in our share of the private
mortgage market. While the private mortgage insurance industry has made
progress in recapturing business from the FHA, the FHA's market share
remains historically high, and is likely to continue to negatively affect
the volume of our new insurance written ("NIW"). We have been more
aggressively marketing our product offerings that favorably compete with
the FHA in order to gain market share back from the FHA. In the second
quarter of 2011, we implemented a series of changes to our underwriting
guidelines and rates, including a more efficient underwriting process for
loans conforming to the GSE guidelines, lower premium rates for mortgage
insurance paid directly by borrowers and an expansion of our
non-conforming "jumbo" loan program. We expect our volume of NIW to
continue to increase in 2012.
Starting in 2008, we implemented a series of changes to our underwriting
guidelines aimed at improving the long-term risk profile and profitability of
our business. As a result of these changes, the credit profile of our mortgage
insurance portfolio has improved. Our implementation of these stricter
guidelines has also contributed to the lower levels of NIW compared to
historical levels. Since 2009, almost all of our new business production has
been prime business. In addition, Fair Isaac and Company ("FICO") scores for the
borrowers of these insured mortgages have increased, while the loan-to-value
("LTV") on these mortgages has decreased, meaning that borrowers generally are
making larger down payments in connection with the more recent mortgages that we
are insuring.
• Statutory Capital. Under state insurance regulations, Radian Guaranty is
required to maintain minimum surplus levels and, in certain states, a
minimum amount of statutory capital relative to the level of risk in
force, or "risk-to-capital." Sixteen states (the risk-based capital or "RBC States") currently have a statutory or regulatory risk-based capital
requirement (a "Statutory RBC Requirement"), the most common of which
(imposed by 11 of the RBC States) is a requirement that a mortgage
insurer's risk-to-capital ratio may not exceed 25 to 1. As a result of ongoing incurred losses, Radian Guaranty's risk-to-capital ratio increased
to 21.5 to 1 as of December 31, 2011 (after consideration of a recent $100
million contribution from Radian Group Inc. ("Radian Group")), compared to
16.8 to 1 at December 31, 2010 and 15.4 to 1 at December 31, 2009. Based
on our current projections, which are derived from various assumptions
that are subject to inherent uncertainty and require significant judgment
by management, Radian Guaranty's risk-to-capital ratio is expected to
continue to increase and, absent any further capital contributions fromRadian Group, is expected to exceed 25 to 1 in 2012. We actively manage
Radian Guaranty's risk-to-capital position in various ways, including: (1)
through reinsurance arrangements; (2) by seeking opportunities to reduce
our risk exposure through commutations or other negotiated transactions;
(3) by contributing additional capital from Radian Group to our mortgage
insurance subsidiaries; and (4) by monetizing gains in our investment
portfolio through open market sales of securities. After the recent $100
million contribution to Radian Guaranty, Radian Group currently has
unrestricted cash and liquid investments of $482.8 million (before giving
consideration to Radian Group's Tender Offer commenced on February 23,
2012) that may be used to further support Radian Guaranty's
risk-to-capital position. Depending on the extent of our future incurred
losses, the amount of capital contributions required for Radian Guaranty
to remain in compliance with the Statutory RBC Requirements could be
substantial and could exceed amounts maintained at Radian Group. See "Risk
Factors-Losses in our mortgage insurance and financial guaranty businesses
have reduced Radian Guaranty's statutory surplus and increased Radian
Guaranty's risk-to-capital ratio; additional losses in these businesses,
without a corresponding increase in capital or capital relief would
further negatively impact this ratio, which could limit Radian Guaranty's
ability to write new insurance and increase restrictions and requirements
placed on Radian Guaranty" and "Radian Group's sources of liquidity may be
insufficient to fund its obligations" in Part I, Item 1A of this Annual
Report on Form 10-K.
Financial Guaranty
• Net Par Outstanding. Our financial guaranty segment's net par outstanding
was $69.2 billion as of December 31, 2011, compared to $78.8 billion at
December 31, 2010. The reduction in net par outstanding was primarily due
to: (i) counterparties exercising their early termination rights related
to structured finance transactions, including seven corporate CDO and four
other CDO transactions; (ii) a commutation of reinsurance exposure to one
primary insurer in April 2011; and (iii) the amortization or scheduled
maturity of our insured portfolio and prepayments ("refundings") of public
finance transactions. As a result of the Assured Transaction and the
February 2012 CDO Terminations, our aggregate financial guaranty net par
outstanding has decreased during the first quarter of 2012 by an
additional $21.4 billion, which represents 30.9% of Radian Asset Assurance's net par outstanding as of December 31, 2011. We expect our net
par outstanding will continue to decrease as our financial guaranty
portfolio matures and as we seek to proactively reduce our financial
guaranty net par outstanding.
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• Credit Performance. The overall credit quality of our financial guaranty
insured portfolio improved during 2011. The percentage of internally rated
AAA credits in our portfolio increased to 44.9% of our net par outstanding
at December 31, 2011, from 43.0% at December 31, 2010. In addition, the
percentage of below investment grade ("BIG") exposure declined to 5.9% of
our total portfolio as of December 31, 2011, from 6.2% as of December 31,
2010. This was primarily due to credit improvements in our insured
portfolios of corporate CDOs and CDOs of trust preferred securities
("TruPs") and the removal of $231.2 million of BIG exposure from our
public finance portfolio as part of the commutation of reinsurance
exposure in April 2011. As a result of the Assured Transaction and theFebruary 2012 CDO Terminations, the percentage of our insured portfolio
rated AAA increased from 44.9% to 50.9%, the percentage of our insured
portfolio rated BBB increased from 22.0% to 26.9%, and the percentage of
our BIG exposure increased from 5.9% to 8.5%, while the percentage of our
portfolio rated AA or A decreased from 27.2% to 13.7%.
• Public Finance. Our public finance insured portfolio
continues to
experience some stress from the general economic downturn and slow
economic recovery. As of December 31, 2011, approximately 4.5% of
our financial guaranty segment's net par outstanding consisted of
public finance credits rated BIG, compared to 4.6% as of December
31, 2010. Substantially all of the public finance credits commuted
as part of the Assured Commutation and ceded as part of the Assured
Cession were rated investment grade (BBB- or higher),approximately
76% of which were rated AA or A. Consequently, our exposure to
public finance risk relative to structured finance riskdeclined and
the overall credit quality of our remaining public finance portfolio
declined. As a result of the Assured Transaction, the
percentage of
our public finance portfolio with AAA rating increased (from 6.9% to
8.2%), and the percentage of our public finance portfolio with lower
ratings (BBB or lower) increased significantly (45.6% to 70.4%),
while the percentage of our public finance portfolio rated between
those levels (AA or A) decreased significantly (47.5% to 21.4%). In
addition, as a result of the Assured Transaction and the February
2012 CDO Terminations, the percentage of our total net par
outstanding to public finance obligations decreased from 47.6% to
37.6% of our total net par outstanding, including a decrease in the
percentage of our insured portfolio of general obligation and other
tax supported bonds from 22.8% to 14.2% of our total net par
outstanding.
As of December 31, 2011, we had an aggregate of $5.4 billion net par exposure to
healthcare and long-term care credits. While these sectors were relatively
stable in 2011, hospitals have begun to experience a decrease in patient
revenues as a result of a significant decline in patient volumes, increased
charity care and limited increases in commercial and government reimbursements.
Many healthcare institutions are reporting that further expense reduction
efforts are unrealistic and that operating losses are expected as healthcare
inflation outpaces weak revenue growth. Further, long-term care facilities
generally have been experiencing gradually declining occupancies, thinner debt
service coverage margins and slowly eroding cash positions. If these trends
continue, it could result in further credit deterioration and require increases
in our loss reserves related to our healthcare and long-term care credits.
Although the states and municipalities included within our government-related
insured credits have generally been able to withstand stresses to date, the
lagging impact on municipal governments from the most recent economic downturn
is becoming more evident. We expect the negative trend in this sector to
continue into 2012 due to the protracted economic downturn and slow economic
recovery, the end of federal stimulus revenues and continued stress on tax-based
revenue receipts (in particular where tax revenues are derived from the value of
real estate as discussed below). This negative trend is expected to continue to
strain the ability of government entities to maintain balanced budgets and
adequate liquidity to meet near-term financial obligations. As a result, we may
continue to experience further credit deterioration and municipal defaults in
our government-related insured credits.
We have seen some credit deterioration in our insured portfolio of other tax
supported bond transactions, in particular those that are payable from real
estate tax revenues derived from the value of real estate in narrowly defined
districts or from special assessments for improvements on certain properties.
Declining property values have reduced the assessed value of the tax base in
these jurisdictions, resulting in reduced tax revenues being available to pay
interest and principal on these insured bonds. We may experience further credit
deterioration in these transactions, which would increase the likelihood of
ultimately being required to make claim payments with respect to these bonds,
especially those from special districts. After giving effect to the Assured
Transaction, our net par exposure to this portfolio is approximately $2.4
billion.
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• Structured Finance. The credit performance of our structured finance
portfolio continued to improve during 2011. The percentage of
internally rated AAA credits in our structured finance portfolio
increased to 79.5% at December 31, 2011, from 75.8% atDecember 31,
2010. In addition, the percentage of BIG exposure declined to 7.1%
of our total structured finance portfolio as of December 31, 2011,
compared to 7.7% as of December 31, 2010, primarily due to an
upgrade in the ratings of five CDOs. We have seenstabilization and
improved performance across many of the transactions in our directly
insured TruPs CDO portfolio. Banks within these insured
transactions
continue to show improved performance, while insurance
companies in
these transactions remain generally stable. As a result of this
trend, we have upgraded 15 of our 19 transactions during 2011,
including three transactions from BIG to investment grade. Our
weighted average internal rating for our directly insuredTruPs CDO
bonds improved to BB as of December 31, 2011, from B+ as of December
31, 2010, reflecting the improvement in observed TruPs CDO
performance and our updated internal views of the banking sector and
future TruPs performance. See "Results of Operations-Financial
Guaranty-Financial Guaranty Exposure Information" below for
additional information regarding changes in the creditperformance
of our insured TruPs CDO portfolio.
Our insured CDOs of commercial mortgage-backed securities ("CMBS") transactions
experienced mixed performance in 2011. While delinquency levels in the
collateral supporting our CDOs of CMBS were lower as of December 31, 2011
compared to December 31, 2010, for two of these transactions, loss severities
have risen within many of the CMBS backing these CDOs. In 2011, we also have
seen interest shortfalls across a small number of the CMBS tranches that back
our CDOs as a result of reductions in the appraised value of properties that
allowed servicers to stop making advances for interest. Although none of these
interest shortfalls was large enough in 2011 to reach the tranche we insure in
any of these transactions, the risk of losses has risen during 2011.
Notwithstanding these developments, our internal ratings for our CMBS
transactions (two are internally rated AAA, one AA and one BBB) remained
unchanged during 2011.
The performance of our $450.6 million insured CDO of asset-backed securities
("ABS") also deteriorated further during 2011. See "Financial Guaranty Exposure
Information" below for additional information regarding this transaction.
Results of Operations
Our results for 2011 were positively impacted by the change in fair value of
derivative and other financial instruments, which occurred primarily due to the
widening of Radian Group's CDS spreads. This widening, in turn, resulted in a
corresponding decline in the fair value liability of our insured obligations,
primarily non-corporate CDOs and TruPs CDOs. Because we have the ability to hold
our financial guaranty contracts to maturity, changes in market spreads are not
necessarily indicative of our ultimate net credit loss payments with respect to
these obligations.
Our estimated credit loss payments presented in the table below represent our
current estimate of the present value (net of estimated recoveries) that we
expect to pay in claims with respect to our insured credit derivatives and net
variable interest entity ("VIE") liabilities. The estimated fair value of these
obligations is measured as of a specific point in time and may be influenced by
changes in interest rates, credit spreads, credit ratings and other market,
asset-class and transaction-specific conditions and factors that may be
unrelated to our obligation to pay future claims. Other factors that may cause a
difference between the fair value of these obligations and our estimated credit
loss payments include the effects of our non-performance risk and differing
assumptions regarding discount rate and future performance, as well as the
expected impact of our loss mitigation activities, including commutations. In
the absence of credit losses, unrealized losses related to changes in fair value
will reverse before or at the maturity of these obligations. However, we may
agree to settle some or all of these obligations prior to maturity at amounts
that are greater or less than their fair values at the time of settlement, which
could result in the realization of additional gains or losses.
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The following table summarizes the fair value amounts reflected on our
consolidated balance sheet at December 31, 2011, related to these instruments
and the present value of our estimated credit loss payments on these
instruments. Because the present value of estimated credit loss payments
currently exceeds the net fair value liability, we expect to incur additional
losses related to these instruments in the future.
Financial
Guaranty
Derivatives
(In millions) NIMS and VIEs Total
Balance Sheet
Trading securities $ - $ 94.5 $ 94.5
Derivative assets 1.6 15.4 17.0
Other assets - 105.9 105.9
Total assets 1.6 215.8 217.4
Derivative liabilities - 126.0 126.0
VIE debt-at fair value 9.4 218.8 228.2
Accounts payable and accrued expenses - 0.5 0.5
Total liabilities 9.4 345.3
354.7
Total fair value net liabilities $ 7.8 $ 129.5 $ 137.3
Present value of estimated credit loss payments (1) $ 18.6 $ 146.9
$ 165.5
___________________________
(1) Represents the present value of our estimated credit loss payments (net of
estimated recoveries) for those transactions for which we currently
anticipate paying net losses, calculated using a discount rate of
approximately 2.5%, which represents our current investment yield.
Results of Operations-Consolidated
The following table summarizes our consolidated results of operations for the
years ended December 31, 2011, 2010 and 2009:
Year Ended December 31, % Change
($ in millions) 2011 2010 2009 2011 vs. 2010 2010 vs. 2009
Net income (loss) $ 302.2 $ (1,805.9 ) $ (147.9 ) n/m n/m
Net premiums written-insurance 707.2 691.9 443.8
2.2 % 55.9 %
Net premiums earned-insurance 756.0 825.7 825.9
(8.4 ) -
Net investment income 163.5 178.8 214.2 (8.6 ) (16.5 )
Net gains on investments 202.2 139.9 257.1 44.5 (45.6 )
Net impairment losses recognized
in earnings (1.2 ) (0.1 ) (9.3 ) n/m (98.9 )
Change in fair value of
derivative instruments 628.4 (558.7 ) 100.0 n/m n/m
Net gains (losses) on other
financial instruments 193.3 (211.7 ) (88.6 ) n/m n/m
Gain on sale of affiliate - 34.8 - n/m n/m
Other income 5.6 8.7 14.0 (35.6 ) (37.9 )
Provision for losses 1,296.5 1,739.2 1,337.6 (25.5 ) 30.0
Change in reserve for premium
deficiency (7.1 ) (14.6 ) (61.5 ) (51.4 ) (76.3 )
Policy acquisition costs 52.8 53.5 63.0 (1.3 ) (15.1 )
Other operating expenses 175.8 191.9 203.8 (8.4 ) (5.8 )
Interest expense 61.4 41.8 46.0 46.9 (9.1 )
Equity in net income of
affiliates 0.1 14.7 33.2 (99.3 ) (55.7 )
Income tax provision (benefit) 66.4 226.2 (94.4 )
(70.6 ) n/m
________________________
n/m - not meaningful
98--------------------------------------------------------------------------------
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010
Net Income (Loss). Our results for 2011 reflect significant unrealized gains in
the change in fair value of derivative instruments and net gains on other
financial instruments, compared to significant losses on such items in 2010.
While the provision for losses remained elevated for 2011, it decreased compared
to 2010, which positively impacted the 2011 results. We established a valuation
allowance against our deferred tax assets ("DTA") in the fourth quarter of 2010,
and as a result, our income tax expense was much less in 2011 compared to 2010.
Net Premiums Written and Earned. Net premiums written in 2011 increased slightly
from 2010, due to an increase in premiums written in the mortgage insurance
segment. For 2011, net premiums earned decreased in both our mortgage insurance
and financial guaranty segments compared to 2010. See "Results of
Operations-Mortgage Insurance-Year Ended December 31, 2011 Compared to Year
Ended December 31, 2010-Net Premiums Written and Earned" and "Results of
Operations-Financial Guaranty-Year Ended December 31, 2011 Compared to Year
Ended December 31, 2010-Net Premiums Earned" below for further information.
Net Investment Income. The decrease in net investment income during 2011,
compared to 2010, was primarily due to a decline in our total investment balance
due to negative cash flows, as well as a shift from higher yielding securities
in our investment portfolio to lower yielding investments. Our allocation to
short-term and short duration investments remains high in anticipation of
near-term claim payments in our mortgage insurance segment, and this allocation,
combined with certain sales and subsequent reinvestment of longer duration
securities in a low interest rate environment, resulted in a lower yield profile
for the portfolio.
Net Gains on Investments. The components of the net gains on investments for the
periods indicated are as follows:
Year Ended December 31,
(In millions) 2011 2010
2009
Net unrealized gains related to change in fair
value of trading securities $ 126.4 $ 16.4 $ 56.4
Net realized gains on sales 75.8 123.5 200.7
Net gains on investments $ 202.2 $ 139.9 $ 257.1
During the second quarter of 2011, we sold all of our interests in certain bonds
held in our available for sale portfolio that were issued as part of
securitizations collateralized by the Master Settlement Agreement ("MSA") among
certain domestic tobacco manufacturers and 46 states and certain territories
(the "Tobacco Bonds"), realizing a loss on the sale of $53.7 million. These
losses were more than offset by gains on sales of other securities in our
trading portfolio for 2011, as we took advantage of favorable market conditions
allowing us to monetize the gains embedded in the investment portfolio through
open market sales of securities. The proceeds from the asset sales were used for
liquidity planning purposes or re-invested in similar assets. Realized gains
from these sales were also additive to the respective statutory capital
positions of our subsidiaries that held the investments. In 2010, a majority of
our realized gains on investments occurred as a result of sales from our trading
portfolio, in connection with the strategic repositioning of our investment
portfolio from tax-advantaged securities to securities that provide taxable
investment income.
Change in Fair Value of Derivative Instruments. The components of the gains
(losses) included in change in fair value of derivative instruments for the
years ended December 31, 2011, 2010 and 2009 are as follows:
Year Ended December 31,
Statements of Operations (In millions) 2011 2010 2009
Net premiums earned-derivatives $ 41.7 $ 47.1 $ 55.7
Financial Guaranty credit derivative liabilities 598.0 (583.2 ) 118.0
Financial Guaranty VIE derivative liabilities (10.7 ) (14.5 ) -
NIMS (1.6 ) (0.9 ) (6.2 )
Mortgage insurance domestic and international CDSs - - (4.8 )
Put options on Money Market Committed Preferred
Custodial Trust Securities ("CPS") - (6.1 ) (56.2 )
Other 1.0 (1.1 ) (6.5 )
Change in fair value of derivative instruments $ 628.4 $ (558.7 ) $ 100.0
99
--------------------------------------------------------------------------------
See "Results of Operations-Financial Guaranty-Year Ended December 31, 2011
Compared to Year Ended December 31, 2010-Change in Fair Value of Derivative
Instruments" below for further information.
As a result of the consolidation in 2010 of certain VIEs in which we are the
primary beneficiary, amounts that had previously been reported in change in fair
value of derivative instruments are currently reported as change in fair value
of VIE debt, which is included in net gains (losses) on other financial
instruments.
The unrealized gains experienced during 2011 are primarily due to the
significant widening of our CDS spread, which widened by 2,267 basis points
during the year, compared to spread tightening of 1,065 basis points in 2010.
The unrealized losses experienced during 2010 were primarily due to the
significant tightening of our CDS spread. The five-year CDS spread is presented
below as an illustration of the market's view of our non-performance risk; the
CDS spread used in the valuation of specific fair value liabilities is typically
based on the remaining term of the instrument.
December 31, December 31, December 31,
(In basis points) 2011 December 31, 2010 2009 2008
Radian Group's five-year CDS spread 2,732 465 1,530 2,466
The following tables quantify the impact of our non-performance risk on our
derivative assets, derivative liabilities, as well as net VIE liabilities (in
aggregate by type, excluding assumed financial guaranty derivatives) presented
in our consolidated balance sheets.
Fair Value Liability
before Consideration
of Radian Impact of Radian Fair Value Liability
Non-Performance Risk Non-Performance Risk Recorded
(In millions) December 31, 2011 December 31, 2011 December 31, 2011
Product
Corporate CDOs $ 463.1 $ 458.0 $ 5.1
Non-Corporate CDO-related 1,520.2 1,405.3 114.9
NIMS-related 17.4 9.6 7.8
Total $ 2,000.7 $ 1,872.9 $ 127.8
Fair Value Liability
before Consideration
of Radian Impact of Radian Fair Value Liability
Non-Performance Risk Non-Performance Risk Recorded
December 31, December 31, December 31,
(In millions) 2010 2010 2010
Product
Corporate CDOs $ 387.1 $ 281.5 $ 105.6
Non-Corporate CDO-related 1,696.2 934.1 762.1
NIMS-related 134.1 4.8 129.3
Total $ 2,217.4 $ 1,220.4 $ 997.0
Net Gains (Losses) on Other Financial Instruments. The components of the net
gains (losses) on other financial instruments for the periods indicated are as
follows:
Year Ended December 31,
(In millions) 2011 2010 2009Net gains (losses) related to NIMS VIE debt $ 3.7 $ (39.8 )
$ (100.0 )
Gains (losses) related to change in fair
value of Financial Guaranty VIE debt 134.0 (161.8 ) -
Gains related to other Financial Guaranty VIE
assets 21.4 18.3 -
Gain on the repurchase of long-term debt - 2.5
12.0
Loss related to CPS VIE - (30.9 ) -
Foreign currency gain related to the
liquidation of a foreign subsidiary 39.6 - -
Other (5.4 ) - (0.6 )
Net gains (losses) on other financial
instruments $ 193.3 $ (211.7 ) $ (88.6 )
100--------------------------------------------------------------------------------
The results for 2011 and 2010 were mainly impacted by gains and losses on
financial guaranty VIE debt. The widening of Radian Group's five-year CDS spread
was the dominant driver of the gains in 2011, as discussed above. Radian's
spread tightened during 2010, resulting in losses reported during that time
period. Also impacting the results for 2011 were foreign currency translation
gains resulting from the liquidation of a foreign subsidiary, which occurred
during the second quarter of 2011. See "Results of Operations-Mortgage
Insurance-Year Ended December 31, 2011 Compared to Year Ended December 31,
2010-Net Gains (Losses) on Other Financial Instruments" and "Results of
Operations-Financial Guaranty-Year Ended December 31, 2011 Compared to Year
Ended December 31, 2010-Net Gains (Losses) on Other Financial Instruments" below
for further information.
Gain on Sale of Affiliate. The gain on sale of affiliate for 2010 resulted from
the sale of our remaining equity interest in Sherman on May 3, 2010.
Provision for Losses. The provision for losses decreased during 2011 compared
to 2010, primarily due to decreases in both our mortgage insurance and financial
guaranty provision for losses. See "Results of Operations-Mortgage
Insurance-Year Ended December 31, 2011 Compared to Year Ended December 31,
2010-Provision for Losses" and "Results of Operations-Financial Guaranty-Year
Ended December 31, 2011 Compared to Year Ended December 31, 2010-Provision for
Losses" below for further information.
Other Operating Expenses. The decrease in other operating expenses in 2011
compared to 2010 reflects: (i) a $13 million decrease in stock-based
compensation expense; (ii) a $3 million decrease in director's fees that are
correlated to changes in our stock price; (iii) a $2 million decrease in
salaries; and (iv) a $4 million decrease in consulting, legal and audit fees.
These decreases were partially offset by a $5 million increase in mortgage
insurance sales commissions due to increased NIW and the increased expenses
related to the write-off of certain software and technology projects. In October
2011, we completed an expense initiative aimed at aligning our support services
to the current reduced mortgage market. This re-alignment included a workforce
reduction of approximately 9.8% of our corporate and mortgage insurance staff.
Interest Expense. These amounts reflect interest on our long-term debt. In
November 2010, we issued $450 million of convertible senior notes due November
2017 at a significant discount, which increased our interest expense in 2011
compared to 2010. This significant increase was slightly offset by the repayment
of the remaining balance of $160 million on our 7.75% debentures upon its
maturity in June 2011. See Note 13 of Notes to Consolidated Financial
Statements.
Equity in Net Income of Affiliates. The results for 2010 represent our equity in
the net income related to our 28.7% equity interest in Sherman, which we sold in
the second quarter of 2010.
Income Tax Provision. The income tax provision for 2011 was impacted by
remeasurement of our uncertain income tax positions and a change in the
valuation allowance against our DTA due to results from continuing operations.
The income tax provision for 2010 was mainly impacted by the recording of a
significant valuation allowance against our DTA, tax-exempt interest income,
state and foreign taxes and the tax effect relating to uncertain income tax
positions.
Year Ended December 31, 2010 Compared to Year Ended December 31, 2009
Net Loss. The increase in our net loss for 2010, compared to 2009, mainly
resulted from the establishment of a valuation allowance against our DTA, an
increase in the provision for losses, unrealized losses in the change in fair
value of derivative instruments and net losses on other financial instruments.
Net Premiums Written and Earned. Net premiums written in 2010 increased from
2009, while net premiums earned decreased slightly compared to 2009. See
"Results of Operations-Mortgage Insurance-Year Ended December 31, 2010 Compared
to Year Ended December 31, 2009-Net Premiums Written and Earned" and "Results of
Operations-Financial Guaranty-Year Ended December 31, 2010 Compared to Year
Ended December 31, 2009-Net Premiums Earned" below for further information.
Net Investment Income. The decrease in net investment income during 2010,
compared to 2009, was primarily due to lower yields in our investment portfolio
as a result of a continued reallocation of the investment portfolio to
shorter-term investments in anticipation of increasing claim payments in our
mortgage insurance segment. In addition, assets were also reallocated from
longer duration, higher yielding tax-exempt municipal securities to taxable
securities of intermediate duration with lower interest rates.
101
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Net Gains on Investments. The net gains on investments were positively impacted
in 2010 by net realized gains on investment sales from our trading portfolio, in
connection with the strategic repositioning of our investment portfolio
discussed above.
Change in Fair Value of Derivative Instruments. The unrealized losses
experienced during 2010 were primarily due to the significant tightening of our
CDS spread, which tightened by 1,065 basis points. In addition, as a result of
the consolidation in 2010 of certain VIEs in which we were the primary
beneficiary, amounts that had previously been reported in change in fair value
of derivative instruments were reported as change in fair value of VIE debt,
which is included in net (losses) gains on other financial instruments.
Net (Losses) Gains on Other Financial Instruments. The results for 2010 were
driven by losses on financial guaranty VIE debt. As a result of the adoption in
2010 of the accounting standard update regarding improvements to financial
reporting by enterprises involved with VIEs, we identified and consolidated
additional VIEs with the related fair value gains (losses) recorded in this line
item. Also negatively impacting the results for 2010 were losses related to NIMS
VIE debt, primarily caused by a tightening in Radian Group's CDS spread during
the year, which had the effect of increasing the fair value liabilities of our
VIEs. Our CDS spreads also tightened during 2009.
Net Impairment Losses Recognized in Earnings. Net impairment losses for 2010
compared to 2009 included a lesser amount of impairments on fixed-maturity
investments available for sale and equity securities available for sale.
Gain on Sale of Affiliate. The gain on sale of affiliate for 2010 resulted from
the sale of our remaining equity interest in Sherman on May 3, 2010.
Other Income. The decrease in other income for 2010 compared to 2009 was due to
a decline in contract underwriting income, resulting from the overall decline in
mortgage origination volume.
Provision for Losses. The provision for losses increased during 2010 compared
to 2009, primarily due to an increase in our mortgage insurance provision for
losses, slightly offset by a decrease in our financial guaranty provision for
losses. See "Results of Operations-Mortgage Insurance-Year Ended December 31,
2010 Compared to Year Ended December 31, 2009-Provision for Losses" and "Results
of Operations-Financial Guaranty-Year Ended December 31, 2010 Compared to Year
Ended December 31, 2009-Provision for Losses" below for further information.
Change in Reserve for Premium Deficiency. For 2010, the reserve for second-lien
premium deficiency was impacted by the transfer of premium deficiency reserves
to loss reserves and by updates to assumptions underlying our loss estimates. In
2009, we recorded a decrease in the reserve for second-lien premium deficiency
due to the transfer of premium deficiency reserves to loss reserves and changes
in estimates due to the settlement of certain second-lien transactions at less
than our estimates of reserves.
Policy Acquisition Costs. Policy acquisition costs decreased during 2010 as
compared to 2009, due to a decrease in our financial guaranty segment, which was
partially offset by an increase in our mortgage insurance segment. See "Results
of Operations-Mortgage Insurance-Year Ended December 31, 2010 Compared to Year
Ended December 31, 2009-Policy Acquisition Costs" and "Results of
Operations-Financial Guaranty-Year Ended December 31, 2010 Compared to Year
Ended December 31, 2009-Policy Acquisition Costs" below for further information.
Other Operating Expenses. The decrease in other operating expenses in 2010
compared to 2009 was the result of (i) a $12 million decrease in severance,
(ii) a $7 million decrease in salaries and (iii) a $3 million decrease in rent
expense. These decreases were partially offset by a $5 million increase in cash
and stock-based compensation and a $2 million increase in mortgage insurance
sales commissions.
Interest Expense. These amounts reflected interest on our long-term debt and,
in 2009, interest on our revolving credit facility. In November 2010, we issued
$450 million of convertible senior notes due November 2017, which increased our
interest expense. In January 2010 and August 2009, we repurchased approximately
$31.9 million and $57.7 million, respectively, of outstanding principal amount
of our 7.75% debentures due June 2011. On August 6, 2009, we terminated our
revolving credit facility and paid down the remaining balance of $100 million.
These transactions reduced interest expense in 2010 and 2009.
Equity in Net Income of Affiliates. Before the sale of our remaining equity
interest in Sherman on May 3, 2010, this represented our share of Sherman's
earnings in 2010 and 2009.
102
--------------------------------------------------------------------------------
Income Tax Provision (Benefit). We had an income tax provision of $226.2
million for 2010, compared to an income tax benefit of $94.4 million for 2009.
The income tax provision for 2010 was primarily impacted by the recording of a
valuation allowance against our DTA, tax-exempt interest income, the tax impact
relating to our foreign subsidiary operations and the impact of our accounting
for uncertain income tax positions.
Results of Operations-Mortgage Insurance
The following table summarizes our mortgage insurance segment's results of
operations for the years ended December 31, 2011, 2010 and 2009:
Year Ended December 31, % Change
($ in millions) 2011 2010 2009 2011 vs. 2010 2010 vs. 2009
Net loss $ (643.9 ) $ (1,143.2 ) $ (337.8 ) (43.7 )% n/m
Net premiums written-insurance 717.3 699.9 630.1 2.5 11.1 %
Net premiums earned-insurance 680.9 739.6 724.4 (7.9 ) 2.1
Net investment income 93.7 104.0 129.9 (9.9 ) (19.9 )
Net gains on investments 126.2 84.0 161.6 50.2 (48.0 )
Net impairment losses recognized in
earnings (1.2 ) (0.1 ) (9.2 ) n/m (98.9 )
Change in fair value of derivative
instruments (0.6 ) 32.4 (14.4 ) n/m n/m
Net gains (losses) on other
financial instruments 3.9 (48.1 ) (96.0 ) n/m (49.9 )
Other income 5.4 7.2 12.3 (25.0 ) (41.5 )
Provision for losses 1,293.9 1,730.8 1,300.8 (25.2 ) 33.1
Change in reserve for premium
deficiency (7.1 ) (14.6 ) (61.5 ) (51.4 ) (76.3 )
Policy acquisition costs 36.1 36.1 27.6 - 30.8
Other operating expenses 132.2 141.2 140.5 (6.4 ) 0.5
Interest expense 13.9 11.7 15.4 18.8 (24.0 )
Income tax provision (benefit) 83.2 157.1 (176.4 ) (47.0 ) n/m
________________________
n/m - not meaningful
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010
Net Loss. The results for 2011 compared to 2010 primarily reflect a decrease in
the provision for losses, a decrease in net premiums earned, and a decrease in
income tax expense resulting from the establishment of a valuation allowance in
2010. The results for 2011 also include increased gains on investments compared
to 2010.
Net Premiums Written and Earned. Net premiums written increased in 2011
compared to 2010, primarily due to a decrease in ceded premiums resulting from
the run-off and termination of captive reinsurance arrangements and an increase
in premiums written on single premium policies. Net premiums earned decreased in
2011 compared to 2010, due to a decrease in our insurance in force and an
increase in the impact from rescission refunds in 2011 compared to 2010. This
decrease in premiums earned was partially offset by a decrease in ceded premiums
resulting from the termination of captive reinsurance arrangements.
103
--------------------------------------------------------------------------------The following table provides additional information related to mortgage
insurance premiums written and earned for the years indicated:
Year Ended December 31,
(In thousands) 2011 2010 2009
Premiums written
Primary and pool insurance $ 715,125 $ 698,078 $ 650,060
Second-lien 2,314 1,535 (41 ) (1)
International (175 ) 296 (19,943 ) (1)Total premiums written-insurance $ 717,264$ 699,909$ 630,076
Premiums earned
Primary and pool insurance $ 673,869$ 727,484$ 703,076
Second-lien
2,314 2,501 5,621
International 4,712 9,646 15,726
Total premiums earned-insurance $ 680,895$ 739,631$ 724,423
__________________
(1) Reflects the termination of certain second-lien insurance and international
reinsurance transactions.
Net Investment Income. Our mortgage insurance net investment income decreased
in 2011 compared to 2010, primarily due to our total investment portfolio
balance declining in 2011 due to negative cash flows, as well as a shift from
higher yielding securities in our investment portfolio to lower yielding
investments. Our allocation to short-term and short duration investments remains
high in anticipation of near-term claim payments in our mortgage insurance
segment, and this allocation, combined with certain sales and subsequent
reinvestment of longer duration securities in a low interest rate environment,
resulted in a lower yield profile for the portfolio. All periods include an
allocation to the mortgage insurance segment of net investment income from
Radian Group based on allocated capital, which was lower in 2011 compared to
2010.
Net Gains on Investments. The components of the net gains on investments for the
periods indicated are as follows:
Year Ended December 31,
(In millions) 2011 2010 2009
Net unrealized gains (losses) related to change
in fair value of trading securities $ 67.8 $ (1.5 ) $ 56.8
Net realized gains on sales 58.4 85.5 104.8
Net gains on investments $ 126.2 $ 84.0 $ 161.6
During the second quarter of 2011, we sold our portfolio of Tobacco Bonds, as
discussed above, and as a result recognized $21.7 million in realized losses in
our mortgage insurance segment in connection with that sale. These losses were
more than offset by gains on sales of other securities in our trading portfolio
in 2011. The results for 2010 were positively impacted by net realized gains on
investments in conjunction with the reallocation of our investment portfolio
from tax advantaged securities to securities that provide taxable investment
income.
Change in Fair Value of Derivative Instruments. The components of the (losses)
gains included in change in fair value of derivative instruments for our
mortgage insurance segment for the years indicated are as follows:
Year Ended December
31,
(In millions) 2011 2010
2009
Net premiums earned-derivatives $ - $ 0.7 $
2.3
NIMS (1.6 ) (0.9 ) (6.2 )
Mortgage insurance domestic and international CDS - - (4.8 )
Put Options on CPS - 33.7 -
Other 1.0 (1.1 )
(5.7 )
Change in fair value of derivative instruments $ (0.6 ) $ 32.4 $ (14.4 )
104
--------------------------------------------------------------------------------
Starting in the third quarter of 2010, we began allocating a portion of the
change in fair value on the derivatives held in CPS trusts consolidated by
Radian Group to the mortgage insurance segment. Additionally, Radian had
purchased substantially all the CPS as of December 31, 2010, thereby eliminating
related VIE debt and any related market adjustment in 2011.
Net Gains (Losses) on Other Financial Instruments. The components of the gains
(losses) on other financial instruments for the years indicated are as follows:
Year Ended December 31,
(In millions) 2011 2010 2009
Net gains (losses) related to NIMS VIE debt 3.7 (39.8 ) (100.0 )
Gain on the repurchase of long-term debt - 0.5 4.0
Loss related to CPS VIE - (8.8 ) -
Other 0.2 - -Net gains (losses) on other financial instruments $ 3.9 $ (48.1 ) $ (96.0 )
The net gains for 2011 reflect the impact of the widening of Radian Group's CDS
spread, which widened by 2,267 basis points during the year, on the NIMS bonds
still held by us. The net losses for 2010 also were impacted by the movement of
Radian Group's five-year CDS spread, which tightened by 1,065 basis points
during 2010. Our risk in force related to NIMS has declined from $136 million at
December 31, 2010, to $19 million at December 31, 2011 as a result of payments
made by us as NIMS bonds have matured. In addition, starting in the third
quarter of 2010, we began allocating a portion of the change in fair value
related to CPS VIE to the mortgage insurance segment.
Provision for Losses. The following table details the financial impact of the
significant components of our mortgage insurance provision for losses for the
periods indicated:
Year Ended December 31,
(In millions) 2011 (1) 2010 (1) 2009 (1)
New defaults $ 854.5 $ 940.3 $ 1,605.7
Existing defaults (2) 434.4 847.3 (97.7 )
Second-lien, Loss Adjustment Expense ("LAE
") and Other (3) 5.0 (56.8 ) (207.2 )
Provision for losses $ 1,293.9 $ 1,730.8 $ 1,300.8
_____________________
(1) For 2011, 2010 and 2009, the financial impact for each component has been
recalculated on a year-to-date basis, such that the sum of the individual
quarterly impacts within each respective year will not equal the recalculated
impacts. For example, the impact from a loan that defaults in one quarter
that then cures in the next quarter of the same year is not reflected within
the year-to-date provision for losses, as the net impact is zero for the
year-to-date period.
(2) Represents the provision for losses attributable to loans that were in
default as of the beginning of each period indicated, including: (a) the
change in reserves for loans that were in a default status (including pending
claims) as of both the beginning and end of each period indicated, (b) the
net impact to provision for losses from loans that were in default as of the
beginning of each period indicated but were either a cure, a prepayment, a
paid claim or a rescission or denial during the period indicated and (c) the
impact to our IBNR reserve during the period related to changes in actual and
estimated reinstatements of previously rescinded policies and denied claims.
(3) Includes the effect of reinsurance recoveries from captive and Smart Home
transactions, second-lien activity, LAE and other miscellaneous loss-related
activity.
Our mortgage insurance provision for losses for 2011 improved relative to 2010.
This decrease was driven primarily by a decline in new default notices and a
relative improvement in the composition of the delinquent loan inventory
(including changes associated with the aging of delinquent loans and loans
moving into pending claim status), which more than offset the decrease in cures.
Our aggregate weighted average estimated default to claim rate was approximately
43% at December 31, 2011, compared to 40% at December 31, 2010 and 36% at
December 31, 2009. In addition, existing defaults in 2010 were negatively
affected by increases in our severity assumptions, due mainly to an increase in
estimated severity on pool insurance defaults.
105
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Our reported rescission and denial activity in any given period is subject to
future challenges by our lender customers. Recent trends in insurance
rescissions and claim denial activity reflect lenders challenging a greater
number of rescissions and denials, and the overall challenges have been more
effective (i.e., producing new or additional information that supports a
reinstatement of coverage or a claim payment). Reinstatements of policies and
resubmissions of claims that had been rescinded or denied as of the prior
year-end totaled $114.5 million in 2011, compared to $43.7 million in 2010. As a
result of these trends, we expect that a larger portion of previously rescinded
policies will be reinstated and previously denied claims will be resubmitted
with the required documentation and ultimately paid, and we have considered this
expectation in developing our IBNR reserve estimate. This estimate, which
primarily consists of our estimate of the future reinstatements of previously
rescinded policies and denied claims, was $170.6 million and $39.5 million at
December 31, 2011 and December 31, 2010, respectively.
The following table illustrates the impact to our loss reserve estimates due to
estimated insurance rescissions and claim denials as of the dates indicated:
December 31, December 31, December 31,
(In millions) 2011 2010 2009
Decrease to our loss reserve due to estimated
rescissions and denials $ 631 $ 922 $ 1,155
The following table illustrates the amount of first-lien claims submitted to us
for payment that were rescinded or denied for the periods indicated:
Year Ended
December 31
(In millions) 2011 2010 2009
Rescissions-first loss position $ 360.0 $ 339.2 $ 330.7
Denials-first loss position 133.9 200.2 67.4
Total first loss position (1) 493.9 539.4 398.1
Rescissions-second loss position 114.2 199.1 372.9
Denials-second loss position 37.0 61.5
54.6
Total second loss position (2) 151.2 260.6
427.5
Total first-lien claims submitted for payment that
were rescinded or denied (3) $ 645.1 $ 800.0 $ 825.6
__________________
(1) Related to claims from policies in which we were in a first loss position and
would have paid the claim absent the rescission or denial.
(2) Related to claims from policies in which we were in a second loss position.
These rescissions or denials may or may not have resulted in a claim payment
obligation due to deductibles and other exposure limitations included in our
policies.
(3) Includes a small amount of submitted claims that were subsequently withdrawn
by the insured.
106--------------------------------------------------------------------------------
Rescission and denial rates in 2011 have been affected by an increase in the
number of claims received that we are reviewing for potential violations of our
insurance policies. The following table shows the cumulative denial and
rescission rates, net of reinstatements, as of December 31, 2011, on our total
first-lien portfolio for each quarter in which the claims were received for the
periods indicated:
Claim Cumulative
Received Rescission/Denial Rate Percentage of
Quarter for Each Quarter (1) Claims Resolved (2)
Q1 2009 23.8% 100%
Q2 2009 25.6% 100%
Q3 2009 22.7% 100%
Q4 2009 20.8% 100%
Q1 2010 18.9% 99%
Q2 2010 18.3% 99%
Q3 2010 16.6% 98%
Q4 2010 18.2% 97%
Q1 2011 21.4% 92%
Q2 2011 22.6% 79%
__________________
(1) Rescission/Denial rates represent the ratio of claims rescinded or denied to
claims received (by claim count) and represent (as of December 31, 2011) the
cumulative rate for each quarter based on number of claims received during
that quarter. Until all of the claims received during the periods shown have
been internally resolved, the rescission/denial rates for each quarter will
be subject to change. These rates also will remain subject to change based on
reinstatements of previously rescinded policies or denied claims.
(2) The percentage of claims resolved for each quarter presented in the table
above, represents the number of claims that have been internally resolved as
a percentage of the total number of claims received for that specific
quarter. A claim is considered internally resolved when it is either paid or
it is concluded that the claim should be denied or rescinded, though such
denials or rescissions could be challenged and, potentially reinstated. For
the third and fourth quarters of 2011, a significant portion of claims
received for those quarters have not been internally resolved; therefore, we
do not believe the cumulative rescission rates for those periods are
presently meaningful and are therefore not presented.
Change in Reserve for Premium Deficiency. For 2011 and 2010, the provision for
second-lien premium deficiency was impacted by the transfer of incurred losses
to second-lien loss reserves and by updates to our underlying assumptions. This
had the effect of reducing our second-lien premium deficiency reserve. See
"Critical Accounting Policies-Reserve for Premium Deficiency" below for a
description of our reserving process.
Other Operating Expenses. Other operating expenses decreased in 2011 as
compared to 2010, due to a reduction in salaries as well as stock-based
compensation expenses that are correlated to changes in our stock price. These
were partially offset by increases in sales commissions due to our increased NIW
and increased expenses related to the write-off of certain software and
technology projects in 2011. In October 2011, we completed an expense initiative
aimed at aligning our support services to the current reduced mortgage
market. This re-alignment included a workforce reduction of approximately 9.8%
of our corporate and mortgage insurance staff. Contract underwriting expenses
for 2011, including the impact of reserves for contract underwriting remedies,
were $16.1 million compared to $6.1 million for 2010, primarily due to an
increase in estimated remedy expenses for loans previously written via contract
underwriting. During 2011, loans underwritten via contract underwriting for flow
business accounted for 8.8% of applications, 8.2% of commitments for insurance
and 8.7% of insurance certificates issued, compared to 17.9%, 16.5% and 13.9%,
respectively, for 2010.
Interest Expense. Interest expense includes an allocation to the mortgage
insurance segment of interest on our long-term debt based on allocated capital.
Our consolidated interest expense significantly increased during 2011 as a
result of the issuance of $450 million of convertible notes at a large discount
in November 2010. This increase more than offset the decrease in the allocation
percentage to the mortgage insurance segment in 2011, which is based on relative
equity for this segment calculated in accordance with accounting principles
generally accepted in the United States of America ("GAAP").
Income Tax Provision. The income tax provision for 2011 was impacted by
remeasurement of our uncertain income tax positions and a change in the
valuation allowance against our DTA due to results from continuing operations.
The income tax expense for 2010 was primarily impacted by our establishment of a
significant valuation allowance in the fourth quarter. The 2010 tax provision
was also impacted by tax-exempt interest income, state and foreign taxes, and
tax expense relating to uncertain income tax positions.
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Year Ended December 31, 2010 Compared to Year Ended December 31, 2009
Net Loss. The increase in net loss for 2010, compared to 2009, was primarily
the result of the increase in the provision for losses and the recording of a
valuation allowance against our DTA in 2010, which resulted in an income tax
provision for 2010 compared to an income tax benefit in 2009.
Net Premiums Written and Earned. The increase in net premiums written for 2010
compared to 2009 was due primarily to decreases in ceded premiums resulting from
the termination of captive reinsurance arrangements and the run-off of existing
captives. Excluding the impact of the termination of captive reinsurance
arrangements, net premiums written decreased in 2010 compared to 2009, primarily
as a result of the smaller mortgage market, increased competition from the FHA
and more restrictive underwriting guidelines. Net premiums earned increased
slightly in 2010, mainly due to a reduction in the accrual for premium refunds
related to insurance rescissions and a decrease in ceded premiums, partially
offset by a decrease in premiums earned from second-liens and international
business as this business runs off. Net premiums earned in 2010 and 2009 were
reduced by $24.7 million and $72.8 million, respectively, due to a significant
increase in estimated premium refunds associated with our expectation of
increased rescissions.
Net Investment Income. The decrease in net investment income during 2010,
compared to 2009, was due to lower yields in our investment portfolio, as a
result of a continued reallocation of our investment portfolio to shorter term
investments in anticipation of future claim payments. In addition, assets were
also reallocated from longer duration, higher yielding tax-exempt municipal
securities to taxable securities of intermediate duration with lower interest
rates.
Net Gains on Investments. The net gains on investments were positively impacted
in 2010 by net realized gains on investments as we continued to reallocate our
investment portfolio.
Change in Fair Value of Derivative Instruments. The change in fair value of
derivative instruments for 2010 included an allocation of unrealized gains
related to derivatives held on CPS trusts that were consolidated by Radian
Group. The change in fair value of derivative instruments for 2009 included a
loss related to the termination of all of our remaining domestic CDS
transactions in our mortgage insurance business.
Net Gains (Losses) on Other Financial Instruments. The gains (losses) on other
financial instruments for both 2010 and 2009 were negatively impacted by losses
related to NIMS VIE debt, primarily caused by a tightening in Radian Group's CDS
spread, which had the effect of reducing the impact of our non-performance risk
adjustment included within the fair value estimate of our NIMS VIE debt.
Additionally, Radian Group purchased CPS securities, which resulted in an
allocation of losses associated with these investments and related VIE debt.
Net Impairment Losses Recognized in Earnings. Net impairment losses for 2010,
compared to 2009, included a lesser amount of impairments on fixed-maturity
investments available for sale and equity securities available for sale.
Other Income. The decrease in other income for 2010 as compared to 2009 is due
to a decline in contract underwriting income resulting from the overall decline
in mortgage origination volume.
Provision for Losses. Our mortgage insurance provision for losses for 2010
increased compared to 2009, primarily as a result of a decrease in the impact of
changes in our estimated insurance rescissions and claim denials in 2010
compared to 2009. During 2009, we significantly increased our estimate for
rescissions and denials, which resulted in a lower default to claim rate used in
determining our loss reserve estimate as of December 31, 2009, and benefited our
loss reserve estimate by approximately $1 billion in 2009. During 2010, the
impact to our loss reserve from estimated rescissions and denials declined,
primarily due to the realization of actual rescissions and denials.
Change in Reserve for Premium Deficiency. For 2010, the reserve for second-lien
premium deficiency was impacted by the transfer of premium deficiency reserves
to loss reserves and by updates to assumptions underlying our loss estimates. In
2009, we recorded a decrease in the reserve for second-lien premium deficiency
due to the transfer of premium deficiency reserves to loss reserves and changes
in estimates due to the settlement of certain second-lien transactions at less
than our estimates of reserves.
Policy Acquisition Costs. The increase in policy acquisition costs for 2010
compared to 2009 was mainly due to an increase in our estimated loss rate
assumptions, which resulted in an acceleration of amortization.
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Other Operating Expenses. Other operating expenses increased slightly in 2010
as compared to 2009, due to increases in sales commissions, cash and stock-based
compensation and information technology services expenses. These increases were
partially offset by a reduction in contract underwriting expenses. Contract
underwriting expenses for 2010, including the impact of reserves for contract
underwriting remedies, were $6.1 million compared to $11.6 million for 2009. The
decrease in contract underwriting expenses in 2010 resulted from a decreased
demand for this service due to the overall decline in mortgage origination
volume. During 2010, loans underwritten via contract underwriting for flow
business accounted for 17.9% of applications, 16.5% of commitments for insurance
and 13.9% of insurance certificates issued, compared to 14.1%, 12.5% and 13.0%,
respectively, for 2009.
Interest Expense. Interest expense for 2010 and 2009 included an allocation to
the mortgage insurance segment of interest on our long-term debt based on
allocated capital. For 2010, this allocation had decreased for our mortgage
insurance segment relative to our financial guaranty segment.
Income Tax Provision (Benefit). The mortgage insurance segment had an income
tax provision of $157.1 million for 2010, compared to an income tax benefit of
$176.4 million for 2009. The difference between the effective tax rate and the
statutory tax rate of 35% for 2010 was mainly related to the recording of a
valuation allowance against our DTA and the tax effect relating to uncertain
income tax positions.
Selected Mortgage Insurance Information
The following tables provide selected information as of and for the periods
indicated for our mortgage insurance segment. Certain statistical information
included in the following tables is recorded based on information received from
lenders and other third-parties.
Year Ended December 31,
($ in millions) 2011 2010
2009
Primary new insurance written
Prime $ 15,499 99.9 % $ 11,553 100.0 % $ 16,942 99.8 %
Alternative-A ("Alt-A") 2 - - - 11 0.1
A minus and below 9 0.1 5 - 16 0.1
Total Primary $ 15,510 100.0 % $ 11,558 100.0 % $ 16,969 100.0 %
Year Ended December 31,
($ in millions) 2011 2010 2009
Total primary new insurance
written by FICO (a) Score
>=740 $ 12,142 78.3 % $ 9,294 80.4 % $ 12,293 72.5 %
680-739 3,192 20.6 2,261 19.6 4,403 25.9
620-679 175 1.1 3 - 272 1.6
<=619 1 - - - 1 -
Total Primary $ 15,510 100.0 % $ 11,558 100.0 % $ 16,969 100.0 %
__________________(a) FICO credit scoring model.
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Year Ended December 31,
($ in millions) 2011 2010 2009
Percentage of primary new insurance written
Refinances 39 % 42 % 41 %
LTV (b)
95.01% and above 1.9 % 0.4 % 0.1 %
90.01% to 95.00% 36.3 % 29.5 % 29.3 %
Adjustable rate mortgages ("ARMs")
Less than five years 0.1 % 0.1 % 0.1 %
Five years and longer 4.8 % 5.3 % 1.6 %
Primary risk written $ 3,694 $ 2,663 $ 3,663
__________________
(b) LTV ratio: The ratio of the original loan amount to the original value of the
property.
December 31,
($ in millions) 2011 2010 2009
Primary insurance in forceFlow $ 113,438 89.9 % $ 115,532 89.2 % $ 121,596 84.3 %
Structured 12,747 10.1 14,034 10.8 22,672 15.7
Total Primary $ 126,185 100.0 % $ 129,566 100.0 % $ 144,268 100.0 %
Prime $ 106,407 84.3 % $ 106,466 82.2 % $ 111,398 77.2 %
Alt-A 12,344 9.8 14,542 11.2 22,941 15.9
A minus and below 7,434 5.9 8,558 6.6 9,929 6.9
Total Primary $ 126,185 100.0 % $ 129,566 100.0 % $ 144,268 100.0 %
110--------------------------------------------------------------------------------
December 31,
($ in millions) 2011 2010 2009
Modified pool
insurance in force (1)
Prime $ 920 31.2 % $ 671 22.1 % $ 1,508 16.0 %
Alt-A 1,890 64.0 2,216 73.2 7,649 81.2
A minus and below 143 4.8 143 4.7 258 2.8
Total modified pool $ 2,953 100.0 % $ 3,030 100.0 % $ 9,415 100.0 %
Primary risk in force
Flow
Prime $ 24,401 87.3 % $ 24,213 85.3 % $ 25,036 83.5 %
Alt-A 2,200 7.9 2,618 9.2 3,121 10.4
A minus and below 1,336 4.8 1,566 5.5 1,814 6.1
Total Flow $ 27,937 100.0 % $ 28,397 100.0 % $ 29,971 100.0 %
Structured
Prime $ 1,610 58.4 % $ 1,788 58.4 % $ 2,059 54.3 %
Alt-A 625 22.7 702 22.9 1,083 28.5
A minus and below 520 18.9 574 18.7 652 17.2
Total Structured $ 2,755 100.0 % $ 3,064 100.0 % $ 3,794 100.0 %
Total
Prime $ 26,011 84.8 % $ 26,001 82.6 % $ 27,095 80.2 %
Alt-A 2,825 9.2 3,320 10.6 4,204 12.5
A minus and below 1,856 6.0 2,140 6.8 2,466 7.3
Total Primary $ 30,692 100.0 % $ 31,461 100.0 % $ 33,765 100.0 %
Modified pool risk in
force (1)
Prime $ 80 29.6 % $ 74 25.6 % $ 104 17.8 %
Alt-A 172 63.7 197 68.2 456 78.2
A minus and below 18 6.7 18 6.2 23 4.0
Total modified pool $ 270 100.0 % $ 289 100.0 % $ 583 100.0 %
__________________(1) Included in primary insurance amounts.
111--------------------------------------------------------------------------------
December 31,
($ in millions) 2011 2010 2009
Total primary risk in
force by FICO score
Flow
>=740 $ 12,242 43.8 % $ 11,039 38.9 % $ 10,526 35.1 %
680-739 9,205 33.0 9,849 34.7 10,790 36.0
620-679 5,503 19.7 6,359 22.4 7,329 24.5
<=619 987 3.5 1,150 4.0 1,326 4.4
Total Flow $ 27,937 100.0 % $ 28,397 100.0 % $ 29,971 100.0 %
Structured
>=740 $ 732 26.6 % $ 825 26.9 % $ 1,036 27.3 %
680-739 802 29.1 892 29.1 1,168 30.8
620-679 738 26.8 815 26.6 990 26.1
<=619 483 17.5 532 17.4 600 15.8
Total Structured $ 2,755 100.0 % $ 3,064 100.0 % $ 3,794 100.0 %
Total
>=740 $ 12,974 42.3 % $ 11,864 37.7 % $ 11,562 34.3 %
680-739 10,007 32.6 10,741 34.1 11,958 35.4
620-679 6,241 20.3 7,174 22.8 8,319 24.6
<=619 1,470 4.8 1,682 5.4 1,926 5.7
Total Primary $ 30,692 100.0 % $ 31,461 100.0 % $ 33,765 100.0 %Percentage of primary
risk in force
Refinances 32 % 31 % 31 %
LTV
95.01% and above 17 % 19 % 21 %
90.01% to 95.00% 35 % 33 % 33 %
ARMs
Less than five years 5 % 6 % 8 %
Five years and longer 7 % 7 % 8 %
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December 31,
($ in millions) 2011 2010 2009
Total primary risk in force by
policy year
2005 and prior $ 6,887 22.4 % $ 8,145 25.9 % $ 9,709 28.7 %
2006 3,172 10.3 3,690 11.7 4,390 13.0
2007 6,960 22.7 8,072 25.7 9,443 28.0
2008 5,206 17.0 5,935 18.9 6,725 19.9
2009 2,656 8.7 3,099 9.8 3,498 10.4
2010 2,244 7.3 2,520 8.0 - -
2011 3,567 11.6 % - - - -
Total Primary $ 30,692 100.0 % $ 31,461 100.0 % $ 33,765 100.0 %
Total modified pool
risk in force by
policy year (1)
2005 and prior $ 194 71.9 % $ 186 64.4 % $ 243 41.7 %
2006 31 11.5 41 14.2 98 16.8
2007 39 14.4 55 19.0 235 40.3
2008 6 2.2 7 2.4 7 1.2
Total modified pool $ 270 100.0 % $ 289 100.0 % $ 583 100.0 %
Pool risk in force
Prime $ 1,601 77.4 % $ 1,828 74.5 % $ 1,918 71.1 %
Alt-A 122 5.9 165 6.7 246 9.1
A minus and below 345 16.7 460 18.8 534 19.8
Total Pool $ 2,068 100.0 % $ 2,453 100.0 % $ 2,698 100.0 %
Total pool risk in force by policy
year
2005 and prior $ 1,852 89.6 % 2,038 83.1 % $ 2,183 80.9 %
2006 92 4.4 179 7.3 236 8.7
2007 103 5.0 190 7.7 223 8.3
2008 21 1.0 46 1.9 56 2.1
Total Pool $ 2,068 100.0 % $ 2,453 100.0 % $ 2,698 100.0 %
__________________(1) Included in primary insurance amounts.
December 31,
($ in millions) 2011 2010 2009
Non-traditional risk in force
Second-lien
1stloss $ 102 $ 114 $ 147
2ndloss 29 79 116
NIMS 19 136 353
International1stloss-Hong Kong primary mortgage insurance 64 126 257
CDSs
- - 127
Total non-traditional risk in force $ 214$ 455$ 1,000
The default and claim cycle in the mortgage insurance business begins with our
receipt of a default notice from the servicer. For financial statement reporting
and internal tracking purposes, we do not consider a loan to be in default until
the borrower has missed two monthly payments.
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December 31,
2011 2010 2009
Default Statistics-Primary Insurance:
Flow
Prime
Number of insured loans 569,190 584,213 614,590
Number of loans in default 65,238 71,196 78,130
Percentage of total loans in default 11.46 % 12.19 % 12.71 %
Alt-A
Number of insured loans
44,355 51,765 60,616
Number of loans in default 14,481 17,934 22,177
Percentage of total loans in default 32.65 % 34.65 % 36.59 %
A minus and below
Number of insured loans
40,884 47,044 53,932
Number of loans in default 13,560 16,401 20,911
Percentage of total loans in default 33.17 % 34.86 % 38.77 %
Total Flow
Number of insured loans
654,429 683,022 729,138
Number of loans in default 93,279 105,531 121,218
Percentage of total loans in default 14.25 % 15.45 % 16.62 %
Structured
Prime
Number of insured loans 41,248 42,131 52,629
Number of loans in default 6,308 6,735 7,520
Percentage of total loans in default 15.29 % 15.99 % 14.29 %
Alt-A
Number of insured loans
18,484 20,234 43,615
Number of loans in default 5,563 6,635 15,295
Percentage of total loans in default 30.10 % 32.79 % 35.07 %
A minus and below
Number of insured loans
15,477 16,716 19,287
Number of loans in default 5,711 6,569 7,965
Percentage of total loans in default 36.90 % 39.30 % 41.30 %
Total Structured
Number of insured loans
75,209 79,081 115,531
Number of loans in default 17,582 19,939 30,780
Percentage of total loans in default 23.38 % 25.21 % 26.64 %
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December 31,
2011 2010 2009
Total Primary Insurance
Prime
Number of insured loans 610,438 626,344 667,219
Number of loans in default 71,546 77,931 85,650Percentage of total loans in default 11.72 % 12.44 % 12.84 %
Alt-A
Number of insured loans
62,839 71,999 104,231
Number of loans in default 20,044 24,569 37,472
Percentage of total loans in default 31.90 % 34.12 % 35.95 %
A minus and below
Number of insured loans
56,361 63,760 73,219
Number of loans in default 19,271 22,970 28,876
Percentage of loans in default 34.19 % 36.03 % 39.44 %
Total Primary
Number of insured loans
729,638 762,103 844,669
Number of loans in default 110,861 125,470 151,998
Percentage of loans in default 15.19 % 16.46 % 17.99 %
Default Statistics-Pool Insurance:
Number of loans in default
21,685 32,456 36,397
The following table shows the number of modified pool loans that we have
insured, the number of loans in default and the percentage of loans in default
as of the dates indicated. All modified pool statistics are also included within
our primary insurance statistics.
December 31,
2011 2010 2009
Default Statistics-Modified Pool Insurance:
Number of insured loans in force 17,468 15,487 42,509
Number of loans in default 3,461 4,009 12,677
Percentage of loans in default 19.81 % 25.89 % 29.82 %
The following table shows a rollforward of our primary loans in default:
For the Year Ended December 31,
2011 2010 2009
Beginning default inventory 125,470 151,998 110,553
Plus: New defaults (1) 94,817 115,360 164,003
Less: Cures (1) 77,997 100,166 87,934
Less: Claims paid (2) 24,479 25,765 16,744
Less: Rescissions and denials (3) 6,950 7,203 5,305
Less: Terminations of transactions - 8,754 12,575
Ending default inventory 110,861 125,470 151,998
__________________
(1) Amounts reflected are compiled on a monthly basis consistent with reports
received from loan servicers. The number of new defaults and cures presented
includes the following number of monthly defaults that defaulted and cured
within the period indicated:
115--------------------------------------------------------------------------------
For The Year Ended December 31,
2011 2010 2009
Intra-period new defaults 53,103 67,276 72,768
(2) Includes those charged to a deductible or captive.
(3) Net of any previously rescinded policies or denied claims that were
reinstated during the period. Such reinstated rescissions may ultimately
result in a paid claim, while any previously denied claims are generally
reviewed for possible rescission prior to any claim payment.
The table below shows the details related to the number of rescinded policies
and denied claims for the periods indicated. Recent trends in insurance
rescissions and claim denial activity reflect both an overall increase in the
number of policies rescinded and claims denied, as well as an increase in the
number of rescissions and denials that have been reinstated. This increase in
reinstatements is partly due to lenders challenging a greater number of
rescissions and denials and the overall challenges have been more effective
(i.e. producing new or additional information that supports a reinstatement of
coverage or a claim payment).
For The Year Ended December 31,
2011 2010 2009
Rescinded policies:
Rescinded (5,779 ) (4,854 ) (4,306 )
Reinstated 927 414 45
Denied claims:
Denied (5,370 ) (3,927 ) (1,761 )
Reinstated 3,272 1,164 717Total net rescissions and denials (6,950 ) (7,203 ) (5,305 )
The following tables show additional information about our primary loans in
default as of the dates indicated:
December 31, 2011
Projected Default to Claim Rate
Reserve for
Gross (1) Net (2) Losses % of Reserve
($ in thousands) # % % % $ %
Missed payments:
Three payments or less 21,803 20 % 23 % 21 % $ 215,230 8 %
Four to eleven payments 30,267 27 50 % 45 % 676,418 25
Twelve payments or more 58,791 53 67 % 54 % 1,766,277 67
Total 110,861 100 % 54 % 45 % 2,657,925 100 %
IBNR 151,965
LAE and Other 73,320
Total primary reserves $ 2,883,210
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December 31, 2010
Projected Default to Claim Rate
Reserve for
Gross (1) Net (2) Losses % of Reserve
($ in thousands) # % % % $ %
Missed payments:
Three payments or less 25,153 20 % 23 % 21 % $ 231,845 8 %
Four to eleven payments 39,827 32 49 % 41 % 815,897 29
Twelve payments or more 60,490 48 68 % 52 % 1,783,459 63
Total 125,470 100 % 53 % 42 % 2,831,201 100 %
IBNR 33,127
LAE and Other 67,764
Total primary reserves $ 2,932,092
_________________(1) Represents the weighted average default to claim rate before consideration of
estimated rescissions and denials for each category of defaulted loans.
Pending claims are included with a 100% default to claim rate.
(2) Net of estimate of rescissions and denials.
The following table shows information regarding our average loss reserves per
default, including IBNR and LAE reserves:
December 31,
2011 2010 2009
First-lien reserve per default (1)
Primary reserve per default $ 26,007$ 23,374$ 20,474
Pool reserve per default (2)
16,305 17,456 8,132
Total first-lien reserve per default 24,420 22,158 18,089
_________________
(1) Calculated as total reserves divided by total defaults.
(2) If calculated before giving effect to deductibles and stop losses in pool
transactions, the pool reserve per default at December 31, 2011, 2010 and
2009, would be $25,402, $28,265 and $17,007 respectively.
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Year Ended December 31,
(In thousands) 2011 2010 2009
Net claims paid (1):
Prime $ 796,940 $ 691,922 $ 344,760
Alt-A 257,448 308,113 215,350
A minus and below 164,429 180,078 150,466
Total primary claims paid 1,218,817 1,180,113 710,576
Pool 178,610 147,667 40,858
Second-lien and other 11,331 20,630 66,583
Subtotal 1,408,758 1,348,410 818,017
Impact of first-lien terminations 75,101 223,099 197,692
Impact of captive terminations (1,166 ) (324,365 ) (132,941 )
Impact of second-lien terminations 16,550 10,834 87,323
Total net claims paid $ 1,499,243 $ 1,257,978 $ 970,091
Average net claim paid (2):
Prime $ 49.6 $ 44.6 $ 43.5
Alt-A 60.7 57.5 55.2
A minus and below 40.2 37.6 38.6
Total average net primary claim paid 50.0 46.0 45.2
Pool 76.2 71.7 38.4
Second-lien and other 25.8 35.3 41.2
Total average net claim paid $ 51.9 $ 47.7 $ 44.5
Average direct primary claim paid (2) (3) $ 54.6 $ 52.5 $
47.9
Average total direct claim paid (2) (3) $ 56.0 $ 53.6 $
46.8
__________________
(1) Net of reinsurance recoveries.
(2) Calculated without giving effect to the impact of terminations of captive
reinsurance transactions and first- and second-lien transactions.
(3) Before reinsurance recoveries.
Our mortgage insurance total loss reserve as a percentage of our mortgage
insurance total risk in force was 9.8% at December 31, 2011, compared to 10.2%
at December 31, 2010 and 9.2% at December 31, 2009.
California accounted for 15.3% of our mortgage insurance segment's direct
primary new insurance written for the year ended December 31, 2011, compared to
12.8% and 16.9% for the years ended December 31, 2010 and 2009, respectively. At
December 31, 2011, California accounted for 11.8% of our mortgage insurance
segment's primary risk in force, compared to 11.4% at December 31, 2010.
California also accounted for 10.5% of our mortgage insurance segment's pool
risk in force at December 31, 2011, compared to 10.9% at December 31, 2010.
The largest single customer of our mortgage insurance segment (including
branches and affiliates of such customer), measured by primary new insurance
written, accounted for 10.1% of primary new insurance written for 2011 compared
to 15.5% for 2010 and 16.1% for 2009.
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The following table shows information regarding our reserve for losses and
reserve for premium deficiency as of the dates indicated:
December 31
(In thousands) 2011 2010 2009
Reserves for losses by category:
Prime $ 1,748,412 $ 1,607,741 $ 1,265,859
Alt-A 612,423 687,960 767,043
A minus and below 370,806 413,137 456,281
Reinsurance recoverable (1) 151,569 223,254 621,644
Total primary reserves 2,883,210 2,932,092 3,110,827
Pool insurance 353,583 566,565 295,996
Total first-lien reserves 3,236,793 3,498,657 3,406,823
Second-lien (2) 11,070 26,161 43,579
Other 37 153 136
Total reserve for losses $ 3,247,900 $ 3,524,971 $ 3,450,538
Modified pool reserves (included in primary
reserves above) $ 63,582 $ 87,218 $ 239,824
Reserve for premium deficiency on second-liens $ 3,644$ 10,736$ 25,357
__________________
(1) Represents ceded losses on captive transactions and Smart Home.
(2) Does not include second-lien premium deficiency reserve.
The following table reconciles our mortgage insurance segment's beginning and
ending reserves for losses and LAE for the years indicated:
(In thousands) 2011 2010 2009
Mortgage Insurance
Balance at January 1 $ 3,524,971 $ 3,450,538 $ 2,989,994
Less reinsurance recoverables (1) 223,254 621,644 491,836
Balance at January 1, net of reinsurance
recoverables 3,301,717 2,828,894 2,498,158
Add total losses and LAE incurred in respect of
default notices reported and unreported 1,293,857 1,730,801 1,300,827
Deduct paid claims and LAE 1,499,243 1,257,978 970,091
Balance at December 31, net of reinsurance
recoverables 3,096,331 3,301,717 2,828,894
Add reinsurance recoverables (1) 151,569 223,254 621,644
Balance at December 31 $ 3,247,900 $ 3,524,971 $ 3,450,538
__________________
(1) Related to ceded losses on captive reinsurance transactions and Smart Home.
At or For the Year Ended December 31
2011 2010 2009
First-Lien Captives
Premiums ceded to captives (in thousands) $ 28,816 $ 83,384 $ 129,808
% of total premiums 4.1 % 10.2 % 15.4 %
NIW subject to captives (in thousands) $ - $ 129 $ 1,655,642
% of primary NIW - <1% 9.8 %
IIF (1) subject to captives 8.9 % 10.6 % 29.3 %
RIF (2) subject to captives 8.8 % 10.4 % 31.5 %
Persistency (12 months ended) (3) 85.4 % 81.8 %
82.0 %
__________________
(1) Insurance in force ("IIF") on captives as a percentage of total insurance in
force.
(2) RIF on captives as a percentage of total risk in force.
(3) Reflects the impact of terminations of captive reinsurance transactions and
first- and second-lien transactions.
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Results of Operations-Financial Guaranty
The following table summarizes the results of operations for our financial
guaranty segment for the years ended December 31, 2011, 2010 and 2009:
Year Ended December 31, % Change
($ in millions) 2011 2010 2009 2011 vs. 2010 2010 vs. 2009
Net income (loss) $ 946.1 $ (695.4 ) $ 165.8 n/m n/m
Net premiums earned-insurance 75.1 86.1 101.5
(12.8 )% (15.2 )%
Net investment income 69.8 74.7 84.3 (6.6 ) (11.4 )
Net gains on investments 76.0 55.9 95.5 36.0 (41.5 )
Change in fair value of
derivative instruments 629.0 (591.1 ) 114.4 n/m n/m
Net gains (losses) on other
financial instruments 189.4 (163.6 ) 7.4 n/m n/m
Other income 0.2 0.4 1.4 (50.0 ) (71.4 )
Provision for losses 2.7 8.4 36.7 (67.9 ) (77.1 )
Policy acquisition costs 16.7 17.4 35.5 (4.0 ) (51.0 )
Other operating expenses 43.6 50.5 67.2 (13.7 ) (24.9 )
Interest expense 47.5 30.1 30.6 57.8 (1.6 )
Income tax (benefit) provision (16.8 ) 51.5 68.6
n/m (24.9 )
__________________
n/m-not meaningful
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010
Net Income (Loss). The results for 2011 reflect significant unrealized gains in
the change in fair value of derivative instruments and gains on other financial
instruments compared to unrealized losses on both items for 2010. The 2011
results were also impacted by an income tax benefit in 2011, compared to an
income tax provision in 2010 as a result of our establishment of a valuation
allowance in 2010.
Net Premiums Earned. Net premiums earned continue to decline as a result of the
decrease in our net par outstanding, which decreased 12% from December 31, 2010,
to December 31, 2011. Net premiums earned were positively impacted in 2011 by a
reinsurance commutation that occurred in April 2011, which accelerated certain
premiums earned. Net premiums earned were negatively affected by fewer
refundings in 2011 compared to 2010.
The following table shows net premiums earned by our financial guaranty
segment's various product lines for the periods indicated:
Year Ended December 31,
($ in thousands) 2011 2010 2009
Net premiums earned:
Public finance direct $ 40,797 $ 54,734 $ 49,965
Public finance reinsurance 25,942 25,297 44,232
Structured finance direct 2,093 2,498 6,364
Structured finance reinsurance 3,434 3,544
15,714
Trade credit reinsurance 35 46
191
Total premiums earned-insurance 72,301 86,119
116,466
Impact of commutations/recaptures 2,829 (17 ) (14,988 )
Total net premiums earned-insurance $ 75,130 $ 86,102 $
101,478
Refundings included in total net premiums earned $ 27,187$ 35,782 $
40,989
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Net Investment Income. Our financial guaranty net investment income decreased
during 2011 compared to 2010, primarily due to the shift from higher yielding
securities in our investment portfolio to lower yielding investments, as well as
a decline in our total investment balance due to negative cash flows. Both
periods include an allocation to the financial guaranty segment of net
investment income from Radian Group based on allocated capital.
Net Gains on Investments. The components of the net gains on investments for the
periods indicated are as follows:
Year Ended December 31,
(In millions) 2011 2010 2009
Net unrealized gains (losses) related to change
in fair value of trading securities $ 58.6 $ 17.9 $ (0.4 )
Net realized gains on sales 17.4 38.0 95.9
Net gains on investments $ 76.0 $ 55.9 $ 95.5
During the second quarter of 2011, we sold our portfolio of Tobacco Bonds, as
discussed above, and recognized $32.0 million in realized losses in our
financial guaranty segment in connection with that sale. These losses were more
than offset by gains on sales of other securities in our trading portfolio in
2011.
Change in Fair Value of Derivative Instruments. The components of the gains
(losses) included in change in fair value of derivative instruments for our
financial guaranty segment for the periods indicated are as follows:
Year Ended December 31,
(In millions) 2011 2010
2009
Net premiums earned-derivatives $ 41.7 $ 46.4 $
53.4
Financial Guaranty credit derivatives 598.0 (583.2 )
118.0
Financial Guaranty VIE derivative liabilities (10.7 ) (14.5 )
-
Put options on CPS - (39.8 ) (56.2 )
Other - -
(0.8 )
Change in fair value of derivative instruments $ 629.0 $ (591.1 ) $ 114.4
The results for 2011, were impacted by the movement of Radian Group's five-year
CDS spread, which widened by 2,267 basis points during the year, compared to
spread tightening of 1,065 basis points in 2010. The widening of Radian Group's
spread was the dominant driver of the gains in 2011. It increased the benefit of
the credit quality adjustment required under the accounting standard for fair
value and resulted in a positive impact across the entire derivatives portfolio.
The large unrealized fair value loss for 2010 is primarily due to the
significant tightening of our CDS spread. During 2010, we also experienced
multi-notch downgrades from the rating agencies in one project finance
transaction and one CDO of middle market collateralized loan obligation ("CLO")
transaction, which resulted in significant widening of the underlying credit
risk spread and increased our unrealized losses for these transactions. Slightly
offsetting these losses in 2010, were improvements in the underlying credit
spreads of our insured Corporate CDOs, CMBS, residential mortgage-backed
securities ("RMBS"), and TruPs.
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Net Gains (Losses) on Other Financial Instruments. The components of the gains
(losses) on other financial instruments for the periods indicated are as
follows:
Year Ended December 31,
(In millions) 2011 2010 2009
Gain (loss) related to change in fair value
of Financial Guaranty VIE debt $ 134.0 $ (161.8 ) $ -
Gain related to other Financial Guaranty VIE
assets 21.4 18.3
-
Gain on the repurchase of long-term debt - 2.0
8.0
Losses related to CPS VIE - (22.1 )
-
Foreign currency gain related to the
liquidation of a foreign subsidiary 39.6 -
-
Other (5.6 ) - (0.6 )
Net gains (losses) on other financial
instruments $ 189.4 $ (163.6 )
$ 7.4
The results for 2011 and 2010 were impacted by the movement of Radian Group's
five-year CDS spread. The widening of Radian Group's spread was the dominant
driver of the gains in 2011, as discussed above. Also impacting 2011, were
foreign currency translation gains resulting from the liquidation of a foreign
subsidiary, which occurred during 2011. Additionally, Radian Group had purchased
substantially all the CPS as of December 31, 2010 thereby eliminating related
VIE debt and any related market adjustment in 2011. The final purchase of CPS
was completed in January 2012. During 2010, our CDS spread tightened, and credit
spreads on our insured corporate CDOs widened, causing unrealized losses.
Provision for Losses. The provision for losses for 2011 decreased compared to
2010 due to favorable loss developments in our direct public finance and
structured finance business, which were partially offset by an increase in the
provision for losses in our assumed public finance and structured finance
business.
Other Operating Expenses. The decrease in other operating expenses for 2011
compared to 2010, resulted from a decrease in employee and director compensation
associated with our stock-based compensation programs and a decrease in audit
and legal fees.
Interest Expense. The results for 2011 were impacted by an increase in the
allocation of interest expense to our financial guaranty segment, which is based
on its relative GAAP equity, and also by an increase in interest expense
resulting from the issuance of $450 million in convertible debt in 2010 at a
significant discount.
Income Tax (Benefit) Provision. The income tax benefit for 2011 was impacted by
the liquidation of a foreign subsidiary and a decrease in the valuation
allowance against our DTA due to results from continuing operations. The
difference between the effective tax rate and the statutory tax rate of 35% for
2010 was mainly related to the recording of a valuation allowance against our
DTA, the tax benefit relating to our tax-exempt interest income, and the tax
provision relating to our foreign subsidiary operations.
Financial Guaranty General Claims and Reserve for Losses
The following table shows financial guaranty claims paid and reserve for losses
as of or for the periods indicated:
Year Ended December 31,
(In thousands) 2011 2010 2009
Claims Paid:
Financial guaranty $ 11,048$ 64,032$ 134,019 (1 )
Trade credit reinsurance 379 1,091 776
Total
$ 11,427 $ 65,123 $ 134,795
__________________
(1) Includes $53.9 million related to a commutation of $9.8 billion in assumed
net par outstanding.
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Year Ended December 31,
(In thousands) 2011 2010 2009
Reserve for Losses:
Financial guaranty $ 60,550$ 67,446$ 121,833
Trade credit reinsurance 2,452 4,318 6,611
Total
$ 63,002 $ 71,764 $ 128,444
Financial Guaranty Exposure Information
The following tables show the distribution of the financial guaranty segment's
net par outstanding, by type of exposure, as a percentage of financial
guaranty's total net par outstanding and the related net claim (asset) liability
and fair value net (asset) liability as of the dates indicated. The amounts for
December 31, 2011 are prior to the Assured Transaction.
December 31, 2011
% of Total Net Fair Value
Net Par Net Par Claim (Asset) Net (Asset)
Outstanding (1) Outstanding (1) Liability (2) Liability (3)
Type of Obligation (In billions) (In millions) (In millions)
Public finance:
General obligation and other tax
supported (4) $ 15.8 22.8 % $ 6.1 $ 0.3
Healthcare and long-term care 5.4 7.8 17.4 0.7
Water/sewer/electric gas and
investor-owned utilities 3.6 5.2 33.9 1.0
Airports/transportation 3.3 4.8 0.4 7.9
Education 2.2 3.2 (13.7 ) -
Escrowed transactions (5) 1.4 2.0 - -
Housing 0.3 0.4 0.4 -
Other municipal (6) 0.9 1.3 (8.0 ) 0.9
Total public finance (7) 32.9 47.5 36.5 10.8
Structured finance:
CDO 35.1 50.7 1.5 111.9
Asset-backed obligations 0.9 1.3 22.5 7.9
Other structured (8) 0.3 0.5 - (1.1 )
Total structured finance 36.3 52.5 24.0 118.7
Total $ 69.2 100.0 % $ 60.5 $ 129.5
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December 31, 2010
% of Total Net Fair Value
Net Par Net Par Claim (Asset) Net (Asset)
Outstanding (1) Outstanding (1) Liability (2) Liability (3)
Type of Obligation (In billions) (In millions) (In millions)
Public finance:
General obligation and other tax
supported (4) $ 17.5 22.2 % $ (0.3 ) $ 0.4
Healthcare and long-term care 6.2 7.9 18.1 (0.6 )
Water/sewer/electric gas and
investor-owned utilities 4.2 5.3 30.0 2.3
Airports/transportation 3.9 4.9 2.7 45.4
Education 2.6 3.3 (10.4 ) 0.3
Escrowed transactions (5) 1.9 2.4 - -
Housing 0.3 0.4 0.3 -
Other municipal (6) 1.1 1.4 (3.5 ) 0.7
Total public finance (7) 37.7 47.8 36.9 48.5
Structured finance:
CDO 39.6 50.3 1.2 825.9
Asset-backed obligations 1.1 1.4 29.3 20.4
Other structured (8) 0.4 0.5 - (1.3 )
Total structured finance 41.1 52.2 30.5 845.0
Total $ 78.8 100.0 % $ 67.4 $ 893.5
__________________(1) Represents our exposure to the aggregate outstanding principal on insured
obligations.
(2) A claim liability is recorded on the balance sheet when there is evidence
that deterioration has occurred and the net present value of our expected
losses for a particular policy exceeds the unearned premium reserve for that
policy. The claim liability reported is net of estimated salvage and
subrogation, which may result in a net claim asset.
(3) Represents either the net (asset) liability recorded within derivative assets
or derivative liabilities for derivative contracts, or the net (asset)
liability recorded within VIE debt and other financial statement line items
for financial guaranty consolidated VIEs.
(4) Includes $3.0 billion and $3.3 billion at December 31, 2011 and 2010,
respectively, of tax supported revenue bonds.
(5) Legally defeased bond issuances where our financial guaranty policy is not
extinguished, but cash or securities in an amount sufficient to pay remaining
obligations under such bonds have been deposited in an escrow account for the
benefit of the bondholders.
(6) Represents other types of municipal obligations, including human service
providers, second-to-pay international public finance, non-profit
institutions, project finance accommodations and stadiums, none of which
individually constitutes a material amount of our financial guaranty net par
outstanding.
(7) Includes $3.2 billion and $3.8 billion at December 31, 2011 and 2010,
respectively, of international public finance insured obligations (which
includes sovereign debt), of which $119.0 million and $118.0 million at
December 31, 2011 and 2010, respectively, of such obligations were in the
five Eurozone countries whose sovereign obligations have been under stress
due to economic uncertainty, potential restructuring and ratings downgrades.
We had no exposure to Ireland at either December 31, 2011 or 2010.
(8) Represents other types of structured finance obligations, including
diversified payment rights ("DPRs"), collateralized guaranteed investment
contracts or letters of credit, foreign commercial assets and life insurance
securitizations, none of which individually constitutes a material amount of
our financial guaranty net par outstanding.
We provide additional information below regarding the performance of certain
financial guaranty transactions for which claim payments (including amounts
previously paid) are expected to exceed $25 million.
• We have provided credit protection on the senior-most tranche of a CDO of
ABS transaction (the "CDO of ABS") with $450.6 million net par outstanding
at December 31, 2011. The underlying collateral consists predominantly of
mezzanine tranches of mortgage-backed securities ("MBS"). As of
December 31, 2011, $376.6 million (or 89.5%) of the underlying collateral
was rated BIG by at least one rating agency, of which $263.5 million (or
62.6%) of the underlying collateral had defaulted. As of December 31,
2011, this transaction was rated D by Standard & Poor's Rating Service
("S&P") and Ca by Moody's Investor Service ("Moody's"). Our own internal
rating for this transaction is D.
124--------------------------------------------------------------------------------
Due to the structure of the CDO of ABS, we do not expect to pay claims related
to shortfalls in principal payments for this transaction until sometime between
2036 and the legal final maturity date for the transaction in 2046. Although
losses for this transaction are difficult to estimate, we continue to believe
that absent a commutation of our exposure or other successful loss mitigation,
our ultimate claim payments with respect to principal payments for this
transaction will be an amount that is substantially all of our net par
outstanding for this transaction.
In November 2011, the CDO of ABS experienced an approximately $36 thousand
interest shortfall, which was subsequently repaid in December 2011. We expect
the transaction will again begin to experience interest shortfalls in 2012. As a
result of the November 2011 interest shortfall, we established a reserve for
this transaction in the fourth quarter of 2011 for statutory accounting
purposes. Because Radian Asset Assurance is a direct subsidiary of Radian
Guaranty, this statutory reserve had a direct, negative impact on the statutory
capital position and risk-to-capital ratio of Radian Guaranty as well. We
continue to explore loss mitigation alternatives with respect to this
transaction, including the possibility of commuting our remaining risk. We can
provide no assurance that we will be successful in such loss mitigation efforts.
See "Risk Factors-Our financial guaranty portfolio has experienced deterioration
as a result of general erosion in credit markets and the overall economy and is
susceptible to further deterioration which could have a material adverse effect
on the capital adequacy of Radian Guaranty."
Under GAAP, this CDO of ABS constitutes a VIE. Therefore, we consolidate the
assets and liabilities of this VIE and have elected to record them at fair
value. As such, our fair value liability associated with this transaction is
included in VIE debt on our consolidated balance sheets. Because the interest
shortfall discussed above has not significantly altered our cash flow
projections for this transaction, we do not expect that the interest shortfall
will have a significant impact on our GAAP related fair value liability for the
CDO of ABS.
• We have reinsured several primary financial guaranty insurers' obligations
with respect to $227.6 million in net par outstanding at December 31,
2011, related to Jefferson County, Alabama (the "County") sewer warrants
(the "Obligations"). The County's sewer system operations have generated
sufficient revenues since the beginning of 2009 to pay interest on its
outstanding debt, as well as regularly scheduled annual installments of
principal in February of 2010, 2011 and 2012, primarily due to
historically low prevailing interest rates on the County's variable rate obligations. We believe a number of factors continue to adversely affect
the performance of our insured obligations, including the County's highly
leveraged capital position, the sub-par performance of the sewer
facilities, the possibility that the County will be unable to generate
sufficient revenues to make regularly scheduled payments of principal and
interest on the Obligations if interest rates increase, and the filing by
the County on November 9, 2011, of a petition for bankruptcy (the
"Bankruptcy Petition") under Chapter 9 of the U.S. Bankruptcy Code (the
"Bankruptcy Code") with the U.S. Bankruptcy Court in the Northern District
of Alabama (the "Bankruptcy Court").
The County's financial condition is suffering from a liquidity crisis
occasioned, in part, by court decisions invalidating an occupational tax, which
contributed approximately $70 million (or one-third of the County's operating
revenues) to finance the County's operations unrelated to the sewer system
operations. The County has been unable to replace these tax revenues to date,
placing an additional strain on the County's finances. Currently, the County
cannot raise taxes or fees without state approval and the majority of its tax
revenues are for specific purposes.
On September 16, 2011, the County voted to accept an agreement in principle
that, if implemented, would have resulted in the refinancing of the County's
sewer Obligations by July 2012, and the settlement of outstanding claims and
litigation with respect to the Obligations. The County and the State court
appointed receiver for the sewer system (the "Receiver") had been in
negotiations to reach a definitive agreement. Negotiations abruptly ended on
November 9, 2011, when the County filed the Bankruptcy Petition. The Receiver
promptly filed a motion in the Bankruptcy Court to have his receivership order
and its continuing effectiveness accepted by the Bankruptcy Court. Creditors
also sought to have the Bankruptcy Petition dismissed as ineligible. On January
6, 2012, the Bankruptcy Court ruled (the "January 6th Order") that the sewer
system is under the exclusive jurisdiction of the Bankruptcy Court and that the
Receiver was without power to exercise authority over the system. In practical
terms, the County was restored to operational control of the system subject to
the Bankruptcy Court's jurisdiction. We believe the removal of the Receiver will
make the ultimate structuring of a plan for the County emergence from bankruptcy
more difficult.
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The Bankruptcy Court ruled that the system's net revenues are exempt from the
automatic stay provisions of the U.S. Bankruptcy Code and may be paid to
creditors, but may be paid only after the payment of operating expenses of the
system. In addition, it has been reported that the relevant parties have agreed
upon a monthly distribution amount of the net revenues to be paid to creditors,
which reduces the risk of a deficiency in the payment of interest on the
Obligations in the near future. The Bankruptcy Court did not rule on the issue
of whether the County was eligible to file the Bankruptcy Petition, and the
Bankruptcy Court's ruling on this issue is still pending.
While the full potential impact of the Bankruptcy is uncertain at this time, the
trustee for the Obligations has the ability, with Bankruptcy Court approval, to
accelerate the payment of these Obligations. This would likely result in more
frequent direct claims of up to $9.6 million of our reinsurance net par exposure
related to regularly scheduled payments of debt service under reserve fund
surety policies issued by our primary insurers. To date, the trustee has not
sought to accelerate these payments. Similarly, the withholding of net revenues
by the County for payment of operating expenses as defined by the County, could
result in further draws on those sureties for payments of regularly scheduled
debt service and the reduction of current salvage amounts receivable by us
against claims that we had paid in 2008.
We began paying claims related to the Obligations in 2008, and have paid $20.6
million of claims, net of salvage, on this transaction through December 31,
2011. In addition, as of December 31, 2011, we had a $26.8 million net claim
liability for all of our exposure on this transaction.
In addition, we are closely monitoring our exposure to our insured portfolio of
15 directly insured senior bonds ("TruPs bonds") issued pursuant to TruPs CDOs.
We provide credit protection on these TruPs bonds through 19 separate CDS
contracts, meaning that with respect to four of the TruPs bonds we insure, we
entered into two separate CDS contracts (each with a different counterparty)
covering the same TruPs bond. Our total aggregate net par outstanding related to
TruPs bonds was $1,894.2 million as of December 31, 2011, which is a 10.5%
decrease from December 31, 2010. Many issuers of the TruPs collateral underlying
our insured obligations have been negatively affected by the most recent U.S.
economic recession and slow recovery, and as a result, have defaulted on their
obligation to pay interest on their TruPs or have voluntarily chosen to defer
interest payments, which is permissible for up to five years. Recently, however,
the number of cures of previous defaults and the payment of deferred interest
payments on the TruPs collateral has outpaced new initial defaults and
deferrals. As of December 31, 2011, $1.0 billion of our net par outstanding
related to TruPs bonds was internally rated BIG. The fair value liability of our
TruPs bonds, which are accounted for as derivatives, was $26.4 million as of
December 31, 2011.
One of our insured TruPs bonds, with $111.3 million of net par outstanding as of
December 31, 2011, experienced interest shortfalls from October 2009 through
April 2011, for which we paid an aggregate of $0.7 million in interest shortfall
claims. In July 2011, as a result of excess cash flows that became available
from collateral prepayments, these interest shortfalls were repaid to us and
this bond is no longer in default. While we currently do not expect to pay
additional interest or principal shortfall claims on this TruPs bond, if
additional shortfalls were to occur, we may be required to pay a liquidity claim
(as discussed in "Liquidity and Capital Resources-Financial Guaranty" below) on
this CDS contract.
It should be noted that even relatively small changes in TruPs default rates or
economic conditions from current projections could have a material impact on the
timing and amount of cash available to make principal and interest payments on
the underlying TruPs bonds. Therefore, the occurrence, timing and duration of
any event of default and the amount of any ultimate principal or interest
shortfall payments are uncertain and difficult to predict. We continue to
explore loss mitigation alternatives with respect to our TruPs bond portfolio,
including the possibility of commuting our remaining risk. We can provide no
assurance that we will be successful in such loss mitigation efforts.
Year Ended December 31, 2010 Compared to Year Ended December 31, 2009
Net Income (Loss). The net loss in 2010 compared to net income in 2009 was
primarily due to the significant unrealized losses on financial instruments,
including derivatives, in 2010. These unrealized losses resulted primarily from
the tightening of our CDS spread. The 2010 results were also negatively impacted
by the recording of a valuation allowance against our DTA.
Net Premiums Earned. Net premiums earned for 2010 were lower than 2009,
primarily due to a large commutation in June 2009, which reduced our net par
outstanding by $9.8 billion and reduced our premiums earned by $15.3 million,
and also due to the maturity and termination of policies written in previous
years without any corresponding new policies. In addition, refundings, earned
premiums resulting from moving financial guaranty policies to case reserve from
intensified surveillance and adjustments to installment policies were lower in
2010 compared to 2009.
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Net Investment Income. The decrease in net investment income during 2010,
compared to 2009, was due to lower yields in our investment portfolio as a
result of a continued reallocation of our investment portfolio to shorter term
investments. In addition, assets were also reallocated from longer duration,
higher yielding tax-exempt municipal securities to taxable securities of
intermediate duration with lower interest rates.
Net Gains on Investments. The realized gains on investments in 2010 and 2009
reflected improved market conditions and activity related to the reallocation of
our investment portfolio to investments with shorter duration.
Change in Fair Value of Derivative Instruments. The large unrealized fair value
loss for 2010 was primarily due to the significant tightening of our CDS spread.
We also experienced multi-notch downgrades from the rating agencies in one
project finance transaction and one CDO of middle market CLO transaction, which
resulted in significant widening of the underlying credit risk spread and
increased our unrealized losses for these transactions. Slightly offsetting
these losses were improvements in the underlying credit spreads of our insured
Corporate CDOs, CMBS, RMBS, and TruPs.
Net Gains (Losses) on Other Financial Instruments. The results for 2010 reflect
the adoption of the accounting standard update regarding improvements to
financial reporting by enterprises involved with VIEs. As a result of this
update, we identified and consolidated additional VIEs and recorded the related
fair value gains (losses) in this line item. The losses related to changes in
fair value of our VIE debt for 2010 were mainly due to the significant
tightening of our CDS spread.
Provision for Losses. The provision for losses for 2010 decreased compared to
2009 due to favorable loss developments in our public finance business, which
were partially offset by an increase in the provision for losses in our
structured finance business. The 2009 provision for losses was reduced by $38.6
million as a result of adjustments made to our estimate of losses based on the
June 2009 commutation of $9.8 billion in assumed net par outstanding and certain
favorable developments in our structured finance direct line of business.
Policy Acquisition Costs. The decrease in policy acquisition costs for 2010
compared to 2009 was primarily due to the decrease in net premiums earned in
2010 and the commutation of $9.8 billion of net par outstanding in June 2009,
which resulted in our accelerating $8.9 million of policy acquisition costs and
reduced the base asset to be amortized.
Other Operating Expenses. The decrease in other operating expenses for 2010
compared to 2009 was primarily due to decreases in salaries, severance, audit
fees and consulting fees, which were partially offset by an increase in expenses
related to consolidated VIEs.
Interest Expense. Interest expense for 2010 and 2009 included interest on our
long-term debt, which was allocated to the financial guaranty segment based on
allocated capital.
Income Tax Provision. The financial guaranty segment had an income tax provision
of $51.5 million for 2010 compared to an income tax provision of $68.6 million
for 2009. The difference between the effective tax rate and the statutory tax
rate of 35% for 2010 was mainly related to the recording of a valuation
allowance against our DTA, the tax benefit relating to our tax-exempt interest
income, and the tax provision relating to our foreign subsidiary operations.
Results of Operations-Financial Services
As stated above in "-Business Summary," as of January 1, 2011, we did not have a
Financial Services segment. The following table shows a summary of the results
of operations for our Financial Services segment prior to January 1, 2011:
Year Ended December 31,
(In millions) 2010
2009
Equity in net income of affiliates-Sherman $ 14.6 $
33.2
Gain on sale of affiliate-Sherman 34.8 -
Net income 32.7 24.1
See "Business Summary" above for more information regarding this prior segment.
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Contractual Obligations and Commitments
We have various contractual obligations that are recorded as liabilities in our
consolidated financial statements. Other items, including payments under
operating lease agreements, are not recorded on our consolidated balance sheets
as liabilities but represent a contractual commitment to pay.
The following table summarizes certain of our contractual obligations and
commitments, including our expected claim payments on insurance policies, as of
December 31, 2011, and the future periods in which such obligations are expected
to be settled in cash. Additional details regarding these obligations are
provided in the narrative following the table and in the Notes to Consolidated
Financial Statements that are referenced in the table.
Payments Due by Period
Less than More than
(In thousands) Total 1 Year 1-3 years 3-5 years 5 years Uncertain
Long-term debt
obligations (principal
and interest) (Note 13) $ 1,099,125 $ 41,000 $ 310,906 $ 283,719 $ 463,500 $ -
Capital lease obligations - - - - - -
Operating lease
obligations (Note 18) 54,896 12,619 24,831 14,440 3,006 -
NIMS (1) 18,609 4,501 8,678 302 5,128 -
Derivative instruments
and VIEs (1) 146,874 210,318 6,483 15 (69,942 ) -
Purchase obligations - - - - - -
Reserve for losses and
LAE (Note 10) (2) 3,310,902 1,293,700 2,032,500 1,000 (15,000 ) (1,298 )
Unrecognized tax benefits
(Note 14) 179,599 86,236 - - - 93,363 (3)
Total $ 4,810,005 $ 1,648,374 $ 2,383,398 $ 299,476 $ 386,692 $ 92,065
__________________
(1) Amounts represent management's estimate of credit loss payments related to
these instruments as described in "Results of Operations" above.
(2) Our reserve for losses and LAE reflects the application of accounting
policies described below in "Critical Accounting Policies-Reserve for
Losses." The payments due by period are based on management's estimates and
assume that all of the loss reserves included in the table will result in
claim payments, net of expected recoveries. Included in the uncertain
category is $13.7 million of unearned premium reserves, which are included in
our reserve for losses and LAE. Negative amounts presented are primarily
related to expected recoveries on our financial guaranty claims.
(3) The timing of these potential payments is uncertain given the nature of the
obligation.
As of December 31, 2011, $86.2 million of our total $179.6 million of gross
liability for unrecognized tax benefits associated with the provisions of the
accounting standard regarding accounting for income taxes is expected to be paid
in less than a year. We cannot make a reasonably reliable estimate of the period
of cash settlement for the remaining $93.4 million of liability for unrecognized
tax benefits due to the high degree of uncertainty regarding the timing of
future cash outflows associated with certain of our liabilities for unrecognized
tax benefits. See Note 14 of Notes to Consolidated Financial Statements.
Other Contractual Obligations and Commitments
In addition to the contractual obligations set forth in the table above, we have
the following contractual obligations and commitments.
Investment Commitments. As part of the non-investment grade component of our
investment portfolio, we had unfunded commitments of $9.6 million at
December 31, 2011, related to alternative investments that are primarily private
equity structures. These commitments have capital calls expected through 2015,
with the possibility of additional calls through 2017, and certain fixed
expiration dates or other termination clauses.
GSE Approvals. In February 2012, the GSEs each approved Radian Mortgage
Assurance to write new mortgage insurance in certain RBC States, subject to
certain terms and conditions. Pursuant to the GSE Approvals, Radian Group will
be required to make a $50 million capital contribution to Radian Guaranty upon
Radian Guaranty's breach of a Statutory RBC Requirement such that the use of
Radian Mortgage Assurance is required to continue to write new business in the
applicable RBC State. In addition, the GSE Approvals are conditioned upon our
compliance with a broad range of conditions and restrictions. See
"Business-Regulation-State Regulation-Risk-to-Capital."
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Affiliate Guaranty/Indemnification Agreements. We and certain of our
subsidiaries have entered into the following intercompany guarantees:
• Radian Guaranty and Radian Mortgage Assurance are parties to a
cross-guaranty agreement. This agreement provides that if either party
fails to make a payment to a policyholder, then the other party will
step in and make the payment. The obligations of both parties are
unconditional and irrevocable; however, no payments may be made without
prior approval by the insurance regulatory authority of the payor's
state of domicile. Radian Mortgage Assurance had no risk in force
exposure as of December 31, 2011.
• Radian Guaranty has agreed to maintain Radian Insurance's tangible net
worth at a minimum of $30 million and to cause Radian Insurance to at
all times have sufficient liquidity to meet its current obligations,
pursuant to a Net Worth and Liquidity Maintenance Agreement between the
two companies.
• Radian Group has agreed to guarantee, up to a maximum amount of $300
million, Radian Guaranty's obligations to Radian Insurance under the
Net Worth and Liquidity Maintenance Agreement discussed immediately
above, in the event that Radian Guaranty is not able to or permitted by
the Pennsylvania Insurance Department to perform under the agreement.
• Radian Group and Radian Mortgage Insurance Inc. ("Radian Mortgage
Insurance"), a subsidiary of Radian Guaranty, are parties to a guaranty
agreement in which Radian Group has agreed for the benefit of Radian
Mortgage Insurance's creditors to make funds available on demand for
the full and complete payment of all due but unpaid liabilities.
• Prior to our acquisition of Enhance Financial Services Group Inc. ("EFSG") in 2001, EFSG issued a guaranty of payment of the liabilities
and obligations of its subsidiary, Radian Reinsurance (Bermuda)
Limited, deriving from any insurance or reinsurance contract (the
"Enhance Guaranty"), for the purpose of maintaining certain regulatory
solvency and liquidity margin requirements of the Bermuda Monetary
Authority. Following our acquisition of EFSG, Radian Group issued a
guaranty for the benefit of EFSG to make funds available to EFSG for
its performance of the Enhance Guaranty, to the extent that EFSG is
unable to satisfy those obligations. As of January 2010, this
subsidiary no longer had any insurance liabilities, and in February
2012, was placed into liquidation.
• Radian Group and Radian Mortgage Assurance are parties to a guaranty
agreement. This agreement provides that Radian Group will make
sufficient funds available to Radian Mortgage Assurance to ensure that
Radian Mortgage Assurance has a minimum of $5 million of statutory
surplus every calendar quarter.
• To allow our mortgage insurance customers to comply with applicable
securities regulations for issuers of ABS (including MBS), we have been
required, depending on the amount of credit enhancement we were
providing, to provide (1) audited financial statements for the
insurance subsidiary participating in these transactions or (2) a full and unconditional holding-company level guarantee for our insurance
subsidiaries' obligations in such transactions. Radian Group has
guaranteed two structured transactions for Radian Guaranty with
approximately $166.8 million of remaining credit exposure.
• Radian Group's U.S. Consolidated federal income tax returns, which
include Commonwealth Mortgage Assurance Company of Texas's ("CMAC of
Texas") federal tax returns, were under examination by the Internal
Revenue Service ("IRS") for tax years 2000 through 2007. We are
currently contesting proposed adjustments resulting from the IRS
examination of these tax years. Effective December 2011, Radian Group
and CMAC of Texas entered into an Assumption and Indemnification
Agreement with regard to these proposed adjustments. Through this
agreement, Radian Group agreed to indemnify CMAC of Texas for any tax
payments ultimately due to the IRS for the proposed adjustments, which
relate to the recognition of certain tax losses and deductions that
were generated through our investment in a portfolio of residual
interests in Real Estate Mortgage Investment Conduits ("REMICs")
currently held by CMAC of Texas. This indemnification was in lieu of an
immediate capital contribution that otherwise would have been needed
from Radian Group to CMAC of Texas, based on an estimate for this
potential liability, in order for CMAC of Texas to maintain its minimum
statutory surplus requirements. There remains significant uncertainty
with regard to the amount and timing of any resolution with the IRS,
and we are currently contesting the proposed adjustments related to the
REMICs.
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In addition to the foregoing, we use reinsurance from affiliated companies to
allow Radian Guaranty to remain in compliance with insurance regulations that
limit the amount of risk that a mortgage insurance company may retain on a
single loan to 25% of the indebtedness of the insured. Further, in 2011 and
2010, Radian Guaranty, in order to support its capital position, entered into
excess-of-loss reinsurance agreements with Radian Insurance. Under these
agreements, Radian Guaranty transferred a total of approximately $7.4 billion of
risk in force to Radian Insurance. These pools of loans generally consist of a
higher concentration of fixed-rate, prime, high FICO loans than our overall
mortgage insurance portfolio. As of December 31, 2011, the remaining risk in
force under these agreements was $6.2 billion.
Off-Balance Sheet Arrangements
All VIEs must be evaluated for consolidation in accordance with the accounting
standard regarding consolidation of VIEs. VIEs are entities as defined by the
accounting standard and include corporations, trusts or partnerships in which
equity investors do not have a controlling financial interest or do not have
sufficient equity at risk to finance its activities without additional
subordinated financial support.
Our interests in VIEs may be accounted for as insurance contracts or financial
guaranty derivatives or in some cases, as described more fully below, we have
consolidated the VIEs. For insurance contracts with VIEs that we do not
consolidate, we record reserves for losses and LAE, and for derivative interests
in VIEs that we do not consolidate, we record changes in the fair value as a
corresponding derivative asset or derivative liability. Our primary involvement
with VIEs relates to transactions in which we provide a financial guaranty to
one or more classes of beneficial interest holders in the VIE. VIEs may also be
used to create securities with a unique risk profile desired by investors and as
a means of transferring risk, such as our Smart Home transactions. We do not
record the underlying assets or liabilities of the VIEs on our balance sheets
unless we are the primary beneficiary of the VIE.
Smart Home
In 2004, we developed a program referred to as "Smart Home," for reinsuring risk
associated with non-prime mortgages and riskier products. These reinsurance
transactions, through the use of VIE structures, effectively transfer risk from
our portfolio to investors in the capital markets. Since August 2004, we have
completed four Smart Home reinsurance transactions. We exercised our option to
terminate two of these transactions in March 2011, with RIF of approximately $41
million. The two remaining transactions will mature within the next 18 months
(one in November 2012 and one in June 2013), and the ultimate recoverable
amounts from these transactions will be dependent upon the amount and timing of
paid losses in these transactions through their respective maturity dates.
Details of the two remaining transactions (aggregated) as of the initial closing
of each transaction and as of December 31, 2011, are as follows:
As
of December 31,
Initial 2011
Pool of mortgages (par value) $ 12.2 billion $3.3 billion
Risk in force (par value) $ 3.1 billion
$0.8 billion
Notes sold to investors/risk ceded (principal amount) $534.0 million$406 million
Each transaction began with the formation of an unaffiliated, offshore
reinsurance company. We then entered into an agreement with the Smart Home
reinsurer to cede to the reinsurer a portion of the risk (and premium)
associated with a portfolio of loans. Each class of notes relates to the loss
coverage levels on the reinsured portfolio and is assigned a rating by one or
more of the three major rating agencies. We do not hold any of the credit-linked
notes issued as part of this structure; therefore, we have no significant
variable interests in the structures, and are not subject to consolidation under
this standard.
Financial Guaranty VIEs
As a provider of credit enhancement, we have entered into insurance contracts
with VIEs and derivative contracts with counterparties in which we have provided
credit protection directly on variable interests by VIEs or, in some cases,
obtained the contractual rights of our counterparties with respect to the VIEs.
See Note 6 of Notes to Consolidated Financial Statements for more information.
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Put Options on CPS
In September 2003, Radian Asset Assurance entered into a contingent capital
transaction pursuant to which three custodial trusts issued an aggregate of $150
million in CPS ($50 million by each custodial trust) to various holders. Based
on our additional involvement in these trusts, we concluded that we are the
party that directs the activities that most significantly influence the economic
performance of these VIEs and has the right to receive benefits that would be
significant to these VIEs. See Note 6 of Notes to Consolidated Financial
Statements for more information.
Liquidity and Capital Resources
Radian Group-Short-Term Liquidity Needs
Radian Group serves as the holding company for our insurance subsidiaries and
does not have any significant operations of its own. Radian Group's principal
liquidity demands for the next 12 months include funds for: (i) the payment of
certain corporate expenses; (ii) interest payments on our outstanding long-term
debt; (iii) repayments of our 5.625% Senior Notes due February 2013; (iv)
capital support for our mortgage insurance subsidiaries; (v) potential payments
to the IRS resulting from the examination by the IRS for the 2000 through 2007
tax years; and (vi) the payment of dividends on our common stock.
Radian Group had immediately available, directly or through an unregulated
direct subsidiary, unrestricted cash and liquid investments of $482.8 million at
December 31, 2011. This amount includes $150 million of investments contained in
our CPS custodial trusts as discussed below. In November 2011 and February 2012,
Radian Group contributed approximately $50.6 million and $100.0 million,
respectively, to its mortgage insurance subsidiaries to support their capital
positions, as further discussed below. Both of these contributions were
effective as of December 31, 2011, and therefore, the $482.8 million of
unrestricted cash and liquid investments reflects amounts remaining after giving
effect to these contributions.
We expect to fund Radian Group's short-term liquidity needs with (i) existing
cash and marketable securities, including, if necessary, $150 million held in
the CPS trust accounts, and (ii) cash received under the expense-sharing
arrangements with our subsidiaries. If Radian Group's current sources of
liquidity are insufficient for Radian Group to fund its obligations, Radian
Group may be required to seek additional capital by incurring additional debt,
by issuing additional equity, or by selling assets, which we may not be able to
do on favorable terms, if at all.
At December 31, 2011, we did not have the intent to sell any debt securities
classified as held to maturity or available for sale and 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 or maturity.
Corporate Expenses and Interest Expense. Radian Group has expense-sharing
arrangements in place with its principal operating subsidiaries that require
those subsidiaries to pay their share of holding-company-level expenses,
including coupon rate interest payments on our outstanding long-term debt.
Payments of such corporate expenses for the next 12 months, excluding interest
payments, are expected to be approximately $59.6 million. For the same period,
payments of interest on our long-term debt are expected to be approximately
$41.0 million. These amounts are expected to be fully reimbursed by our
subsidiaries under our existing expense-sharing arrangements. These
expense-sharing arrangements, as amended, have been approved by applicable state
insurance departments, but such approval may be modified or revoked at any time.
In addition, pursuant to the GSEs' approval of Radian Mortgage Assurance as an
eligible mortgage insurer, GSE consent is required to modify or amend the
expense-sharing agreements. Approximately $30.7 million of future expected
corporate expenses and interest expense (approximately $16.7 million for the
next 12 months) has been accrued for and paid by certain subsidiaries to Radian
Group as of December 31, 2011, and therefore, the total unrestricted cash and
liquid investments held by Radian Group as of December 31, 2011, includes these
amounts. A portion of these expenses (approximately $15.8 million) relates to
performance-based compensation expenses that could be reversed in whole or in
part, depending on changes in our stock price and other factors. To the extent
these expenses are reversed, Radian Group would be required to reimburse the
subsidiaries that paid these expenses to Radian Group.
In addition, under the Fannie Mae approval for Radian Mortgage Assurance, Radian
Group is required to contribute to Radian Guaranty the amount of any future
interest expense payments made by Radian Guaranty or Radian Mortgage Assurance
to Radian Group pursuant to the terms of the interest expense sharing
arrangements among these entities. Pursuant to the terms of our expense sharing
arrangements, any interest expense payments from Radian Guaranty or Radian
Mortgage Assurance to Radian Group in 2012 are expected to be immaterial.
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Repayment of 2013 Senior Notes. Our 5.625% Senior Notes with $250 million in
principal amount are due in February 2013. On February 23, 2012, Radian Group
commenced a "Modified Dutch Auction" tender offer (the "Tender Offer") to
purchase a portion of its outstanding 5.625% Senior Notes Due 2013 (the "Notes")
for an aggregate purchase price not to exceed $100 million which may be
increased at our discretion (subject to increase, the "Tender Cap"). Radian
Group set an early participation deadline of 5:00 P.M., New York City time, on
March 7, 2012, and holders of Notes that validly tender, and do not withdraw
their Notes, on or before such time will be eligible to receive an additional
payment for their early participation. In the Modified Dutch Auction, the
holders of Notes indicate how much principal in Notes, and at what price within
Radian Group's specified range, they wish to tender. Based on the aggregate
principal amount of Notes tendered and the prices specified by the tendering
Note holders, Radian Group will determine the lowest price per $1,000 principal
amount of Notes within the range that will enable Radian Group to purchase up to
the Tender Cap (or a lower amount if the offer is not fully subscribed). Except
for the potential early participation payment, all Notes purchased by Radian
Group in the Tender Offer will be purchased at the same price. Radian Group will
not purchase Notes below a holder's indicated price per $1,000 principal amount
of Notes, and in some cases, Radian Group may actually purchase Notes at a price
that is above a holder's indicated price under the terms of the Tender Offer.
The Tender Offer is scheduled to expire on March 21, 2012, unless extended or
earlier terminated. The Tender Offer is conditioned on the satisfaction or
waiver of certain conditions as described in the offering documents for the
Tender Offer. Subject to applicable law, we may terminate the Tender Offer if,
before such time as any Notes have been accepted for payment, any condition of
the Tender Offer is not satisfied or not waived by us. The Tender Offer will be
financed using a portion of the $482.8 million of available cash and liquid
investments.
Tax Payments. Under our current tax-sharing agreement between Radian Group and
its subsidiaries, our subsidiaries are required to pay to Radian Group, on a
quarterly basis, amounts representing their estimated separate company tax
liability for the current tax year. Radian Group is required to refund to each
subsidiary, any amount that such subsidiary overpaid to Radian Group for a
taxable year, as well as any amount that the subsidiary could utilize through
existing carryback provisions of the Internal Revenue Code ("IRC") had such
subsidiary filed its federal tax return on a separate company basis. During
October 2011, Radian Group paid approximately $77 million to Radian Guaranty,
which was the maximum amount required to be paid under the tax-sharing
agreement. Radian Group was also obligated to make tax-sharing payments during
October 2011 of approximately $7 million to other subsidiaries within our
consolidated group. We do not expect that Radian Group will be required to pay
any material amounts in 2012 under the tax-sharing agreement. Our tax-sharing
agreement may not be changed without the pre-approval of the applicable state
insurance departments for certain of the insurance subsidiaries that are party
to the agreement. In addition, pursuant to the GSEs' approval of Radian Mortgage
Assurance as an eligible mortgage insurer, GSE consent is required to modify or
amend the tax-sharing agreement.
As of the balance sheet date, certain of our insurance subsidiaries, including
Radian Guaranty, have incurred net operating losses ("NOLs") that could not be
carried-back and utilized on a separate company tax return basis. As a result,
we are not currently obligated to reimburse these subsidiaries for their
separate company NOL carryforward. However, if in a future period our
consolidated NOL is fully utilized before a subsidiary has utilized its share of
NOL on a separate entity basis, then Radian Group may be obligated to fund such
subsidiary's share of our consolidated tax liability to the IRS. Currently, we
do not expect to fund material obligations under the provisions described in
this paragraph with regard to subsidiary NOLs incurred to date.
Capital Support for Subsidiaries. In light of on-going losses in our mortgage
insurance business, Radian Group may be required to make additional capital
contributions to Radian Guaranty in order to support Radian Guaranty's ability
to continue writing insurance in those states that impose certain risk-based
capital requirements. Radian Group contributed approximately $30 million and
$100 million to Radian Guaranty in November 2011 and February 2012,
respectively, and completed a series of internal transactions in order to
benefit Radian Guaranty's statutory risk-based capital position. In December
2011, Radian Group contributed its ownership interest in Radian Mortgage
Assurance to Radian Guaranty, which equaled approximately $17 million, and
Radian Guaranty sold its minority ownership interest in EFSG, the parent company
of CMAC of Texas, to Radian Group for approximately $6 million. Radian
Guaranty's risk-to-capital ratio was approximately 21.5 to 1 as of December 31,
2011, after giving effect to all of these transactions, including the February
2012 contribution, which was accrued for in Radian Guaranty's statutory capital
as of December 31, 2011.
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Based on our current projections, Radian Guaranty's risk-to-capital ratio is
expected to increase and, absent any future capital contributions from Radian
Group, is expected to exceed 25 to 1 in 2012. In order to maximize our financial
flexibility, we have applied for waivers or similar relief for Radian Guaranty
in each of the states that impose risk based capital requirements. In addition
to filing for waivers in these states, we intend to write new first-lien
mortgage insurance business in Radian Mortgage Assurance in any state that does
not permit Radian Guaranty to continue writing insurance while it is out of
compliance with applicable risk-based capital requirements. Both of the GSEs
have approved Radian Mortgage Assurance as an eligible mortgage insurer in
certain states and subject to certain conditions. Pursuant to these approvals,
Radian Group will be required to contribute $50 million to Radian Mortgage
Assurance in the event Radian Guaranty is not in compliance with the risk-based
capital requirements in any state and has been unable to obtain a waiver or
similar relief from such state. See "Risk Factors-Losses in our mortgage
insurance and financial guaranty business have reduced Radian Guaranty's
statutory surplus and increased Radian Guaranty's risk-to-capital ratio;
additional losses in these businesses, without a corresponding increase in new
capital or capital relief, would further negatively impact this ratio, which
could limit Radian Guaranty's ability to write new insurance and increase
restrictions and requirements placed on Radian Guaranty" in Part I, Item 1A of
this Annual Report on Form 10-K.
Radian Group also could be required to provide capital support for our other
mortgage insurance subsidiaries if additional capital is required pursuant to
insurance laws and regulations, by the GSEs or the rating agencies. Certain of
our mortgage insurance subsidiaries that provide reinsurance to Radian Guaranty
currently are operating at or near minimum capital levels and have required, and
may continue to require in the future, additional capital contributions from
Radian Group. In October 2011, Radian Group contributed approximately $20.6
million to CMAC of Texas to satisfy its minimum capital requirements.
As of December 31, 2011, Radian Group and CMAC of Texas entered into an
Assumption and Indemnification Agreement with regard to certain proposed
adjustments resulting from the examination by the IRS for the 2000 through 2007
tax years. Through this agreement, Radian Group agreed to indemnify CMAC of
Texas for the amount of any tax payments ultimately due to the IRS for the
proposed adjustments, which relate to the recognition of certain tax losses and
deductions that were generated through our investment in a portfolio of REMICs
currently held by CMAC of Texas. See "Risk Factors-The IRS is examining our tax
returns for the years 2000 through 2007" in Part I, Item 1A of this Annual
Report on Form 10-K. This indemnification was made in lieu of an immediate
capital contribution to CMAC of Texas that otherwise would have been required as
a result of our remeasurement, as of December 31, 2011, of uncertain tax
positions related to the portfolio of REMICs. There remains significant
uncertainty with regard to the amount and timing of any resolution with the IRS,
and we are currently contesting the proposed adjustments related to the REMICs.
Dividends. Our quarterly common stock dividend is $0.0025 per share. Assuming
that our outstanding common stock remains constant at 133,199,159 shares (the
number of shares outstanding at December 31, 2011), we would require
approximately $1.3 million in the aggregate to pay our quarterly dividends for
the next 12 months.
In addition to existing available cash and marketable securities, Radian Group's
principal sources of cash include dividends from Radian Guaranty (to the extent
permitted under applicable laws and regulations) and permitted payments to
Radian Group under tax- and expense-sharing arrangements with our subsidiaries.
Radian Guaranty's ability to pay dividends to Radian Group is subject to various
conditions imposed by the GSEs and rating agencies, and by insurance regulations
requiring insurance department approval. In general, dividends in excess of
prescribed limits are deemed "extraordinary" and require insurance department
approval. In light of ongoing losses in Radian Guaranty, we do not anticipate
that it will be permitted under applicable insurance laws to issue dividends to
Radian Group for the foreseeable future. To the extent Radian Asset Assurance is
permitted to issue dividends, these dividends will be issued to its direct
parent, Radian Guaranty, and not to Radian Group.
In September 2003, Radian Asset Assurance entered into a contingent capital
transaction pursuant to which three custodial trusts issued an aggregate of $150
million in CPS ($50 million by each custodial trust) to various holders. As part
of this transaction, Radian Asset Securities Inc. ("Radian Asset Securities"),
our wholly-owned subsidiary, entered into a separate perpetual put option
agreement with each custodial trust, and Radian Asset Assurance entered into
three corresponding perpetual put option agreements with Radian Asset
Securities. Radian Group and its subsidiaries have purchased by tender offer and
privately negotiated transactions, all of the face amount of the CPS issued by
the custodial trusts. We expect to ultimately dissolve the custodial trusts,
which would result in the distribution of the $150 million in cash held by the
custodial trusts to Radian Group and its non-insurance subsidiaries, as a holder
of the CPS for such custodial trusts.
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Radian Group-Long-Term Liquidity Needs
Our most significant needs for liquidity beyond the next 12 months are: (i) the
repayment of the principal amount of our outstanding long-term debt, including
approximately $250 million in principal amount due in 2015 and $450 million in
principal amount due in 2017; and (ii) potential additional capital
contributions to our mortgage insurance subsidiaries. We may, from time to time,
seek to redeem or repurchase, prior to maturity, some or all of our outstanding
debt in the open market, through private transactions, one or more tender offers
or otherwise, as circumstances may allow. At this time, we cannot determine the
timing or amount of any potential repurchases, which will depend on a number of
factors, including our capital and liquidity needs. If necessary, we may seek to
refinance all or a portion of our long-term debt, which we may not be able to do
on favorable terms, if at all.
Pursuant to Freddie Mac's approval of Radian Mortgage Assurance as a special
purpose mortgage insurer, dated February 28, 2012, Radian Group is required to
make contributions to Radian Guaranty as may be necessary so that the "Liquid
Assets" of Radian Guaranty are at least $700 million throughout the term of the
approval. "Liquid Assets" are the sum of: (i) aggregate cash and cash
equivalents; and (ii) fair market value of the following investments: (a)
residential mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac or
Government National Mortgage Association ("Ginnie Mae"); (b) securities rated
single A or higher by either Moody's, S&P or Fitch Ratings ("Fitch") with a
remaining maturity of five years or less; and (c) U.S. Treasury securities with
maturities not to exceed ten years, provided that, U.S. Treasury securities with
remaining maturities in excess of five years may not exceed ten percent of the
Liquid Assets. As of December 31, 2011, Liquid Assets were approximately $1.2
billion. Although we do not expect that Radian Guaranty's Liquid Assets will
fall below $700 million before December 31, 2012, we do expect the amount of
Liquid Assets to continue to decline materially after December 31, 2011, and
through the end of 2012 (and potentially thereafter) as Radian Guaranty's claim
payments and other uses of cash continue to exceed cash generated from
operations.
We expect to meet the long-term liquidity needs of Radian Group with a
combination of (i) available cash and marketable securities, including, if
necessary, $150 million held in the CPS trust accounts; (ii) potential private
or public issuances of debt or equity securities; (iii) potential cash received
under expense-sharing arrangements with our subsidiaries; (iv) the potential
sale of assets; and (v) dividends from our subsidiaries, to the extent
available. See "Risk Factors-Radian Group's sources of liquidity may be
insufficient to fund its obligations."
Mortgage Insurance
The principal liquidity requirements of our mortgage insurance business include
the payment of claims, operating expenses (including those allocated from Radian
Group) and taxes. The principal sources of liquidity in our mortgage insurance
business are capital contributions from Radian Group, insurance premiums, net
investment income, and cash dividends from Radian Asset Assurance. Our mortgage
insurance business has incurred significant losses over the past four years due
to the housing and related credit market downturns. We believe that the
operating cash flows generated by each of our mortgage insurance subsidiaries
will provide these subsidiaries with a portion of the funds necessary to satisfy
their claim payments and operating expenses for the foreseeable future. We
believe that any shortfall can be funded from sales of marketable securities
held by our mortgage insurance subsidiaries and from maturing fixed-income
investments.
As of December 31, 2011, Radian Asset Assurance maintained claims paying
resources of $2.2 billion, including statutory surplus of approximately $1.0
billion. In June 2011, Radian Asset Assurance paid an ordinary dividend of $53.4
million to Radian Guaranty. We expect that Radian Asset Assurance will continue
to have capacity to pay ordinary dividends to Radian Guaranty in 2012 and 2013,
although these dividends are expected to be equal to or below the amounts paid
in 2011.
The amount, if any, and timing of Radian Asset Assurance's dividend paying
capacity will depend, in part, on the performance of our insured financial
guaranty portfolio, including the establishment of, or change in, statutory
reserves, as well as the amount we pay to commute transactions. If the exposure
in our financial guaranty business is reduced on an accelerated basis through
the recapture or settlement of business from the primary customers in our
financial guaranty reinsurance business or otherwise, we may have the ability to
pay dividends to our mortgage insurance business more quickly and in a greater
amount. However, if the performance of our financial guaranty portfolio
deteriorates materially, Radian Asset Assurance may have limited or no capacity
to pay dividends to Radian Guaranty. In the event of a default giving rise to a
claim payment obligation in our financial guaranty business, the statutory
capital of Radian Asset Assurance (and consequently Radian Guaranty) would be
reduced in an amount equal to the present value of our expected future net claim
liability (net of taxes) for such transactions. Any significant reduction in
statutory capital would also likely reduce Radian Asset Assurance's capacity to
pay dividends to Radian Guaranty, and Radian Asset Assurance could be restricted
from paying dividends altogether without prior approval from the New York State
Insurance Department.
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Financial Guaranty
The principal short-term and long-term liquidity requirements of our financial
guaranty business include the payment of operating expenses (including those
allocated from Radian Group), claim and commutation payments, taxes, and
dividends to Radian Guaranty. As of December 31, 2011, Radian Asset Assurance
had an aggregate of $789.7 million net par outstanding with respect to seven
TruPs bonds issued under eight CDS contracts pursuant to which Radian Asset
Assurance could be required under certain circumstances to pay to the
counterparty the outstanding par amount of the insured TruPs bonds (a "liquidity
claim"). A liquidity claim may arise if an event of default under the TruPs bond
(e.g., a failure to pay interest or a breach of covenants requiring the
maintenance of a certain level of performing collateral) existed as of the
termination date of the CDS contract. The termination dates of these CDS
contracts currently range between 2016 and 2017, but will automatically extend
for additional one-year increments (but no later than the maturity date of the
TruPs CDO) unless terminated by the counterparty. If Radian Asset Assurance is
required to pay a liquidity claim, the counterparty would be obligated under the
CDS to either deliver the insured TruPs bond to Radian Asset Assurance or to pay
Radian Asset Assurance cash periodically in an amount equal to any future
amounts paid in respect of principal and interest on the insured TruPs bond.
The principal sources of liquidity in our financial guaranty business are
premium collections, credit enhancement fees on credit derivative contracts and
net investment income. We believe that the cash flows generated by our financial
guaranty subsidiaries will provide these subsidiaries with the funds necessary
to satisfy their claim payments and operating expenses for the foreseeable
future. We believe that we have the ability to fund any operating cash flow
shortfall from sales of marketable securities in our investment portfolio
maintained at our operating companies and from maturing fixed-income
investments. In the event that we are unable to fund excess claim payments and
operating expenses through the sale of these marketable securities and from
maturing fixed-income investments, we may be required to incur unanticipated
capital losses or delays in connection with the sale of less liquid marketable
securities held by our financial guaranty business.
Reconciliation of Consolidated Net Income (Loss) to Cash (Used in) Provided by
Operations
The following table reconciles consolidated net income (loss) to cash (used in)
provided by operations for the years ended December 31, 2011, 2010 and 2009:
Year Ended December 31,
(In thousands) 2011 2010 2009
Net income (loss) $ 302,150 $ (1,805,867 ) $ (147,879 )
Adjustments to reconcile net income (loss) to
net cash (used in) provided by operating
activities:
Net (gains) losses on other financial
instruments, change in fair value of derivatives
and net impairment losses recognized in earnings (1,022,699 ) 630,539 (259,261 )
Net payments related to derivative contracts and
VIE debt (1) (119,888 ) (291,936 ) (38,044 )
Equity in net income of affiliates (65 ) (14,668 ) (33,226 )
Distributions from affiliate (1) - 29,498 11,040
Gain on sale of affiliate - (34,815 ) -
Proceeds from sales of trading securities (1) - - 4,286,336
Purchases of trading securities (1) - - (3,880,824 )
Net cash (paid) received for commutations,
terminations, and recaptures (1) (92,599 ) 85,657 (369,926 )
Deferred income tax provision (benefit) 6,758 381,408 (55,344 )
Depreciation and other amortization, net 63,120 39,789 20,080
Change in:
Unearned premiums (46,665 ) (136,291 ) (178,677 )
Deferred policy acquisition costs 8,420 11,949 19,954
Reinsurance recoverables 86,047 58,266 (197,764 )
Reserve for losses and LAE (194,486 ) 252,908 629,873
Reserve for premium deficiency (7,092 ) (14,621 ) (61,504 )
Prepaid federal income taxes (1) - - 248,828
Other assets 65,388 (34,405 ) 3,641
Accounts payable and accrued expenses 53,836
(20,014 ) 30,342
Cash flows (used in) provided by operations $ (897,775 ) $ (862,603 ) $ 27,645
_____________
(1) Represents a cash item.
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Cash flows used in operating activities for 2011 increased slightly compared to
2010, primarily related to increased payments for commutations, terminations and
recaptures in 2011. During 2010, we received net cash from these transactions
due to the termination of several captive arrangements. The increase in 2011 was
partially offset by a decrease in net payments related to derivative contracts
and VIE debt. During most of 2009, our trading securities activity reflected
active and frequent buying and selling, as market prices of our investments
strengthened due to improving domestic and global economic environment, and we
made the decision to opportunistically realize gains in the investment
portfolio. As such, this activity was reflected as cash flows from operating
activities within our consolidated statements of cash flows during most of 2009.
Beginning in the fourth quarter of 2009, we have classified purchases of trading
securities within cash flows from investing activities, since those purchases
are more consistent with our overall investment strategy. We expect that we will
use more cash than we generate from operations during the next 12 months.
Stockholders' Equity
Stockholders' equity was $1.2 billion at December 31, 2011, compared to $0.9
billion at December 31, 2010. The increase in stockholders' equity resulted
primarily from our net income of $302.2 million for 2011.
Ratings
Radian Group and our principal operating subsidiaries have been assigned the
financial strength ratings provided in the chart below. We believe that ratings
often are considered by others in assessing our credit strength and the
financial strength of our insurance subsidiaries and, historically, it also has
been a significant factor in determining Radian Guaranty's eligibility with the
GSEs. Currently, we include this information only for disclosure-related
purposes. See "Risk Factors-We could lose our eligibility status with the GSEs,
causing Freddie Mac and Fannie Mae to decide not to purchase mortgages insured
by us, which would significantly impair our mortgage insurance franchise" in
Item 1A of Part I of this Annual Report on Form 10-K.
MOODY'S (1) S&P (2)
Radian Group Caa1 CCC
Radian Guaranty Ba3 B
Radian Insurance B1 (3 )
Radian Mortgage Assurance Ba3 B
Radian Asset Assurance Ba1 B+
___________________(1) Moody's ratings for Radian Group and all our rated insurance subsidiaries are
currently under review for possible downgrade.
(2) S&P's ratings outlook for Radian Group and all our rated insurance
subsidiaries is currently Negative.
(3) Ratings have been withdrawn.
On August 25, 2011, S&P published its updated methodologies and assumptions for
rating bond insurers, which significantly re-calibrated its bond insurance
criteria. The new criteria, among other things, increases capital requirements,
especially to obtain S&P's highest ratings, and adds a new leverage test. On
November 17, 2011, as a consequence of these updated methodologies and
assumptions, S&P downgraded the financial strength ratings of Radian Asset
Assurance to B+, and maintained its outlook for Radian Asset Assurance as
Negative. Since Radian Asset Assurance is not currently writing new business and
the downgrade has no direct material impact on its existing contracts, we do not
anticipate that this downgrade will have a material adverse effect on Radian
Asset Assurance.
On November 22, 2011, Moody's downgraded Radian Group's rating to Caa1 from B3.
This downgrade reflects the rating agency's views regarding Radian Group's
current liquidity position and the potential for additional contributions of
holding company resources to support our mortgage insurance businesses, as well
as our ability to meet our senior debt obligations in the future.
On January 30, 2012, S&P downgraded the ratings of Radian Guaranty and Radian
Mortgage Assurance to B from B+ and also lowered the rating of Radian Group to
CCC from CCC+. These decisions were impacted by the high level of losses in the
mortgage insurance sector resulting from an economy that is struggling to
recover and that is continuing to exhibit significant weakness in the job and
housing markets.
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Critical Accounting Policies
Securities and Exchange Commission ("SEC") guidance defines Critical Accounting
Policies as those that require the application of management's most difficult,
subjective, or complex judgments, often because of the need to make estimates
about the effect of matters that are inherently uncertain and that may change in
subsequent periods. In preparing our consolidated financial statements in
accordance with GAAP, management has made estimates, assumptions and judgments
that affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting periods. In preparing these financial statements, management has
utilized available information, including our past history, industry standards
and the current and projected economic and housing environment, among other
factors, in forming its estimates, assumptions and judgments, giving due
consideration to materiality. Because the use of estimates is inherent in GAAP,
actual results could differ from those estimates. In addition, other companies
may utilize different estimates, which may impact comparability of our results
of operations to those of companies in similar businesses. A summary of the
accounting policies that management believes are critical to the preparation of
our consolidated financial statements is set forth below.
Reserve for Losses
We establish reserves to provide for losses and LAE and the estimated costs of
settling claims in both our mortgage insurance and financial guaranty segments,
in accordance with the accounting standard regarding accounting and reporting by
insurance enterprises. Although this standard specifically excludes mortgage
insurance from its guidance relating to the reserve for losses, it does not
provide any other specific guidance. Therefore, because of the lack of specific
guidance, we establish reserves for mortgage insurance using the guidance
contained in this standard, supplemented with other accounting guidance as
described below.
Estimating the loss reserves in both our mortgage insurance and financial
guaranty business segments involves significant reliance upon assumptions and
estimates with regard to the likelihood, magnitude and timing of each potential
loss. The models, assumptions and estimates we use to establish loss reserves
may not prove to be accurate, especially during an extended economic downturn or
a period of extreme market volatility and uncertainty such as currently exists.
As such, we cannot be certain that our established reserves will be adequate to
cover ultimate losses on incurred defaults.
Commutations, recaptures and other negotiated terminations of our insured risks
in both our mortgage insurance and financial guaranty segments provide us with
an opportunity to exit exposures to entire policies with insureds and reinsureds
for an agreed upon payment, or payments, often at a discount to the previously
estimated ultimate liability. As a result of exiting all exposures to such
policies, all reserves for losses and LAE and other balances relating to the
insured or reinsured policy are eliminated. Upon completion of a commutation,
recapture or other negotiated termination, all such related balances, including
deferred policy acquisition costs and unearned premiums, are reversed, with any
remaining net gain or loss typically recorded through provision for losses. We
take into consideration the specific contractual and economic terms for each
individual agreement when accounting for our commutations, recaptures, or other
negotiated terminations, which may result in differences in the accounting
between transactions, or between our statutory financial statements and
financial statements presented on a GAAP basis.
Mortgage Insurance
In the mortgage insurance segment, reserves for losses are established upon
receipt of notification by servicers that a borrower has missed two monthly
payments. We also establish reserves for associated LAE, consisting of the
estimated cost of the claims administration process, including legal and other
fees and expenses associated with administering the claims process. We maintain
an extensive database of claim payment history and use models, based on a
variety of loan characteristics, including the status of the loan as reported by
its servicer and the type of loan product to determine the likelihood that a
default will reach claim status. Our process includes forecasting the impact of
our loss mitigation efforts in protecting us against fraud, underwriting
negligence, breach of representation and warranties, inadequate documentation
and other items that may give rise to insurance rescissions and claim denials,
to help determine the default to claim rate. Lastly, we project the amount that
we will pay if a default becomes a claim (referred to as "claim severity").
Based on these estimates, we arrive at our estimate of loss reserves at a given
point in time.
The default and claim cycle in our mortgage insurance business begins with our
receipt of a default notice from the servicer. For financial statement reporting
and internal tracking purposes, we do not consider a loan to be in default until
the borrower has missed two monthly payments.
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With respect to loans that are in default, considerable judgment is exercised as
to the adequacy of reserve levels. Loss reserves are increased as defaulted
loans age, because they are considered to be closer to foreclosure and more
likely to result in a claim payment. In the past, as the default proceeded
towards foreclosure, there was generally more certainty around these estimates.
However, in light of existing foreclosure backlogs and efforts to increase loan
modifications among defaulted borrowers, significantly more uncertainty remains
regarding current estimates with respect to the later stage defaults than was
historically typical. This uncertainty requires management to use considerable
judgment in estimating the rate at which these loans will result in claims. If a
default cures, the reserve for that loan is removed from the reserve for losses
and LAE.
We also establish reserves for defaults that we estimate have been incurred but
have not been reported to us on a timely basis by the servicer, and for defaults
related to previously rescinded policies and denied claims which are likely to
be reinstated (in the case of previously rescinded policies) or resubmitted (in
the case of previously denied claims). Our estimates of amounts related to
reinstatements and resubmissions are included in IBNR. Due to the period of time
(generally up to 90 days) that we give the insured to rebut our decision to
rescind coverage before we consider a policy to be rescinded and removed from
our default inventory, we currently expect only a limited percentage of policies
that were rescinded to ultimately be reinstated. We currently expect a greater
percentage of claims that were denied to ultimately be resubmitted as a
perfected claim and paid. Most often, a claim denial is the result of the
servicer's inability to provide the loan origination file or other servicing
documents for review. Under the terms of our Master Policy, our insureds have up
to one year after foreclosure to provide to us the necessary documents to
perfect a claim. All estimates are periodically reviewed and adjustments are
made as they become necessary.
We do not establish reserves for loans that are in default if we believe that we
will not be liable for the payment of a claim with respect to that default. For
example, for those defaults in which we are in a second loss position, we
initially calculate the reserve for defaulted loans in the transaction as if
there were no deductible. If the existing deductible for a given structured
transaction is greater than the reserve amount for the defaults contained within
the transaction, we do not establish a reserve for the defaults, or if
appropriate, we record only a partial reserve. We do not establish loss reserves
for expected future claims on insured mortgages that are not in default. See
"Reserve for Premium Deficiency" below for an exception to this general
principle.
For purposes of reserve modeling, loans are aggregated into groups using a
variety of factors. The attributes used to define the groups include, but are
not limited to, the default status of the loans (i.e., number of days in
default), product type (i.e., Prime, Alt-A, or Subprime), type of insurance
(i.e., primary or pool), vintage year, loss position (i.e., with or without a
deductible), and the state where the property is located (segregated into three
state groups in order to adjust for differences in foreclosure timing). We use
an actuarial projection methodology referred to as a "roll rate" analysis that
uses historical claim frequency information to determine the projected ultimate
default to claim rates for each product and default status. The default to claim
rate also includes our estimates with respect to expected insurance rescissions
and claim denials, which have the effect of reducing our default to claim rates.
In recent years, we have experienced an elevated level of insurance rescissions
and claim denials for various reasons, including, without limitation,
underwriting negligence, fraudulent applications and appraisals, breach of
representations and warranties, and inadequate documentation, reflecting the
poor underwriting periods of 2005 through 2008. After estimating the default to
claim rate, we estimate the severity of each product type, type of insurance,
and state grouping based on the average of recently observed severity rates.
These average severity estimates are then applied to individual loan coverage
amounts to determine reserves.
Our aggregate weighted average default to claim rate assumption (net of denials
and rescissions) used in estimating our reserve for losses was 43% at
December 31, 2011, compared to 40% at December 31, 2010. The increase from
December 31, 2010, to December 31, 2011, was primarily attributable to an
increase in the weighted average age of underlying defaulted loans and a
decrease in our estimate of rescissions and denials for our default inventory as
of December 31, 2011. Our default to claim rate estimate varies depending on the
age of the underlying defaulted loans, as measured by the number of monthly
payments missed. As of December 31, 2011, our default to claim rate estimate,
net of our estimate for insurance rescissions and claim denials, ranged from 19%
for insured loans that had missed two to three monthly payments, to 52% for such
loans that had missed 12 or more monthly payments. A key assumption affecting
our reserving methodology is that our default to claim rates and severities will
be consistent with our recent experience. Our estimate of expected insurance
rescissions and claim denials embedded in our default to claim rate is generally
based on our experience over the past year, with consideration given for
differences in characteristics between those rescinded policies and denied
claims and the remaining default inventory.
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We expect our rescission and denial rates to remain at elevated levels as long
as defaults related to the poor underwriting periods of 2005 through 2008
represent a significant percentage of our total default portfolio. The elevated
levels in the rate of rescissions and denials since 2009 have led to an
increased risk of litigation by lenders and policyholders challenging our right
to rescind coverage or deny claims. Under our master insurance policy, any suit
or action arising from any right of the insured under the policy must be
commenced within two years after such right first arose and within three years
for certain other policies, including certain pool insurance policies. Recently,
we have faced an increasing number of challenges from certain lender customers
regarding our insurance rescissions and claim denials, which have resulted in
some reversals of our decisions regarding rescissions and denials. Although we
believe that our rescissions and denials are justified under our policies, if we
are not successful in defending the rescissions and denials in any potential
legal or other actions, we may need to reassume the risk on, and increase loss
reserves for, those policies or pay additional claims. The assumptions embedded
in our estimated default to claim rate on our in-force default inventory
includes an adjustment to our estimated rescission and denial rate, to account
for the fact that we expect a certain number of policies for which an initial
intent to rescind letter has been sent to our lender customers to remain
in-force and ultimately to be paid, as a result of valid challenges by such
policy holders during the limited period specified in such letters. As discussed
above, we also establish reserves for IBNR defaults related to previously
rescinded policies and denied claims which we believe are likely to be
reinstated (in the case of previously rescinded policies), or resubmitted (in
the case of previously denied claims).
We considered the sensitivity of first-lien loss reserve estimates at
December 31, 2011, 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 primary claim
severity (which we estimate to be 27% of unpaid principal balance at
December 31, 2011), we estimated that our loss reserves would change by
approximately $96 million at December 31, 2011. For every one percentage point
change in pool claim severity (which we estimate to be 44% of unpaid principal
balance at December 31, 2011), we estimated that our loss reserves would change
by approximately $6 million at December 31, 2011. For every one percentage point
change in our overall default to claim rate (which we estimate to be 43.0% at
December 31, 2011, including our assumptions related to rescissions and
denials), we estimated a $67 million change in our loss reserves at December 31,
2011.
Financial Guaranty
In our financial guaranty segment, we recognize a claim liability on our
non-derivative transactions prior to an event of default (insured event) when
there is evidence that credit deterioration has occurred for a particular policy
and the present value of the expected claim loss exceeds 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, or in connection with, 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
possible outcomes, including potential settlements or commutations, based on
information currently available. We determine the existence of credit
deterioration on directly insured policies based on periodic reporting from the
insured party, indenture trustee or servicer, and based on our surveillance
efforts. These expected cash outflows are discounted using a risk-free rate. 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 use information provided by the ceding company, as well as our
specific knowledge of the credit for determining expected loss.
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 is also primarily responsible for claims
prevention and loss mitigation strategies. This discipline is applied during the
ongoing monitoring and surveillance of each exposure in the portfolio.
There are both performing and under-performing credits in our financial guaranty
portfolio. Performing credits generally have investment-grade internal ratings,
denoting nominal to moderate credit risk. However, claim liabilities may 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. If our risk management department concludes that a
directly insured transaction should no longer be considered performing, it is
placed in one of three designated watch list 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 ceding company for such transaction downgrades it
to an equivalent watch list classification. However, should our financial
guaranty risk management group disagree with the risk rating assigned by the
ceding company, we may assign our own risk rating rather than use the risk
rating assigned by the ceding company.
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Reserve for Premium Deficiency ("PDR")
Insurance enterprises are required to establish a PDR if the net present value
of the expected future losses and expenses for a particular product exceeds the
net present value of expected future premiums and existing reserves for that
product. We reassess our expectations for premiums, losses and expenses for our
financial guaranty and mortgage insurance businesses at least quarterly and
update our premium deficiency analysis accordingly. Expected future expenses
include consideration of maintenance costs associated with maintaining records
relating to insurance contracts and with the processing of premium collections.
We also consider investment income in the premium deficiency calculation, and
utilize our pre-tax investment yield to discount certain cash flows for this
analysis.
For our financial guaranty business, in order to determine whether a premium
deficiency charge is necessary, we compare projected earned premiums and
investment income to projected future losses, LAE, unamortized deferred
acquisition costs and maintenance costs. If the sum of the costs exceeds the
amount of the revenues, the excess is first charged against deferred acquisition
costs and is referred to as a premium deficiency charge.
For purposes of our premium deficiency analysis, we group our mortgage insurance
products into two categories, first-lien and second-lien.
Numerous factors affect our ultimate default to claim rates, including home
price changes, unemployment and the impact of our loss mitigation efforts and
interest rates, as well as potential benefits associated with lender and
governmental initiatives to modify loans and ultimately reduce foreclosures. To
assess the need for a PDR on our first-lien insurance portfolio, we develop loss
projections based on modeled loan defaults related to our current RIF. This
projection is based on recent trends in default experience, severity, and rates
of defaulted loans moving to claim (such default to claim rates are net of our
estimates of rescissions and denials), as well as recent trends in the rate at
which loans are prepaid. As of December 31, 2011, our modeled loan default
projections for our first-lien insured portfolio assume that the rate at which
current loans will default will remain consistent for the next twelve months
with those rates observed during 2011, and then gradually return to normal
historical levels over the subsequent three years.
For our first-lien insurance business, 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 December 31, 2011. Our pre-tax
investment yield used as the discount rate in these present value calculations
was 2.62% and 2.44% as of December 31, 2011 and 2010, respectively. Expected
losses are based on an assumed paid claim rate of approximately 14.2% on our
total first-lien insurance portfolio (8.9% on performing loans and 43.1% on
defaulted loans). Assuming all other factors remained constant, if our paid
claim rate increased from 14.2% to 15.8%, we would be required to establish a
premium deficiency reserve. New business originated since the beginning of 2009
is expected to be profitable, which has contributed to the overall expected net
profitability of our first-lien portfolio. In addition, estimated rescissions
and denials on insured loans are expected to partially offset the impact of
expected defaults and claims. Our expectations regarding the future net
profitability of our total first-lien mortgage insurance portfolio have
decreased significantly as of December 31, 2011, compared to our expectations at
December 31, 2010, primarily due to our revised expectations regarding future
macroeconomic conditions. As a result, the possibility of a future PDR on our
first-lien mortgage insurance business has increased.
For our second-lien mortgage insurance business, we project future premiums and
losses for this business on a transaction-by-transaction basis, using historical
results to help determine future performance for both repayments and claims. An
estimated expense factor is then applied, and the result is discounted using a
rate of return that approximates our investment yield. This net present value,
less any existing reserves, is recorded as a premium deficiency and the reserve
is updated at least quarterly based on actual results for that quarter, along
with updated transaction level projections.
Evaluating the expected profitability of our existing mortgage insurance
business and the need for a premium deficiency reserve for our first-lien
business involves significant reliance upon assumptions and estimates with
regard to the likelihood, magnitude and timing of potential losses and premium
revenues. The models, assumptions and estimates we use to evaluate the need for
a premium deficiency reserve may not prove to be accurate, especially during an
extended economic downturn or a period of extreme market volatility and
uncertainty such as currently exists. We cannot be certain that we have
correctly estimated the expected profitability of our existing first-lien
mortgage portfolio or that the second-lien PDR established will be adequate to
cover the ultimate losses on our second-lien business.
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Fair Value of Financial Instruments
Our estimated fair value measurements are intended to reflect the assumptions
market participants would use in pricing an asset or liability based on the best
information available. Assumptions include the risks inherent in a particular
valuation technique (such as a pricing model) and the risks inherent in the
inputs to the model. Changes in economic conditions and capital market
conditions, including but not limited to, credit spread changes, benchmark
interest rate changes, market volatility and declines in the value of underlying
collateral, could cause actual results to differ materially from our estimated
fair value measurements. We define fair value as the current amount that would
be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. In the event
that our investments or derivative contracts were sold, commuted, terminated or
settled with a counterparty, or transferred in a forced liquidation, the amounts
received or paid may be materially different from those determined in accordance
with the accounting standard regarding fair value measurements. Differences may
arise between our recorded fair value and the settlement or termination value
with a counterparty based upon consideration of information that may not be
available to another market participant. Those differences, which may be
material, are recorded as transaction realized gains/(losses) in our
consolidated statements of operations in the period in which the transaction
occurs.
We have included the additional disclosures required by the update to the
accounting standard regarding fair value measurements and disclosures pertaining
to the reconciliation of Level III fair value measurements. See Note 5 of Notes
to Consolidated Financial Statements.
When determining the fair value of our liabilities, we are required to
incorporate into the fair value of those liabilities an adjustment that reflects
our own non-performance risk. Our CDS spread is an observable quantitative
measure of our non-performance risk and is used by typical market participants
to determine the likelihood of our default. As our CDS spread tightens or
widens, it has the effect of increasing or decreasing, respectively, the fair
value of our liabilities.
We established a fair value hierarchy by prioritizing the inputs to valuation
techniques used to measure fair value. The hierarchy gives the highest priority
to unadjusted quoted prices in active markets for identical assets or
liabilities (Level I measurements) and the lowest priority to unobservable
inputs (Level III measurements). The three levels of the fair value hierarchy
under this standard are described below:
Level I - Unadjusted quoted prices for identical assets or liabilities in
active markets that are accessible at the measurement date for
identical, unrestricted assets or liabilities;
Level II - Prices or valuations based on observable inputs other than quoted
prices in active markets for identical or similar assets and
liabilities; and
Level III - Prices or valuations that require inputs that are both significant
to the fair value measurement and unobservable.
The level of market activity used in determining the fair value hierarchy is
based on the availability of observable inputs market participants would use to
price an asset or a liability, including market value price observations. For
markets in which inputs are not observable or limited, we use significant
judgment and assumptions that a typical market participant would use to evaluate
the market price of an asset or liability. Given the level of judgment, another
market participant may derive a materially different estimate of fair value.
These assets and liabilities are classified in Level III of our fair value
hierarchy.
A financial instrument's level within the fair value hierarchy is based on the
lowest level of any input that is significant to the fair value measurement. At
December 31, 2011, our total Level III assets were approximately 4.9% of total
assets measured at fair value and total Level III liabilities accounted for 100%
of total liabilities measured at fair value.
Available for sale securities, trading securities, VIE debt, derivative
instruments, and certain other assets are recorded at fair value as described in
Note 5 of Notes to Consolidated Financial Statements. All derivative instruments
and contracts are recognized in our consolidated balance sheets as either
derivative assets or derivative liabilities. All changes in fair value of
trading securities, VIE debt, derivative instruments, and certain other assets
are included in our consolidated statements of operations. All changes in the
fair value of available for sale securities are recorded in accumulated other
comprehensive income (loss).
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The following are descriptions of our valuation methodologies for financial
assets and liabilities measured at fair value.
Investments
U.S. government and agency securities-The fair value of U.S. government and
agency securities is estimated using observed market transactions, including
broker-dealer quotes and actual trade activity as a basis for valuation. U.S.
government and agency securities are categorized in either Level I or Level II
of the fair value hierarchy.
State and municipal obligations-The fair value of state and municipal
obligations is estimated using recent transaction activity, including market and
market-like observations. Evaluation models are used, which incorporate bond
structure, yield curve, credit spreads, and other factors. These securities are
generally categorized in Level II of the fair value hierarchy or in Level III
when market-based transaction activity is unavailable.
Money market instruments-The fair value of money market instruments is based on
daily prices, which are published and available to all potential investors and
market participants. As such, these securities are categorized in Level I of the
fair value hierarchy.
Corporate bonds and notes-The fair value of corporate bonds and notes is
estimated using recent transaction activity, including market and market-like
observations. Spread models are used that incorporate issuer and structure
characteristics, such as credit risk and early redemption features, where
applicable. These securities are generally categorized in Level II of the fair
value hierarchy or in Level III when market-based transaction activity is
unavailable.
RMBS-The fair value of RMBS is estimated based on prices of comparable
securities and spreads, and observable prepayment speeds. These securities are
generally categorized in Level II of the fair value hierarchy or in Level III
when market-based transaction activity is unavailable. The fair value of the
Level III securities is generally estimated by discounting estimated future cash
flows.
CMBS-The fair value of CMBS is estimated based on prices of comparable
securities and spreads, and observable prepayment speeds. These securities are
generally categorized in Level II of the fair value hierarchy or in Level III
when market-based transaction activity is unavailable. The fair value of the
Level III securities is generally estimated by discounting estimated future cash
flows.
CDO-These securities are categorized in Level III of the fair value hierarchy.
The fair value of the Level III securities is generally estimated by discounting
estimated future cash flows.
Other ABS-The fair value of other ABS is estimated based on prices of comparable
securities and spreads, and observable prepayment speeds. These securities are
generally categorized in Level II of the fair value hierarchy or in Level III
when market-based transaction activity is unavailable. The fair value of the
Level III securities is generally estimated by discounting estimated future cash
flows.
Foreign government securities-The fair value of foreign government securities is
estimated using observed market yields used to create a maturity curve and
observed credit spreads from market makers and broker dealers. These securities
are categorized in Level II of the fair value hierarchy.
Hybrid securities-These instruments are convertible securities. The estimated
fair value is derived, in part, by utilizing dealer quotes and observed bond and
stock prices. For certain securities, the underlying security price may be
adjusted to account for observable changes in the conversion and investment
value from the time the quote was obtained. These securities are categorized in
Level II of the fair value hierarchy.
Equity securities-The fair value of these securities is generally estimated
using observable market data in active markets or bid prices from market makers
and broker-dealers. Generally, these securities are categorized in Level I or II
of the fair value hierarchy, as observable market data is readily available. A
small number of our equity securities, however, are categorized in Level III of
the fair value hierarchy due to a lack of market-based transaction data or the
use of model-based evaluations.
Other investments-These securities primarily consist of short-term commercial
paper within CPS trusts and short-term certificates of deposit, which are
categorized in Level II of the fair value hierarchy. The fair value of the
remaining securities is categorized in Level III of the fair value hierarchy,
and is generally estimated by discounting estimated future cash flows.
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We are responsible for the determination of the value of all investments carried
at fair value and the supporting methodologies and assumptions. To assist us in
this responsibility, we utilize independent third-party valuation service
providers to gather, analyze, and interpret market information and estimate fair
values based upon relevant methodologies and assumptions for various asset
classes and individual securities. We perform monthly quantitative and
qualitative analysis on the prices received from third parties to determine
whether the prices are reasonable estimates of fair value. Our analysis
includes: (i) a review of the methodology used by third party pricing services;
(ii) a comparison of pricing services' valuations to other independent sources;
(iii) a review of month to month price fluctuations; and (iv) a comparison of
actual purchase and sale transactions with valuations received from third
parties. These processes are designed to ensure that our investment values are
accurately recorded, that the data inputs and valuation techniques utilized are
appropriate and consistently applied, and that the assumptions are reasonable
and consistent with the objective of determining fair value.
Derivative Instruments and Related VIE Assets/Liabilities
We define fair value as the current amount that would be exchanged to sell an
asset or transfer a liability, other than in a forced liquidation. In
determining an exit market, we consider the fact that most of our derivative
contracts are unconditional and irrevocable, and contractually prohibit us from
transferring them to other capital market participants. Accordingly, there is no
principal market for such highly structured insured credit derivatives. In the
absence of a principal market, we value these insured credit derivatives in a
hypothetical market where market participants include other monoline mortgage
and financial guaranty insurers with similar credit quality to us, as if the
risk of loss on these contracts could be transferred to these other mortgage and
financial guaranty insurance and reinsurance companies. We believe that in the
absence of a principal market, this hypothetical market provides the most
relevant information with respect to fair value estimates.
We determine the fair value of our derivative instruments primarily using
internally-generated models. We utilize market observable inputs, such as credit
spreads on similar products, whenever they are available. When one of our
transactions develops characteristics that are inconsistent with the
characteristics of transactions that underlie the relevant market-based index
that we use in our credit spread valuation approach, and more relevant inputs or
projections become available that we believe would represent the view of a
typical market participant, we change to an approach that is based on that more
relevant available information. This change in approach is generally prompted
when the credit component, and not market factors, becomes the dominant driver
of the estimated fair value for a particular transaction. There is a high degree
of uncertainty about our fair value estimates since our contracts are not traded
or exchanged, which makes external validation and corroboration of our estimates
difficult, particularly given the current market environment, in which very few,
if any, contracts are being traded or originated. In very limited recent
instances, we have negotiated terminations of financial guaranty contracts with
our counterparties and believe that such terminations provide relevant data with
respect to validating our fair value estimates and such data has been generally
consistent with our fair value estimates.
Our derivative liabilities valuation methodology incorporates our own
non-performance risk by including our observable CDS spread as an input into the
determination of the fair value of our derivative liabilities. Considerable
judgment is required to interpret market data to develop the estimates of fair
value. Accordingly, the estimates may not be indicative of amounts we could
realize in a current market exchange or negotiated termination. Our derivative
liability valuation is not counterparty specific and is intended to estimate the
average exchange price between typical participants. The use of different market
assumptions or estimation methodologies may have a material effect on the
estimated fair value amounts or negotiated terminations. In a negotiated
termination, certain factors unique to the counterparty may have a greater
impact on the amount exchanged than in an estimated fair value amount between
typical market participants, and another market participant could have
materially different views given the level of judgment associated with the
valuation.
Corporate CDOs
The fair value of each of our corporate CDO transactions is estimated based on
the difference between (1) the present value of the expected future contractual
premiums we charge, and (2) the fair premium amount that we estimate that
another financial guarantor would require to assume the rights and obligations
under our contracts. The fair value estimates reflect the fair value of the
asset or liability, which is consistent with the "in-exchange" approach, in
which fair value is determined based on the price that would be received or paid
in a current transaction as defined by the accounting standard regarding fair
value measurements. These credit derivatives are categorized in Level III of the
fair value hierarchy.
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Present Value of Expected Future Contractual Premiums-Our contractual premiums
are subject to change primarily for two reasons: (1) all of our contracts
provide our counterparties with the right to terminate upon our default, and
(2) 90% of the aggregate net par outstanding of our corporate CDO transactions
(as of December 31, 2011) provide our counterparties with the right to terminate
these transactions based on certain rating agency downgrades that occurred
during 2008. In determining the expected future premiums of these transactions,
we adjust the contractual premiums for such transactions to reflect the
estimated fair value of those premiums based on our estimate of the probability
of our counterparties exercising this downgrade termination right and the impact
it would have on the remaining expected lifetime premium. We also cap the total
estimated fair value of the contracts subject to termination at zero, such that
none of these contracts are in a derivative asset position. As of December 31,
2011, 19% of the aggregate net par outstanding of our corporate CDO transactions
were capped in this manner. The discount rate we use to determine the present
value of expected future premiums is our CDS spread plus a risk-free rate. This
discount rate reflects the risk that we may not collect future premiums due to
our inability to satisfy our contractual obligations, which provides our
counterparties the right to terminate the contracts.
Determining the Fair Premium Amount-For each corporate CDO transaction, we
perform three principal steps in determining the fair premium amount:
• first, we define a tranche on the CDX index (defined below) that equates
to the risk profile of our specific transaction (we refer to this tranche
as an "equivalent-risk tranche");
• second, we determine the fair premium amount on the equivalent-risk
tranche for those market participants engaged in trading on the CDX index
(we refer to each of these participants as a "typical market
participant"); and
• third, we adjust the fair premium amount for a typical market participant
to account for the difference between the non-performance or default risk
of a typical market participant and the non-performance or default risk of
a financial guarantor of similar credit quality to us (in each case, we
refer to the risk of non-performance as "non-performance risk").
Defining the Equivalent-Risk Tranche-Direct observations of fair premium amounts
for our transactions are not available since these transactions cannot be traded
or transferred pursuant to their terms and there is currently no active market
for these transactions. However, CDSs on tranches of a standardized index (the
"CDX index") are widely traded and observable, and provide relevant market data
for determining the fair premium amount of our transactions, as described more
fully below.
The CDX index is an index based on a synthetic corporate CDO that comprises a
list of corporate obligors and is segmented into multiple tranches of synthetic
senior unsecured debt of these obligors ranging from the equity tranche (i.e.,
the most credit risk or first-loss position) to the most senior tranche (i.e.,
the least credit risk). We refer to each of these tranches as a "standard CDX
tranche." A tranche is defined by an attachment point and detachment point,
representing the range of portfolio losses for which the protection seller would
be required to make a payment.
Our corporate CDO transactions possess similar structural features to the
standard CDX tranches, but often differ with respect to the referenced corporate
entities, the term, the attachment points and the detachment points. Therefore,
in order to determine the equivalent-risk tranche for each of our corporate CDO
transactions, we determine the attachment and detachment points on the CDX index
that have comparable estimated probabilities of loss as the attachment and
detachment points in our transactions. We begin by performing a simulation
analysis of referenced entity defaults in our transactions to determine the
probability of portfolio losses exceeding our attachment and detachment points.
The referenced entity defaults are primarily determined based on the following
inputs: the market observed CDS credit spreads of the referenced corporate
entities, the correlations between each of the referenced corporate entities,
and the term of the transaction.
For each referenced corporate entity in our corporate CDO transactions, the CDS
spreads associated with the term of our transactions ("credit curve") define the
estimated expected loss for each entity (as applied in a market standard
approach known as "risk neutral" modeling). The credit curves on individual
referenced entities are generally observable. The expected cumulative loss for
the portfolio of referenced entities associated with each of our transactions is
the sum of the expected losses of these individual referenced entities. With
respect to the correlation of losses across the underlying referenced entities,
two obligors belonging to the same industry or located in the same geographical
region are assumed to have a higher probability of defaulting together (i.e.,
they are more correlated). An increase in the correlations between the
referenced entities generally causes a higher expected loss for the portfolio
associated with our transactions. The estimated correlation factors that we use
are derived internally based on observable third-party inputs that are based on
historical data. The impact of our correlation assumptions currently does not
have a material effect on our fair premium estimates in light of the significant
impact of our non-performance risk adjustment as described below.
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Once we have established the probability of portfolio losses exceeding the
attachment and detachment points in our transactions, we then use the same
simulation method to locate the attachment and detachment points on the CDX
index with comparable probabilities. These equivalent attachment and detachment
points define the equivalent-risk tranche on the CDX index that we use to
determine fair premium amounts.
Determining the Typical Fair Premium Amount-The equivalent-risk tranches for our
corporate CDO transactions often are not identical to any standard CDX tranches.
As a result, fair premium amounts generally are not directly observable from the
CDX index for the equivalent-risk tranche and must be separately determined. We
make this determination through an interpolation in which we use the observed
premium rates on the standard CDX tranches that most closely match our
equivalent-risk tranche to derive the typical fair premium amount for the
equivalent-risk tranche.
Non-Performance Risk Adjustment on Corporate CDOs-The typical fair premium
amount estimated for the equivalent-risk tranche represents the fair premium
amount for a typical market participant-not Radian. Accordingly, the final step
in our fair value estimation is to convert this typical fair premium amount into
a fair premium amount for a financial guarantor of similar credit quality to us.
A typical market participant is contractually bound by a requirement that
collateral be posted regularly to minimize the impact of that participant's
default or non-performance. This collateral posting feature makes these
transactions less risky to the protection buyer, and therefore, priced
differently. None of our contracts require us to post collateral with our
counterparties, which exposes our counterparties fully to our non-performance
risk. We make an adjustment to the typical fair premium amount to account for
both this contractual difference, as well as for the market's perception of our
default probability, which is observable through our CDS spread.
The amount of the non-performance risk adjustment is computed based, in part, on
the expected claim payment by Radian. To estimate this expected payment, we
first determine the expected claim payment of a typical market participant by
using a risk-neutral modeling approach. A significant underlying assumption of
the "risk-neutral" model approach that we use is that the typical fair premium
amount is equal to the present value of expected claim payments from a typical
market participant. Expected claim payments on a transaction are based on the
expected loss on that transaction (also determined using the "risk-neutral
modeling" approach). Radian's expected claim payment is calculated based on the
correlation between the default probability of the transaction and our default
probability. The default probability of Radian is determined from the observed
Radian Group CDS spread, and the default probability of the transaction is
determined as described above under "Defining the Equivalent-Risk Tranche." The
present value of Radian's expected claim payments is discounted using a
risk-free interest rate, as the expected claim payments have already been
risk-adjusted.
The reduction in our fair premium amount related to our non-performance risk is
limited to a minimum fair premium amount, which is determined based on our
estimate of the minimum fair premium that a market participant would require to
assume the risks of our obligations. Approximately 43% of our corporate CDO
contracts as of December 31, 2011 are subject to this minimum fair premium. Our
non-performance risk adjustment currently results in a material reduction of our
typical fair premium amounts, which in turn has a positive impact on the fair
value of these derivatives.
Non-Corporate CDOs and Other Derivative Transactions
Our non-corporate CDO transactions include our guaranty of TruPs CDOs, CDOs of
ABS, CDOs of CMBS, and CDOs backed by other asset classes such as (i) municipal
securities, (ii) synthetic financial guarantees of ABS, and (iii) project
finance transactions. The fair value of our non-corporate CDOs and other
derivative transactions is calculated as the difference between the present
value of the expected future contractual premiums and our estimate of the fair
premium amount for these transactions. The present value of expected future
contractual premiums is determined based on the methodology described above for
corporate CDOs. The contractual premiums associated with 89% of the aggregate
net par outstanding of our non-corporate CDO contracts are subject to change due
to counterparties being provided the right to terminate these transactions based
on certain rating agency downgrades that occurred during 2008. We also cap the
total estimated fair value of the contracts subject to termination at zero, such
that none of these contracts are in a derivative asset position. As of December
31, 2011, 26% of the aggregate net par outstanding of our non-corporate CDO
transactions were capped in this manner. For our credit card transactions, the
fair premium amount is estimated using observed spreads on recent trades of
securities that are similar to the securities that we guaranty. In all other
instances, we utilize internal models to estimate the fair premium amount as
described below. These credit derivatives are categorized in Level III of the
fair value hierarchy.
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TruPs CDOs-Our TruPs transactions are CDSs on CDOs where the collateral consists
primarily of deeply subordinated securities issued by banks, insurance
companies, real estate investment trusts and other financial institutions whose
individual spreads are not observable. In each case, we provide credit
protection on a specific tranche of each CDO. To determine fair value for these
transactions, we use a discounted cash flow valuation approach that captures the
credit characteristics of each transaction. We estimate projected claims based
on our internal credit analysis, which is based on the current performance of
each underlying reference obligation. The present value of the expected cash
flows to the TruPs transaction is then determined using a discount rate derived
from the observed market pricing for a TruPs transaction with similar
characteristics. The present value of the insured cash flows is determined using
a discount rate that is equal to our CDS rate plus a risk-free rate.
For certain of our TruPs transactions, our counterparties may require that we
pay them the outstanding par on the underlying TruPs bond if an event of default
has occurred and remains outstanding as of the termination date of our CDS
coverage (a "conditional liquidity claim"). For these transactions, an
additional fair value adjustment is made. To calculate this adjustment, a
probability that we will be required to pay a conditional liquidity claim is
assigned based on our internal cash flow projections. A discounted cash flow
valuation is also performed for this scenario where we are required to make a
conditional liquidity claim. The fair value is set equal to the probability
weighted average of the valuations from the two scenarios: one in which our
counterparty makes a conditional liquidity claim and one in which the claim is
not made.
CDOs of ABS, including Related VIE Liabilities-The fair value amounts for our
CDOs of ABS transactions are derived using standard market indices and
discounted cash flows, to the extent expected losses can be estimated.
One of our CDO of ABS transactions matured during 2010, requiring no payment by
us. The investment securities for the remaining CDO of ABS transaction, which is
consolidated, have experienced significant credit deterioration. Fair value for
these securities is estimated using a discounted cash flow analysis. We estimate
cash flows for the transaction based on our internal credit analysis, which is
based on the current performance of each security. The estimated fair value of
the underlying collateral securities is determined using either observed market
transactions, including broker-dealer quotes and actual trade activity on
similar bonds, or expected cash flows discounted using the yield observed on
similar bonds. The present value of the insured cash flows (which represents the
VIE debt) is determined using a risk-free rate that is applied to the cash flows
adjusted for Radian's non-performance risk. We continue to utilize this model to
estimate the fair value of our exposure, and to derive the fair value of this
consolidated VIE debt.
The VIE debt and derivative liability within this CDO of ABS transaction are
categorized in Level III of the fair value hierarchy. Our maximum principal
exposure to loss from this CDO of ABS transaction is $450.6 million at
December 31, 2011, which reflects principal due in 2036. The recorded net fair
value of our consolidated assets and liabilities related to this consolidated
CDO of ABS as of December 31, 2011, was less than our maximum principal
exposure. The fair value of the VIE debt and other liabilities exceeds the net
value of the assets of the VIE; however, because our fair value estimate of the
VIE debt incorporates a discount rate that is based on our CDS spread, the fair
value is substantially less than our expected ultimate claim payments.
CDOs of CMBS-The fair premium amounts for our CDOs of CMBS transactions for a
typical market participant are derived first by observing the spreads of the
CMBX indices that match the underlying reference obligations of our
transactions. A mezzanine tranche, which represents our insured tranche, is then
priced through a standard CDO model. The CMBX indices represent standardized
lists of CMBS reference obligations. A different CMBX index exists for different
types of underlying referenced obligations based on vintages and credit rating.
For each of our CDO of CMBS transactions, we use the CMBX index that most
directly correlates to our transaction with respect to vintage and credit
rating. Because the observable CMBS indices do not have a similar mezzanine
tranche, we use an internal CDO pricing model in order to adjust fair value for
this structural feature. A standard CDO pricing model was calibrated to
establish the market pricing at inception. This CDO pricing model is then
applied to the current valuation period to derive the fair premium for the
mezzanine tranche. The typical fair premium amount represents the estimated fair
value of the expected future fair premiums determined by using a discount rate
equal to the CDS spread of a typical market participant plus a risk-free rate.
All Other Non-Corporate CDOs and Other Derivative Transactions-For all of our
other non-corporate CDO and other derivative transactions, observed prices and
market indices are not available. As a result, we utilize an internal model that
estimates fair premium. The fair premium amount is calculated such that the
expected profit (fair premium amount net of expected losses and other expenses)
is proportional to an internally-developed risk-based capital amount. Expected
losses and our internally developed risk-based capital amounts are projected by
our model using the internal credit rating, term, and current par outstanding
for each transaction.
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For each of the non-corporate CDOs and other derivative transactions discussed
above, with the exception of CDOs of ABS and TruPs transactions that are valued
using a discounted cash flow analysis, we make an adjustment to the fair premium
amounts, as described above under Non-Performance Risk Adjustments on Corporate
CDOs, to incorporate our own non-performance risk. The non-performance risk
adjustment associated with our CDOs of ABS and our TruPs transactions is
incorporated in the fair value as described above; therefore, no separate
adjustment is required. These credit derivatives are categorized in Level III of
the fair value hierarchy.
Assumed Financial Guaranty Credit Derivatives
In making our determination of fair value for these credit derivatives, we use
information provided to us by our counterparties to these reinsurance
transactions, which are the primary insurers (the "primaries") of the underlying
credits, including the primaries' fair valuations for these credits. The
information obtained from our counterparties is not received with sufficient
time for us to refine our estimates of the mark-to-market liability as of the
balance sheet date. Therefore, the amount recorded as of December 31, 2011, is
based on the most recent available financial information, which is reported on a
quarterly lag. The lag in reporting is consistent from period to period. The
fair value is based on credit spreads obtained by the primaries from market data
sources published by third parties (e.g., dealer spread tables for collateral
similar to assets within the transactions being valued) as well as
collateral-specific spreads provided by trustees or obtained from market sources
if such data is available. If observable market spreads are not available or
reliable for the underlying reference obligations, then the primaries'
valuations are predominantly based on market indices that most closely resemble
the underlying reference obligations, considering asset class, credit quality
rating and maturity of the underlying reference obligations. In addition, these
valuations incorporate an adjustment for non-performance risk. The primaries'
models used to estimate the fair value of these instruments include a number of
factors, including credit spreads, changes in interest rates and the credit
ratings of referenced entities. In establishing our fair value for these
transactions, we assess the reasonableness of the primaries' valuations by
(1) reviewing the primaries' publicly available information regarding their
mark-to-market processes, including methodology and key assumptions, and
(2) analyzing and discussing the changes in fair value with the primaries where
the changes appear unusual or do not appear materially consistent with credit
loss related information when provided by the primaries for these transactions.
These credit derivatives are categorized in Level III of the fair value
hierarchy.
Other Financial Guaranty VIE Consolidated Assets/Liabilities
We are the primary beneficiary for two other VIEs for which we have provided
financial guarantees. These VIEs primarily consist of manufactured housing loans
and VIE debt to noteholders in the trust. The fair value of the VIE debt related
to these other financial guaranty VIEs is estimated based on prices of
comparable securities and spreads observed in the market. The overall net fair
value for these transactions is determined using a discounted cash flow
analysis. We do not currently estimate any projected claims based on our
internal credit analysis, which is based on the current performance of the
underlying collateral and the remaining subordination available to support the
transaction. The present value of the insured cash flows is determined by using
a discount rate that is equal to our CDS rate plus a risk-free rate. We utilize
this model to determine the fair value of our exposure to these VIEs, and to
derive the fair value of the assets in these VIEs, which are reported within
other assets on our consolidated balance sheets.
The assets and VIE debt related to these transactions are categorized in Level
III of the fair value hierarchy. Our maximum principal exposure to loss from
these transactions is $129.4 million; however, we do not currently expect to pay
any claims related to these two VIEs. At December 31, 2011, we recorded $104.0
million of other assets, $103.7 million of VIE debt and $0.3 million of accounts
payable and accrued expenses associated with these two VIEs.
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NIMS Credit Derivatives, NIMS Derivative Assets and NIMS VIE Debt
NIMS credit derivatives are financial guarantees that we have issued on NIMS.
NIMS derivative assets primarily represent derivative assets in the NIMS trusts
that we are required to consolidate. NIMS VIE debt represents the debt of
consolidated NIMS trusts, which we account for at fair value. The estimated fair
value amounts of these financial instruments are derived from
internally-generated discounted cash flow models. We estimate losses in each
securitization underlying either the NIMS credit derivatives, NIMS derivative
assets or NIMS VIE debt by applying expected default rates separately to loans
that are delinquent and those that are paying currently. These default rates are
based on historical experience of similar transactions. We then estimate the
rate of prepayments on the underlying collateral in each securitization,
incorporating historical prepayment experience. The estimated loss and rate of
prepayments are used to estimate the cash flows for each underlying
securitization and NIMS bond, and ultimately, to produce the projected credit
losses for each NIMS bond. In addition to expected credit losses, we consider
the future expected premiums to be received from the NIMS trust for each credit
derivative. The projected net losses are then discounted using a rate of return
that incorporates our own non-performance risk, and based on our current CDS
spread, results in a reduction of the derivative liability. Since NIMS
guarantees are not market-traded instruments, considerable judgment is
required in estimating fair value. The use of different assumptions and/or
methodologies could have a material effect on estimated fair values. The NIMS
credit derivatives, NIMS derivative assets and NIMS VIE debt are all categorized
in Level III of the fair value hierarchy. As a result of our having to
consolidate our NIMS VIEs, the fair value of derivative assets held by the NIMS
VIEs and the NIMS VIE debt are determined by using the same internally-generated
valuation model.
Changes in expected principal credit losses on NIMS could impact our fair value
estimate. The gross expected principal credit losses were $18.0 million and
$135.6 million as of December 31, 2011 and 2010, respectively, and represent
substantially all of our total NIMS RIF. Our fair value estimate incorporates a
discount rate that is based on our CDS spread, which has resulted in a fair
value amount that is $10.2 million and $6.3 million less than the expected
principal credit losses at December 31, 2011 and 2010, respectively. Changes in
the credit loss estimates will impact the fair value directly, reduced only by
the present value factor, which is dependent on the timing of the expected
losses and our credit spread.
Put Options on CPS and Consolidated CPS VIE Debt
The fair value of our put options on CPS and the CPS VIE debt, in the absence of
observable market data, is estimated based on the present value of the spread
differential between the current market rate of issuing a perpetual preferred
security and the maximum contractual rate of our perpetual preferred security as
specified in our put option agreements. In determining the current market rate,
consideration is given to any relevant market observations that are available.
We purchased substantially all of the securities issued by the three trusts, and
we consolidated the assets and liabilities of those trusts during 2010. As of
December 31, 2011, there is no consolidated CPS VIE debt because we had
purchased all of the CPS in the three trusts and, as such, the put options on
CPS are eliminated in consolidation as well.
VIEs
Effective January 1, 2010, we adopted the accounting standard update regarding
improvements to financial reporting by enterprises involved with VIEs. As a
provider of credit enhancement, we have entered into insurance contracts with
VIEs and derivative contracts with counterparties where we have provided credit
protection directly on variable interests and, in some cases, obtained the
contractual rights of our counterparties with respect to the VIEs. As defined by
the accounting standard, VIEs include corporations, trusts or partnerships in
which equity investors do not have a controlling financial interest or do not
have sufficient equity at risk to finance activities without additional
subordinated financial support. In addition, as a result of the update to the
standard regarding accounting for transfers of financial assets, effective
January 1, 2010, special purpose entities that were previously considered
qualifying special purpose entities ("QSPEs") are to be considered in the VIE
accounting framework as prescribed by the standard regarding financial reporting
by enterprises involved with VIEs.
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An entity is considered the primary beneficiary and is required to consolidate a
VIE if its variable interest (i) gives it the power to most significantly impact
the economic performance of the VIE, and (ii) has the obligation to absorb
losses or the right to receive residual benefits that could potentially be
significant to the VIE. For all VIEs in which we have a variable interest, we
determine whether we are the primary beneficiary. In determining whether we are
the primary beneficiary, a number of factors are considered, including the
structure of the entity, provisions in our contracts that grant us additional
rights to influence or control the economic performance of the VIE upon the
occurrence of an event of default or a servicer termination event or the breach
of a performance trigger, and our obligation to absorb significant losses. Due
to the continued deterioration of the performance of many of our financial
guaranty transactions, the breach of these performance tests or other events
giving rise to our right to influence or control the economic performance of the
VIE could occur. When we obtain control rights, we perform an analysis to
reassess our involvement with these VIEs to determine whether we have become the
primary beneficiary.
When evaluating whether we are the primary beneficiary of a VIE, we determine
which activities most significantly impact the economic performance of the VIE.
As part of our qualitative analysis, we consider whether we have any contractual
rights that would allow us to direct those activities. As of December 31, 2011,
we have determined that we are the primary beneficiary of our NIMS transactions,
our CPS transactions and certain financial guaranty structured transactions, and
we did not identify any new VIEs to be consolidated in 2011. Our control rights
in these VIEs, which we obtained due to an event of default or breach of a
performance trigger as defined in the transaction, generally provide us with
either a right to replace the VIE servicer, or, in some cases, the right to
direct the sale of the VIE assets. In those instances where we have determined
that we are the primary beneficiary, we consolidate the assets and liabilities
of the VIE. We have elected to carry the financial assets and financial
liabilities of these VIEs at fair value.
For certain hybrid financial instruments that would be required to be separated
into a host contract and a derivative instrument, the accounting standard
regarding derivatives and hedging permits an entity to irrevocably elect to
initially and subsequently measure that hybrid financial instrument in its
entirety at fair value (with changes in fair value recognized in earnings). We
elected to record our convertible securities meeting these criteria at fair
value with changes in the fair value recorded as net gains or losses on
investments. All hybrid financial instruments are classified as trading
securities.
Investments
We group assets in our investment portfolio into one of three main categories:
held to maturity, available for sale or trading securities. Fixed-maturity
securities for which we have the positive intent and ability to hold to maturity
are classified as held to maturity and are reported at amortized cost.
Investments in securities not classified as held to maturity or trading
securities are classified as available for sale and are reported at fair value,
with unrealized gains and losses (net of tax) reported as a separate component
of stockholders' equity as accumulated other comprehensive income. Investments
classified as trading securities are reported at fair value, with unrealized
gains and losses reported as a separate component of income. Short term
investments consist of assets invested in money market instruments, certificates
of deposit and highly liquid, interest bearing instruments with an original
maturity of three months or less at the time of purchase. Amortization of
premium and accretion of discount are calculated principally using the interest
method over the term of the investment. Realized gains and losses on investments
are recognized using the specific identification method.
For certain hybrid financial instruments that would be required to be separated
into a host contract and a derivative instrument, the accounting standard
regarding derivatives and hedging permits an entity to irrevocably elect to
initially and subsequently measure that hybrid financial instrument in its
entirety at fair value (with changes in fair value recognized in earnings). We
elected to record our convertible securities meeting these criteria at fair
value with changes in the fair value recorded as net gains or losses on
investments. All hybrid financial instruments are classified as trading
securities.
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On April 1, 2009, we adopted a new accounting standard regarding recognition and
presentation of other-than-temporary impairment ("OTTI"). In accordance with
this new standard, we record an OTTI on a security if we intend to sell the
impaired security or if it is more likely than not that we will be required to
sell the impaired security prior to recovery of its amortized cost basis, or if
the present value of cash flows we expect to collect is less than the amortized
cost basis of the security. If a sale is likely, the security is classified as
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 that are other-than-temporarily impaired are separated into: (i) the
portion of loss that represents the credit loss, and (ii) the portion that 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
accumulated other comprehensive income (loss), net of taxes. A credit loss is
determined to exist if the present value of discounted cash flows expected to be
collected from the security is less than the cost basis of the security. The
present value of discounted cash flows is determined using the original yield of
the security. For securities held as of April 1, 2009, that had previously been
other-than-temporarily impaired, an after-tax transition adjustment of $21.5
million was booked to reclassify the non-credit loss portion of these
impairments from retained earnings to accumulated other comprehensive income
(loss). In evaluating whether a decline in value is other-than-temporary, we
consider several factors in addition to the above, including, but not limited
to, the following:
• the extent and the duration of the decline in value;
• the reasons for the decline in value (e.g., credit event, interest related
or market fluctuations); and
• the financial position, access to capital and near term prospects of the
issuer, including the current and future impact of any specific events.
Income Taxes
We provide for income taxes in accordance with the provisions of the accounting
standard regarding accounting for income taxes. As required under this standard,
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 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.
In 2010, we were required to establish a valuation allowance against our DTA as
it was more likely than not that all or some portion of our DTA would not be
realized. At each balance sheet date, we re-assess our need for a valuation
allowance and this assessment is based on all available evidence, both positive
and negative, and requires management to exercise judgment and make assumptions
regarding whether such DTA will be realized in future periods. Future
realization of our DTA will ultimately depend on the existence of sufficient
taxable income of the appropriate character (ordinary income versus capital
gains) within the applicable carryback and carryforward periods provided under
the tax law. The primary sources of negative evidence that we considered are our
cumulative losses in recent years, and the continued uncertainty around our
future operating results. We also considered several sources of positive
evidence when assessing the need for a valuation allowance such as future
reversals of existing taxable temporary differences, future projections of
taxable income, taxable income within the applicable carryback periods, and
potential tax planning strategies. In making our assessment of the more likely
than not standard, the weight assigned to the effect of both negative and
positive evidence is commensurate with the extent to which such evidence can be
objectively verified.
In 2010, in accordance with the accounting standard regarding the accounting and
disclosure of income taxes in interim periods, we used an annualized effective
tax rate to compute our tax expense each quarter. We adjusted this annualized
effective tax rate each quarter by the following discrete items: (i) net gains
or losses resulting from the change in fair value of our derivatives and other
financial instruments, (ii) investment gains or losses, (iii) the liabilities
recorded under the accounting standard regarding accounting for uncertainty in
income taxes, and (iv) prior year provision-to-filed tax return adjustments.
Given the impact on our pre-tax results of net gains or losses resulting from
our derivative transactions and our investment portfolio, and the continued
uncertainty around our ability to rely on short-term financial projections,
which directly affects our ability to estimate an effective tax rate for the
full year of 2011, we booked our income tax expense (benefit) in interim periods
based on actual results of operations.
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Recent Accounting Pronouncements
In October 2010, the Financial Accounting Standards Board ("FASB") issued an
update to the accounting standard regarding accounting for costs associated with
acquiring or renewing insurance contracts. This update is effective for fiscal
years beginning after December 15, 2011, and redefines acquisition costs as
costs that are related directly to the successful acquisition of new, or the
renewal of existing, insurance contracts. Previously, acquisition costs were
defined as costs that vary with and are primarily related to the acquisition of
insurance contracts. The effect of this revised definition of acquisition costs
will result in additional expenses being charged to earnings immediately, rather
than being deferred. There is no change to amortization requirements due to this
update. We have adopted this update on a prospective basis as of January 1,
2012. Since we have discontinued writing any new financial guaranty business,
there will be no impact to our financial guaranty segment from this update.
However, while we are currently still evaluating the impact this new guidance
will have on our consolidated financial statements and disclosures, we expect
that the implementation of this new guidance will materially reduce the amount
of policy acquisition costs that we defer associated with acquiring new mortgage
insurance contracts, which totaled $46.2 million and $42.2 million in initial
deferred costs for the years ended December 31, 2011 and 2010, respectively,
accelerating the recognition of certain expenses associated with these
contracts. The lower amount of deferred acquisition costs will also result in
decreased amortization expense, which should partially offset the effect to our
net income. While the timing of when certain costs are reflected in our results
of operations will change as a result of the adoption of this update, there will
be no effect to the total acquisition costs to be recognized over time or to our
cash flows.
In May 2011, the FASB issued an update to the accounting standard regarding fair
value measurements and disclosure. This update changes the language used to
describe the requirements in GAAP for measuring fair value and for disclosing
information about fair value measurements. The amendments: (i) clarify the
FASB's intent about the application of existing fair value measurement and
disclosure requirements, and (ii) change a particular principle or requirement
for measuring fair value or for disclosing information about fair value
measurements. The amendments in this update do not require additional fair value
measurements and are not intended to establish valuation standards or affect
valuation practices outside of financial reporting. This update is effective for
fiscal years beginning after December 15, 2011. We are currently evaluating the
impact this new guidance will have on our consolidated financial statements and
disclosures.
In June 2011, the FASB issued an update to the accounting standard regarding
comprehensive income. This update eliminates the current presentation options
related to comprehensive income and provides an entity with the option to
present the components of net income, other comprehensive income and total
comprehensive income, either in a single continuous statement of comprehensive
income or in two separate but consecutive statements. Regardless of which option
an entity chooses, the entity is required to present, on the face of the
consolidated financial statements, reclassification adjustments for items that
are reclassified from other comprehensive income to net income in the
statement(s) in which the components of net income and the components of other
comprehensive income are presented. In December 2011, the FASB issued another
update to the accounting standard regarding comprehensive income, which defers
the effective date for the requirement noted above to present, on the face of
the consolidated financial statements, the reclassification of items out of
accumulated other comprehensive income. This update is effective for fiscal
years beginning after December 15, 2011. We are currently evaluating the impact
this new guidance will have on our consolidated financial statements and
disclosures.
We have adopted the accounting standard updates requiring additional disclosures
regarding the reconciliation of Level III fair value measurements for interim
and annual periods beginning after December 15, 2010. We have updated our 2010
disclosures to be consistent with the 2011 disclosure. See Note 5 of Notes to
Consolidated Financial Statements for additional information.
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