SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended
SEPTEMBER 30, 2001
------------------
OR
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from_____________________to_____________________
Commission file number 1-11356
--------
RADIAN GROUP INC.
-----------------
(Exact name of registrant as specified in its charter)
DELAWARE 23-2691170
--------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1601 MARKET STREET, PHILADELPHIA, PA 19103
- ------------------------------------ -----
(Address of principal executive offices) (zip code)
(215) 564-6600
---------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or if such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
---------- ------------
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date: 93,781,435 shares of
Common Stock, $0.001 par value, outstanding on November 9, 2001.
RADIAN GROUP INC. AND SUBSIDIARIES
INDEX
PAGE NUMBER
-----------
Part I - Financial Information
Unaudited Condensed Consolidated Balance Sheets - September 30, 2001 and
December 31, 2000........................................ 3
Unaudited Condensed Consolidated Statements of Income - For the quarters
and nine month periods ended September 30, 2001 and 2000. 4
Unaudited Condensed Consolidated Statement of Changes in Common
Stockholders' Equity - For the nine month period ended
September 30, 2001....................................... 5
Unaudited Condensed Consolidated Statements of Cash Flows - For the nine
month periods ended September 30, 2001 and 2000.......... 6
Notes to Unaudited Condensed Consolidated Financial Statements.. 7 - 10
Management's Discussion and Analysis of Results of
Operations and Financial Condition....................... 11 - 18
Quantitative and Qualitative Disclosures about Market Risk...... 18
Part II - Other Information, as applicable.............................. 19 - 20
Signatures.............................................................. 21
2
RADIAN GROUP INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
September 30 December 31
2001 2000
------------ -----------
(In thousands, except share amounts)
Assets
Investments
Fixed maturities held to maturity - at amortized cost
(fair value $485,322 and $490,792) .............................................. $ 458,510 $ 469,591
Fixed maturities available for sale - at fair value
(amortized cost $2,372,995 and $1,087,191) ...................................... 2,429,533 1,120,840
Trading securities - at fair value (cost $18,972) ................................ 14,514 --
Equity securities - at fair value (cost $85,673 and $58,877) ..................... 76,649 64,202
Short-term investments ........................................................... 248,750 95,824
Other invested assets ............................................................ 8,380 --
Cash ................................................................................. 35,957 2,424
Investment in affiliates ............................................................. 176,381 --
Deferred policy acquisition costs .................................................... 143,375 70,049
Prepaid federal income taxes ......................................................... 316,514 270,250
Provisional losses recoverable ....................................................... 45,709 43,740
Other assets ......................................................................... 276,435 135,891
----------- -----------
$ 4,230,707 $ 2,272,811
========== ===========
Liabilities and Stockholders' Equity
Unearned premiums .................................................................... $ 477,627 $ 77,241
Reserve for losses ................................................................... 575,803 390,021
Long-term debt ....................................................................... 324,059 --
Federal income taxes, principally deferred ........................................... 379,515 291,294
Accounts payable and accrued expenses ................................................ 211,071 112,058
----------- -----------
1,968,075 870,614
=========== ===========
Redeemable preferred stock, par value $.001 per share;
800,000 shares issued and outstanding - at
redemption value ..................................................................... 40,000 40,000
----------- -----------
Common stockholders' equity
Common stock, par value $.001 per share; 200,000,000 shares authorized;
93,462,006 shares and 37,907,777 shares issued
and outstanding .................................................................. 94 38
Treasury stock; 188,092 shares redeemed .............................................. (7,874) (2,159)
Additional paid-in capital ........................................................... 1,199,789 549,154
Retained earnings .................................................................... 1,000,230 789,831
Accumulated other comprehensive income ............................................... 30,393 25,333
---------- -----------
2,222,632 1,362,197
---------- -----------
$ 4,230,707 $ 2,272,811
=========== ===========
See notes to unaudited condensed consolidated financial
statements.
3
RADIAN GROUP INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Quarter Ended Nine Months Ended
September 30 September 30
2001 2000 2001 2000
---- ---- ---- ----
(In thousands, except per-share amounts)
Revenues:
Premiums written:
Direct.............................. $177,769 $ 144,969 $ 524,924 $ 430,506
Assumed ............................ 21,836 2 63,143 75
Ceded............................... (15,667) (8,824) (44,677) (29,892)
-------- -------- -------- --------
Net premiums written................... 183,938 136,147 543,390 400,689
Increase in unearned premiums.......... (3,448) (5,911) (27,896) (13,617)
-------- -------- -------- --------
Premiums earned........................ 180,490 130,236 515,494 387,072
Net investment income.................. 39,956 21,179 107,431 60,310
Equity in net income of affiliates..... 7,389 -- 32,193 --
Other income........................... 13,188 2,003 28,763 4,642
-------- -------- -------- --------
241,023 153,418 683,881 452,024
-------- -------- -------- --------
Expenses:
Provision for losses................... 50,968 38,251 152,550 115,038
Policy acquisition costs............... 20,327 12,428 59,364 38,822
Other operating expenses............... 34,149 14,503 91,048 40,314
Interest expense....................... 6,003 -- 11,852 --
-------- -------- -------- --------
111,447 65,182 314,814 194,174
-------- -------- ------- --------
Gains and losses:
Gain on sales of investments........... 2,968 2,313 5,730 3,410
Change in fair value of derivative
instruments............................ (4,267) -- (4,458) --
-------- -------- -------- --------
(1,299) 2,313 1,272 3,410
-------- -------- -------- --------
Pretax income.............................. 128,277 90,549 370,339 261,260
Provision for income taxes................. 36,745 26,480 105,973 76,733
-------- -------- -------- --------
Net income................................. 91,532 64,069 264,366 184,527
Dividends to preferred stockholder......... 825 825 2,475 2,475
-------- -------- -------- --------
Net income available to common stockholders $ 90,707 $ 63,244 $ 261,891 $ 182,052
======== ========== ======== ========
Basic net income per share................. $ 0.97 $ 0.84 $ 2.93 $ 2.42
======== ========== ======== ========
Diluted net income per share............... $ 0.96 $ 0.83 $ 2.88 $ 2.39
======== ========== ======== ========
Average number of common shares outstanding -
basic..................................... 93,281 75,480 89,360 75,167
======== =========== ======== ========
Average number of common and common
equivalent shares outstanding - diluted.... 94,784 76,383 90,892 76,129
======== =========== ======== ========
See notes to unaudited condensed consolidated financial
statements.
4
RADIAN GROUP INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN
COMMON STOCKHOLDERS' EQUITY
Accumulated Other
Comprehensive
Income (Loss)
--------------------------
Foreign Unrealized
Additional Currency Holding
Common Treasury Paid-in Retained Translation Gains/
Stock Stock Capital Earnings Adjustment Losses Total
----- ----- ------- -------- ---------- ------ -----
(In thousands)
Balance, January 1, 2001 ................ $ 38 $ (2,159) $ 549,154 $ 789,831 $ -- $ 25,333 $ 1,362,197
Comprehensive income:
Net income ............................ -- -- -- 264,366 -- -- 264,366
Unrealized foreign currency translation
adjustment, net of tax benefit of
$286 ................................ -- -- -- -- (525) -- (525)
Unrealized holding gains arising
during period, net of tax of
$710 ................................ -- -- -- -- -- 1,319
Plus: Reclassification adjustment
for net gains included in net income,
net of tax of $2,297 ................ -- -- -- -- -- 4,266
---------
Net unrealized gains on investments,
net of tax of $3,007 ................ -- -- -- -- -- 5,585 5,585
-----------
Comprehensive income .................... -- 269,426
Issuance of common stock related to
acquisition ......................... 9 -- 574,017 -- -- -- 574,026
Issuance of common stock under
incentive plans ..................... 1 -- 30,046 -- -- -- 30,047
Treasury stock redeemed ................. -- (5,715) -- -- -- -- (5,715)
Two-for-one stock split ................. 46 -- 46,572 (46,618) -- -- --
Dividends ............................... -- -- -- (7,349) -- -- (7,349)
------- ----------- ----------- ----------- --------- ----------- -----------
Balance, September 30, 2001.. $ 94 $ (7,874) $ 1,199,789 $ 1,000,230 $ (525) $ 30,918 $ 2,222,632
======= =========== =========== =========== ========= =========== ===========
See notes to unaudited condensed consolidated financial
statements.
5
RADIAN GROUP INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30
2001 2000
---- ----
(In thousands)
Cash flows from operating activities........................... $ 323,079 $ 231,917
-------- --------
Cash flows from investing activities:
Proceeds from sales of investments available for sale.... 535,579 365,445
Proceeds from sales of equity securities available for
sale .................................................. 3,515 16,873
Proceeds from redemptions of investments available for
sale................................................... 173,776 29,175
Proceeds from redemptions of investments held to maturity 15,826 2,245
Purchases of investments available for sale.............. (980,790) (613,401)
Purchases of equity securities available for sale........ (41,439) (27,947)
Purchases of short-term investments - net................ (66,197) (13,607)
Purchases of property and equipment - net................ (6,490) (2,037)
Other.................................................... (6,249) (1,389)
-------- --------
Net cash used in investing activities................. (372,469) (244,643)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock under incentive
plans.................................................. 30,047 17,193
Repayment of short-term debt............................. (173,724) --
Issuance of long-term debt............................... 247,058 --
Acquisition costs........................................ (7,394) --
Redemption of treasury stock............................. (5,715) (2,159)
Dividends paid........................................... (7,349) (5,832)
-------- --------
Net cash from financing activities.................... 82,923 9,202
-------- --------
Increase (decrease) in cash.................................... 33,533 (3,524)
Cash, beginning of period...................................... 2,424 7,507
-------- --------
Cash, end of period............................................ $ 35,957 $ 3,983
========= ========
Supplemental disclosures of cash flow information:
Income taxes paid.............................................. $ 96,880 $ 69,768
======== ========
Interest paid.................................................. $ 9,127 $ 602
======== ========
See notes to unaudited condensed consolidated financial
statements.
6
RADIAN GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1 - UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The unaudited condensed consolidated financial statements as of and for
the quarter and nine month periods ended September 30, 2001, include the
accounts of Radian Group Inc. (the "Company") and its subsidiaries,
including its principal mortgage guaranty subsidiaries, Radian Guaranty Inc.
and Amerin Guaranty Corporation (together referred to as "Radian"), its
principal financial guaranty operating subsidiaries, Enhance Reinsurance
Company and Asset Guaranty Insurance Company ("Asset Guaranty"), (together
referred to as "Enhance"), and its principal minority owned asset-based
subsidiaries, Credit-Based Asset Servicing and Securitization LLC ("C-BASS")
and Sherman Financial Group LLC ("Sherman"). For periods prior to the first
quarter of 2001, the financial statements do not include any results from
operations from Enhance Financial Services Group Inc. ("Enhance Financial"),
parent of Enhance. These statements are presented in accordance with
accounting principles generally accepted in the United States of America.
The financial information for the interim periods included herein is
unaudited; however, such information reflects all adjustments which are, in
the opinion of management, necessary for a fair presentation of the
financial position, results of operations, and cash flows for the interim
periods. The results of operations for interim periods are not necessarily
indicative of results to be expected for the full year or for any other
period.
Basic net income per share is based on the weighted average number of
common shares outstanding, while diluted net income per share is based on
the weighted average number of common shares outstanding and common share
equivalents that would arise from the exercise of stock options. Preferred
stock dividends are deducted from net income in the net income per share
computation.
For a summary of significant accounting policies and additional
financial information, see the Company's Annual Report on Form 10-K for the
year ended December 31, 2000 and Enhance Financial's Annual Report on Form
10-K for the year ended December 31, 1999.
2 - ACQUISITION OF ENHANCE FINANCIAL
On February 28, 2001, the Company acquired Enhance Financial for
approximately $581.5 million, such sum representing the value of the
Company's common stock and stock options issued in connection with the
acquisition and other consideration in accordance with an Agreement and Plan
of Merger, dated November 13, 2000, by and between the Company, a
wholly-owned subsidiary of the Company and Enhance Financial. The
acquisition, which was structured as a merger of a wholly-owned subsidiary
of the Company with and into Enhance Financial, entitled Enhance Financial
stockholders to receive 0.22 shares of the Company's common stock in a
tax-free exchange for each share of Enhance Financial common stock that they
owned at the time of the merger. The Company's stockholders continued to own
their existing shares after the acquisition. The acquisition was treated as
a purchase for accounting purposes, and accordingly, the assets and
liabilities were recorded based on their fair values at the date of
acquisition. The excess of purchase price over fair value of net assets
acquired of $56.7 million represents the future value of insurance profits
which will be amortized over a period that approximates the future life of
the insurance book of business. The results of Enhance Financial's
operations have been included in the Company's financial statements for the
period from March 1, 2001 through September 30, 2001.
The purchase price of Enhance Financial reflects the issuance of
8,462,861 shares (pre-stock split) of the Company's common stock at $65.813
per share (pre-stock split) which represents the average closing price of
the Company's common stock for the three days preceding and following the
announcement of the acquisition, and the issuance of 1,222,853 options
(pre-stock split) to purchase shares of the Company's common stock to
holders of options to purchase shares of Enhance Financial common stock. The
value of the option grant was based on a Black-Scholes valuation model
assuming an average life of 2.8 years, a risk-free interest rate of 4.75%,
volatility of 43.4% and a dividend yield of 0.22%.
In conjunction with the acquisition, the Company has guaranteed payment
of up to $12.5 million of a $25.0 million revolving credit facility issued
to Sherman, a 45.5% owned affiliate of Enhance Financial. In the third
quarter of 2001, Sherman used $500,000 of the line of credit and this amount
was repaid in October 2001.
7
RADIAN GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
The following unaudited pro forma information presents a summary of the
consolidated operating results of Radian Group Inc. and Enhance Financial as
if the acquisition occurred on January 1, 2000 (in thousands except
per-share information):
2001 2000
---- ----
For the nine months ended September 30:
Net revenues................................................. $689,745 $615,699
Net income................................................... 188,435 205,706
Net income per share - basic................................. $1.96 $2.21
Net income per share - diluted............................... $1.93 $2.18
These unaudited pro forma results have been prepared for comparative
purposes only and are not necessarily indicative of the results of
operations which actually would have resulted had the acquisition occurred
on the date indicated, nor are they indicative of any future results of
operations.
3 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 133, "Accounting for Derivative Instruments and Hedging Activities", as
amended, on January 1, 2001. The statement establishes accounting and
reporting standards for derivative instruments and hedging activity and
requires that all derivatives be measured at fair value and recognized as
either assets or liabilities in the financial statements. Changes in the
fair value of derivative instruments will be recorded each period in current
earnings. This represents a change from the Company's prior accounting
practices whereby these changes were recorded as a component of
stockholders' equity. Transactions that the Company has entered into that
will be accounted for under SFAS 133, as amended, include convertible debt
securities and certain financial guaranty contracts.
Upon adoption of SFAS 133, the balance of the Company's convertible debt
portfolio was approximately $104.6 million. SFAS 133 requires that the
Company split its convertible debt securities into the derivative and debt
host components. Over the term of the securities, changes in the fair value
of the debt instrument will be recorded in the Company's consolidated
statement of changes in common stockholders' equity, through accumulated
other comprehensive income or loss. Concurrently, a deferred tax liability
or benefit will be recognized as the recorded value of the debt host
increases or decreases. Changes in the fair value of the derivative will be
recorded to gain or loss on sales of investments in the Company's
consolidated statement of income. In connection with the adoption of SFAS
133, the Company reclassified $13.8 million from fixed maturities available
for sale to trading securities on its consolidated balance sheet as of
January 1, 2001. During the first nine months of 2001, the fair value of the
Company's derivative instruments decreased to $14.5 million, as compared to
amortized value of $19.0 million, and the Company recognized $2.9 million,
net of tax, of loss on changes in the fair value of derivative instruments
in the consolidated statement of income for the nine months ended September
30, 2001. During the third quarter of 2001, the fair value of the Company's
derivative instruments decreased $4.3 million, and the Company recognized
$2.8 million, net of tax, of loss on changes in the fair value of derivative
instruments in the consolidated statement of income for the quarter ender
September 30, 2001.
In connection with the acquisition of Enhance Financial, the Company has
identified certain financial guaranty contracts that may require measurement
at fair value under SFAS 133. The Company does not anticipate any material
adjustments to its financial position or results of operations for these
contracts as a result of SFAS 133.
The application of SFAS 133, as amended, could result in volatility from
period to period in investment income or expense as reported on the
Company's consolidated statement of income. The Company is unable to predict
the effect this volatility may have on its financial position or results of
operations.
8
RADIAN GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
4 - STOCK SPLIT
On May 1, 2001, the Company's board of directors authorized a stock
split, paid June 20, 2001, in the form of a dividend of one additional share
of the Company's common stock for each share owned by stockholders of record
on June 14, 2001. To effect the stock split, the Company's stockholders
approved an increase in the number of authorized sharesof common stock, from
80 million to 200 million, on June 14, 2001. The dividend was accounted for
as a two-for-one stock split and the par value of the Company's common stock
remained at $.001 per share. Accordingly, all references to common per share
data have been adjusted to give effect to the stock split. In conjunction
with the stock split, the Company's board of directors voted to increase the
quarterly dividend from $.015 per share to $.02 per share of common stock
outstanding after the split was effected.
5 - SEGMENT REPORTING
The Company has three reportable segments: mortgage insurance and
related businesses, financial guaranty and credit-related insurance
businesses and asset-based businesses. The mortgage insurance segment
provides private mortgage insurance and risk management services to mortgage
lending institutions located throughout the United States. Private mortgage
insurance protects lenders from default-related losses on residential first
mortgage loans made to homebuyers who make downpayments of less than 20% of
the purchase price and facilitates the sale of these mortgages in the
secondary market. The financial guaranty and credit-related insurance
segment provides credit-related insurance coverage to meet the needs of
customers in a wide variety of domestic and international markets. The
Company's largest insurance business within this segment is the provision of
reinsurance to the monoline primary financial guaranty insurers for both
municipal bonds and non-municipal obligations. The Company also provides
trade credit reinsurance, financial responsibility bonds, excess-SIPC
insurance and direct financial guaranty insurance. The asset-based
businesses segment deals primarily with credit-based servicing and
securitization of assets in underserved markets, in particular, the purchase
and servicing of and securitization of special assets, including
sub-performing/non-performing and seller financed residential mortgages and
delinquent consumer assets. The Company's reportable segments are strategic
business units, which are managed separately as each business requires
different marketing and sales expertise.
The Company evaluates performance based on net income. Summarized
financial information concerning the Company's operating segments is
presented in the following tables:
September 30, 2001
-----------------------------------------------
In thousands Mortgage Financial
Related Guaranty Asset-based Consolidated
------- -------- ------------ ------------
Nine months ended:
Revenues from external customers...... $ 469,328 $ 72,435 $ 2,494 $ 544,257
Net investment income ................. 72,716 34,715 -- 107,431
Net income before taxes ............... 281,508 57,749 31,082 370,339
Quarter ended:
Revenues from external customers ...... 161,475 29,838 2,365 193,678
Net investment income ................. 24,791 15,165 -- 39,956
Net income before taxes ............... 94,147 26,805 7,325 128,277
Segment assets .......................... 2,603,908 1,410,112 216,687 4,230,707
9
RADIAN GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
September 30, 2000
-----------------------------------------------
In thousands Mortgage Financial
Related Guaranty Asset-based Consolidated
------- -------- ----------- ------------
Nine months ended:
Revenues from external customers $ 391,714 $ -- $ -- $ 391,714
Net investment income .......... 60,310 -- -- 60,310
Net income before taxes ........ 261,260 -- -- 261,260
Quarter ended:
Revenues from external customers 132,239 -- -- 132,239
Net investment income .......... 21,179 -- -- 21,179
Net income before taxes ........ 90,549 -- -- 90,549
Segment assets ................... 2,116,774 -- -- 2,116,774
6 - RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued two new pronouncements: SFAS No. 141,
"Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS 141 is effective as follows: a) use of the pooling-of-interest
method is prohibited for business combinations initiated after June 30,
2001; and b) the provisions of SFAS 141 also apply to all business
combinations accounted for by the purchase method that are completed after
June 30, 2001 (that is, the date of the acquisition is July 2001 or later).
There are also transition provisions that apply to business combinations
completed before July 1, 2001, that were accounted for by the purchase
method. SFAS 142 is effective for fiscal years beginning after December 15,
2001 to all goodwill and other intangible assets recognized in an entity's
statement of financial position at that date, regardless of when those
assets were initially recognized. The Company is currently evaluating the
provisions of SFAS 141 and SFAS 142 and has not adopted such provisions in
its September 30, 2001 condensed consolidated financial statements. The
Company does not expect the adoption of SFAS 141 or SFAS 142 to have a
material impact on its financial position or results of operations.
In September 2000, the FASB issued SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities" which replaces, in its entirety, SFAS No. 125. Although SFAS
140 has changed many of the rules regarding securitizations, it continues to
require an entity to recognize the financial and servicing assets it
controls and the liabilities it has incurred and derecognize financial
assets when control has been surrendered in accordance with the criteria
provided in the statement. The Company previously adopted the provisions of
SFAS 140 that related to applicable disclosures of securitization
transactions, and has adopted the remaining provision of the new statement
beginning in the second quarter of 2001. The adoption of SFAS 140 did not
have a material impact on the financial position or results of operations of
the Company.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" which addresses the financial
accounting and reporting for the impairment or disposal of long-lived
assets. This statement supercedes SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of," and the accounting and reporting provisions of APB No. 30, "Reporting
the Results of Operations - Reporting the Effects of Disposal of a Segment
of a Business, and Extraordinary, Unusual and Infrequently Occurring Events
and Transactions", for disposal of a segment of a business. This statement
is effective for fiscal years beginning after December 15, 2001 and when
adopted, is not expected to have a material impact on the financial position
or results of operations of the Company.
10
RADIAN GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
The following is a "Safe Harbor" Statement under the Private Securities
Litigation Reform Act of 1995:
The statements contained in this Form 10-Q that are not historical facts
are forward-looking statements. Actual results may differ materially from those
projected in the forward-looking statements. These forward-looking statements
involve risks and uncertainties including, but not limited to, the following
risks: that interest rates may increase rather than remain stable or decrease;
that housing demand may decrease for any number of reasons, including changes in
interest rates, adverse economic conditions or other reasons; that Radian's
market share may decrease as a result of changes in underwriting criteria by
Radian or its competitors, or other reasons; and changes in the performance of
the financial markets, in the demand for and market acceptance of Radian
products, increased competition from government programs and the use of
substitutes for mortgage insurance, and in general conditions. Investors are
also directed to other risks discussed in documents filed by the Company with
the Securities and Exchange Commission.
RESULTS OF CONSOLIDATED OPERATIONS
Consolidated net income for the first nine months of 2001 was $264.4
million, a 43.3% increase compared to $184.5 million for the same period of 2000
and consolidated net income for the third quarter of 2001 was $91.5 million as
compared to $64.1 million for the third quarter of 2000, an increase of 42.9%.
This improvement was a result of growth in premiums earned and net investment
income and the inclusion of equity in net income of affiliates, offset by an
increase in provision for losses, policy acquisition costs and other operating
expenses. As a result of the acquisition of Enhance Financial by the Company on
February 28, 2001, net income for the first nine months of 2001 included the
results from operations for March 2001 through September 2001 for Enhance
Financial, which contributed $62.8 million and $23.4 million to net income for
the nine month period and the quarter ended September 30, 2001, respectively.
Consolidated earned premiums increased $128.4 million or 33.2% from $387.1
million for the first nine months of 2000 to $515.5 million for the same period
of 2001, with the inclusion of Enhance Financial contributing $70.3 million of
the increase. For the third quarter of 2001, consolidated earned premiums were
$180.5 million as compared to $130.2 million for the third quarter of 2000, a
38.6% increase, with the inclusion of Enhance Financial contributing $28.4
million of the increase. Net consolidated investment income increased from $60.3
million for the first nine months of 2000 to $107.4 million in the same period
of 2001, a 78.1% increase, with Enhance Financial contributing $34.7 million of
the increase. For the third quarter of 2001, net consolidated investment income
was $40.0 million as compared to $21.2 million for the third quarter of 2000,
with Enhance Financial contributing $15.2 million of the increase. Equity in net
income of affiliates for the first nine months and third quarter of 2001 was
$32.2 million and $7.4 million, respectively. Consolidated provision for losses
increased $37.6 million for the first nine months of 2001 from $115.0 million in
2000 to $152.6 million for the same period of 2001, an increase of 32.6% with
the inclusion of Enhance Financial accounting for $18.9 million of the increase.
For the third quarter of 2001, consolidated provision for losses was $51.0
million, a 33.2% increase from $38.3 million for the same quarter of 2000, with
the inclusion of Enhance Financial accounting for $7.3 million of the increase.
Consolidated policy acquisition and other operating expenses also increased from
the first nine months of 2000 by 90.1% from $79.1 million to $150.4 for the
first nine months of 2001 and Enhance Financial accounted for $27.6 million of
the increase. For the third quarter of 2001, consolidated policy acquisition and
other operating expenses were $54.5 million as compared to $26.9 million for the
same quarter of 2000, a 102.3% increase, with Enhance Financial accounting for
$11.8 million of the increase. Interest expense for the first nine months and
third quarter of 2001 was $11.9 million and $6.0 million, respectively. Diluted
net income per share for the nine month period ended September 30, 2001
increased 20.5% from $2.39 per share in the first nine months of 2000 (after
adjusting for the stock split - See note 4 of Notes to Unaudited Condensed
Consolidated Financial Statements) to $2.88 per share for the same period in
2001 and for the third quarter of 2001, diluted net income per share increased
15.7% to $0.96 per share from $0.83 per share for the same quarter of 2000
(after adjusting for the stock split). The weighted average shares for the nine
months ended September 30, 2001 included seven months of outstanding shares
issued in connection with the Enhance Financial acquisition.
MORTGAGE INSURANCE AND RELATED SERVICES - RESULTS OF OPERATIONS
Net income for the first nine months of 2001 was $201.6 million, a 9.3%
increase compared to $184.5 million
11
RADIAN GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
(CONTINUED)
for the first nine months of 2000 and net income for the quarter ended September
30, 2001 was $68.2 million, a 6.4% increase compared to $64.1 million for the
same period in 2000. These improvements in net income were the result of growth
in premiums earned, net investment income and other income, offset by a higher
provision for losses and an increase in policy acquisition costs and other
operating expenses.
New primary insurance written during the first nine months of 2001 was
$31.7 billion, a 79.7% increase compared to $17.6 billion for the first nine
months of 2000 and for the third quarter of 2001, new primary insurance written
of $12.3 billion was 74.4% higher than the $7.0 billion written in the third
quarter of 2000. This increase in Radian's primary new insurance written volume
for the first nine months and third quarter of 2001 was primarily due to a 69.6%
and 71.6%, respectively, increase in new insurance written volume in the private
mortgage insurance industry compared to the same periods of 2000. In addition,
Radian's market share of the industry increased to 15.6% for the nine months
ended September 30, 2001 as compared to 14.7% for the same period of 2000.
Radian believes the market share increase was due in part to an increase in the
Company's share of new insurance written under bulk transactions which are
included in industry new insurance written figures. During the first nine months
and third quarter of 2001, Radian wrote $5.2 billion and $2.6 billion,
respectively, of such transactions as compared to $389.9 million and $364.2
million, respectively, for the nine months and quarter ended September 30, 2000.
Radian's participation in the bulk transaction market is likely to vary
significantly from quarter to quarter due to the competitive bidding process
associated with such business. During the first nine months of 2001, Radian
wrote $110.3 million of pool insurance risk as compared to $130.0 million in the
first nine months of 2000 and for the quarter ended September 30, 2001, Radian's
pool risk written was $22.4 million as compared to $25.7 million for the same
period of 2000. Most of this pool insurance volume relates to a group of
structured transactions composed primarily of Fannie Mae- and Freddie
Mac-eligible conforming mortgage loans ("GSE Pool"). This business contains
loans with loan-to-value ratios above 80% which have primary insurance that
places the pool insurance in a secondary loss position and loans with
loan-to-value ratios of 80% and below for which the pool coverage is in a first
loss position. The performance of this business written in prior years has been
better than anticipated although the historical performance might not be an
indication of future performance.
Radian's volume in the first nine months and third quarter of 2001 was
positively impacted by relatively lower interest rates that affected the entire
mortgage industry. The trend toward lower interest rates, which began in the
fourth quarter of 2000, caused refinancing activity during the first nine months
of 2001 to increase significantly and contributed to the increase in the
mortgage insurance industry new insurance written volume for the first nine
months of 2001. Radian's refinancing activity as a percentage of primary new
insurance written was 38.0% and 37.0%, respectively, for the nine months and
quarter ended September 30, 2001 as compared to 12.0% for each of the same
periods in 2000. The persistency rate, which is defined as the percentage of
insurance in force that is renewed in any given year, was 68.6% for the twelve
months ended September 30, 2001 as compared to 79.4% for the twelve months ended
September 30, 2000. This decrease was consistent with the increasing level of
refinancing activity during the last quarter of 2000 which has continued into
the first nine months of 2001, which has caused the cancellation rate to
increase. The expectation for the fourth quarter of 2001 is a continuation of
strong industry volume and a continuation of low persistency rates.
Radian insures non-traditional mortgage loans, specifically Alternative
A and A-minus loans (collectively, referred to as "non-prime" business).
Alternative A ("Alt A") borrowers have credit profiles similar to Radian's
typical insured borrowers, but their loans are underwritten with reduced
documentation and verification of information. Radian typically charges a higher
premium rate for this business due to the reduced documentation, but does not
consider this business to be significantly more risky than its prime business.
The A-minus loan programs typically have non-traditional credit standards which
are less stringent than standard credit guidelines. To compensate for this
additional risk, Radian receives a higher premium for insuring this product that
Radian believes is commensurate with the additional default risk. During the
nine months and quarter ended September 30, 2001, non-prime business accounted
for $10.8 billion and $4.8 billion, respectively, or 34.2% and 39.0%,
respectively, of Radian's new primary insurance written as compared to $3.0
billion and $1.4 billion, respectively, for the same periods of 2000, which
accounted for 17.3% and 19.2%, respectively,
12
RADIAN GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
(CONTINUED)
of Radian's new primary insurance written during 2000. Of the $10.8 billion and
$4.8 billion, respectively, of non-prime business written in the nine months and
quarter ended September 30, 2001, Alt A business accounted for $5.1 billion and
$2.4 billion, respectively, or 47.1% and 50.1% of the total non-prime business
originated. For the same periods of 2000, Alt A business accounted for $1.8
billion and $722.5 million, respectively, or 60.0% and 53.1% of the total
non-prime business originated.
In the third quarter of 2000, the Company began to insure obligations
secured by mortgage-related assets in a Pennsylvania domiciled credit insurer,
Radian Insurance Inc. ("Radian Insurance"). Radian Insurance is rated AA by
Standard & Poor's Insurance Rating Service and Fitch IBCA and Aa3 by Moody's
Investors Service and was formed to write credit insurance and financial
guaranty insurance on obligations secured by mortgage-related assets that are
not permitted to be insured by monoline mortgage guaranty insurers. Such assets
include second mortgages, manufactured housing loans, home equity loans and
mortgages with loan-to-value ratios above 100%. During the first nine months and
third quarter of 2001, Radian Insurance wrote $2.3 billion and $426.0 million,
respectively, of insurance as compared to $1.2 billion for each of the same
periods in 2000. Such business is written under varying structures and thus
premium rates and commensurate risk levels will vary on a deal by deal basis.
The performance of such business is too young to determine whether the premium
rates charged will compensate the Company for the anticipated level of risk.
Beginning in October 2001, Radian Insurance entered into a reinsurance agreement
with its affiliate, Asset Guaranty, whereby Radian Insurance will cede the
insurance risk associated with certain obligations secured by mortgage-backed
securities and manufactured housing loans.
Net premiums earned in the first nine months of 2001 were $445.2
million, a 15.0% increase compared to $387.1 million for the first nine months
of 2000 and premiums earned for the quarter ended September 30, 2001 were $152.1
million, a 16.8% increase compared to $130.2 million for the same period of
2000. These increases, which were greater than the increase in insurance in
force, reflected the premiums earned in Radian Insurance of $27.2 million and
$12.8 million, respectively, for the nine months and quarter ended September 30,
2001 and the change in the mix of new insurance written volume originated by
Radian during the second half of 2000 and the first nine months of 2001,
combined with the increase in new insurance written volume. This change in mix
included a higher percentage of non-prime business. This type of business has
higher premium rates, which are commensurate with the increased level of risk
associated with the insurance. The insurance in force growth resulting from
strong new insurance volume in the first nine months of 2001 was offset by the
decrease in persistency levels. Radian's direct primary insurance in force
increased 5.9%, from $100.9 billion at December 31, 2000 to $106.8 billion at
September 30, 2001. GSE Pool risk in force also grew to $1.2 billion at
September 30, 2001 from $1.1 billion at the end of 2000, an increase of 6.4% for
the nine month period while total pool risk in force grew from $1.4 billion at
the end of 2000 to $1.5 billion at September 30, 2001, an increase of 1.4% for
the nine month period.
Radian and the industry have entered into risk-sharing arrangements with
various customers that are designed to allow the customer to participate in the
risks and rewards of the mortgage insurance business. One such product is
captive reinsurance, in which a mortgage lender sets up a mortgage reinsurance
company that assumes part of the risk associated with that lender's insured book
of business. In most cases, the risk assumed by the reinsurance company is an
excess layer of aggregate losses that would be penetrated only in a situation of
adverse loss development. For the first nine months and third quarter of 2001,
premiums ceded under captive reinsurance arrangements were $38.0 million and
$12.6 million, respectively, or 8.3% of total premiums earned during both the
nine month and quarterly period and for the same periods of 2000, premiums ceded
were $24.0 million and $8.0 million, respectively, or 5.7% and 5.8%, of total
premiums earned during the period. New primary insurance written under captive
reinsurance arrangements for the nine months and quarter ended September 30,
2001 were $11.0 billion and $5.2 billion, respectively, accounting for 34.7% and
42.6%, of total new primary insurance written during the periods. For the same
periods of 2000, new primary insurance written under captive reinsurance
arrangements was $5.7 billion and $2.6 billion, respectively, representing 32.5%
and 37.5%, of total new primary insurance written during those periods in 2000.
13
RADIAN GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
(CONTINUED)
Net investment income for the first nine months of 2001 was $72.7
million, a 20.6% increase compared to $60.3 million for the same period of 2000
and for the third quarter of 2001, net investment income was $24.8 million as
compared to $21.2 million for the third quarter of 2000, a 17.1% increase. These
increases were a result of continued growth in invested assets primarily due to
positive operating cash flows of $291.4 million for the first nine months of
2001. Radian has continued to invest some of its new operating cash flow in
tax-advantaged securities, primarily municipal bonds, although the Company
modified its investment policy to allow the purchase of various other asset
classes, including common stock and convertible securities, beginning in the
second quarter of 1998 and some of Radian's cash flows have been used to
purchase these classes of securities. The Company's intent is to target the
common equity exposure at a maximum of 5% of the investment portfolio's market
value while the investment-grade convertible securities and investment-grade
asset-backed securities exposures are targeted not to exceed 10%.
Net realized gains on sales of investments were $6.4 million and $2.7
million, respectively, for the nine months and quarter ended September 30, 2001
and for the same periods in 2000, net realized gains on investments were $3.4
million and $2.3 million, respectively. For the nine months and quarter ended
September 30, 2001, net realized losses from the change in the fair value of
Radian's derivative instruments were $3.8 million and $3.5 million,
respectively.
The provision for losses was $133.7 million for the first nine months of
2001, an increase of 16.2% compared to $115.0 million for the first nine months
of 2000, and for the third quarter of 2001, the provision was $43.7 million as
compared to $38.3 million for the third quarter of 2000, an increase of 14.3%.
These increases reflected an increase in the number of delinquent loans as a
result of the maturation of Radian's book of business combined with an overall
increase in delinquencies on both the prime and non-prime books of business as a
result of the slowing economy. Claim activity is not spread evenly throughout
the coverage period of a book of business. Relatively few claims are received
during the first two years following issuance of the policy. Historically, claim
activity has reached its highest level in the third through fifth years after
the year of loan origination. Approximately 71.3% of Radian's primary risk in
force and 60.8% of Radian's pool risk in force at September 30, 2001 had not yet
reached its anticipated highest claim frequency years. Radian's overall
delinquency rate at September 30, 2001 was 2.0% as compared to 1.6% at December
31, 2000, while the delinquency rate on the primary business was 3.1% at
September 30, 2001 as compared to 2.3% at December 31, 2000. The Company
believes the increase in Radian's overall delinquency rate is primarily a result
of the slowing economy. A continued weakening of the economy could negatively
impact Radian's overall delinquency rates, which would result in an increase in
the provision for losses. The number of delinquencies rose from 26,520 at
December 31, 2000 to 34,745 at September 30, 2001 and the average loss reserve
per delinquency declined from $14,707 at the end of 2000 to $12,693 at September
30, 2001, although the reserve as a percentage or risk in force rose to 162
basis points at September 30, 2001 from 148 basis points at the end of 2000. The
delinquency rate in California was 1.7% (including pool) at September 30, 2001
as compared to 1.5% at December 31, 2000 and claims paid in California during
the first nine months of 2001 were $5.5 million, representing approximately 8.3%
of total claims as compared to 17.0% for the same period of 2000. California
represented approximately 16.1% of primary risk in force at September 30, 2001
as compared to 16.8% at December 31, 2000. The delinquency rate in Florida was
3.3% (including pool) at September 30, 2001 as compared to 2.7% at December 31,
2000 and claims paid in Florida during the first nine months of 2001 were $6.3
million, representing approximately 9.5% of total claims as compared to 14.1%
for the same period of 2000. Florida represented approximately 7.4% of primary
risk in force at September 30, 2001 and December 31, 2000. No other state
represented more than 6.2% of Radian's primary risk in force at September 30,
2001. Radian has reported an increased number of delinquencies on non-prime
business insured beginning in 1997. Although the delinquency rate on this
business is higher than on Radian's prime books of business, it is within the
expected range for this type of business, and the higher premium rates charged
are expected to compensate for the increased level of risk. The number of
delinquent non-prime loans at September 30, 2001 was 5,662, which represented
20.8% of the total number of delinquent primary loans, as compared to 2,690 at
December 31, 2000, which represented 13.1% of the delinquent primary loans. The
delinquency rate on this business rose from 4.1% at December 31, 2000 to 5.1% at
September 30, 2001 as compared to the primary delinquency rate on Radian's prime
business at September 30, 2001 and December 31, 2000 of 2.8% and
14
RADIAN GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
(CONTINUED)
2.3%, respectively. At September 30, 2001, the delinquency rate on Radian's Alt
A business was 3.4% as compared to 2.9% at December 31, 2000 and Alt A
delinquencies represented 28.9% of the total number of non-prime delinquent
loans. The delinquency rate on A minus business was 6.4% as compared to 6.0% at
December 31, 2000. Direct losses paid in the first nine months of 2001 declined
to $66.0 million as compared to $72.2 million in the same period of 2000, a
decrease of 8.6% and direct losses paid during the third quarter of 2001 were
$24.4 million, an increase of 3.0% compared to $23.7 for the same period in
2000. Most of the increase in the third quarter of 2001 was as a result of $1.7
million of losses paid on the second lien insurance business insured by Radian
Insurance beginning in the third quarter of 2000 while for the first nine months
of 2001, these losses were $3.1 million. The Company expects that the paid
losses resulting from the Radian Insurance second lien business will continue at
similar or increasing levels as compared to the level experienced this quarter.
The severity of loss payments on Radian's traditional mortgage insurance
business has declined over the past several years due to property value
appreciation, but any negative impact on future property values would most
likely increase both the loss frequency and the loss severity.
Underwriting and other operating expenses were $122.8 million for the
first nine months of 2001, an increase of 55.2% compared to $79.1 million for
the same period of 2000 and for the third quarter of 2001, these expenses were
$42.7 million as compared to $26.9 million for the third quarter of 2000, an
increase of 58.6%. These expenses consisted of policy acquisition expenses,
which relate directly to the acquisition of new business, and other operating
expenses, which primarily represent contract underwriting expenses, overhead and
administrative costs.
Policy acquisition costs in the first nine months of 2001 were $46.3
million, an increase of 19.3% compared to $38.8 million for the first nine
months of 2000 and these expenses were $15.5 million in the third quarter of
2001, an increase of 24.5% compared to $12.4 million for the same period in
2000. This reflects an increase in expenses to support the higher new insurance
written volume during the first nine months of 2001 as compared to the same
period of 2000. In addition, the Company has continued development of its
marketing and e-commerce efforts. Other operating expenses for the nine months
ended September 30, 2001 were $76.5 million, an increase of $36.2 million or
89.8% as compared to $40.3 million for the same period in 2000 and these
expenses were $27.2 million for the third quarter of 2000, an increase of 87.9%
compared to $14.5 million for the third quarter of 2000. This reflects an
increase in expenses associated with contract underwriting. Contract
underwriting expenses for the first nine months of 2001 included in other
operating expenses were $30.6 million as compared to $13.5 million for the same
period of 2000, an increase of 127.7%, and for the third quarter of 2001, these
expenses were $10.7 million, an increase of 72.4% as compared to $6.2 million
for the same period of 2000. This $17.1 million increase in contract
underwriting expenses during the first nine months of 2001 reflected the
increasing demand for contract underwriting services as mortgage origination
volume has increased. Consistent with the increase in contract underwriting
expenses, other income related to contract underwriting services increased
172.0% to $11.3 million for the first nine months of 2001 as compared to $4.2
million for the same period in 2000. For the third quarter of 2001, other income
related to contract underwriting services increased 115.0% to $3.9 million as
compared to $1.8 million for the third quarter of 2000. During the first nine
months of 2001, loans underwritten via contract underwriting accounted for 30.5%
of applications, 28.0% of commitments, and 23.1% of certificates issued by
Radian as compared to 30.8% of applications, 27.0% of commitments, and 20.1% of
certificates issued in the first nine months of 2000.
Included in mortgage insurance and related services are the results of
ExpressClose.com, Inc. ("ExpressClose"), an internet-based mortgage processing,
closing and settlement services company. ExpressClose had other income and
operating expenses of $9.7 million and $11.2 million, respectively, for the nine
months ended September 30, 2001 and for the third quarter of 2001, other income
and operating expenses were $4.7 million and $4.8 million, respectively.
ExpressClose processed 264,000 and 100,000 transactions, respectively, for the
nine months and quarter ended September 30, 2001 and approximately 21,000 and
11,000, respectively, of the transactions processed during these periods,
related to net funding services whereby ExpressClose receives and disburses
mortgage funds on behalf of its customers.
15
RADIAN GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
(CONTINUED)
Interest expense for the nine months and quarter ended September 30,
2001 of $6.6 million and $4.9 million, respectively, represented interest on the
$250.0 million long-term debt of the Company, which was obtained on May 29, 2001
through a private placement.
The effective tax rate for the nine months ended September 30, 2001 was
28.4% as compared to 29.4% for the same period in 2000 and the tax rate for the
third quarter of 2001 was 27.6% as compared to 29.2% for the third quarter of
2000. Operating income accounted for 72.7% and 73.8%, respectively, of net
income for the nine months and quarter ended September 30, 2001, as compared to
75.6% and 74.1%, respectively, for the same periods in 2000, thus resulting in
the decrease in effective tax rates for 2001 as the tax advantaged investment
income represented a larger share of pretax net income.
FINANCIAL GUARANTY INSURANCE - RESULTS OF OPERATIONS
The financial guaranty insurance operations are conducted through
Enhance and primarily involve the reinsurance and direct underwriting of
financial guaranties of municipal and asset-backed debt obligations. Reinsurance
is assumed primarily from four monoline financial guaranty insurers. In
addition, another insurance subsidiary, Van-American Insurance Company, is
engaged on a run-off basis in reclamation bonds for the coal mining industry and
surety bonds covering closure and post-closure obligations of landfill
operators. Such business is not expected to be material to the financial results
of the Company. The Company's consolidated results of operations include only
seven months of operating results from Enhance Financial and prior periods
include no Enhance Financial results so prior period comparisons are not
contained herein.
Net written premiums for the year-to-date period and quarter ended
September 30, 2001 were $85.1 million and $35.7 million, respectively and net
earned premiums for the year-to-date period and quarter ended September 30, 2001
were $70.3 million and $28.4 million, respectively. Included in net earned
premiums for the year-to-date period and quarter ended September 30, 2001 were
refundings of $4.8 million and $2.0 million, respectively. Net written premiums
for the year-to-date period ended September 30, 2001 were composed of $46.2
million of assumed reinsurance, $22.6 million in direct financial guaranty, and
$16.3 million of trade credit insurance and reinsurance. Net written premiums
for the quarter ended September 30, 2001 were composed of $16.9 million of
assumed reinsurance, $13.2 million in direct financial guaranty, and $5.6
million of trade credit insurance and reinsurance. The breakdown of net earned
premiums for the year-to-date period ended September 30, 2001 included $37.6
million in assumed reinsurance, $16.5 million in direct financial guaranty, and
$16.2 million in trade credit. The breakdown of net earned premiums for the
quarter ended September 30, 2001 included $15.3 million in assumed reinsurance,
$6.6 million in direct financial guaranty, and $6.5 million in trade credit. Net
investment income for the year-to-date period and quarter ended September 30,
2001 was $34.7 million and $15.2 million, respectively. Other income for the
year-to-date period and quarter ended September 30, 2001 was $4.6 million and
$3.8 million, respectively, and resulted primarily from non-recurring advisory
fees on financial guaranty deals and unusually high inducement fees on residual
interests in real estate mortgage investment conduits. Net realized losses on
sales of investments for the year-to-date period ended September 30, 2001 were
$668,000 and for the quarter ended September 30, 2001, net realized gains on
sales of investments were $269,000. Net realized losses from the change in the
fair value of derivative instruments were $630,000 and $730,000, respectively,
for the same periods.
Incurred losses and loss adjustment expenses for the year-to-date period
and quarter ended September 30, 2001 were $18.9 million or 26.9% of earned
premium and $7.3 million and 25.6% of earned premium, respectively. Policy
acquisition costs for the year-to-date period and quarter ended September 30,
2001 were $13.0 million and $4.9 million, respectively. Other insurance
operating expenses for the year-to-date period and quarter ended September 30,
2001 totaled $12.8 million and $6.2 million, respectively. Together these
expenses resulted in an insurance expense ratio for the year-to-date period and
quarter ended September 30, 2001 of 36.8% and 38.9%, respectively. A
non-recurring expense that was incurred during the quarter resulted in a higher
insurance expense ratio for the quarter compared to the
16
RADIAN GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
(CONTINUED)
year-to-date period. The combined ratio for the year-to-date period and quarter
ended September 30, 2001 was 63.7% and 64.5%, respectively. Interest expense for
the year-to-date period and quarter ended September 30, 2001 of $5.2 million and
$1.1 million, respectively, represented interest on the $75.0 million long-term
public debt of Enhance Financial and $173.7 million of short-term bank debt. The
$173.7 million of short-term bank debt was retired on May 29, 2001. The
effective tax rate for the year-to-date period and quarter ended September 30,
2001 was 29.3% and 31.5% respectively.
ASSET-BASED BUSINESS - RESULTS OF OPERATIONS
Enhance Financial's asset-based businesses are conducted primarily
through its minority owned subsidiaries, Sherman and C-BASS. A subsidiary of
Enhance Financial and Mortgage Guaranty Insurance Company ("MGIC") each own 46%
interests in C-BASS and the Company and MGIC each own a 45.5% interest in
Sherman. C-BASS is engaged in the purchasing, servicing and/or securitization of
special assets, including sub-performing/non-performing and seller-financed
residential mortgages, real estate and subordinated residential mortgage-based
securities. Sherman conducts a business that focuses on purchasing and servicing
delinquent unsecured consumer assets. In addition, two wholly owned
subsidiaries, Singer Asset Finance Company, L.L.C. and Enhance Consumer Services
LLC, which had been engaged in the purchase, servicing, and securitization of
assets including state lottery awards, structured settlement payments, and
viatical settlements, are currently operating on a run-off basis, primarily
servicing prior originations, and the results of these subsidiaries are not
expected to be material to the financial results of the Company. Equity in net
income from affiliates for the year-to-date period and quarter ended September
30, 2001 was $32.2 million and $7.4 million, respectively. C-BASS accounted for
$30.3 million and $5.5 million of the total income from affiliates for the
year-to-date period and quarter ended September 30, 2001, respectively. The
year-to-date period was influenced by strong results from C-Bass, which are
expected to be similar in the last quarter of 2001 to those results in the third
quarter of 2001, and are likely to vary significantly from period to period due
to a significant portion of income generated from capital market transactions.
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of funds consist primarily of premiums and
investment income. Funds are applied primarily to the payment of the Company's
claims and operating expenses.
Cash flows from operating activities for the nine months ended September
30, 2001 were $323.1 million as compared to $231.9 million for the same period
of 2000. This increase consisted of an increase in net premiums written and
investment income received offset by an increase in operating expenses. In
addition, the September 30, 2001 operating cash flows included seven months of
cash flows from the Enhance Financial operations of $31.6 million. Positive cash
flows are invested pending future payments of claims and other expenses; cash
flow shortfalls, if any, are funded through sales of short-term investments and
other investment portfolio securities.
Stockholders' equity plus redeemable preferred stock of $40.0 million,
increased from $1.4 billion at December 31, 2000 to $2.3 billion at September
30, 2001, primarily as a result of the issuance of stock associated with the
acquisition of Enhance Financial of $574.0 million, net income of $264.4
million, proceeds from the issuance of common stock associated with incentive
plans of $30.0 million and an increase in the market value of securities
available for sale of $5.1 million, net of tax, offset by dividends of $7.3
million.
As of September 30, 2001, the Company and its subsidiaries had plans to
invest in significant information technology upgrades and infrastructure at an
anticipated cost of approximately $10.0 million to $15.0 million over the next
two years.
17
RADIAN GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
(CONTINUED)
A subsidiary of Enhance Financial and Mortgage Guaranty Insurance
Company ("MGIC") each own 46% interests in C-BASS. The Company has not made any
capital contributions to C-BASS since the Company acquired its interest in
C-BASS in connection with the acquisition of Enhance Financial. C-BASS has paid
$5.3 million of dividends to the Company for the year-to-date period ended
September 30, 2001.
The Company and MGIC each own a 45.5% interest in Sherman. The Company
has made $15.0 million of capital contributions to Sherman since the Company
acquired its interest in Sherman in connection with the acquisition of Enhance
Financial. In conjunction with the acquisition, the Company has guaranteed
payment of up to $12.5 million of a $25.0 million revolving credit facility
issued to Sherman. During the third quarter of 2001, Sherman used $500,000 of
the credit facility and this amount was repaid in October 2001.
The Company obtained long-term financing through privately placed,
ten-year Senior Unsecured Notes with a face value of $250.0 million. The notes
were issued on May 29, 2001 at an offering price of 99.615% of par value with
registration rights and mature on June 1, 2011. The notes bear interest at 7.75%
which is payable annually in June and December. Enhance Financial was party to a
credit agreement (as amended, the "Credit Agreement") with major commercial
banks providing Enhance Financial with a borrowing facility aggregating up to
$175.0 million, the proceeds of which were to be used for general corporate
purposes. The outstanding principal balance under the Credit Agreement of $173.7
million was retired on May 29, 2001 with proceeds from the Senior Unsecured
Notes. On October 12, 2001, pursuant to the terms of the offering for the
privately placed Senior Unsecured Notes, the Company commenced an offer to
exchange the privately placed notes for notes (on substantially identical terms
and conditions) registered under the Securities Act of 1933, as amended. Such
exchange offer has been extended to November 26, 2001.
The Company believes that Radian will have sufficient funds to satisfy
its claims payments and operating expenses and to pay dividends to the Company
for at least the next 12 months. The Company also believes that it will be able
to satisfy its long-term (more than 12 months) liquidity needs with cash flow
from Radian. As a holding company, the Company conducts its principal operations
through Radian and Enhance. The Company's ability to pay dividends on the $4.125
Preferred Stock is dependent upon Radian's ability to pay dividends or make
other distributions to the Company. In connection with obtaining approval from
the New York Insurance Department for the change of control of Enhance when the
Company acquired Enhance Financial, Enhance agreed not to declare or pay
dividends for a period of two years following consummation of the acquisition.
Consequently, the Company cannot rely upon or expect any dividends or other
distributions from Enhance. Based on the Company's current intention to pay
quarterly common stock dividends of approximately $0.02 per share, the Company
will require distributions from Radian of $10.8 million annually to pay the
dividends on the outstanding shares of $4.125 Preferred Stock and common stock.
In addition, the Company will require distributions from Radian of $24.4 million
annually to pay the debt service on its long-term debt financing. There are
regulatory and contractual limitations on the payment of dividends or other
distributions; however, the Company does not believe that these restrictions
will prevent the payment by Radian or the Company of these anticipated dividends
or distributions in the foreseeable future.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
During the first nine months of 2001, the Company experienced an
increase in the fair market value of the available for sale portfolio, which
resulted in an increase in the net unrealized gain on the investment portfolio
of $5.1 million, from a net unrealized gain of $25.3 million at December 31,
2000 to a net unrealized gain of $30.4 million at September 30, 2001. This
increase in value was a result of changes in market interest rates and not as a
result of changes in the composition of the Company's investment portfolio. In
addition, the Company's long-term debt financing is subject to market interest
rate risk. For a more complete discussion about the potential impact of interest
rate changes upon the fair value of the financial instruments in the Company's
investment portfolio, see "Quantitative and Qualitative Disclosures about Market
Risk" in the Company's 2000 Form 10-K.
18
RADIAN GROUP INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings - None
ITEM 2. Changes in Securities - None
ITEM 3. Defaults upon Senior Securities - None
ITEM 4. Submission of Matters to a Vote of Security Holders - None
ITEM 5. Other Information - Recent Developments
On July 19, 2001, the Office of Federal Housing Enterprise Oversight
("OFHEO") issued new risk-based capital regulations for Fannie Mae
and Freddie Mac (together, known as Government Sponsored Entities, or
"GSEs"). The most relevant provision for the Company of the
regulations is a new distinction that is being made between AAA rated
insurers and AA rated insurers. Specifically, the new regulations
create guidelines that reduce the credit the GSEs are given for
exposure ceded to AAA insurers by 5% while exposure ceded to AA
insurers, like Radian, is reduced by 15%. The regulations are
expected to take effect in July 2002 and phase in these cuts on a
straight-line basis over a period of five years.
The Company has been strongly advocating that the AAA/AA distinction
be eliminated or, if not eliminated, significantly reduced. The
Company believes that given the length and complexity of these
regulations and the possibility of it being amended before it becomes
effective, the effect of the new regulations on its results of
operations is uncertain at this time. Furthermore, the GSEs may
determine that the reduction does not have a material effect on their
ability to meet the capital adequacy test and therefore may decide
not to distinguish between AAA and AA insurers in their business
practices. They may also try to avoid concentrating all of their
risks in the two AAA rated mortgage insurers.
Should the regulation take effect in substantially its current form,
and the GSEs start distinguishing between the AAA insurers and the AA
insurers in their business practices, the Company has several
contemplated actions it believes should mitigate the adverse effects
of the regulations. These include one or more of the following:
- upgrading the ratings of one or more of its operating
subsidiaries by obtaining additional capital, reinsurance or a
soft capital facility,
- increasing the amount of coverage so as to eliminate the
reduction,
- utilizing Enhance Reinsurance Company, which is AAA rated, or;
- providing protection against loss to the GSEs through a
derivative contract rather than through an insurance policy - the
form favored under the current version of the regulations.
Given these alternatives and the strong incentive the GSEs have to
work with the Company, the Company believes it is sufficiently
positioned to implement whatever solutions the new regulation will
ultimately require.
ITEM 6. a. Exhibits
*Exhibit 11.1 - Statement Re: Computation of Per Share Earnings
-----------------
*Filed Herewith.
19
RADIAN GROUP INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
(CONTINUED)
b. Reports on Form 8-K
On November 8, 2001, the Company filed a Current Report on Form 8-K
reporting the Company's announcement on November 7, 2001 that it extended
the expiration of its exchange offering for $250 million of its 7.75%
Debentures due 2011, which were privately placed under Rule 144A, for $250
million of its 7.75% Debentures due 2011, that have been registered under
the Securities Act of 1933, to 5:00 p.m. eastern standard time on November
26, 2001.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RADIAN GROUP INC.
Date: November 14, 2001 /s/ C. Robert Quint
---------------------------------------
C. Robert Quint
Executive Vice President, Chief Financial Officer
/s/ John J. Calamari
-----------------------------------------
John J. Calamari
Vice President, Corporate Controller
(Principal Accounting Officer)
21