EXHIBIT 13
SELECTED FINANCIAL AND STATISTICAL DATA (1)
(in millions, except per-share amounts and ratios) 2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
Condensed Consolidated Statements of Income
Net premiums written $ 954.9 $ 783.6 $ 544.3 $ 451.8 $ 406.5
======== ======== ======== ======== ========
Net premiums earned $ 847.1 $ 715.9 $ 520.9 $ 472.6 $ 405.3
Net investment income 178.8 147.5 82.9 67.3 59.9
Equity in net income of affiliates 81.8 41.3 -- -- --
Other income 44.4 42.5 7.4 11.3 15.3
Total revenues 1,152.1 947.2 611.3 551.2 480.4
Provision for losses 243.4 208.1 154.3 174.1 166.4
Policy acquisition costs and other operating
expenses 276.1 216.8 108.6 121.4 118.2
Interest expense 28.8 17.8 -- --
Merger expenses -- -- -- 37.8 1.1
Net (losses) gains (2.5) 1.0 4.2 1.6 3.2
Pretax income 601.3 505.5 352.5 219.5 197.9
Net income 427.2 360.4 248.9 148.1 142.2
Net income per share (2) (3) $ 4.41 $ 3.88 $ 3.22 $ 1.91 $ 1.84
Cash dividends declared per share $ .08 $ .075 $ .06 $ .05 $ .04
Average shares outstanding 95.7 92.0 76.3 75.7 75.6
Condensed Consolidated Balance Sheets
Assets $5,393.4 $4,438.6 $2,272.8 $1,776.7 $1,513.4
Investments 4,200.3 3,369.5 1,750.5 1,388.7 1,175.5
Unearned premiums 618.1 513.9 77.2 54.9 75.5
Reserve for losses and loss adjustment expenses 624.6 588.6 390.0 335.6 245.1
Short-term and long-term debt 544.1 324.1 -- -- --
Redeemable preferred stock -- 40.0 40.0 40.0 40.0
Common stockholders' equity 2,753.4 2,306.3 1,362.2 1,057.3 932.2
Book value per share (3) $ 29.42 $ 24.54 $ 17.97 $ 14.17 $ 12.65
Statutory Ratios - Mortgage Insurance
Loss ratio 30.4% 30.2% 30.5% 37.6% 42.0%
Expense ratio (4) 22.5 20.4 17.9 24.2 24.6
-------- -------- -------- -------- --------
Combined ratio 52.9% 50.6% 48.4% 61.8% 66.6%
Selected Ratios - Financial Guaranty
Loss ratio 26.2% 27.2% n/a n/a n/a
Expense ratio 33.0 40.8 n/a n/a n/a
-------- -------- -------- -------- --------
Combined ratio 59.2% 68.0%
Other Data - Mortgage Insurance
Primary new insurance written $ 48,767 $ 44,754 $ 24,934 $ 33,256 $ 37,067
Direct primary insurance in force 110,273 107,918 100,859 97,089 83,178
Direct primary risk in force 26,273 26,004 24,622 22,901 19,840
Direct pool risk in force 1,732 1,571 1,388 1,361 933
Other risk in force (5) 459 348 211 -- --
Other Data - Financial Guaranty
Net premiums written $ 286 $ 143 -- -- --
Net premiums earned 187 106 -- -- --
Net par insured 66,337 59,544 -- -- --
Net debt service outstanding 104,756 97,940 -- -- --
1
(1) Effective June 9, 1999, Radian Group Inc. was formed by the merger of
CMAC Investment Corporation and Amerin Corporation pursuant to an Agreement and
Plan of Merger dated November 22, 1998. The transaction was accounted for on a
pooling of interests basis and, therefore, all financial statements presented
reflect the combined entity. On February 28, 2001, the Company acquired Enhance
Financial Services Group Inc. The results for 2001 include the results of
operations for Enhance Financial Services Group Inc. from the date of
acquisition. See note 1 of Notes to Consolidated Financial Statements set forth
on page 20 herein.
(2) Diluted net income per share and average share information per
Statement of Financial Accounting Standards No. 128, "Earnings Per Share." See
note 1 of Notes to Consolidated Financial Statements set forth on page 20
herein.
(3) All share and per-share data for periods prior to 2001 have been
restated to reflect a 2-for-1 stock split in 2001.
(4) Expense ratio in 1999 calculated net of merger expenses of $21.8
million recognized by statutory companies.
(5) Consists primarily of second lien mortgage insurance risk.
See Notes to Consolidated Financial Statements.
2
CONSOLIDATED BALANCE SHEETS
December 31
-----------------------
(in thousands, except share and per-share amounts) 2002 2001
---------- ----------
ASSETS
Investments
Fixed maturities held to maturity --at amortized cost (fair value $379,643 and
$ 461,962) $ 356,000 $ 442,198
Fixed maturities available for sale --at fair value (amortized cost $3,332,102 and
$ 2,552,930) 3,448,926 2,567,200
Trading securities-- at fair value (amortized cost $39,261 and $22,599) 37,619 21,659
Equity securities-- at fair value (cost $196,766 and $116,978) 168,517 120,320
Short-term investments 180,919 210,788
Other invested assets 8,346 7,310
---------- ----------
Total Investments 4,200,327 3,369,475
Cash 21,969 60,159
Investment in affiliates 259,120 177,465
Deferred policy acquisition costs 183,587 151,037
Prepaid federal income taxes 294,136 326,514
Provisional losses recoverable 48,561 47,229
Other assets 385,705 306,747
---------- ----------
$5,393,405 $4,438,626
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Unearned premiums $ 618,050 $ 513,932
Reserve for losses and loss adjustment expenses 624,577 588,643
Short-term and long-term debt 544,145 324,076
Deferred federal income taxes 570,279 432,098
Accounts payable and accrued expenses 282,919 233,549
---------- ----------
2,639,970 2,092,298
---------- ----------
Commitments and contingencies (Note 12) -- 40,000
Redeemable preferred stock, par value $.001 per share;
800,000 shares issued and outstanding in 2001-- at redemption value
Common stockholders' equity
Common stock, par value $.001 per share; 200,000,000 shares authorized; 95 94
95,134,279 and 94,170,300 shares issued in 2002 and 2001, respectively
Treasury stock; 1,581,989 and 188,092 shares in 2002 and 2001, respectively (51,868) (7,874)
Additional paid-in capital 1,238,698 1,210,088
Retained earnings 1,508,138 1,093,580
Accumulated other comprehensive income 58,372 10,440
---------- ----------
2,753,435 2,306,328
---------- ----------
$5,393,405 $4,438,626
========== ==========
See Notes to Consolidated Financial Statements.
3
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31
--------------------------------
(in thousands, except per share amounts) 2002 2001 2000
---------- -------- --------
Revenues:
Premiums written:
Direct $ 875,190 $753,392 $592,734
Assumed 147,633 90,917 80
Ceded (67,904) (60,665) (48,542)
---------- -------- --------
Net premiums written 954,919 783,644 544,272
Increase in unearned premiums (107,794) (67,764) (23,401)
---------- -------- --------
Net premiums earned 847,125 715,880 520,871
Net investment income 178,841 147,487 82,946
Equity in net income of affiliates 81,749 41,309 --
Other income 44,375 42,525 7,438
---------- -------- --------
Total revenues 1,152,090 947,201 611,255
---------- -------- --------
Expenses:
Provision for losses 243,332 208,136 154,326
Policy acquisition costs 100,818 84,262 51,471
Other operating expenses 175,313 132,516 57,167
Interest expense 28,824 17,803 --
---------- -------- --------
Total expenses 548,287 442,717 262,964
---------- -------- --------
Gains and losses:
Net gains on disposition of investments 10,462 6,824 4,179
Change in fair value of derivative instruments (12,989) (5,777) --
---------- -------- --------
Net (losses) gains (2,527) 1,047 4,179
---------- -------- --------
Pretax income 601,276 505,531 352,470
Provision for income taxes 174,107 145,112 103,532
---------- -------- --------
Net income 427,169 360,419 248,938
Dividends to preferred stockholder 2,475 3,300 3,300
Premium paid to redeem preferred stock 3,003 -- --
---------- -------- --------
Net income available to common stockholders $ 421,691 $357,119 $245,638
========== ======== ========
Basic net income per share $ 4.47 $ 3.95 $ 3.26
========== ======== ========
Diluted net income per share $ 4.41 $ 3.88 $ 3.22
========== ======== ========
Average number of common shares outstanding-basic 94,306 90,474 75,268
========== ======== ========
Average number of common and common
equivalent shares outstanding -- diluted 95,706 91,958 76,298
========== ======== ========
See Notes to Consolidated Financial Statements.
4
CONSOLIDATED STATEMENTS OF CHANGES IN COMMON STOCKHOLDERS' EQUITY
Accumulated Other
Comprehensive
Income (Loss)
--------------------------
Foreign
Additional Currency Unrealized
Common Treasury Paid-in Retained Translation Holding
(in thousands) Stock Stock Capital Earnings Adjustment Gains/Losses Total
------ -------- ---------- ---------- ----------- ------------ ----------
BALANCE, JANUARY 1, 2000 $37 $ -- $ 524,408 $ 548,684 $ -- $(15,873) $1,057,256
Comprehensive income:
Net income -- -- -- 248,938 -- -- 248,938
Unrealized holding gains
arising during period, net of
tax of $23,658 -- -- -- -- -- 43,937
Less: Reclassification
adjustment for net gains
included in net income, net of
tax of $1,470 -- -- -- -- -- (2,731)
--------
Net unrealized gain on
investments, net of tax of
$22,188 -- -- -- -- -- 41,206 41,206
----------
Total comprehensive income 290,144
Issuance of common stock under
incentive plans 1 -- 24,746 -- -- -- 24,747
Treasury stock purchased, net -- (2,159) -- -- -- -- (2,159)
Dividends -- -- -- (7,791) -- -- (7,791)
--- -------- ---------- ---------- ----- -------- ----------
BALANCE, DECEMBER 31, 2000 38 (2,159) 549,154 789,831 -- 25,333 1,362,197
Comprehensive income:
Net income -- -- -- 360,419 -- -- 360,419
Unrealized foreign currency
translation adjustment, net of
tax benefit of $306 -- -- -- -- (586) -- (586)
Unrealized holding losses
arising during period, net of
tax benefit of $5,316 -- -- -- -- -- (9,871)
Less: Reclassification
adjustment for net gains
included in net income, net of
tax of $2,388 -- -- -- -- -- (4,436)
--------
Net unrealized loss on
investments, net of tax
benefit of $7,704 -- -- -- -- -- (14,307) (14,307)
----------
Total comprehensive income 345,526
Issuance of common stock related
to acquisition 9 -- 574,676 -- -- -- 574,685
Issuance of common stock under
incentive plans 1 -- 39,686 -- -- -- 39,687
Treasury stock purchased, net (5,715) (5,715)
Two-for-one stock split 46 -- 46,572 (46,618) -- -- 0
Dividends -- -- -- (10,052) -- -- (10,052)
--- -------- ---------- ---------- ----- -------- ----------
BALANCE, DECEMBER 31, 2001 94 (7,874) 1,210,088 1,093,580 (586) 11,026 2,306,328
Comprehensive income:
Net income -- -- -- 427,169 -- -- 427,169
Unrealized foreign currency
translation adjustment, net of
tax of $441 -- -- -- -- 819 -- 819
Unrealized holding gains
arising during period, net of
tax of $29,030 -- -- -- -- -- 53,913
Less: Reclassification
adjustment for net gains
included in net income, net of
tax of $3,662 -- -- -- -- -- (6,800)
--------
Net unrealized gains on
investments net of tax of
$25,368 -- -- -- -- -- 47,113 47,113
----------
Total comprehensive income 475,101
Issuance of common stock under 1 -- 28,610 -- -- -- 28,611
incentive plans
Treasury stock purchased, net -- (43,994) -- -- -- -- (43,994)
Premium paid to redeem preferred
stock -- -- -- (3,003) -- -- (3,003)
Dividends -- -- -- (9,608) -- -- (9,608)
--- -------- ---------- ---------- ----- -------- ----------
BALANCE, DECEMBER 31, 2002 $95 $(51,868) $1,238,698 $1,508,138 $ 233 $ 58,139 $2,753,435
=== ======== ========== ========== ===== ======== ==========
5
See Notes to Consolidated Financial Statements.
6
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
-------------------------------------
(in thousands) 2002 2001 2000
----------- ----------- ---------
Cash flows from operating activities:
Net income $ 427,169 $ 360,419 $ 248,938
Adjustments to reconcile net income to net cash provided
by operating activities:
Net losses (gains) 2,527 (1,047) (4,179)
Equity in net income of affiliates (81,749) (41,309) --
Proceeds from sales of trading securities 9,820 14,204 --
Purchase of trading securities (27,444) (24,978) --
Increase in unearned premiums, net 106,128 65,685 22,316
Net increase in deferred policy acquisition costs (32,550) (24,336) (8,369)
Increase in reserve for losses and loss adjustment expenses, net 33,634 90,980 54,437
Increase in deferred federal income taxes 138,181 140,804 62,942
Increase in provisional losses recoverable (1,545) (3,276) (3,675)
Depreciation and other amortization, net 796 2,486 3,158
Change in prepaid federal income taxes, other assets, accounts 11,841 (98,483) (95,591)
payable and accrued expenses
----------- ----------- ---------
Net cash provided by operating activities 586,808 481,149 279,977
----------- ----------- ---------
Cash flows from investing activities:
Proceeds from sales of fixed maturity investments available for sale 1,736,378 1,039,762 552,439
Proceeds from sales of fixed maturity investments held to maturity -- -- 1,922
Proceeds from sales of equity securities available for sale 20,727 8,425 18,988
Proceeds from redemptions of fixed maturity investments 81,141 111,674 16,467
available for sale
Proceeds from redemptions of fixed maturity investments held
to maturity 93,112 21,509 2,897
Proceeds from sales of other invested assets 1,076 -- --
Purchases of fixed maturity investments available for sale (2,557,606) (1,595,179) (813,627)
Purchases of equity securities available for sale (116,818) (66,098) (29,713)
Sales (purchases) of short-term investments, net 29,895 (28,101) (38,859)
Purchases of other invested assets (3,466) -- --
Purchases of property and equipment, net (41,573) (8,538) (9,419)
Acquisitions, net of cash acquired -- 6,788 --
Investment in affiliates (20,000) (15,020) --
Distributions from affiliates 20,137 12,761 --
Other (15,943) (1,084) (952)
----------- ----------- ---------
Net cash used in investing activities (772,940) (513,101) (299,857)
----------- ----------- ---------
Cash flows from financing activities:
Dividends paid (9,608) (10,052) (7,791)
Proceeds from issuance of common stock under incentive plans 28,611 39,687 24,747
Purchase of treasury stock, net (43,994) (5,715) (2,159)
Repayment of short-term debt -- (173,724) --
Redemption of preferred stock (43,003) -- --
Issuance of long-term debt 215,936 246,885 --
Acquisition costs -- (7,394) --
----------- ----------- ---------
Net cash provided by financing activities 147,942 89,687 14,797
----------- ----------- ---------
(Decrease) increase in cash (38,190) 57,735 (5,083)
Cash, beginning of year 60,159 2,424 7,507
----------- ----------- ---------
Cash, end of year $ 21,969 $ 60,159 $ 2,424
=========== =========== =========
7
Supplemental disclosures of cash flow information
Income taxes (received)/paid $ (14,913) $ 98,960 $ 74,768
=========== =========== =========
Interest paid $ 27,608 $ 19,099 $ 817
=========== =========== =========
See Notes to Consolidated Financial Statements.
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Basis of Presentation and Nature of Operations
Radian Group Inc. (the "Company"), provides through its subsidiaries
and affiliates, insurance and mortgage services to financial institutions in the
United States of America and globally. The principal business segments of the
Company are mortgage insurance, financial guaranty and mortgage services.
Private mortgage insurance and risk management services are provided
to mortgage lending institutions located throughout the United States through
the Company's wholly-owned principal mortgage guaranty subsidiaries, Radian
Guaranty Inc. ("Radian Guaranty"), Amerin Guaranty Corporation ("Amerin
Guaranty") and Radian Insurance Inc. ("Radian Insurance") (together referred to
as "Mortgage Insurance"). Private mortgage insurance generally protects lenders
from default-related losses on residential first mortgage loans made to home
buyers who make down payments of less than 20% of the purchase price and
facilitates the sale of these mortgages in the secondary market. Mortgage
Insurance currently offers two principal types of private mortgage insurance
coverage, primary and pool. At December 31, 2002, primary insurance comprised
93.8% of Mortgage Insurance's risk in force and pool insurance comprised 6.2% of
Mortgage Insurance's risk in force. During the third quarter of 2000, the
Company commenced operations in Radian Insurance, a subsidiary that writes
credit insurance on non-traditional mortgage related assets such as second
mortgages and manufactured housing, and provides credit enhancement to mortgage
related capital market transactions. Other risk in force in Radian Insurance was
$0.5 billion at December 31, 2002, which represented less than 1% of the
business.
On February 28, 2001, the Company acquired the financial guaranty and
other businesses of Enhance Financial Services Group Inc. ("Financial
Guaranty"), a New York based insurance holding company that primarily insures
and reinsures credit-based risks, at a purchase price of approximately $581.5
million. The financial guaranty insurance business is conducted primarily
through two insurance subsidiaries, Radian Asset Assurance Inc. ("Radian Asset
Assurance," formerly Asset Guaranty Insurance Company) and Radian Reinsurance
Inc. ("Radian Re," formerly Enhance Reinsurance Company). In addition, as part
of the acquisition, Radian has an interest in two active credit-based asset
businesses (See note 3). Several smaller businesses are either in run-off or
have been terminated. The purchase price represented 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 among the Company, a wholly-owned subsidiary of the
Company and Financial Guaranty. The acquisition, which was structured as a
merger of a wholly-owned subsidiary of the Company with and into Financial
Guaranty, entitled Financial Guaranty stockholders to receive 0.22 shares of the
Company's common stock in a tax-free exchange for each share of Financial
Guaranty's common stock that they owned at the time of the merger. 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 fair value of assets acquired was $1,357.9 million. The
liabilities assumed were $833.1 million. The excess of purchase price over fair
value of net assets acquired of $56.7 million represents the future value of
insurance profits, which is being amortized over a period that approximates the
future life of the insurance book of business. During 2002 and 2001, the Company
amortized $4.5 million and $3.9 million, respectively, related to this
transaction. The results of Financial Guaranty's operations for 2001 have been
included in the Company's financial statements for the period from the date of
the acquisition through December 31, 2001.
The purchase price of Financial Guaranty 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 represented 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 1,320,079 options
(pre-stock split) to purchase shares of the Company's common stock to holders of
options to purchase shares of Financial Guaranty's common stock.
9
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%.
10
The following unaudited pro forma information presents a summary of
the consolidated operating results of the Company as if the acquisition of
Financial Guaranty had occurred on January 1, 2000 (in thousands, except
per-share information):
Year Ended December 31
----------------------
2001 2000
-------- --------
Total revenues $951,206 $801,665
Net income $265,147 $239,529
Net income per share-basic $ 2.89 $ 3.14
Net income per share-diluted $ 2.85 $ 3.10
The unaudited pro forma financial information is not necessarily
indicative of the combined results that would have occurred had the acquisition
occurred on that date, nor is it indicative of the results that may occur in the
future.
On November 9, 2000, the Company completed the acquisition of
RadianExpress.com Inc. ("RadianExpress," formerly Expressclose.com Inc.), an
Internet-based settlement company that provides real estate information products
and services to the first and second mortgage industry, for approximately $8.0
million consisting of cash, the Company's common stock and stock options and
other consideration. 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 $7.4 million was allocated to goodwill.
During 2000 and 2001, a portion of this amount was amortized against earnings.
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 142,
"Goodwill and Other Intangible Assets," the Company ceased amortization of
goodwill effective January 1, 2002 and will continue to evaluate goodwill
annually for impairment. The financial results for the year ended December 31,
2000 include the results of RadianExpress' operations for the period from
November 10, 2000 through December 31, 2000. The cash component of the
acquisition was financed using the Company's cash flow from operations. The pro
forma results for 2000 including this acquisition would not be materially
different from reported results.
In connection with the Company's internet-based mortgage services,
revenues and the related expenses are recorded when the service is rendered.
Consolidation
The accompanying financial statements include the accounts of all
subsidiaries. Investments in which the Company, or one of its subsidiaries, owns
from 20% to 50% of those companies, or where the Company has a majority voting
interest, but where the minority shareholders have substantive participating
rights, or where the Company has significant influence, are accounted for in
accordance with the equity method of accounting (See note 3). All significant
intercompany accounts and transactions, and intercompany profits and losses,
including those transactions with equity method investee companies, have been
eliminated.
The consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America
("GAAP").
Use of Estimates
The preparation of financial statements in conformity with GAAP
requires the Company to make estimates and assumptions that affect the reported
amounts of assets and liabilities as of the dates of the financial statements
and the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.
Insurance Premiums
11
SFAS No. 60, "Accounting and Reporting by Insurance Enterprises,"
specifically excludes mortgage guaranty insurance from its guidance relating to
the earning of insurance premiums. Consistent with GAAP and industry accounting
practices, mortgage insurance premiums written on an annual and multiyear basis
are initially deferred as unearned premiums and earned over the policy term, and
premiums written on a monthly basis are earned over the period coverage is
provided. Annual premiums are amortized on a monthly, straight-line basis.
Multiyear premiums are amortized over the terms of the contracts in accordance
with the anticipated claim payment pattern based on historical industry
experience. Ceded premiums written are initially set up as prepaid reinsurance
and are amortized in accordance with direct premiums earned.
In the financial guaranty business, insurance premiums are earned in
proportion to the level of amortization of insured principal over the contract
period or over the period that coverage is provided. Unearned premiums represent
that portion of premiums which will be earned over the remainder of the contract
period, based upon information reported by ceding companies and management's
estimates of amortization of insured principal on policies written on a direct
basis. When insured issues are refunded or called, the remaining premiums are
generally earned at that time, since the risk to the Company is eliminated.
Credit enhancement fees on derivative financial guaranty contracts are included
in premiums written and are earned over the period credit protection is
provided.
Reserve for Losses and Loss Adjustment Expenses ("LAE")
The mortgage insurance reserve for losses and LAE consists of the
estimated cost of settling claims on defaults (or delinquencies) reported and
defaults that have occurred but have not been reported. SFAS No. 60 specifically
excludes mortgage guaranty insurance from its guidance relating to the reserve
for losses. Consistent with GAAP and industry accounting practices, the Company
does not establish loss reserves for future claims on insured loans that are not
currently in default. In determining the liability for unpaid losses related to
reported outstanding defaults, the Company establishes loss reserves on a
case-by-case basis. The amount reserved for any particular loan is dependent
upon the characteristics of the loan, the status of the loan as reported by the
servicer of the insured loan as well as the economic condition and estimated
foreclosure period in the area in which the default exists. As the default
progresses closer to foreclosure, the amount of loss reserve for that particular
loan is increased, in stages, to approximately 100% of the Company's exposure
and that adjustment is included in current operations. If the default cures, the
reserve for that loan is removed from the reserve for losses and LAE. The
Company also reserves for defaults that have occurred but have not been reported
using historical information on defaults not reported on a timely basis by
lending institutions. The estimates are continually reviewed and, as adjustments
to these liabilities become necessary, such adjustments are reflected in current
operations.
Reserves for losses and LAE in the financial guaranty business are
established based on the Company's estimate of specific and non-specific losses,
including expenses associated with settlement of such losses on its insured and
reinsured obligations. The Company's estimation of total reserves considers
known defaults, reports and individual loss estimates reported by ceding
companies and annual increases in the total net par amount outstanding of the
Company's insured obligations. The Company records a specific provision for
losses and related LAE when reported by primary insurers or when, in the
Company's opinion, an insured risk is in default or default is probable and the
amount of the loss is reasonably estimable. In the case of obligations with
fixed periodic payments, the provision for losses and LAE represents the present
value of the Company's ultimate expected losses, adjusted for estimated
recoveries under salvage or subrogation rights. The non-specific reserves
represent the Company's estimate of total reserves, less provisions for specific
reserves. Generally, when a case basis reserve is established or adjusted, an
offsetting adjustment is made to the non-specific reserve. The Company discounts
certain financial guaranty liabilities arising from defaults over the life of
the claim payment at annual rates, which correspond to the financial guaranty
insurance subsidiaries' investment yields ranging from 4.10% to 5.25% in 2002
and 4.95% to 5.51% in 2001. Discounted liabilities at December 31, 2002 were
$18.5 million, net of discounts of $7.3 million compared to discounted
liabilities of $16.6 million at December 31, 2001, net of discounts of $9.9
million.
12
Reserves for losses and LAE for Financial Guaranty's other lines of
business, primarily trade credit reinsurance, are based on reports and
individual loss estimates received from ceding companies, net of anticipated
estimated recoveries under salvage and subrogation rights. In addition, a
reserve is included for losses and LAE incurred but not reported on trade credit
reinsurance.
The Company periodically evaluates its estimates for losses and LAE
and adjusts such reserves based on its actual loss experience, mix of business
and economic conditions. Changes in total estimates for losses and LAE are
reflected in current earnings. The Company believes that its total reserves for
losses and LAE are adequate to cover the ultimate cost of all claims net of
reinsurance recoveries. However, the reserves are based on estimates of losses
and LAE, and there can be no assurance that the ultimate liability will not
exceed such estimates.
Fair Value of Derivative Financial Guaranty Contracts
The gains and losses on derivative financial guaranty contracts are
derived from internally generated models. The estimated fair value amounts have
been determined by the Company using available market information and
appropriate valuation methodologies. Considerable judgment is necessarily
required to interpret market data to develop the estimates of fair value. The
fair value of derivative financial guaranty contracts is included in accounts
payable and accrued expenses on the Consolidated Balance Sheets. Settlements
under derivative financial guaranty contracts are charged to the fair value of
derivative financial guaranty contracts.
Real Estate Acquired and Other Restructurings
Real estate is acquired in the mortgage insurance business segment to
mitigate losses. The real estate acquired is included in other assets on the
Consolidated Balance Sheets at the lower of cost or net realizable value. Gains
or losses from the holding or disposition of real estate acquired are recorded
as provision for losses. At December 31, 2002, the Company held $6.2 million of
real estate acquired to mitigate losses.
Other restructurings in the financial guaranty business segment may
consist of purchasing the insured debt security to mitigate losses. Insured debt
securities purchased to mitigate losses are included in other assets on the
Consolidated Balance Sheets at the lower of cost or net realizable value. Gains
or losses from the holding or disposition of the securities acquired are
recorded as net gains and losses on the disposition of securities. At December
31, 2002, the Company held $13.1 million of insured debt securities purchased to
mitigate losses.
Deferred Policy Acquisition Costs
Costs associated with the acquisition of mortgage insurance business,
consisting of compensation and other policy issuance and underwriting expenses,
are initially deferred. Because SFAS No. 60 specifically excludes mortgage
guaranty insurance from its guidance relating to the amortization of deferred
policy acquisition costs, amortization of these costs for each underwriting year
book of business are charged against revenue in proportion to estimated gross
profits over the life of the policies using the guidance provided by SFAS No.
97, "Accounting and Reporting by Insurance Enterprises For Certain Long Duration
Contracts and for Realized Gains and Losses From the Sale of Investments." This
includes accruing interest on the unamortized balance of capitalized acquisition
costs. The estimate for each underwriting year is updated annually to reflect
actual experience and any changes to key assumptions such as persistency or loss
development.
Deferred policy acquisition costs in the financial guaranty business
comprise those expenses that vary with, and are primarily related to, the
production of insurance premiums, including: commissions paid on reinsurance
assumed, salaries and related costs of underwriting and marketing personnel,
rating agency fees, premium taxes and certain other underwriting expenses,
offset by ceding commission income on premiums ceded to reinsurers. Acquisition
costs are deferred and amortized over the period in which the
13
related premiums are earned. Deferred policy acquisition costs are reviewed
periodically to determine that they do not exceed or are less than recoverable
amounts, after considering investment income.
Origination Costs of Derivative Financial Guaranty Contracts
Origination costs of derivative financial guaranty contracts are
expensed as incurred.
Income Taxes
Deferred income taxes are provided for the temporary difference
between the financial reporting basis and the tax basis of the Company's assets
and liabilities using enacted tax rates applicable to future years.
Investments
The Company is required to group assets in its investment portfolio
into one of three categories: held to maturity, available for sale, and trading
securities. Fixed maturity securities for which the Company has the positive
intent and ability to hold to maturity are classified as held to maturity and
reported at amortized cost. Fixed maturity and equity securities purchased and
held principally for the purpose of selling them in the near term are classified
as trading securities and are reported at fair value, with unrealized gains and
losses included in earnings. All other investments 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. Realized gains and losses are determined on a
specific identification method and are included in income. Other invested assets
consist of residential mortgage-backed securities and are carried at fair value.
Fair Values of Financial Instruments
The following methodology was used by the Company in estimating the
fair value disclosures for its financial instruments: fair values for fixed
maturity securities (including redeemable preferred stock) and equity securities
are based on quoted market prices, dealer quotes and prices obtained from
independent pricing services. Short-term investments are carried at amortized
cost, which approximates fair value.
Derivative Instruments and Hedging Activities
The Company adopted 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 are 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 are
accounted for under SFAS No. 133, as amended, include investments in convertible
securities, and the selling of credit protection in the form of credit default
swaps and certain financial guaranty contracts that are considered credit
default swaps. Credit default swaps and certain financial guaranty contracts
that are accounted for under SFAS No. 133 are part of the Company's overall
business strategy of offering financial guaranty protection to its customers.
Currently, none of the derivatives qualifies as a hedge under SFAS No. 133.
Therefore, changes in fair value are included in the periods presented.
Upon adoption of SFAS No. 133, the balance of the Company's
convertible fixed maturity securities was approximately $104.6 million. SFAS No.
133 requires that the Company split its convertible fixed maturity securities
into the derivative and fixed maturity security components. Over the term of the
securities, changes in the fair value of fixed maturity securities available for
sale are 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 is recognized as the
14
recorded value of the fixed maturity security increases or decreases. A change
in the fair value of the derivative is recorded as a gain or loss in the
Company's Consolidated Statements of Income. In connection with the adoption of
SFAS No. 133, the Company reclassified $13.8 million from fixed maturities
available for sale to trading securities on its Consolidated Balance Sheets as
of January 1, 2001. At December 31, 2002 the fair value of the Company's
derivative instruments, classified as trading securities was $37.6 million, as
compared to an amortized value of $39.3 million, and the Company recognized $0.5
million, net of tax, as a loss on changes in the fair value of derivative
instruments in the Consolidated Statements of Income for 2002. The notional
value of the Company's credit default swaps and certain other financial guaranty
contracts accounted for under SFAS No. 133 was $7.3 billion and $2.9 billion at
December 31, 2002 and 2001, respectively, and the Company recognized $8.0
million and $3.1 million, respectively, net of tax, as a loss on the change in
the fair value of derivative instruments in the Consolidated Statements of
Income for 2002 and 2001. Net unrealized losses on credit default swaps and
certain other financial guaranty contracts of $17.5 million at December 31,
2002, are included in other liabilities in the Consolidated Balance Sheets. This
net unrealized loss in 2003 is composed of gross unrealized gains of $52.4
million and gross unrealized losses of $69.9 million. Net unrealized losses on
credit default swaps and certain other financial contracts at December 31, 2001
were $4.8 million, which was composed of gross unrealized gains of $6.9 million
and gross unrealized losses of $11.7 million.
The application of SFAS No. 133, as amended, could result in
volatility from period to period in gains and losses as reported on the
Company's Consolidated Statements of Income. The Company is unable to predict
the effect this volatility may have on its financial position or results of
operations.
Company-Owned Life Insurance
The Company is the beneficiary of insurance policies on the lives of
certain officers and employees of the Company. The Company has recognized the
amount that could be realized under the insurance policies as an asset in its
Consolidated Balance Sheets. At December 31, 2002 and 2001, the amount of
Company-owned life insurance totaled $53.2 million and is included as a
component of other assets.
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 shares of 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 shares and per share data prior
to 2001, except where noted otherwise, 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.
Accounting for Stock-Based Compensation
The Company accounts for stock-based compensation in accordance with
SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 requires
expanded disclosures of stock-based compensation arrangements with employees and
encourages, but does not require, the recognition of compensation expense for
the fair value of stock options and other equity instruments granted as
compensation to employees. The Company has chosen to continue to account for
stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," ("APB 25"), and related interpretations. Accordingly, compensation
cost for stock options is measured as the excess, if any, of the quoted market
price of the Company's stock at the date of the grant over the amount an
employee must pay to acquire the stock. To date, there have been no options
issued at a price that was less than the market price at the date of issuance.
15
In December 2002, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and
Disclosure, an amendment of FASB Statement No. 123." SFAS No. 148 amends SFAS
No. 123 to provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
In addition, this Statement amends the disclosure requirements of SFAS No. 123
to require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. This statement is effective for
financial statements for fiscal years ending after December 15, 2002.
The following table illustrates the effect on net income and earnings
per share if the Company had applied the fair value recognition provisions of
SFAS No. 123 to stock-based employee compensation.
Year Ended December 31
------------------------------
2002 2001 2000
-------- -------- --------
Net income, as reported $427,169 $360,419 $248,938
Deduct: Total stock-based employee compensation expense 7,438 6,783 4,189
determined under fair value based method for all awards,
net of tax
-------- -------- --------
Pro forma net income $419,731 $353,636 $244,749
======== ======== ========
Pro forma net income available to common stockholders $414,253 $350,336 $241,449
======== ======== ========
Earnings per share
Basic - as reported $ 4.47 $ 3.95 $ 3.26
======== ======== ========
Basic - pro forma $ 4.39 $ 3.87 $ 3.21
======== ======== ========
Diluted - as reported $ 4.41 $ 3.88 $ 3.22
======== ======== ========
Diluted - pro forma $ 4.33 $ 3.81 $ 3.16
======== ======== ========
In accordance with the adoption of SFAS No. 123, the pro forma effect
on net income for 2002, 2001 and 2000 is not representative of the pro forma
effect on net income in future years because it does not take into consideration
pro forma compensation expense related to grants made prior to 1995.
Net Income Per Share
The Company is required to disclose both "basic" net income per share
and "diluted" net income per share. 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.
16
The calculation of the basic and diluted net income per share was as
follows (in thousands, except per-share amounts):
Year Ended December 31
------------------------------
2002 2001 2000
-------- -------- --------
Net income $427,169 $360,419 $248,938
Preferred stock dividend adjustment (2,475) (3,300) (3,300)
Premium paid to redeem preferred stock (3,003) -- --
-------- -------- --------
Net income available to common stockholders $421,691 $357,119 $245,638
======== ======== ========
Average diluted stock options outstanding 5,139.0 5,924.1 3,852.6
Average exercise price per share $ 27.42 $ 25.05 $ 15.59
Average market price per share - diluted basis $ 43.77 $ 36.63 $ 27.66
Weighted average common shares outstanding 94,306 90,474 75,268
Increase in shares due to exercise of options - diluted basis 1,400 1,484 1,030
-------- -------- --------
Average shares outstanding - diluted 95,706 91,958 76,298
======== ======== ========
Net income per share - basic $ 4.47 $ 3.95 $ 3.26
======== ======== ========
Net income per share - diluted $ 4.41 $ 3.88 $ 3.22
======== ======== ========
At December 31, 2002, 2001 and 2000, there were 770,000 options,
789,000 options, and 70,000 options, respectively, excluded from the net income
per share calculation because the options were antidilutive.
Comprehensive Income
The Company is required to present, as a component of comprehensive
income, the amounts from transactions and other events that are currently
excluded from the Statements of Income and are recorded directly to
stockholders' equity.
Segment Reporting
The Company has three reportable segments: mortgage insurance,
mortgage services, and financial guaranty. The mortgage insurance segment
provides private mortgage insurance and risk management services to mortgage
lending institutions located throughout the United States. Private mortgage
insurance primarily 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 mortgage services segment deals primarily with
credit-based servicing and securitization of assets in underserved markets, in
particular, the purchase, servicing and securitization of special assets,
including sub-performing/non-performing and seller financed residential
mortgages and the purchase and servicing of delinquent consumer assets. In
addition, mortgage services include the results of RadianExpress, an
Internet-based settlement company that provides real estate information and
closing products and services to the first and second lien mortgage industry.
The financial guaranty segment provides credit-related insurance coverage,
credit default swaps and certain other financial guaranty contracts to meet the
needs of customers in a wide variety of domestic and international markets. The
Company's insurance businesses within this segment include the assumption of
reinsurance from monoline financial guaranty insurers for both municipal bonds
and structured finance obligations. The Company also provides direct financial
guaranty insurance for municipal bonds and structured transactions, and trade
credit reinsurance, which may or may not include political risk cover. The
Company's reportable segments are strategic business units, which are managed
separately, as each business requires different marketing and sales expertise.
Certain corporate income and expenses have been allocated to the segments. For
the years ended December 31, 2002 and 2001, the Company's revenue attributable
to foreign countries was approximately 6% and 3%, respectively. In addition,
long-lived assets located in foreign countries were immaterial for the periods
presented.
17
In the mortgage insurance segment, the highest state concentration of
risk is California at 16.4%. At December 31, 2002, California also accounted for
16.2% of Mortgage Insurance's total direct primary insurance in force and 11.8%
of Mortgage Insurance's total direct pool insurance in force. California
accounted for 18.7% of Mortgage Insurance's direct primary new insurance written
in 2002. The largest single customer of Mortgage Insurance (including branches
and affiliates of such customer) measured by new insurance written, accounted
for 8.1% of new insurance written during 2002 compared to 12.6% in 2001 and
11.2% in 2000.
In the financial guaranty segment, the Company derives a substantial
portion of its premiums written from a small number of primary insurers. In
2002, 19.9% of gross written premiums were derived from two primary insurers
compared to 34.0% from the same two insurers in 2001. Five primary insurers,
including one trade credit primary insurer, were responsible for 32.9% of gross
written premiums in 2002 compared to 42.0% in 2001. This customer concentration
results from the small number of primary insurance companies who participate in
writing financial guaranty insurance.
The Company evaluates performance based on net income. Summarized financial
information concerning the Company's operating segments as of and for the
year-to-date periods indicated, is presented in the following tables:
December 31, 2002
-------------------------------------------------
Mortgage Mortgage Financial
(in thousands) Insurance Services Guaranty Consolidated
---------- -------- ---------- ------------
Net premiums written $ 668,583 -- $ 286,336 $ 954,919
========== ======== ========== ==========
Net premiums earned $ 660,492 -- $ 186,633 $ 847,125
Net investment income 107,138 $ 162 71,541 178,841
Equity in net income of affiliates -- 81,872 (123) 81,749
Other income 20,390 22,471 1,514 44,375
---------- -------- ---------- ----------
Total revenues 788,020 104,505 259,565 1,152,090
---------- -------- ---------- ----------
Provision for losses 194,486 -- 48,846 243,332
Policy acquisition costs 66,814 -- 34,004 100,818
Other operating expenses 109,043 38,716 27,554 175,313
Interest expense 17,155 2,110 9,559 28,824
---------- -------- ---------- ----------
Total expenses 387,498 40,826 119,963 548,287
---------- -------- ---------- ----------
Net gains (losses) 5,105 3,450 (11,082) (2,527)
---------- -------- ---------- ----------
Pretax income 405,627 67,129 128,520 601,276
Income tax provision 111,823 26,854 35,430 174,107
---------- -------- ---------- ----------
Net income $ 293,804 $ 40,275 $ 93,090 $ 427,169
========== ======== ========== ==========
Total assets $3,262,741 $246,156 $1,884,508 $5,393,405
Deferred policy acquisition costs 75,673 -- 107,914 183,587
Reserve for losses and loss adjustment
expenses 484,705 -- 139,872 624,577
Unearned premiums 112,575 -- 505,475 618,050
Equity 1,639,205 201,427 912,803 2,753,435
December 31, 2001
-------------------------------------------------
Mortgage Mortgage Financial
(in thousands) Insurance Services Guaranty Consolidated
---------- -------- ---------- ------------
Net premiums written $ 640,414 -- $ 143,230 $ 783,644
========== ======== ========== ==========
Net premiums earned $ 609,425 -- $ 106,455 $ 715,880
Net investment income 97,110 $ 127 50,250 147,487
Equity in net income of affiliates -- 42,517 (1,208) 41,309
Other income 20,412 19,122 2,991 42,525
---------- -------- ---------- ----------
Total revenues 726,947 61,766 158,488 947,201
---------- -------- ---------- ----------
18
Provision for losses 179,146 -- 28,990 208,136
Policy acquisition costs 62,439 -- 21,823 84,262
Other operating expenses 91,967 18,942 21,607 132,516
Interest expense 10,454 1,330 6,019 17,803
---------- -------- ---------- ----------
Total expenses 344,006 20,272 78,439 442,717
---------- -------- ---------- ----------
Net gains (losses) 4,451 (1,034) (2,370) 1,047
---------- -------- ---------- ----------
Pretax income 387,392 40,460 77,679 505,531
Income tax provision 107,394 16,184 21,534 145,112
---------- -------- ---------- ----------
Net income $ 279,998 $ 24,276 $ 56,145 $ 360,419
========== ======== ========== ==========
Total assets $2,783,705 $202,505 $1,452,416 $4,438,626
Deferred policy acquisition costs 76,035 -- 75,002 151,037
Reserve for losses and loss adjustment
expenses 465,444 -- 123,199 588,643
Unearned Consolidated 106,151 -- 407,781 513,932
Equity 1,445,680 155,740 704,908 2,306,328
December 31, 2000
-------------------------------------------------
Mortgage Mortgage Financial
(in thousands) Insurance Services Guaranty Consolidated
---------- -------- ---------- ------------
Net premiums written $ 544,272 $ 544,272
========== ======== ========== ==========
Net premiums earned $ 520,871 $ 520,871
Net investment income 82,946 82,946
Other income 7,438 7,438
---------- -------- ---------- ----------
Total revenues 611,255 611,255
---------- -------- ---------- ----------
Provision for losses 154,326 154,326
Policy acquisition costs 51,471 51,471
Other operating expenses 57,167 57,167
---------- -------- ---------- ----------
Total expenses 262,964 262,964
---------- -------- ---------- ----------
Net gains 4,179 4,179
---------- -------- ---------- ----------
Pretax income 352,470 352,470
Income tax provision 103,532 103,532
---------- -------- ---------- ----------
Net income $ 248,938 $ 248,938
========== ======== ========== ==========
Total assets $2,272,811 $2,272,811
Deferred policy acquisition costs 70,049 70,049
Reserve for losses and loss adjustment 390,021 390,021
expenses
Unearned premiums 77,241 77,241
Equity 1,362,197 1,362,197
The reconciliation of segment net income to consolidated net income is
as follows:
Consolidated Year Ended December 31
-----------------------------------
(in thousands) 2002 2001 2000
-------- -------- --------
Net Income
Mortgage Insurance $293,804 $279,998 $248,938
Financial Guaranty 93,090 56,145 --
Mortgage Services 40,275 24,276 --
-------- -------- --------
Total $427,169 $360,419 $248,938
======== ======== ========
Subsequent Events
19
In February 2003, the Company issued $250 million of unsecured Senior
Notes. These notes bear interest at the rate of 5.625% per annum, payable
semi-annually on February 15 and August 15, beginning August 15, 2003. These
notes mature in February 2013. The Company used a portion of the proceeds to
repay the $75.0 million in principal on the 6.75% debentures of Financial
Guaranty due March 1, 2003 (see note 6). The remainder will be used for general
corporate purposes, including potential acquisitions.
Assignment Operations
The Company is seeking to sell or otherwise dispose of the remaining
assets and operations of Singer Asset Finance Company, L.L.C. ("Singer"), an
entity acquired in connection with the purchase of Financial Guaranty. During
this process, any net servicing expenses will be charged against an existing
servicing liability and any gains or losses on assets will be charged against an
existing asset reserve. If and when these reserves become depleted, future
results will be charged to current operations.
Singer, which had been engaged in the purchase, servicing and
securitization of assets including state lottery awards and structured
settlement payments, is currently operating on a run-off basis. Its operations
consist of servicing the prior originations of non-consolidated special purpose
vehicles containing approximately $505 million and $479 million of off-balance
sheet assets and liabilities, respectively at December 31, 2002. At December 31,
2001 the comparable amount of off-balance sheet assets and liabilities was
$600.0 million and $568.0 million, respectively. The Company's investment in the
non-consolidated special purpose vehicles at December 31, 2002 and 2001 is $26.3
million and $32.0 million, respectively, and the results of these subsidiaries
operating on a run-off basis are not material to the financial results of the
Company. In August 2002, the Company sold substantially all of the assets of a
related subsidiary, Enhance Consumer Services LLC ("ECS"), which had been
engaged in the purchase, servicing and securitization of viatical settlements,
to an independent third party for an aggregate purchase price of $8.4 million.
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 No. 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 No. 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 No. 142 is
effective for fiscal years beginning after December 15, 2001, for 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 adopted the provisions of SFAS No. 141 and SFAS No. 142
as of January 1, 2002. The adoption of SFAS No. 141 and SFAS No. 142 did not
have a material impact on the Company's financial position or results of
operations.
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 supersedes 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. The adoption of SFAS No. 144 did not
have a material impact on the financial position or results of operations of the
Company.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." The provisions of this statement related to the rescission of SFAS
No. 4 are effective for fiscal years beginning after May 15, 2002. Certain
20
provisions of the statement relating to SFAS No. 13 are effective for
transactions occurring after May 15, 2002. All other provisions of the statement
are effective for financial statements issued on or after May 15, 2002. The
provisions of this statement did not have a material impact on the Company's
financial statements.
In July 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." The standard requires companies to
recognize costs associated with exit or disposal of activities when they are
incurred rather than at the date of commitment to exit or disposal plan.
Examples of costs covered by the standard include lease termination costs and
certain other employee severance costs that are associated with restructuring,
discontinued operations, plant closing, or other exit or disposal activity.
Statement No. 146 is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of
Certain Financial Institutions, an amendment of FASB Statements No. 72 and 144
and FASB Interpretation No. 9." The Company is not within the definition of a
financial institution as defined by SFAS No. 147. Therefore, this statement has
no impact on the Company's financial statements.
In November 2002, the Financial Accounting Standards Board issued FASB
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, including Indirect Guarantees of Indebtedness of Others." This
Interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the fair value of
the obligation undertaken in issuing the guarantee. This Interpretation also
incorporates, without change, the guidance in FASB Interpretation No. 34,
Disclosure of Indirect Guarantees of Indebtedness of Others, which is being
superseded. The initial recognition and initial measurement of provisions of
this Interpretation are applicable on a prospective basis to guarantees issued
or modified after December 31, 2002, irrespective of the guarantor's fiscal
year-end. The disclosure requirements in this Interpretation are effective for
financial statements of interim or annual periods ending after December 15,
2002. The Interpretation does not apply to the financial guaranty insurance
policies issued by the Company. However, the Company has guaranteed the
performance of an affiliate under a revolving credit facility. The Company has
included the disclosures required by the Interpretation in the footnotes to
these financial statements.
In January 2003, the FASB issues FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities." The Interpretation clarifies the
application of Accounting Research Bulletin No. 51, "Consolidated Financial
Statements," to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. The Interpretation applies
immediately to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains interest after that
date. The Interpretation applies in the interim period beginning after June 15,
2003 to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. Currently, the Company is not
the primary beneficiary of a variable interest entity. However, the Company has
been a transferor of financial assets (as discussed above in "Assignment
Operations") considered to be a qualifying special purpose entity ("QSPE")
described in SFAS No. 140, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities." These QSPEs are not within the scope
of the Interpretation. In management's opinion, this Interpretation will not
have a material effect on the Company's financial statements.
Reclassifications
Certain prior period amounts have been reclassified to conform to the
current year's presentation.
2. Investments
Fixed maturity and equity investments at December 31, 2002 and 2001 consisted of
(in thousands):
21
December 31, 2002
-------------------------------------------------
Gross Gross
Amortized Fair Unrealized Unrealized
Cost Value Gains Losses
---------- ---------- ---------- ----------
Fixed maturities held to maturity:
Bonds and notes:
State and municipal obligations $ 356,000 $ 379,643 $ 23,735 $ 92
---------- ---------- -------- -------
$ 356,000 $ 379,643 $ 23,735 $ 92
========== ========== ======== =======
Fixed maturities available for sale:
Bonds and notes:
United States government $ 206,650 $ 210,706 $ 6,387 $ 2,331
State and municipal obligations 2,369,320 2,482,419 113,736 637
Corporate 94,653 100,210 5,647 90
Convertible securities 268,799 266,371 3,220 5,648
Asset-backed securities 227,932 232,301 4,396 27
Private placements 82,857 82,857 -- --
Redeemable preferred stock 73,595 65,400 1,235 9,430
Other 8,296 8,662 370 4
---------- ---------- -------- -------
$3,332,102 $3,448,926 $134,991 $18,167
========== ========== ======== =======
Equity securities available for sale $ 196,766 $ 168,517 $ 6,471 $34,720
========== ========== ======== =======
22
December 31, 2001
-------------------------------------------------
Gross Gross
Amortized Fair Unrealized Unrealized
Cost Value Gains Losses
---------- ---------- ---------- ----------
Fixed maturities held to maturity:
Bonds and notes:
United States government $ 9,730 $ 9,592 $ -- $ 137
State and municipal obligations 432,468 452,370 20,415 514
---------- ---------- ------- -------
$ 442,198 $ 461,962 $20,415 $ 651
========== ========== ======= =======
Fixed maturities available for sale:
Bonds and notes:
United States government $ 102,781 $ 102,174 $ 995 $ 1,602
State and municipal obligations 1,952,650 1,956,321 25,103 21,432
Corporate 231,893 247,648 23,299 7,544
Asset-backed securities 149,670 149,700 637 607
Private placements 89,090 84,544 -- 4,546
Redeemable preferred stock 25,382 25,360 1,352 1,374
Other 1,464 1,453 -- 11
---------- ---------- ------- -------
$2,552,930 $2,567,200 $51,386 $37,116
========== ========== ======= =======
Equity securities available for sale $ 116,978 $ 120,320 $14,394 $11,052
========== ========== ======= =======
The contractual maturities of fixed maturity investments are as
follows (in thousands):
December 31, 2002
-----------------------
Amortized
Cost Fair Value
---------- ----------
Fixed maturities held to maturity:
2003 $ 13,886 $ 14,214
2004-2007 102,096 108,286
2008-2012 151,952 164,790
2013 and thereafter 88,066 92,353
---------- ----------
$ 356,000 $ 379,643
========== ==========
Fixed maturities available for sale:
2003 $ 49,380 $ 50,067
2004-2007 413,506 426,222
2008-2012 527,421 549,009
2013 and thereafter 2,040,268 2,125,927
Asset-backed securities 227,932 232,301
Redeemable preferred stock 73,595 65,400
---------- ----------
$3,332,102 $3,448,926
========== ==========
Net investment income consisted of (in thousands):
Year Ended December 31
------------------------------
2002 2001 2000
-------- -------- --------
Investment income:
Fixed maturities $176,857 $139,508 $ 79,891
Equity securities 1,555 1,772 1,461
Short-term investments 4,325 7,597 3,941
23
Other 902 3,749 1,272
-------- -------- --------
$183,639 $152,626 $ 86,565
Investment expenses (4,798) (5,139) (3,619)
-------- -------- --------
$178,841 $147,487 $ 82,946
======== ======== ========
24
Net gain on sales of investments consisted of (in thousands):
Year Ended December 31
-----------------------------
2002 2001 2000
-------- -------- -------
Gains on sales and redemptions of fixed maturity $ 32,742 $ 22,336 $12,732
investments available for sale
Losses on sales and redemptions of fixed maturity (23,584) (13,782) (9,115)
investments available for sale
Gains on sales and redemptions of fixed maturity 631 59 4
investments held to maturity
Losses on sales and redemptions of fixed maturity (5) (84) (35)
investments held to maturity
Gains on sales of equity securities available for sale 2,509 439 2,206
Losses on sales of equity securities available for sale (2,838) (943) (1,767)
Gains on sales of other invested assets 3,425 -- --
Losses on sales of other invested assets -- (1,058) --
Gains on sales of trading securities 2,916 521 --
Losses on sales of trading securities (5,293) (669) --
Gains on sales of short-term investments 25 5 184
Losses on sales of short-term investments (66) -- (30)
-------- -------- -------
$ 10,462 $ 6,824 $ 4,179
======== ======== =======
For the years ended December 31, 2002 and 2001, the Company did not
sell any fixed maturity investments held to maturity. For the year ended
December 31, 2000, the Company sold fixed maturity investments held to maturity
with an amortized cost of $1,949,000 resulting in losses of $27,000. All
investments were sold in response to a significant deterioration in the issuer's
creditworthiness.
Net change in unrealized appreciation (depreciation) on investments
consisted of (in thousands):
Year Ended December 31
------------------------------
2002 2001 2000
-------- -------- --------
Fixed maturities held to maturity $ 3,879 $ (1,437) $ 14,493
======== ======== ========
Fixed maturities available for sale $102,790 $(19,379) $ 68,718
Deferred tax benefit (provision) (35,720) 6,725 (24,051)
-------- -------- --------
$ 67,070 $(12,654) $ 44,667
======== ======== ========
Equity securities available for sale $(31,210) $ (1,983) $ (5,334)
Deferred tax benefit 10,924 695 1,867
-------- -------- --------
$(20,286) $ (1,288) $ (3,467)
======== ======== ========
Other $ 329 $ (365) $ --
======== ======== ========
Securities on deposit with various state insurance commissioners amounted
to $14,097,000 at December 31, 2002 and $17,512,000 at December 31, 2001. The
Company also had $60,870,000 on deposit at December 31, 2002 and $596,965,000 at
December 31, 2001 for the benefit of reinsurers.
3. Investment in Affiliates
As a result of the acquisition of Financial Guaranty, the Company owns a
46.0% interest in Credit-Based Asset Servicing and Securitization LLC ("C-BASS")
and a 41.5% interest in Sherman Financial Group LLC ("Sherman"). Effective
January 1, 2003, Sherman's management exercised its right to acquire additional
ownership of Sherman, reducing the Company's ownership interest from 45.5% to
41.5%. C-BASS is engaged in the purchasing, servicing and/or securitization of
special assets, including sub-
25
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. At December 31, 2002 and 2001, C-BASS had total assets of $1,754,392,000
and $1,290,425,000, respectively and total liabilities of $1,384,855,000 and
$1,005,907,000, respectively. C-BASS had net income for 2002 and 2001 of
$138,335,000 and $86,481,000, respectively. At December 31, 2002 and 2001,
Sherman had total assets of $385,899,735 and $287,826,297, respectively, and
total liabilities of $269,410,211 and $203,051,815, respectively. Sherman had
net income for 2002 and 2001 of $40,279,294 and $10,624,267, respectively.
The Company owns a 36.5% interest in EIC Corporation Ltd. ("Exporters"), an
insurance holding company that, through its wholly-owned insurance subsidiary
licensed in Bermuda, insures foreign trade receivables. At December 31, 2002 and
2001, Exporters had total assets of $172,903,218 and $168,924,333, respectively
and total liabilities of $115,338,832 and $114,239,933, respectively. Exporters
had a loss for 2001 of $2,240,000 and a loss of $1,936,000 for 2002.
In March 2002, the Company invested $20 million for an approximate 12%
interest in Primus Guaranty, Ltd., a Bermuda holding company and parent company
to Primus Financial Products LLC. ("Primus"), a Triple A rated company that
provides credit risk protection to derivatives dealers and credit portfolio
managers on individual-grade entities. In connection with the capitalization and
Triple A rating of Primus, Radian Re provided Primus with an excess of loss
insurance policy, which is expiring March 30, 2003.
The Company accounts for its investment in these affiliates in
accordance with the equity method of accounting, as the control of these
affiliates does not rest with the Company and since the other shareholders have
substantial participating rights.
4. Reinsurance
The Company utilizes reinsurance as a risk management tool, to reduce
net risk in force to meet regulatory risk-to-capital requirements and to comply
with the regulatory maximum per loan coverage percentage limitation of 25%.
Although the use of reinsurance does not discharge an insurer from its primary
liability to the insured, the reinsuring company assumes the related liability.
Included in other assets are unearned premiums (prepaid reinsurance) of
$8,566,000 and $12,182,000 at December 31, 2002 and 2001, respectively.
The effect of reinsurance on premiums written and earned is as follows:
Year Ended December 31
------------------------------
(in thousands) 2002 2001 2000
-------- -------- --------
Premiums written:
Direct $875,190 $753,392 $592,734
Assumed 147,633 90,917 80
Ceded (67,904) (60,665) (48,542)
-------- -------- --------
Net premiums written $954,919 $783,644 $544,272
======== ======== ========
Premiums earned:
Direct $799,827 $699,085 $570,425
Assumed 116,880 77,569 80
Ceded (69,582) (60,774) (49,634)
-------- -------- --------
Net premiums earned $847,125 $715,880 $520,871
======== ======== ========
The 2002, 2001 and 2000 amounts included ($15,000), $4,062,000 and
$9,561,000, respectively, for premiums written and $173,000, $4,299,000 and
$9,772,000, respectively, for premiums earned, for reinsurance ceded under
variable quota share treaties entered into in 1997, 1996, 1995 and 1994 covering
26
the books of business originated by Radian Guaranty in those years. Ceding
commissions under these treaties were $3,840,000, $2,216,000 and $4,833,000 for
the years ended December 31, 2002, 2001 and 2000, respectively. The Company
recovered variable quota share losses under these treaties of $1,809,000,
$611,000 and $2,262,000 in 2002, 2001 and 2000, respectively.
Provisional losses recoverable were $48,561,000 and $47,016,000 for
2002 and 2001, respectively, and represented amounts due under variable quota
share treaties entered into in 1997, 1996, 1995 and 1994, covering the books of
business originated by Radian Guaranty in those years. The term of each treaty
is ten years and is non-cancelable by either party except under certain
conditions. The treaties also include underwriting year excess coverage in years
four, seven, and ten of the treaty.
Under the terms of these treaties, Radian Guaranty cedes premium to
the reinsurer based on 15% of the premiums received by Radian Guaranty on the
covered business. Radian Guaranty is entitled to receive a ceding commission
ranging from 30% to 32% of the premium paid under the treaty provided that
certain loss ratios are not exceeded. In return for the payment of premium,
Radian Guaranty receives variable quota share loss relief at levels ranging from
7.5% to 15.0% based upon the loss ratio on the covered business.
In addition, Radian Guaranty is entitled to receive, under the
underwriting year excess coverage, 8% of the ceded premium written under each
treaty to the extent that this amount is greater than the total amount received
under the variable quota share coverage business.
Premiums are payable to the reinsurer on a quarterly basis net of
ceding commissions due and any losses calculated under the variable quota share
coverage. At the end of the fourth, seventh, and tenth years of each treaty,
depending on the extent of losses recovered to date under the variable quota
share provisions of the treaty, Radian Guaranty may recover amounts due under
the underwriting year excess coverage provisions of the treaty.
The Company accounts for this reinsurance coverage under guidance
provided in EITF 93-6, "Accounting for Multiple-Year Retrospectively Rated
Contracts by Ceding and Assuming Enterprises." Under EITF 93-6, the Company
recognizes an asset for amounts due from the reinsurer based on experience to
date under the contract.
Radian Guaranty has also entered into captive reinsurance arrangements
with certain customers. The arrangements are typically structured on an excess
layer basis with insured loans grouped by loan origination year. Radian Guaranty
retains the first layer of risk on a particular book of business, the captive
reinsurer assumes the next layer, and Radian Guaranty assumes all losses above
that point. The captive reinsurers are typically required to maintain minimum
capitalization equal to 10% of the risk assumed. Risk ceded under captive
reinsurance arrangements at December 31, 2002, and December 31, 2001, was
$986,266,000 and $681,595,000, respectively. For the years ended December 31,
2002, 2001, and 2000, Radian Guaranty had ceded premiums written of $57,076,000,
$55,653,000, and $39,686,000, respectively, and ceded premiums earned of
$56,641,000, $52,472,000, and $39,501,000, respectively, under these various
captive reinsurance arrangements.
In addition, Radian Guaranty reinsures all of its direct insurance in
force under an excess of loss reinsurance program that is in a run-off period
that will expire December 31, 2007. Under this program, the reinsurer is
responsible for 100% of Radian Guaranty's covered losses (subject to an annual
and aggregate limit) in excess of an annual retention limit. Premiums are paid
to the reinsurer on a quarterly basis, net of any losses due to Radian Guaranty.
Beginning in 2000, this treaty was accounted for under Statements of Position
98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts
That Do Not Transfer Insurance Risk" ("SOP 98-7") and therefore, $7,492,000,
$5,269,000 and $5,370,000 were included in incurred losses during 2002, 2001 and
2000, respectively, relating to the excess of loss reinsurance program.
5. Losses and Loss Adjustment Expenses
27
As described in note 1, the Company establishes reserves to provide
for the estimated costs of settling claims in respect of loans reported to be in
default and loans that are in default that have not yet been reported to the
Company.
The default and claim cycle on mortgage loans that the Company covers
begins with the receipt from the lender of notification of a default on an
insured loan. The master policy with each lender requires the lender to inform
the Company of an uncured default on a mortgage loan within 75 days of the
default. The incidence of default is influenced by a number of factors,
including change in borrower income, unemployment, divorce and illness, the
level of interest rates, and general borrower creditworthiness. Defaults that
are not cured result in claims to the Company. Borrowers may cure defaults by
making all delinquent loan payments or by selling the property and satisfying
all amounts due under the mortgage.
Different regions of the country experience different default rates
due to varying economic conditions and each state has different rules regarding
the foreclosure process. These rules can impact the amount of time it takes for
a default to reach foreclosure, so the Company has developed a reserving
methodology that takes these different time periods into account in calculating
the reserve.
When a specific loan initially defaults, it is uncertain the default
will result in a claim. It is the Company's experience that a significant
percentage of mortgage loans in default are cured. The reserve is increased in
stages, as the foreclosure progresses, to approximate the estimated total loss
for that particular claim. At any time during the foreclosure process, until the
lender takes title to the property, the borrower may cure the default, at which
time the reserve for that loan is removed. Therefore, it is appropriate to
increase the reserve in stages as new insight and information is obtained. At
the time of title transfer, the Company has approximately 100% of the estimated
total loss reserved.
In the financial guaranty business, policies are monitored by the
Company or the primary insurers over the life of the policy. When the policy's
performance deteriorates below underwriting expectations, or if the
circumstances dictate, it is placed on a Watch List. Once a transaction is
placed on a Watch List, the transaction is actively monitored, which may include
communication with the borrower, site inspection or the engagement of a third
party consultant. If the transaction continues to deteriorate to a point where a
default is probable and estimable, the Company will establish a loss reserve.
The following tables present information relating to the liability for
unpaid claims and related expenses (in thousands):
Mortgage Insurance 2002 2001 2000
--------- --------- --------
Balance at January 1 $ 465,444 $ 390,021 $335,584
Add losses and LAE incurred in respect of default notices
received in:
Current year 320,139 320,159 247,759
Prior years (125,653) (141,013) (93,433)
--------- --------- --------
Total incurred $ 194,486 $ 179,146 $154,326
--------- --------- --------
Deduct losses and LAE paid in respect of default notices
received in:
Current year $ 22,374 $ 21,237 $ 8,891
Prior years 152,851 82,486 90,998
--------- --------- --------
Total paid $ 175,225 $ 103,723 $ 99,889
--------- --------- --------
Balance at December 31 $ 484,705 $ 465,444 $390,021
========= ========= ========
Financial Guaranty 2002 2001
-------- --------
Balance at January 1 (or date of acquisition) $123,199 $110,433
Less Reinsurance recoverables 213 185
Balance at January 1 (or date of acquisition), net 122,986 110,248
28
Add losses and LAE incurred related to:
Current year 44,978 17,560
Prior years 3,868 11,430
-------- --------
Total incurred $ 48,846 $ 28,990
-------- --------
Deduct losses and LAE paid related to:
Current year $ 8,738 $ 3,815
Prior years 25,395 12,437
-------- --------
Total paid $ 34,133 $ 16,252
-------- --------
Balance at December 31, net $137,699 $122,986
Add Reinsurance recoverables 2,173 213
-------- --------
Balance at December 31 $139,872 $123,199
======== ========
As a result of changes in estimates of insured events in prior years,
the provision for losses and loss adjustment expenses in the mortgage insurance
business decreased by $125,653,000, $141,013,000 and $93,433,000 in 2002, 2001
and 2000, respectively, due primarily to lower than anticipated claim payments
as compared to the amounts previously reserved.
During 2002 and 2001, the Company incurred losses and LAE of
$3,868,000 and $11,430,000, respectively, in the financial guaranty insurance
business related to prior years. This adverse development is primarily related
to trade credit business and is the result of obtaining additional information
on the assumed reinsurance as well as higher than expected claims.
6. Short-Term and Long-Term Debt
In January 2002, the Company issued, in a private placement, $220
million of 2.25% senior convertible debentures due 2022. Interest on the
debentures is payable semi-annually on January 1 and July 1. Beginning in 2005,
the Company may also be required to pay additional contingent interest in
specified semi-annual periods, if the sale price of its common stock for a
specified period of time is less than 60% of the conversion price. The
debentures are convertible, at the purchaser's option, into shares of common
stock at prices and on dates specified in the offering. Upon conversion, the
shares would become common shares for the purposes of calculating earnings per
share. In July 2002, the Securities and Exchange Commission declared effective a
shelf registration statement previously filed by the Company to register the
resale of the debentures by the holders of the debentures.
In May 2001, the Company issued, in a private placement, $250 million
of 7.75% debentures due June 1, 2011. Interest on the debentures is payable
semi-annually on June 1 and December 1. The Company has the option to redeem
some or all of the debentures any time with not less than 30 days notice. In
November 2001, the Company offered to exchange all of the old debentures for new
debentures with terms of the new debentures substantially identical to the terms
of the old debentures, except that the new debentures are registered and have no
transfer restrictions, rights to additional interest or registration rights,
except in limited circumstances. Substantially all of the initial debt converted
to new public debt.
As discussed in note 1, the Company also has outstanding at December
31, 2002, $75 million of 6.75% debentures, which matures on March 1, 2003.
Interest on the debentures is payable semi-annually in March and September.
The composition of short-term and long-term debt at December 31, 2002
and 2001 was as follows:
2002 2001
-------- --------
2.25% Senior Convertible debentures due 2022 $220,000 $ --
7.75% debentures due 2011 249,145 249,076
6.75% debentures due 2003 75,000 75,000
-------- --------
$544,145 $324,076
======== ========
29
In February 2002, the Company closed on a $50 million Senior Revolving
Credit Facility. The facility is unsecured and expires in May 2003. The facility
will be used for working capital and general corporate purposes. The facility
bears interest on any amounts drawn at either the Borrower's Base rate as
defined in the agreement, or at a rate above LIBOR based on certain
debt-to-capital ratios. There have been no drawdowns on this facility.
7. Redeemable Preferred Stock
On August 15, 2002, the Company redeemed its $4.125 Preferred Stock,
par value $.001 per share. Pursuant to the Company's sinking fund redemption
obligation, 72,000 shares were redeemed at $50.00 per share, and the remaining
728,000 shares were redeemed at $54.125 per share. Accrued and unpaid dividends
on the shares to the date of redemption were also paid as part of the redemption
price. The excess of the amount paid over the carrying value of the preferred
stock of $3.0 million, is accounted for as a charge to equity and resulted in an
approximate $.03 reduction in earnings per share for the year-to-date period of
2002.
8. Income Taxes
Deferred income taxes at the end of each period are determined by
applying enacted statutory tax rates applicable to the years in which the taxes
are expected to be paid or recovered. Deferred income taxes reflect the net tax
effects of temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts for income tax
purposes. The effect on deferred taxes of a change in the tax rate is recognized
in earnings in the period that includes the enactment date.
The components of the Company's consolidated provision for income
taxes are as follows (in thousands):
Year Ended December 31
------------------------------
2002 2001 2000
-------- -------- --------
Current income taxes $ 61,815 $ 22,992 $ 40,594
Deferred income taxes 112,292 122,120 62,938
-------- -------- --------
$174,107 $145,112 $103,532
======== ======== ========
The reconciliation of taxes computed at the statutory tax rate of 35%
for 2002, 2001 and 2000, to the provision for income taxes is as follows (in
thousands):
2002 2001 2000
-------- -------- --------
Provision for income taxes computed at the statutory tax $210,446 $176,936 $123,365
rate
Change in tax provision resulting from:
Tax-exempt municipal bond interest and dividends (39,948) (32,315) (20,482)
received deduction (net of proration)
Capitalized merger costs -- -- 123
Other, net 3,609 491 526
-------- -------- --------
Provision for income taxes $174,107 $145,112 $103,532
======== ======== ========
The significant components of the Company's net deferred tax assets and
liabilities are summarized as follows (in thousands):
December 31
----------------------
2002 2001
--------- ----------
Deferred tax assets:
AMT credit carryforward $ 29,424 $ 35,118
Loss reserves 28,936 30,643
30
Accrued expenses 13,477 12,076
Other 24,772 19,444
--------- ---------
$ 96,609 $ 97,281
--------- ---------
Deferred tax liabilities:
Deduction related to purchase of tax and loss bonds $(462,657) $(390,315)
Deferred policy acquisition costs (64,255) (52,866)
Partnership investments (49,211) (35,001)
Net unrealized gain on investments (FAS 115) (31,656) (5,937)
Assignment sale income (15,992) (9,795)
Unearned premiums (5,354) (8,148)
Depreciation (2,477) (1,842)
Other (35,286) (25,475)
--------- ---------
$(666,888) $(529,379)
--------- ---------
Net deferred tax liability $(570,279) $(432,098)
========= =========
Prepaid federal income taxes includes Tax and Loss Bonds of $294.1
million and $326.5 million as of December 31, 2002 and 2001, respectively. Under
IRC Section 832(e), tax and loss bonds ("TLs") are required to be purchased in
an amount equal to the "tax benefit derived" from deducting any portion of the
Company's statutory contingency reserve. As such, the Company purchases and
redeems TLs on a quarterly basis in the normal course of its business.
Cumulative TLs purchased and subsequent redemptions are reflected in the balance
of "Prepaid Federal Income Taxes" on the Consolidated Balance Sheets. During
2002, the Company redeemed approximately $56 million of TL bonds, which were
purchased in prior years.
9. Stockholders' Equity and Dividend Restrictions
The Company is a holding company whose principal source of income is
dividends from its subsidiaries. The ability of Radian Guaranty to pay dividends
on its common stock is restricted by certain provisions of the insurance laws of
the Commonwealth of Pennsylvania, its state of domicile. The insurance laws of
Pennsylvania establish a test limiting the maximum amount of dividends that may
be paid by an insurer without prior approval by the Pennsylvania Insurance
Commissioner. Under such test, Radian Guaranty may pay dividends during any
12-month period in an amount equal to the greater of (i) 10% of the preceding
year-end statutory policyholders' surplus or (ii) the preceding year's statutory
net income. In accordance with such restrictions, $411.6 million would be
available for dividends in 2003. However, an amendment to the Pennsylvania
statute requires that dividends and other distributions be paid out of an
insurer's unassigned surplus. Because of the unique nature of the method of
accounting for contingency reserves, Radian Guaranty has negative unassigned
surplus. Thus, prior approval by the Pennsylvania Insurance Commissioner is
required for Radian Guaranty to pay dividends or make other distributions so
long as Radian Guaranty has negative unassigned surplus. The Pennsylvania
Insurance Commissioner has approved all distributions by Radian Guaranty since
the passage of this amendment.
The ability of Amerin Guaranty to pay dividends on its common stock is
restricted by certain provisions of the insurance laws of the State of Illinois,
its state of domicile. The insurance laws of Illinois establish a test limiting
the maximum amount of dividends that may be paid from positive unassigned
surplus by an insurer without prior approval by the Illinois Insurance
Commissioner. Under such test, Amerin Guaranty may pay dividends during any
12-month period in an amount equal to the greater of (i) 10% of the preceding
year-end statutory policyholders' surplus or (ii) the preceding year's statutory
net income. In accordance with such restrictions, $29.6 million is available for
dividends in 2003 without prior regulatory approval, which represents the
positive unassigned surplus of Amerin Guaranty at December 31, 2002.
Under New York insurance law, the Financial Guaranty insurance
subsidiaries may declare or distribute dividends only out of earned surplus. The
maximum amount of dividends, which may be paid by the insurance subsidiaries
without prior approval of the New York Superintendent of Insurance, is subject
to restrictions relating to statutory surplus and net investment income as
defined by statute. Under such
31
requirements, Radian Re would be able to pay dividends of approximately $27.2
million in 2003 and Radian Asset Assurance has approximately $30.9 million
available for dividends in 2003, without prior approval.
However, in connection with the approval of the acquisition of
Financial Guaranty, the Company, Radian Re and Radian Asset Assurance agreed
that Radian Re and Radian Asset Assurance would refrain from paying any
dividends to the Company for a period of two years from the date of acquisition
of control without the prior written consent of the New York Insurance
Department. The agreement for Radian Re and Radian Asset Assurance to refrain
from paying dividends to the Company expired on February 28, 2003.
Radian Guaranty's current excess of loss reinsurance arrangement
prohibits the payment of any dividend that would have the effect of reducing the
total of its statutory policyholders' surplus plus its contingency reserve below
$85,000,000. As of December 31, 2002, Radian Guaranty had statutory
policyholders' surplus of $163,545,000 and a contingency reserve of
$1,652,154,000, for a total of $1,815,699,000. During 2001, Radian Guaranty and
Amerin Guaranty entered into an assumption agreement whereby Radian Guaranty
assumed 100% of the rights, duties and obligations related to first lien
mortgage guaranty insurance written by Amerin Guaranty. Amerin Guaranty's
contingency reserve of $310,873,000 was transferred to Radian Guaranty in
accordance with the terms of the assumption agreement.
The Company prepares its statutory financial statements in accordance
with the accounting practices prescribed or permitted by the insurance
department of the respective states of domicile of the Company's insurance
subsidiaries. Prescribed statutory accounting practices include a variety of
publications of the National Association of Insurance Commissioners ("NAIC") as
well as state laws, regulations, and general administrative rules. Permitted
statutory accounting practices encompass all accounting practices not so
prescribed.
Radian Guaranty's statutory policyholders' surplus at December 31,
2002 and 2001 was $163,545,000 and $185,268,000, respectively. Radian Guaranty's
statutory net income for 2002, 2001 and 2000 was $411,594,000, $252,843,000 and
$197,979,000, respectively.
Under Illinois insurance regulations, Amerin Guaranty is required to
maintain statutory basis capital and surplus of $1,500,000. The statutory
policyholders' surplus at December 31, 2002 and 2001 was $296,446,000 and
$298,802,000, respectively. Amerin Guaranty's statutory net income for 2002,
2001 and 2000 was $21,065,000 $53,215,000, and $101,448,000, respectively.
New York insurance law requires financial guaranty insurers to
maintain minimum policyholders' surplus of $65,000,000. When added to the
minimum policyholders' surplus of $3,400,000 separately required for the other
lines of insurance that it is licensed to write, each of the insurance
subsidiaries is required to have an aggregate minimum policyholders' surplus of
$68,400,000. Radian Re had statutory policyholders' surplus of $272,136,000 and
$188,635,000 at December 31, 2002 and 2001, respectively, a contingency reserve
of $280,376,000 and $308,865,000 at December 31, 2002 and 2001, respectively,
and statutory net income for 2002 and 2001 of $78,351,000 and $39,970,000,
respectively. Radian Asset Assurance had statutory policyholders' surplus of
$309,459,000 and $133,131,000 at December 31, 2002 and 2001, respectively, a
contingency reserve of $39,272,000 and $36,665,000 at December 31, 2002 and
2001, respectively, and statutory net income of $33,370,000 for 2002 and
$10,603,000 for 2001.
New York insurance law establishes single-risk limits applicable to
all obligations issued by a single entity and backed by a single revenue source.
Under the limit applicable to municipal bonds, the insured average annual debt
service for a single risk, net of reinsurance and collateral, may not exceed 10%
of the sum of the insurer's policyholders' surplus and contingency reserves. In
addition, insured principal of municipal bonds attributable to any single risk,
net of reinsurance and collateral, is limited to 75% of the insurer's
policyholders' surplus and contingency reserves. Additional single risk limits,
which generally are more restrictive than the municipal bond single risk limit,
are also specified for several other categories of insured obligations.
32
The differences between the statutory net income and surplus and the
consolidated net income and equity presented on a GAAP basis represent
differences between GAAP and statutory accounting practices ("STAT") for the
following reasons:
(a) Under STAT, mortgage guaranty insurance companies are required to
establish each year a contingency reserve equal to 50% of premiums earned in
such year. Such amount must be maintained in the contingency reserve for 10
years after which time it is released to unassigned surplus. Prior to 10 years,
the contingency reserve may be reduced with regulatory approval to the extent
that losses in any calendar year exceed 35% of earned premiums for such year.
Financial guaranty insurance companies are also required to establish
contingency reserves under STAT. Under GAAP, the contingency reserve is not
required.
(b) In accordance with New York insurance law, financial guaranty
insurance companies are required to establish a contingency reserve in the
amount prescribed by legislation. Such legislation requires that for financial
guaranty policies written after June 30, 1989, each primary insurer must
establish a contingency reserve equal to the greater of 50% of premiums written
or a stated percentage of the principal guaranteed, ratably over 15-20 years
dependent upon the category of obligation insured. Reinsurers are required to
establish a contingency reserve equal to their proportionate share of the
reserve established by the primary insurer.
(c) Under STAT, insurance policy acquisition costs are charged against
operations in the year incurred. Under GAAP, such costs other than those
incurred in connection with the origination of derivative contracts, are
deferred and amortized.
(d) Statutory financial statements only include a provision for
current income taxes due and limitations on deferred tax provisions, as revised
effective January 1, 2001, and purchases of tax and loss bonds are accounted for
as investments. GAAP financial statements provide for deferred income taxes, and
purchases of tax and loss bonds are recorded as prepayments of income taxes.
(e) Under STAT, fixed maturity investments are valued at amortized
cost. Under GAAP, those investments that the statutory insurance entities do not
have the ability or intent to hold to maturity are considered to be either
available for sale or trading securities, and are recorded at fair value, with
the unrealized gain or loss recognized, net of tax, as an increase or decrease
to stockholders' equity or current operations, as applicable.
(f) Under STAT, certain assets, designated as non-admitted assets, are
charged directly against statutory surplus. Such assets are reflected on the
GAAP financial statements.
In March 1998, the NAIC adopted the Codification of Statutory
Accounting Principles ("Codification"). The Codification, which is intended to
standardize regulatory accounting and reporting for the insurance industry, was
effective January 1, 2001. However, statutory accounting principles will
continue to be established by individual state laws and permitted practices. The
Commonwealth of Pennsylvania required adoption of the Codification for the
preparation of statutory financial statements effective January 1, 2001. The
Company's adoption of the Codification increased statutory capital and surplus
as of January 1, 2001 by $4,562,000 in Radian Guaranty. The State of Illinois
required adoption of the Codification for the preparation of statutory financial
statements effective January 1, 2001. The Company's adoption of the Codification
increased statutory capital and surplus as of January 1, 2001 by $767,000 in
Amerin Guaranty. The State of New York required adoption of the Codification for
the preparation of statutory financial statements effective January 1, 2001. The
Company's adoption of the Codification decreased statutory capital and surplus
as of January 1, 2001 by $265,000 in Radian Re. There was no impact upon
adoption for Radian Asset Assurance.
10. Stock-Based Compensation
33
The Company has two stock option plans, the Radian Group Inc. 1992
Stock Option Plan and the Radian Group Inc. Equity Compensation Plan, which
together provide for the granting of non-qualified stock options, either alone
or together with stock appreciation rights, as well as other forms of
equity-based compensation. These options may be granted to directors, officers,
and key employees of the Company at prices that are not less than 90% of the
fair market value of the Company's stock at the date of grant. Each stock option
is exercisable for a period of 10 years from the date of grant and is subject to
a vesting schedule as approved by the Company's Compensation and Human Resources
Committee.
In February 2001, as a result of the Financial Guaranty acquisition,
1,320,079 options (pre-split) to purchase shares of the Company's common stock
were issued to holders of options to purchase shares of Financial Guaranty
common stock.
The Company intends to grant any additional options to purchase shares
of the Company's common stock from the Radian Group Inc. Equity Compensation
Plan.
Effective with the stock split in June 2001, all share totals within
the plans were doubled.
34
Information with regard to the Company's stock option plans is as
follows:
Weighted
Average
Number of Exercise Price
Shares Per Share
---------- --------------
Outstanding, January 1, 2000 3,912,888 $13.77
Granted 920,214 22.67
Exercised (1,177,356) 12.43
Cancelled (143,980) 22.00
----------
Outstanding, December 31, 2000 3,511,766 16.22
==========
Granted 1,822,006 31.91
Options granted re: Financial Guaranty acquisition 2,640,158 38.61
Exercised (1,351,468) 19.23
Cancelled (754,871) 49.88
----------
Outstanding, December 31, 2001 5,867,591 26.19
==========
Granted 7,000 45.87
Exercised (881,170) 17.24
Cancelled (91,534) 31.69
----------
Outstanding, December 31, 2002 4,901,887 27.69
==========
Exercisable, December 31, 2000 1,974,334 11.98
==========
Exercisable, December 31, 2001 3,175,377 25.06
==========
Exercisable, December 31, 2002 2,874,516 27.53
==========
Available for grant, December 31, 2002 2,642,690
==========
The Company applies APB 25 in accounting for its stock-based
compensation plans. No stock-based employee compensation cost is reflected in
net income, as all options granted under the stock option plans had an exercise
price equal to the market value of the underlying common stock on the date of
grant.
The weighted average fair values of the stock options granted during
2002, 2001 and 2000 were $21.50, $15.74, and $11.98, respectively. The fair
value of each stock option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions used for grants:
2002 2001 2000
----- ----- -----
Expected life (years) 6.71 7.53 7.07
Risk-free interest rate 4.06% 4.40% 6.69%
Volatility 39.76% 39.09% 39.29%
Dividend yield 0.18% 0.22% 0.16%
The following table summarizes information concerning currently
outstanding and exercisable options at December 31, 2002:
Options Outstanding Options Exercisable
----------------------------------------------- ----------------------------
Weighted Average
Remaining Weighted Weighted
Range of Number Contractual Life Average Number Average
Exercise Prices Outstanding (Years) Exercise Price Exercisable Exercise Price
- --------------- ----------- ---------------- -------------- ----------- --------------
$ 4.97-$ 7.34 332,988 1.30 $ 7.27 332,988 $ 7.27
$11.06-$16.25 324,981 3.40 13.48 324,981 13.48
$16.64-$24.00 1,307,179 5.42 20.61 687,204 20.33
35
$26.47-$37.36 2,332,661 7.34 30.91 963,265 31.17
$38.00-$56.68 471,686 6.62 44.85 433,686 45.24
$65.48-$68.18 132,392 5.07 65.82 132,392 65.82
--------- ---------
4,901,887 2,874,516
========= =========
The Company's option plans include a "reload" feature. The award of a
"reload" option allows the optionee to receive the grant of an additional stock
option, at the then current market price, in the event that such optionee
exercises all or part of an option (the "original option") by surrendering
already owned shares of common stock in full or partial payment of the exercise
price of such original option. The exercise of an additional option issued in
accordance with the "reload" feature will reduce the total number of shares
eligible for award under the stock option plan.
The Company has an Employee Stock Purchase Plan (the "ESPP"). A total
of 200,000 shares of the Company's authorized but unissued common stock has been
made available under the ESPP. The ESPP allows eligible employees to purchase
shares of the Company's stock at a discount of 15% of the beginning-of-period or
end-of-period (each period being the first and second six calendar months) fair
market value of the stock, whichever is lower. Eligibility under the ESPP is
determined based on standard weekly work hours and tenure with the Company, and
eligible employees are limited to a maximum contribution of $400 per payroll
period toward the purchase of the Company's stock. Under the ESPP, the Company
sold 10,101, 7,528, and 5,200 shares to employees in 2002, 2001 and 2000,
respectively. The Company applies APB 25 in accounting for the ESPP. The pro
forma effect on the Company's net income and earnings per share had compensation
cost been determined under SFAS 123 was deemed immaterial in 2002, 2001 and
2000.
11. Benefit Plans
The Company currently maintains a noncontributory defined benefit
pension plan (the "Pension Plan") covering substantially all full-time employees
of Radian Group, Radian Guaranty and RadianExpress. Until its termination
October 31, 2002, Financial Guaranty maintained a defined benefit pension plan
("Financial Guaranty Pension Plan") for the benefit of all eligible employees.
The Company recorded a gain of $3.0 million related to the termination of this
plan. Employers' contributions were based upon a fixed percentage of employee
salaries at the discretion of Financial Guaranty. Financial Guaranty became a
participating employer under the Pension Plan effective November 1, 2002. The
Company granted past service credit for eligibility and vesting purposes under
the Pension Plan for all such service credited under the Financial Guaranty
Pension Plan on behalf of the eligible employees of Radian Re who were active
participants in the Financial Guaranty Pension Plan prior to its termination and
who became participants in the Pension Plan effective November 1, 2002.
Retirement benefits are a function of the years of service and the level of
compensation. Assets of the plan are allocated in a balanced fashion with
approximately 40% in fixed income securities and 60% in equity securities.
On August 6, 2002, the board of directors of the Company approved
amendments to the Pension Plan to (i) revise the Pension Plan's definition of
"Early Retirement Date" effective with respect to participants who earn an hour
of service on or after January 1, 2002, and (ii) include such mandatory changes
required under the Economic Growth and Tax Relief Reconciliation Act of 2001.
The board also amended the Pension Plan to increase the plan's normal retirement
benefit formula with respect to participants who earn an hour of service after
January 1, 2003.
The Company also provides a nonqualified executive retirement plan
(the "SERP") covering certain key executives designated by the board of
directors. Under this plan, participants are eligible to receive benefits in
addition to those paid under the Pension Plan if their base compensation is in
excess of the current IRS compensation limitation for the Pension Plan.
Retirement benefits under the SERP are a function of the years of service and
the level of compensation and are reduced by any benefits paid under the Pension
Plan. Financial Guaranty also maintained a non-qualified restoration plan (the
"Restoration Plan") for eligible employees, which was frozen effective October
31, 2002. The Company recorded a gain
36
of $2.3 million related to the curtailment of this plan. Participants in the
Restoration Plan began participating in the Company's SERP effective November 1,
2002.
In addition to providing pension benefits, the Company provides
certain healthcare and life insurance benefits to retired employees of Radian
Guaranty and Radian Group who were hired before January 1, 1990 under a
postretirement welfare plan (the "Postretirement Welfare Plan"). The Company
accrues the estimated cost of retiree medical and life benefits over the period
during which employees render the service that qualifies them for benefits. All
of the Company's plans together are referred to in the tables below as the
"Radian Plans."
37
The funded status of the Pension Plan and SERP, the Postretirement
Welfare Plan, and the Financial Guaranty Pension Plan and Restoration Plan were
as follows (in thousands):
Radian Plans Pension Plan/SERP Postretirement Welfare Plan
----------------- ---------------------------
2002 2001 2002 2001
------- ------- ----- -----
Change in Benefit Obligation
Benefit obligation at beginning of year $12,780 $ 9,302 $ 444 $ 363
Service cost 1,702 1,376 10 14
Interest cost 864 744 26 28
Increase due to Plan amendments 237 564 -- 41
Plan participants' contributions -- -- 11 10
Actuarial loss (gain) 141 953 (57) 7
Benefits paid (116) (159) (19) (19)
------- ------- ----- -----
Benefit obligation at end of year $15,608 $12,780 $ 415 $ 444
------- ------- ----- -----
Change in Plan Assets
Fair value of plan assets at beginning $ 6,033 $ 5,103 $ -- $ --
of year
Actual return on plan assets (691) (437) -- --
Employer contributions 1,000 1,526 8 9
Plan participants' contributions -- -- 11 10
Benefits paid (116) (159) (19) (19)
------- ------- ----- -----
Fair value of plan assets at end of year $ 6,226 $ 6,033 $ -- $ --
------- ------- ----- -----
Underfunded status of the plan $(9,382) $(6,747) $(415) $(444)
Unrecognized prior service cost 1,277 1,197 (199) (153)
Unrecognized net actuarial loss (gain) 3,918 2,609 (75) (81)
------- ------- ----- -----
Accrued benefit cost $(4,187) $(2,941) $(689) $(678)
======= ======= ===== =====
Financial Guaranty Plan Financial Guaranty Pension
Plan/Restoration Plan
--------------------------
2002 2001
-------- --------
Change in Benefit Obligation
Benefit obligation at beginning of period $ 17,762 $ 14,431
Service cost 1,299 2,531
Interest cost 777 1,060
Curtailments/settlements (12,638) (771)
Actuarial loss -- 1,563
Benefits paid (532) (1,052)
-------- --------
Benefit obligation at end of year $ 6,668 $ 17,762
-------- --------
Change in Plan Assets
Fair value of plan assets at beginning of period $ 3,220 $ 3,551
Actual return on plan assets 1,161 (1,250)
Employer contributions 6,340 1,311
Benefits paid (5,648) (392)
-------- --------
Fair value of plan assets at end of year $ 5,073 $ 3,220
-------- --------
Underfunded status of the plan $ (1,596) $(14,542)
Unrecognized transition obligation -- 8
Unrecognized prior service cost -- 2,218
Unrecognized net actuarial (gain) loss (393) 386
-------- --------
Accrued benefit cost $ (1,989) $(11,930)
======== ========
38
Assumptions used to determine net pension and net periodic
postretirement benefit costs are as follows:
Postretirement
Radian Plans Pension Plan/SERP Welfare Plan
------------------ ------------------
2002 2001 2000 2002 2001 2000
---- ---- ---- ---- ---- ----
Weighted average assumptions
as of December 31:
Discount rate 6.75% 7.00% 7.50% 7.00% 7.00% 7.25%
Expected return on plan assets 8.50% 8.50% 8.50% -- -- --
Rate of compensation increase 4.50% 6.00% 6.00% -- -- --
Financial
Guaranty
Pension Plan/
Restoration
Financial Guaranty Plan Plan
------------
2002 2001
---- ----
Weighted average assumptions as of December 31:
Discount rate 6.25% 7.00%
Expected return on plan assets 8.50% 8.50%
Rate of compensation increase 6.00% 6.00%
Due to the nature of the Postretirement Welfare Plan, no increase is
assumed in the Company's obligation due to any increases in the per capita cost
of covered healthcare benefits.
In addition to pension benefits, Financial Guaranty provides certain
healthcare benefits for retired employees under a postretirement medical plan
(the "Enhance Postretirement Medical Plan"). The plan was frozen effective
August 31, 2002 so that only Financial Guaranty employees hired before February
2, 1990 are eligible for the retirement benefits available under this plan, and
the Company recorded a gain of approximately $700,000 on the curtailment of this
plan. The postretirement benefit cost for 2002 was a credit of $335,000 due to
the curtailment of the Enhance Postretirement Medical Plan while the expense for
2001 was $287,000. These amounts include service cost, interest cost and
amortization of the transition obligation and prior service cost.
At December 31, 2002 and 2001, the accumulated postretirement benefit
obligation under the Enhance Postretirement Medical Plan was $903,000 and
$1,296,000, respectively, and was not funded. At December 31, 2002, the discount
rate used in determining the accumulated postretirement benefit obligation was
7.0% and the healthcare trend was 9.0 %, graded to 5.5 % after 8 years.
In addition to the Pension Plan, the SERP and the Postretirement
Welfare Plan, the Company also maintains a Savings Incentive Plan, which covers
substantially all full-time and all part-time employees of Radian Group, Radian
Guaranty, RadianExpress and, effective January 1, 2003, all employees of Radian
Reinsurance, employed for a minimum of 90 consecutive days. Participants can
contribute up to 15% of their base earnings as pretax contributions. The Company
will match at least 25% of the first 5% of base earnings contributed in any
given year. These matching funds are subject to certain vesting requirements.
The expense to the Company for matching funds for the years ended December 31,
2002, 2001 and 2000 was $1,414,000, $1,511,000, and $1,094,000, respectively.
Until its termination December 31, 2002, Financial Guaranty had a
savings incentive plan. Under this plan, employees of Financial Guaranty could
contribute up to 15% of their base earnings as pretax contributions. Financial
Guaranty would match 50% of the first 6% of base salary made to the plan by
eligible employees. The expense to Financial Guaranty in 2002 and 2001, since
acquisition, was $176,000 and $219,000, respectively. Effective January 1, 2003,
Financial Guaranty's savings incentive plan participants became part of the
Company's Savings Incentive Plan.
12. Commitments and Contingencies
39
The U.S. Department of Housing and Urban Development ("HUD") has
proposed a rule under the Real Estate Settlement Procedures Act ("RESPA") to
create an exemption from the provisions of RESPA that prohibit the giving of any
fee, kickback or thing of value pursuant to any agreement or understanding that
real estate settlement services that will be referred. The proposed rule would
make the exemption available to lenders that, at the time a borrower submits a
loan application, give the borrower a firm, guaranteed price for all settlement
services associated with the loan. Mortgage insurance is currently included in
the proposed rule as one of these settlement services. HUD is currently
considering comments to the proposed rule, and is not expected to finalize the
rule until the summer of 2003. The rule would not be effective until a year
after it is finalized. If the rule is implemented, the premiums charged for
mortgage insurance could be affected. As the final rule has not been issued,
management is unable to determine what impact, if any, it will have on the
Company.
In December 2000, a complaint seeking class action status on behalf of
a nationwide class of home mortgage borrowers was filed against the Company (and
certain of its mortgage insurance subsidiaries) in the United States District
Court for the Middle District of North Carolina (Greensboro Division); in
February 2001 a complaint seeking class action status on behalf of similar
plaintiffs represented by Texas counsel was filed against the Company (and
certain of its mortgage insurance subsidiaries) in the United States District
Court for the Eastern District of Texas. The Radian defendant entities in both
cases are collectively referred to here as "Radian." The complaints allege that
Radian violated Section 8 of the Real Estate Settlement Procedures Act
("RESPA"), which generally prohibits the giving of any fee, kickback or thing of
value pursuant to any agreement or understanding that real estate settlement
services will be referred. The complaints assert that the pricing of pool
insurance, captive reinsurance, contract underwriting, performance notes and
other, unidentified "structured transactions," should be interpreted as imputed
kickbacks made in exchange for the referral of primary mortgage insurance
business, which, according to the complaints, is a settlement service under
RESPA. The complaints seek injunctive relief and damages of three times the
amount of any mortgage insurance premiums paid by persons who were referred to
Radian pursuant to the alleged agreement or understanding.
On September 10, 2002, Radian's motion to dismiss the Texas lawsuit
was granted; the plaintiffs are appealing that decision. The plaintiffs in the
North Carolina lawsuit are represented by the same group of plaintiffs' lawyers
who filed six similar lawsuits in federal court in Georgia against other
providers of primary mortgage insurance. Four of the Georgia lawsuits were
settled; two are currently in discovery. In November 2002, contrary to Radian's
success in Texas described above, the Georgia court ruled against one of the
defendants on certain preliminary motions substantially similar to those on
which Radian prevailed in Texas; however, in February 2003, the Georgia court
refused to certify a class in both of the lawsuits before it. Radian's North
Carolina case is in the motions and early discovery phase, and Radian has filed
a motion to dismiss. Because this case is still developing, it is not possible
to evaluate the outcome, to determine the effect, if any, that the Texas or
Georgia court rulings could have on this case, or to estimate the amount or
range of potential loss.
In addition to the above, the Company is involved in certain
litigation arising in the normal course of its business. The Company is
contesting the allegations in each such other action and believes, based on
current knowledge and consultation with counsel, that the outcome of such
litigation will not have a material adverse effect on the Company's consolidated
financial position or results of operations.
The Company has guaranteed payments of up to $25.0 million of a
revolving credit facility issued to Sherman, a 41.5%-owned affiliate of
Financial Guaranty. As of December 31, 2002, there was $1.0 million outstanding
under this facility.
Mortgage Insurance utilizes its underwriting skills to provide an
outsource contract underwriting service to its customers. Mortgage Insurance
often gives recourse to its customers on loans it underwrites for compliance. If
the loan does not meet agreed-upon guidelines and is not salable in the
secondary market for that reason, Mortgage Insurance agrees to remedy the
situation either by placing mortgage insurance coverage on the loan, by
purchasing the loan, or indemnifying the loan against future loss. Purchasing
the
40
loan would subject the Company to credit risk and interest rate risk. During
2002, less than 1% of all loans were subject to these remedies and the costs
associated with these remedies were immaterial.
The Company is a party to reinsurance agreements with the four largest
primary financial guaranty insurance companies. The Company's facultative and
treaty agreements are generally subject to termination (i) upon written notice
(ranging from 90 to 120 days) prior to the specified deadline for renewal, (ii)
at the option of the primary insurer if the Company fails to maintain certain
financial, regulatory and rating agency criteria which are equivalent to or more
stringent than those the Company is otherwise required to maintain for its own
compliance with New York insurance law and to maintain a specified financial
strength rating for the particular insurance subsidiary or (iii) upon certain
changes of control of the Company. Upon termination under the conditions set
forth in (ii) and (iii) above, the Company may be required (under some of its
reinsurance agreements) to return to the primary insurer all unearned premiums,
less ceding commissions, attributable to reinsurance ceded pursuant to such
agreements. Upon the occurrence of the conditions set forth in (ii) above,
whether or not an agreement is terminated, the Company may be required to obtain
a letter of credit or alternative form of security to collateralize its
obligation to perform under such agreement or it may be obligated to increase
the level of ceding commission paid. See note 16 for additional information
regarding the potential impact that a ratings downgrade from S&P or Moody's may
have on the Company's financial guaranty reinsurance business.
The Company leases office space for use in its operations. Net rental
expense in connection with these leases total $7,086,000, $6,155,000, and
$2,970,000 in 2002, 2001, and 2000, respectively. The commitment for
noncancelable operating leases in future years is as follows (in thousands):
2003 $ 10,850
2004 10,864
2005 10,489
2006 9,679
2007 9,350
Thereafter 73,962
--------
$125,194
========
The commitment for noncancelable operating leases in future years has
not been reduced by future minimum sublease rental payments aggregating
approximately $39,519,000. A portion of these payments relate to subleases to
affiliates of the Company.
13. Quarterly Financial Data (Unaudited)
(in thousands, except per-share information) 2002 Quarter
----------------------------------------------------
First Second Third Fourth Year
-------- -------- -------- -------- --------
Net premiums written $224,638 $237,610 $234,614 $258,057 $954,919
Net premiums earned 209,189 211,031 209,512 217,393 847,125
Net investment income 42,753 44,485 45,503 46,100 178,841
Equity in net income of affiliates 18,620 26,774 12,994 23,361 81,749
Provision for losses 57,427 57,576 57,923 70,406 243,332
Policy acquisition and other operating expenses 68,192 70,103 63,759 74,077 276,131
Net gains (losses) (2,621) (3,302) 595 2,801 (2,527)
Net income 103,933 108,922 106,561 107,753 427,169
Net income per share (1) (2) (3) $ 1.08 $ 1.12 $ 1.07 $ 1.14 $ 4.41
Weighted average shares outstanding (1) (3) 95,881 96,387 96,035 94,521 95,706
2001 Quarter
----------------------------------------------------
First Second Third Fourth Year
-------- -------- -------- -------- --------
Net premiums written $160,249 $199,203 $183,938 $240,254 $783,644
41
Net premiums earned 155,763 179,241 180,490 200,386 715,880
Net investment income 28,020 39,455 39,956 40,056 147,487
Equity in net income of affiliates 12,044 12,760 7,389 9,116 41,309
Provision for losses 49,272 52,310 50,968 55,586 208,136
Policy acquisition and other operating expenses 40,998 54,938 54,476 66,366 216,778
Net gains (losses) 1,823 748 (1,299) (225) 1,047
Net income 80,157 92,677 91,532 96,053 360,419
Net income per share (1) (2) (3) $ 0.96 $ 0.97 $ 0.96 $ 1.00 $ 3.88
Weighted average shares outstanding (1) (3) 83,038 94,854 94,784 95,157 91,958
(1) Diluted net income per share and average shares outstanding per
SFAS No. 128, "Earnings Per Share." See note 1.
(2) Net income per share is computed independently for each period
presented. Consequently, the sum of the quarters may not equal the total net
income per share for the year.
(3) All share and per share amounts have been restated to reflect a
2-for-1 stock split in 2001. See note 1.
14. Fair Value of Financial Instruments
The fair value of a financial instrument is the current amount that
would be exchanged between two willing parties, other than in a forced
liquidation. Fair value is best determined based upon quoted market prices.
However, in many instances, there are no quoted market prices available. In
those cases, fair values are based on estimates using present value or other
valuation methodologies. Accordingly, the estimates presented herein are not
necessarily indicative of the amount the Company could realize in a current
market exchange. The use of different market assumptions or estimation
methodologies could have a material effect on the estimated fair value amounts.
Fixed Maturity and Equity Securities - The fair values of fixed
maturity securities and equity securities are based on quoted market prices or
dealer quotes. For investments that are not publicly traded, management has made
estimates of fair value that consider that issuers' financial results,
conditions and prospects, and the values of comparable public companies.
Trading Securities - The fair values of trading securities are based
on quoted market prices, dealer quotes or estimates using quoted market prices
for similar securities.
Short-Term Investments - Fair values of short-term investments are
assumed to equal amortized cost.
Other Invested Assets - The fair value of other invested assets,
residential mortgage-backed securities, is based on the present value of the
estimated net future cash flows, including annual distributions and net cash
proceeds from the exercise of call rights, using relevant market information.
Unearned Premiums - In the mortgage insurance business, as the
majority of the premiums received are cash basis, the fair value is assumed to
equal the book value. The fair value of unearned premiums in the financial
guaranty insurance business, net of prepaid reinsurance premiums, is based on
the estimated cost of entering into a cession of the entire portfolio with
third-party reinsurers under current market conditions, adjusted for ceding
commissions based on current market rates.
Reserve for Losses - The carrying amount is a reasonable estimate of
the fair value.
Long-Term Debt - The fair value is estimated based on the quoted market
prices for the same or similar issue or on the current rates offered to the
Company for debt of the same remaining maturities.
42
Redeemable Preferred Stock - The redeemable preferred stock was valued
at the redemption value at the mandatory redemption date.
December 31
-------------------------------------------------
2002 2001
----------------------- -----------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
---------- ---------- ---------- ----------
Assets:
Fixed maturity and equity securities $3,973,443 $3,997,086 $3,129,718 $3,149,482
Trading securities 37,619 37,619 21,659 21,659
Short-term investments 180,919 180,919 210,788 210,788
Other invested assets 8,346 8,346 7,310 7,310
Liabilities:
Unearned premiums 618,050 528,652 513,932 456,018
Reserve for losses 624,577 624,577 588,643 588,643
Short-term and long-term debt 544,145 587,402 324,076 346,333
Redeemable preferred stock -- -- 40,000 40,000
15. Capital Stock
On September 24, 2002, the Company announced that its board of
directors had authorized the repurchase of up to 2.5 million shares of its
common stock on the open market. Shares will be purchased from time to time
depending on the market conditions, share price, and other factors. These
purchases will be funded from available working capital. At December 31, 2002,
1.4 million shares had been repurchased under this program at a total price of
approximately $45.1 million. At December 31, 2002, there were 1.6 million
treasury shares held by the Company.
16. Other
On October 4, 2002, Standard & Poor's Rating Service, a division of
The McGraw-Hill Companies, Inc. ("S&P") announced that it had downgraded the
financial strength rating of Radian Re from "AAA" to "AA" (and, on the same
date, Fitch Rating Service ("Fitch") placed the "AAA" rating of Radian Re on
"negative watch" for possible downgrade). Radian Re and Radian Asset Assurance
are parties to numerous reinsurance agreements with primary insurers which grant
the primary insurers the right to recapture all of the business ceded to Radian
Re or Radian Asset Assurance under these agreements if the financial strength
rating of Radian Re or Radian Asset Assurance, as the case may be, is downgraded
below the rating levels established in the agreements, and, in some cases, to
increase the ceding commissions in order to compensate the primary insurers for
the decrease in credit the rating agencies allow the primary insurers for the
reinsurance provided by Financial Guaranty.
As a result of the downgrade by S&P, the primary insurers have the
right described above to recapture the financial guaranty reinsurance ceded to
Radian Re, including substantially all of the unearned premium reserves of
Radian Re. As described above, the primary insurers also have the right to
increase ceding commissions charged to Radian Re for cessions, including the
right to a cash refund of a portion of the unearned premium reserves previously
ceded to Radian Re reflecting the increased ceding commissions. In addition, the
primary insurers may seek amendments to their agreements with Radian Re to
revise ceding commissions or premiums payable or to recapture only a portion of
the business ceded to Radian Re in a given year. Although Radian Re may be able
to offset some of the effects of increased ceding commissions or reduced
reinsurance premiums by posting collateral for the benefit of the reinsurers,
the S&P downgrade, or the exercise by primary insurers of their rights triggered
by the downgrade of Radian Re, could have a
43
material adverse effect on Radian Re's competitive position and/or its prospects
for future reinsurance opportunities. The Company cannot be certain that S&P or
Moody's will not make further revisions to Radian Re's or Radian Asset
Assurance's financial strength ratings which would trigger these rights of the
primary insurers.
44
REPORT ON MANAGEMENT'S RESPONSIBILITY
Management is responsible for the preparation, integrity and
objectivity of the consolidated financial statements and other financial
information presented in this annual report. The accompanying consolidated
financial statements were prepared in accordance with accounting principles
generally accepted in the United States of America, applying certain estimations
and judgments as required.
The Company's internal controls are designed to provide reasonable
assurance as to the integrity and reliability of the financial statements and to
adequately safeguard, verify and maintain accountability of assets. Such
controls are primarily based on established written policies and procedures and
are implemented by trained, skilled personnel with an appropriate segregation of
duties. These policies and procedures prescribe that the Company and all its
employees are to maintain the highest ethical standards and that its business
practices are to be conducted in a manner that is above reproach.
Deloitte & Touche LLP, independent auditor, is retained to audit the
Company's financial statements. Its accompanying report is based on audits
conducted in accordance with auditing standards generally accepted in the United
States of America, which include the consideration of the Company's internal
controls to establish a basis for reliance thereon in determining the nature,
timing and extent of audit tests to be applied.
The board of directors exercises its responsibility for these
financial statements through its Audit and Risk Management Committee, which
consists entirely of independent non-management board members. The Audit and
Risk Management Committee meets periodically with the independent auditor, both
privately and with management present, to review accounting, auditing, internal
controls and financial reporting matters.
Frank P. Filipps
Chairman and Chief Executive Officer
C. Robert Quint
Executive Vice President and Chief Financial Officer
John J. Calamari
Senior Vice President and Corporate Controller
45
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Radian Group Inc.
Philadelphia, Pennsylvania
We have audited the accompanying consolidated balance sheets of Radian
Group Inc. and subsidiaries (the "Company") as of December 31, 2002 and 2001,
and the related consolidated statements of income, changes in common
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 2002. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States of America. Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly,
in all material respects, the financial position of Radian Group Inc. and
subsidiaries at December 31, 2002 and 2001, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 2002 in conformity with accounting principles generally accepted in the
United States of America.
Deloitte & Touche LLP
Philadelphia, Pennsylvania
February 28, 2003
46
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Safe Harbor Statement Under the Private Securities Litigation Reform Act of
1995:
This Annual Report contains "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. These
statements relate to analyses and other information that are based on the
Company's beliefs, assumptions, forecasts of future results, and current
expectations, estimates and projections about the markets and economy in which
the Company operates. Words such as "anticipate," "intend," "may," "expect,"
"believe," "should," "plan," "will" and "estimate" help identify forward-looking
statements. The following are some of the factors that could cause actual
outcomes to differ materially from the matters expressed or implied in the
Company's forward-looking statements:
. changes in the business practices of Fannie Mae and Freddie Mac, the
largest purchasers of mortgage loans insured by the Company;
. general economic developments such as extended national or regional
economic recessions (or expansions), business failures, material
changes in housing values, changes in unemployment rates, interest
rate changes or volatility, changes in investor perceptions of the
strength of private mortgage insurers or financial guaranty providers,
investor concern over the credit quality of municipalities and
corporations, and specific risks faced by the particular businesses,
municipalities or pools of assets covered by the Company's insurance;
. the loss of significant customers with whom the Company has a
concentration of its mortgage insurance and financial guaranty
insurance in force or the addition of new customers;
. economic changes in regions where the Company's mortgage insurance
risk is more concentrated;
. the potential for more severe losses or more frequent losses
associated with certain of the Company's products that are riskier
than traditional mortgage insurance and municipal guaranty insurance
policies, such as insurance on high-LTV, adjustable-rate mortgage and
non-prime mortgage loans, credit insurance on non-traditional mortgage
related assets such as second mortgages and manufactured housing,
credit enhancement of mortgage related capital market transactions,
guaranties on certain asset-backed transactions and securitizations,
guaranties on obligations under credit default swaps and trade credit
reinsurance;
. the potential to be committed to insure a material number of mortgage
loans with unacceptable risk profiles through the Company's delegated
underwriting program;
. material changes in persistency rates of the Company's mortgage
insurance policies caused by changes in refinancing activity,
appreciating or depreciating home values and changes in the mortgage
insurance cancellation requirements of mortgage lenders and investors;
. changed ability of the Company to recover amounts paid on defaulted
mortgages by taking title to a mortgaged property, due to a failure of
housing values to appreciate;
. downgrades of the insurance financial strength ratings assigned by the
major rating agencies to any of the Company's operating subsidiaries
at any time, which has occurred in the past;
. changes to mortgage insurance revenues due to intense competition from
others such as the Federal Housing Administration and Veterans
Administration or other private mortgage insurers, and from
alternative products such as "80-10-10 loan" structures used by
mortgage lenders or other forms of credit enhancement used by
investors;
47
. changes to financial guaranty revenues due to changes in competition
from other financial guaranty insurers, and from other forms of credit
enhancement such as letters of credit, guaranties and credit default
swaps provided by foreign and domestic banks and other financial
institutions;
. changes in the demand for private mortgage insurance caused by
legislative and regulatory changes such as increases in the maximum
loan amount that the Federal Housing Administration can insure;
. changes in claims against mortgage insurance products as a result of
aging of the Company's mortgage insurance policies;
. changes in the demand for financial guaranty insurance caused by
changes in laws and regulations affecting the municipal, asset-backed
and trade credit debt markets; and
. changes to the Company's ability to maintain sufficient reinsurance
capacity needed to comply with regulatory, rating agency and internal
single-risk retention limits as the Company's business grows, in a
reinsurance market that has recently become more concentrated.
Readers are also directed to other risks discussed in documents filed
by the Company with the Securities and Exchange Commission. Readers are
cautioned not to place undue reliance on the Company's forward-looking
statements, which speak only as of their respective dates.
2002 Compared to 2001
Results of Consolidated Operations
Net income for 2002 was $427.2 million or $4.41 per share compared to
$360.4 million or $3.88 per share for 2001. The 18.5% increase in net income was
primarily due to an increase in the Company's business volumes and the inclusion
of the results from the financial guaranty segment and the equity in net income
of affiliates component of the mortgage services segment for all of 2002,
compared to 10 months in 2001, as a result of the acquisition of Enhance
Financial Services Group Inc. ("EFSG") on February 28, 2001. Direct primary
insurance in force for the mortgage insurance business ("Mortgage Insurance"),
which includes the activities of Radian Guaranty Inc. ("Radian Guaranty"),
Amerin Guaranty Corporation ("Amerin Guaranty") and Radian Insurance Inc.
("Radian Insurance"), increased from $107.9 billion at December 31, 2001 to
$110.3 billion at December 31, 2002. Total net debt service outstanding (par
plus interest) on transactions insured by Financial Guaranty increased from
$97.9 billion at December 31, 2001, to $104.8 billion at December 31, 2002. The
financial guaranty insurance business ("Financial Guaranty") is conducted
primarily through two insurance subsidiaries, Radian Asset Assurance Inc.
("Radian Asset Assurance," formerly Asset Guaranty Insurance Company) and Radian
Reinsurance Inc. ("Radian Reinsurance," formerly Enhance Reinsurance Company).
These increases in business volumes produced increases in written and earned
premiums and investment income. In addition, equity in net income of affiliates
increased by $40.4 million or almost 98% in 2002 to $81.7 million from $41.3
million in 2001, primarily due to strong results at Credit-Based Asset Servicing
and Securitization LLC ("C-BASS") and Sherman Financial Group LLC ("Sherman").
Partially offsetting these increases were increases in the provision for losses,
policy acquisition costs, other operating expenses and interest expense to
support the business growth.
Consolidated earned premiums for 2002 of $847.1 million increased
$131.2 million or 18.3% from $715.9 million in 2001. Mortgage Insurance
contributed $51.1 million of this increase and Financial Guaranty contributed
$80.1 million. Net investment income of $178.8 million for 2002 increased $31.3
million or 21.2% from $147.5 million in 2001. This increase was primarily due to
a large increase in the investment portfolio balance as a result of continued
operating cash flows, the proceeds from the issuance of $220 million of
convertible debt in January 2002, as well as a full year's use of the proceeds
from the $250 million debt offering in May 2001. Other income increased slightly
to $44.4 million for 2002 from $42.5 million in 2001.
48
The provision for losses was $243.3 million for 2002, an increase of
$35.2 million or 16.9% from $208.1 million in 2001. Approximately $15.3 million
of this was related to Mortgage Insurance to support an increase in
delinquencies and claims payments, and $19.9 million was due to loss reserve
increases at Financial Guaranty to support business growth and an increase in
trade credit reinsurance claims. The provision for losses in the fourth quarter
of 2002 increased $14.8 million from the comparable period of 2001 for the same
reasons. Policy acquisition costs for 2002 were $100.8 million, up $16.5 million
or 19.6% from $84.3 million in 2001. Other operating expenses of $175.3 million
for 2002 increased $42.8 million or 32.3% from $132.5 million in 2001. This was
primarily due to increases in salaries and benefits related to an increase in
head count to support higher volumes, increased professional fees, fees for
outside services and increased depreciation and software costs due to increased
capital expenditures in the information technology and infrastructure areas. The
increase in capital expenditures began in late 2001 and will continue at least
through 2003. Interest expense of $28.8 million for 2002 increased from $17.8
million in 2001 as a result of the issuance of $220 million of convertible debt
in January 2002 and $250 million of long-term debt in May 2001.
The Company's effective tax rate was 29.0% for 2002 compared to 28.7%
for 2001.
Mortgage Insurance - Results of Operations
Net income for 2002 was $293.8 million, an increase of $13.8 million
or 4.9% from $280.0 million in 2001. This increase resulted from increases in
earned premiums and investment income, partially offset by increases in the
provision for losses, policy acquisition and other operating expenses and
interest expense.
Mortgage Insurance is dependent on a small number of lenders for
providing a substantial portion of its business. Mortgage Insurance's top ten
lenders were responsible for 49.3% of the direct primary risk in force at
December 31, 2002. The top ten lenders were also responsible for 46.5% of
primary new insurance written in 2002. The highest state concentration of risk
is California. At December 31, 2002, California accounted for 16.2% of Mortgage
Insurance's total direct primary insurance in force and 18.7% of Mortgage
Insurance direct primary new insurance written for 2002. The largest single
customer of Mortgage Insurance (including branches and affiliates of such
customer), measured by new insurance written, accounted for 8.1% of new
insurance written during 2002, compared to 12.6% in 2001.
The concentration of business with lenders may increase or decrease as
a result of many factors. These lenders may reduce the amount of business
currently given to Mortgage Insurance or cease doing business with it
altogether. Mortgage Insurance's master policies and related lender agreements
do not, and by law cannot, require its lenders to do business with it. The loss
of business from a major lender could materially adversely affect Mortgage
Insurance's and the Company's business and financial results.
Primary new insurance written during 2002 was $48.8 billion, an 8.9%
increase from $44.8 billion written in 2001. This increase in Mortgage
Insurance's primary new insurance written volume in 2002 was primarily due to a
large increase in the mortgage origination market, as well as, an increase in
insurance written through structured transactions. The industry experienced an
approximate 20% increase in new insurance written during 2002, compared to 2001.
The Company's market share of the industry based on new insurance written was
14.4% compared to 15.6% in 2001. During 2002, Mortgage Insurance wrote $11.8
billion in structured transactions compared to $8.7 billion in 2001. The
Company's participation in the structured transaction market is likely to vary
from year to year as the Company competes with other mortgage insurers, as well
as capital market executions for these transactions. During 2002, Mortgage
Insurance wrote $173.6 million of pool insurance risk compared to $255.4 million
in 2001.
Mortgage Insurance's volume in 2002 continued to be impacted by low
interest rates that affected the entire mortgage industry. The continued low
interest rate environment caused refinancing activity to remain high throughout
2002, and contributed to relatively strong new insurance volume in 2002.
Mortgage Insurance's refinancing activity as a percentage of primary new
insurance written was 40.5% for 2002
49
compared to 40.3% in 2001. The persistency rate, which is defined as the
percentage of insurance in force that remains on our books after any 12 month
period, was 57.0% for the twelve months ended December 31, 2002, as compared to
63.3% for the same period of 2001. This decrease was consistent with the
increasing level of refinancing activity, which caused the cancellation rate to
increase. The expectation for 2003 is strong volume for the first half of the
year and continued low persistency followed by a decrease in refinancing
activity during the second half of the year.
Net premiums earned in 2002 were $660.5 million, a $51.1 million or
8.4% increase from $609.4 million for 2001. However, the increase occurred in
the first half of the year and the trend decreased significantly in the second
half of the year. This increase included a slightly higher percentage of
non-prime business, which has higher premium rates, commensurate with the
increased level of risk associated with such insurance. The insurance in force
growth resulting from strong new insurance volume in 2002 was offset by a
decrease in persistency levels. These lower persistency levels will impact
premiums earned in future periods to the extent that insurance in force growth
slows. Direct primary insurance in force increased to $110.3 billion at December
31, 2002 from $107.9 billion a year ago. Total pool risk in force was $1.7
billion at December 31, 2002, compared to $1.6 billion at December 31, 2001.
The Office of Federal Housing Enterprise Oversight issued new
risk-based capital regulations for Fannie Mae and Freddie Mac, which took effect
September 13, 2002. The most relevant provision to the Company is a distinction
between "AAA"-rated insurers and "AA"-rated insurers. The new regulations would
impose a credit haircut that Fannie Mae and Freddie Mac are given for exposure
ceded to "AAA" insurers by 3.5% and to "AA" insurers by 8.75%. Currently, Radian
Guaranty is rated "AA"; two other mortgage insurance providers are rated "AAA."
The provisions of the new regulations are to be phased in over a ten-year period
commencing on the effective date of the regulation. The Company believes that
this distinction will not have a material effect on its business.
The Company insures non-traditional loans, specifically Alternative A
and A minus loans (collectively, referred to as "non-prime" business).
Alternative A borrowers have a similar credit profile to the Company's prime
borrowers, but these loans are underwritten with reduced documentation and
verification of information. The Company typically charges a higher premium rate
for this business due to the reduced documentation, but the Company 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 that
are less stringent than standard credit guidelines. To compensate for this
additional risk, the Company receives a higher premium for insuring this
product, which the Company believes is commensurate with the additional default
risk. During 2002, non-prime business accounted for $16.2 billion or 33.1% of
Mortgage Insurance's new primary insurance written compared to $14.3 billion or
31.9% for the same period in 2001. Much of this business was written in the form
of structured transactions. At December 31, 2002, non-prime insurance in force
was $25.6 billion or 23.2% of total primary insurance in force as compared to
$18.2 billion or 16.8% of primary insurance in force a year ago. Of the $16.2
billion of non-prime business in 2002, $11.8 billion or 72.8% was Alternative A.
The Company anticipates that the mix of non-prime insurance in force could
gradually increase but will stay below a targeted level of 30%.
The Company insures mortgage related assets in a Pennsylvania
domiciled insurer, Radian Insurance. Radian Insurance is rated "AA" by Standard
& Poor's Insurance Rating Service and Fitch Ratings and "Aa3" by Moody's
Investors Service and was formed to write credit insurance and financial
guaranty insurance on 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%. In October 2001, Radian Insurance entered into
a reinsurance agreement with one of its affiliates, Radian Asset Assurance, for
a substantial part of its business. Because most Financial Guaranty business on
mortgage-related assets is now written in Radian Asset Assurance, the business
written by Radian Insurance has been reduced in 2002.
Mortgage Insurance and other companies in 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
50
lender establishes 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 2002,
premiums ceded under captive reinsurance arrangements were $57.1 million, or
8.3% of total premiums earned during 2002, as compared to $52.8 million, or 8.4%
of total premiums earned for the same period of 2001. New primary insurance
written under captive reinsurance arrangements was $17.0 billion, or 34.8% of
total new primary insurance written in 2002 as compared to $14.7 billion, or
32.9% of total new primary insurance written in 2001.
Net investment income for 2002 was $107.1 million, a $10.0 million or
10.3% increase compared to $97.1 million in 2001. This increase was a result of
continued growth in invested assets, primarily due to positive operating cash
flows during 2002 and the allocation of interest income from net financing
activities. This was offset by declining investment yields that were experienced
throughout the year. The Company has continued to invest some of its net
operating cash flow in tax-advantaged securities, primarily municipal bonds,
although the Company's investment policy allows the purchase of various other
asset classes including common stock and convertible securities. The Company's
common equity exposure is targeted at a maximum of 5% of the investment
portfolio's market value, while the investment grade convertible securities and
investment-grade taxable bond exposure are each targeted not to exceed 10%.
The provision for losses was $194.5 million for 2002, an increase of
$15.4 million or 8.6% from $179.1 million in 2001. 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 a policy.
Historically, claim activity has reached its highest level in the third through
fifth years after the year of loan origination. Approximately 70.7% of the
primary risk in force and approximately 31.9% of the pool risk in force at
December 31, 2002 had not yet reached its highest claim frequency years. The
combined default rate for both primary and pool insurance, excluding second lien
insurance coverage, was 2.8% at December 31, 2002, compared to 2.2% at December
31, 2001, while the default rate on the primary business was 4.1 % at December
31, 2002 compared to 3.5% at December 31, 2001. The change in the default rate
on the primary business was caused principally by a 230 basis point increase in
the delinquency rate on the non-prime business as a result of that business
seasoning, with the delinquency rate on the prime business down slightly from
year to year as described in the following tables. A strong economy generally
results in better loss experience and a decrease in the overall level of losses.
A continued weakening of the economy could negatively impact the Company's
overall default rates, which would result in an increase in the provision for
losses.
The total number of defaults increased from 41,147 at December 31,
2001 to 43,773 at December 31, 2002. The average loss reserve per default
decreased from $11,291 at the end of 2001 to $11,073 at December 31, 2002. The
slowing of the economy contributed to the rising level of mortgage
delinquencies. The loss reserve as a percentage of risk in force was 1.7% at
December 31, 2002, up from 1.6% at December 31, 2001. The non-prime mortgage
insurance business has experienced a consistent increase in the number of
defaults. Although the default rate on this business is higher than on the prime
book of business, it is within Radian's 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 non-prime loans in default at
December 31, 2002 was 14,305, which represented 40% of the total primary loans
in default, compared to 7,704 non-prime loans in default at December 31, 2001,
which represented 24.8% of the total primary loans in default. The default rate
on the Alt A business was 5.2% at December 31, 2002 compared to 4.5% at December
31, 2001. The default rate on the A minus and below loans was 11.3% at December
31, 2002 compared to 6.4% at December 31, 2001. The default rates are within
management's expectations. The default rate on the prime business was 3.1% at
December 31, 2002 and 2001.
Direct claims paid for 2002 were $165.0 million compared to $97.7
million for 2001. The severity of loss payments has increased due to deeper
coverage amounts and larger loan balances. In addition, claims paid in 2002 have
been impacted by the rise in delinquencies in 2001 that have proceeded to
foreclosure. The disproportionately higher incidence of claims in Georgia and
Utah is directly related to questionable property value estimates in those
states. The Company's risk management department
51
identified these issues over a year ago and has put into place several property
valuation checks and balances to prevent these issues from recurring. Further,
these same techniques are being applied to all mortgage insurance transactions.
The Company expects this higher incidence of claims in Georgia and Utah to
continue until loans originated in Georgia and Utah prior to the implementation
of these preventive measures become sufficiently seasoned. The Company
anticipates that claim payments will continue to increase in 2003.
The following table provides selected information as of and for the
periods indicated for the Mortgage Insurance segment:
Year Ended December 31
----------------------
($ thousands, unless specified otherwise) 2002 2001
-------- --------
Provision for losses $194,486 $179,146
Reserve for losses $484,705 $465,444
Primary Insurance
Prime:
Number of insured loans 698,910 752,519
Number of loans in default 21,483 23,312
Percentage of total loans in default 3.07% 3.10%
Alt A:
Number of insured loans 102,839 59,778
Number of loans in default 5,300 2,666
Percentage of total loans in default 5.15% 4.46%
A Minus and below:
Number of insured loans 79,871 79,396
Number of loans in default 9,005 5,038
Percentage of loans in default 11.27% 6.35%
Total:
Number of insured loans 881,620 891,693
Number of loans in default 35,788 31,016
Percentage of loans in default 4.06% 3.48%
Direct claims paid:
Prime $ 89,095 $ 64,157
Non-prime
Alt A 27,281 5,882
A minus and below 32,114 19,083
Seconds 16,502 8,569
-------- --------
Total $164,992 $ 97,691
Claims Paid:
Georgia $ 12,731 $ 4,459
Utah 9,895 4,817
Texas 9,770 4,032
Florida 8,864 8,701
California 8,691 6,889
Percentage of total claims paid:
Georgia 7.7% 4.6%
Utah 6.0 4.9
Texas 5.9 4.1
52
Florida 5.4 8.9
California 5.3 7.1
Year Ended December 31
----------------------
2002 2001
-------- --------
Risk in Force: ($millions)
California $ 4,308 $ 4,253
Florida 2,084 1,927
New York 1,647 1,659
Texas 1,379 1,344
Georgia 1,196 1,148
Total Risk in Force: $ 26,273 $ 26,004
Percentage of total risk in force:
California 16.4% 16.4%
Florida 7.9 7.4
New York 6.3 6.4
Texas 5.2 5.2
Georgia 4.6 4.4
New insurance written: ($millions)
Prime $ 32,603 $ 30,481
Alt A 11,771 8,717
A minus and below 4,393 5,556
-------- --------
Total $ 48,767 $ 44,754
Primary risk written ($millions) $ 12,063 $ 10,975
Direct primary insurance in force $110,273 $107,918
Pool Insurance: ($millions)
Pool risk written $ 174 $ 255
GSE pool risk in force $ 1,218 $ 1,222
Total pool risk in force $ 1,732 $ 1,571
Underwriting and other operating expenses were $175.9 million in 2002,
an increase of 13.9% compared to $154.4 million for 2001. These expenses consist
of policy acquisition expenses, which relate directly to the acquisition of new
business and other expenses, which primarily represent contract underwriting
expenses, overhead and administrative costs. Policy acquisition costs were $66.8
million in 2002, an increase of 7.0% from $62.4 million in 2001. The
amortization of these expenses is related to the recognition of gross profits
over the life of the policies. Much of the amortization in the current year
represents costs that were expended in 2001. Other operating expenses were
$109.0 million for 2002, an increase of 18.5% from $92.0 million for 2001. This
reflects an increase in expenses associated with the Company's technological,
administrative and support functions. Contract underwriting expenses for 2002,
included in other operating expenses, were $46.2 million as compared to $44.6
million in 2001, an increase of 3.6%. Other income, which primarily includes
income related to contract underwriting services, was $20.4 million for 2002 and
2001. During 2002, loans underwritten via contract underwriting accounted for
30.4% of applications, 28.7% of commitments, and 23.0% of certificates issued by
Mortgage Insurance as compared to 34.5%, 32.0% and 25.8%, respectively, in 2001.
Interest expense for 2002 and 2001 was $17.2 million and $10.5
million, respectively. This primarily represented the allocation of interest on
the Company's long-term debt issued during 2001 and 2002.
The effective tax rate for 2002 was 27.6% compared to 27.9% in 2001.
The tax rate is lower then the statutory rate of 35% primarily due to the
investment in tax advantaged securities.
53
The U.S. Department of Housing and Urban Development ("HUD") has
proposed a rule under the Real Estate Settlement Procedures Act ("RESPA") to
create an exemption from the provisions of RESPA that prohibit the giving of any
fee, kickback or thing of value pursuant to any agreement or understanding that
real estate settlement services will be referred. The proposed rule would make
the exemption available to lenders that, at the time a borrower submits a loan
application, give the borrower a firm, guaranteed price for all the settlement
services associated with the loan. Mortgage insurance is currently included in
the proposed rule as one of these settlement services. HUD is currently
considering comments to the proposed rule, and is not expected to finalize the
rule until the summer of 2003. The rule would not be effective until a year
after it is finalized. If the rule is implemented, the premiums charged for
mortgage insurance could be affected. As the final rule has not yet been issued,
management is unable to determine what impact, if any, it will have on the
Company.
Financial Guaranty - Results of Operations
The financial guaranty insurance segment operations are conducted
through EFSG and primarily involve the direct insurance and reinsurance of
municipal bonds and asset-backed securities, and other structured financial
obligations, including credit default swaps and certain other financial guaranty
contracts. Financial guaranty and trade credit reinsurance (which protects
sellers of goods under certain circumstances against non-payment of the
receivables they hold from buyers of their goods) is assumed primarily from five
direct insurers. Radian Reinsurance currently derives substantially all of its
reinsurance premium revenues from four of these insurers. Approximately 32.9% of
total gross written premiums for Financial Guaranty were derived from those five
insurers in 2002. A substantial reduction in the amount of insurance ceded by
one or more of those five principal clients could have a material adverse effect
on Financial Guaranty's gross written premiums and, consequently, its results of
operations. The Company's trade credit reinsurance may cover receivables as to
which the buyer and seller are in the same country, as well as cross-border
receivables. In such cross-border transactions, the Company sometimes provides
coverage that extends to certain political risks, such as foreign currency
controls and expropriation, which could interfere with the payment by the buyer
of the goods that are the subject of the transaction being reinsured by the
Company.
On October 4, 2002, Standard & Poor's Rating Service, a division of
The McGraw-Hill Companies, Inc. ("S&P") announced that it had downgraded the
financial strength rating of Radian Reinsurance from "AAA" to "AA" (and, on the
same date, Fitch Rating Service ("Fitch") placed the "AAA" rating of Radian
Reinsurance on "negative watch" for possible downgrade). Radian Reinsurance and
Radian Asset Assurance are parties to numerous reinsurance agreements with
primary insurers which grant the primary insurers the right to recapture all of
the business ceded to Radian Reinsurance or Radian Asset Assurance under these
agreements if the financial strength rating of Radian Reinsurance or Radian
Asset Assurance, as the case may be, is downgraded below the rating levels
established in the agreements, and, in some cases, to increase the ceding
commissions in order to compensate the primary insurers for the decrease in
credit the rating agencies give the primary insurers for the reinsurance
provided by Financial Guaranty.
As a result of the downgrade by S&P, the primary insurers have the
right described above to recapture the financial guaranty reinsurance ceded to
Radian Reinsurance, including substantially all of the unearned premium reserves
of Radian Reinsurance. As described above, the primary insurers also have the
right to increase ceding commissions charged to Radian Reinsurance for cessions,
including the right to a cash refund of a portion of the unearned premium
reserves previously ceded to Radian Reinsurance reflecting the increased ceding
commissions. In addition, the primary insurers may seek amendments to their
agreements with Radian Reinsurance to revise ceding commissions or premiums
payable or to recapture only a portion of the business ceded to Radian
Reinsurance in a given year. Although Radian Reinsurance may be able to offset
some of the effects of increased ceding commissions or reduced reinsurance
premiums by posting collateral for the benefit of the reinsurers, the S&P
downgrade, or the exercise by primary insurers of their rights triggered by the
downgrade of Radian Reinsurance, could have a material adverse effect on Radian
Reinsurance's competitive position and/or its prospects for future
54
reinsurance opportunities. The Company cannot be certain that S&P or Moody's
will not make further revisions to Radian Reinsurance's or Radian Asset
Assurance's financial strength ratings which would trigger these rights of the
primary insurers.
The results of operations for the financial guaranty segment for the
year-to-date period of 2001 include the results of EFSG from the date of its
acquisition, February 28, 2001. Since the acquisition, business volumes in the
financial guaranty segment have increased significantly, leading to large
increases in premiums written and more gradual increases in premiums earned
since premiums are often earned over many years.
Net income for 2002 was $93.1 million, a $37.0 million or 66.0%
increase from $56.1 million for 2001. Net premiums written and earned for 2002
were $286.3 million and $186.6 million, respectively, compared to $143.2 million
and $106.5 million for 2001. Included in net premiums written and earned for
2002 were $40.4 million and $19.8 million, respectively, of credit enhancement
fees on derivative financial guaranty contracts, compared to $5.3 million for
both net premiums written and earned in 2001. In 2002, Financial Guaranty
originated $2.1 billion of par in the municipal bond area, including $1.0
billion in the healthcare sector and $.4 billion in the higher education sector.
In the global structured products area, Financial Guaranty originated $6.6
billion of par for 2002, primarily in the form of guarantees on collateralized
debt obligations and asset-backed securities. The following table shows the
breakdown of premiums written and earned for each period. In 2001, Financial
Guaranty originated $1.4 billion in par in the municipal bond area, including
$.6 billion in the healthcare sector and $.3 billion in the higher education
sector. Financial Guaranty also originated $2.0 billion of par in the structured
products area in 2001, primarily in the form of collateralized debt obligations
and asset-backed securities.
Year Ended December 31
----------------------
(in thousands) 2002 2001
-------- --------
Net premiums written:
Muni direct $ 62,849 $ 35,652
Muni reinsurance 48,130 36,773
Structured direct 66,644 12,016
Structured reinsurance 60,297 36,427
Trade credit 48,416 22,362
-------- --------
Total net premiums written $286,336 $143,230
======== ========
Net premiums earned:
Muni direct $ 14,717 $ 13,097
Muni reinsurance 39,228 26,431
Structured direct 42,534 12,804
Structured reinsurance 57,597 32,099
Trade credit 32,557 22,024
-------- --------
Total net premiums earned $186,633 $106,455
======== ========
Included in net premiums earned for 2002 and 2001 were refundings of
$7.8 million and $6.7 million, respectively.
Net investment income was $71.5 million for 2002 compared to $50.3
million for 2001. The provision for losses was $48.8 million for 2002 compared
to $29.0 million for 2001. The provision for losses represented 26.2% of net
premiums earned for 2002 compared to 27.2% for 2001. Financial Guaranty paid one
large claim totaling $9.0 million in 2002. The remaining claims of $25.1 million
for 2002 relate primarily to trade credit reinsurance. Policy acquisition and
other operating expenses were $61.6 million for 2002 compared to $43.4 million
in 2001. This increase resulted from an increase in expenses to support the
growth in business volumes. The operating expense ratio of 33.0% for 2002 was
down from 40.8% in 2001, due to higher business volumes and a higher mix of
direct written business. Included in other operating expenses for 2002 were $4.3
million of origination costs related to derivative
55
financial guaranty contracts. Interest expense was $9.6 million for 2002
compared to $6.0 million for 2001. This represented interest on the $75.0
million of long-term debt, as well as interest allocated on the Company's debt
financing. Net losses on dispositions of investments and changes in the fair
value of derivative instruments of $11.1 million for 2002 increased from the
$2.4 million in 2001. This related primarily to the change in the fair value of
derivative instruments, primarily convertible debt securities and financial
guaranty contracts that are considered to be derivative instruments.
The effective tax rate was 27.6% for 2002, lower than the statutory
rate of 35% primarily due to the investment in tax-advantaged securities,
compared to 27.7% for 2001.
Mortgage Services - Results of Operations
The mortgage services results include the operations of
RadianExpress.com Inc. ("RadianExpress") and the asset-based business conducted
through EFSG's minority owned subsidiaries, C-BASS and Sherman. The Company owns
a 46% interest in C-BASS and a 41.5% interest in Sherman. Effective January 1,
2003, Sherman's management exercised its right to acquire additional ownership
of Sherman, reducing the Company's ownership interest in Sherman from 45.5% to
41.5%. The Company has no current intention of reducing this interest any
further. C-BASS is engaged in the purchasing, servicing, and/or securitizing 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, primarily unsecured consumer assets.
Net income for 2002 was $40.3 million, up from $24.3 million in 2001.
Equity in net income of affiliates was $81.9 million for 2002, up $39.4 million
or 92.7% from the $42.5 million in 2001. C-BASS accounted for $63.5 million
(pre-tax) of the total income from affiliates in 2002 compared to $38.1 million
(pre-tax) in 2001. These results could vary significantly from period to period
due to a substantial portion of C-BASS's income being generated from sales of
mortgage-backed securities in the capital markets. These markets can be
volatile, subject to change in interest rates, the credit environment and
liquidity.
RadianExpress contributed $17.4 million of other income and $23.2
million of operating expenses for 2002 compared to $16.0 million and $17.4
million, respectively, in 2001. RadianExpress processed approximately 341,000
applications during 2002 compared to 402,000 during 2001. In June 2002, the
Company received a cease and desist order from the State of California in
connection with the offering of its Radian Lien Protection product, which it
appealed. On January 6, 2003, the Company received a decision from an
administrative law judge in California sustaining the cease and desist order,
which is subject to the approval of the California Commissioner of Insurance by
mid-April 2003. The cease and desist order has not had a material impact on the
Company's overall operations, but it has significantly reduced the potential for
future revenues of RadianExpress, the Radian entity through which Radian Lien
Protection sales would be processed. The Company has reduced expenses in
RadianExpress as a result of the business volume reduction caused by the cease
and desist order pending the California Commissioner of Insurance's decision. If
the Commissioner upholds the cease and desist order, the Company intends to
pursue alternative strategies, including an appeal to the California court
system.
Other
A wholly-owned subsidiary of EFSG, Singer Asset Finance Company L.L.C.
("Singer"), which had been engaged in the purchase, servicing, and
securitization of assets including state lottery awards and structured
settlement payments is currently operating on a run-off basis. Its operations
consist of servicing the prior organizations of non-consolidated special purpose
vehicles and the results of these subsidiaries are not material to the financial
results of the Company. At December 31, 2002, the Company has approximately $505
million and $479 million of non-consolidated assets and liabilities,
respectively, associated with Singer special purpose vehicles. The Company's
investment in these special purpose vehicles is $26.3 million at December 31,
2002. In August 2002, the Company sold substantially all of the assets of a
related subsidiary, Enhance Consumer Services LLC ("ECS"), which had been
engaged in the
56
purchase, servicing and securitization of viatical settlements, to an
independent third party for an aggregate purchase price of $8.4 million, which
approximated the carrying value.
Another insurance subsidiary, Van-American Insurance Company, Inc., is
operating, on a run-off basis, in reclamation bonds for the coal mining industry
and surety bonds covering closure and post-closure obligations of landfill
operations. Such business is not material to the financial results of the
Company.
At December 31, 2002, the Company, through its ownership of EFSG,
owned an indirect 36.5% equity interest in EIC Corporation Ltd. ("Exporters"),
an insurance holding company that, through its wholly-owned insurance subsidiary
licensed in Bermuda, insures primarily foreign trade receivables for
multinational companies. Financial Guaranty provides significant reinsurance
capacity to this joint venture on a quota-share, surplus share and
excess-of-loss basis. The Company's exposure at December 31, 2002 was
approximately $400 million.
2001 Compared to 2000
Results of Consolidated Operations
Net income for 2001 was $360.4 million, a 44.8% increase compared to
$248.9 million for 2000. The improvement in net income was a result of an
increase in earned premiums and investment income and the inclusion of equity in
net income of affiliates, as a result of the EFSG acquisition, partially offset
by increases in the provision for losses, policy acquisition costs and other
operating expenses. As a result of the acquisition of EFSG on February 28, 2001,
net income for 2001 included the results of operations from March 2001 through
December 2001 for EFSG, which contributed $81.3 million to net income and which
is included as a component of mortgage services and financial guaranty net
income. Consolidated earned premiums of $715.9 million increased $195.0 million
or 37.4% from $520.9 million for 2000. Financial Guaranty contributed $106.5
million of this increase. Net investment income increased from $82.9 million in
2000 to $147.5 million in 2001. This increase of $64.6 million or 77.9% included
$50.4 million from Financial Guaranty. Equity in net income of affiliates was
$41.3 million for 2001. The provision for losses of $208.1 million increased
$53.8 million or 34.9% from the $154.3 million in 2000, with Financial Guaranty
contributing $29.0 million of the increase. Policy acquisition and other
operating expenses increased by $108.2 million or 99.5% to $216.8 million in
2001 from $108.6 million in 2000. Financial Guaranty contributed $44.9 million
of this increase. Interest expense for 2001 was $17.8 million primarily related
to the issuance of long-term debt during 2001. The Company's effective tax rate
was 28.7% for 2001 compared to 29.4% for 2000.
Mortgage Insurance - Results of Operations
Net income for 2001 was $280.0 million, a $31.1 million or 12.5%
increase from $248.9 million in 2000. This increase resulted from improvements
in net 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.
Mortgage Insurance's top ten lenders were responsible for 46.1% of the
direct primary risk in force at December 31, 2001. The top ten lenders were also
responsible for 45.0% of primary new insurance written in 2001. Consistent with
the rest of the private mortgage insurance industry, the highest state
concentration of risk is in California. As of December 31, 2001, California
accounted for 16.6% of Mortgage Insurance's total direct primary insurance in
force and 11.3% of Mortgage Insurance's total direct pool insurance in force. In
addition, California accounted for 16.0% of Mortgage Insurance's direct primary
new insurance written for the year ended December 31, 2001. The largest single
customer of Mortgage Insurance (including branches and affiliates of such
customer), measured by new insurance written, accounted for 12.6% of new
insurance written during 2001, compared to 11.2% in 2000 and 12.2% in 1999.
New primary insurance written for 2001 was $44.8 billion, a 79.9%
increase from the $24.9 billion written in 2000. This increase in primary new
insurance written volume was primarily due to a substantial
57
increase in new insurance written volume in the private mortgage insurance
industry compared to 2000. Mortgage Insurance's market share increased to 15.6%
compared to 15.2% in 2000. The Company believes that this market share increase
was due, in part, to an increase in its share of new insurance written under
structured transactions, which are included in industry new insurance written
figures. During 2001, Mortgage Insurance wrote $8.7 billion of such transactions
compared to $1.2 billion in 2000.
During 2001, the Company wrote $255.4 million of pool insurance risk
compared to $187.9 million in 2000. The majority of the pool insurance
outstanding relates to a group of structured transactions composed primarily of
Fannie Mae and Freddie Mac eligible conforming mortgage loans (known as "GSE
Pool" loans). 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.
The Company's mortgage insurance volume was positively impacted by low
interest rates in 2001, which affected the entire mortgage industry. The trend
toward lower interest rates, which began in the fourth quarter of 2000, caused
refinancing activity during 2001 to increase significantly and contributed to
the increase in the mortgage insurance industry new insurance written volume in
2001. The Company's refinancing activity as a percentage of primary new
insurance written was 40.3% in 2001 compared to 14.0% in 2000. The persistency
rate, which is defined as the percentage of insurance in force that is renewed
in any given year, was 63.3% for 2001 compared to 78.2% for 2000. This decrease
was consistent with the increased level of refinancing activity, which started
in the fourth quarter of 2000 and continued throughout 2001, and has caused
cancellation rates to increase.
During 2001, non-prime business accounted for $14.3 billion or 31.8%
of Mortgage Insurance's new primary insurance written as compared to $5.4
billion or 21.8% for the same period in 2000. At December 31, 2001, non-prime
insurance in force was $18.2 billion or 16.8% of total insurance in force as
compared to $8.4 billion or 8.3% of insurance in force a year ago.
During 2001, Radian Insurance wrote $3.4 billion of insurance compared
to $1.6 billion in 2000. Risk in force at December 31, 2001 was $348.3 million
compared to $211.0 million of risk at December 31, 2000.
Net premiums earned in 2001 were $609.4 million, an $88.5 million or
17.0% increase from $520.9 million for 2000. This increase, which was greater
than the increase in insurance in force, reflected the premiums earned in Radian
Insurance of $38.8 million in 2001, and the change in the mix of new insurance
written volume originated by the Company throughout 2001 combined with the
increase in insurance in force. 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 during 2001
was offset by the decrease in persistency levels. Direct primary insurance in
force increased 7.0% from $100.9 billion at December 31, 2000 to $107.9 billion
at December 31, 2001. GSE pool risk in force also grew to $1.2 billion at
December 31, 2001 from $1.1 billion at the end of 2000. Total pool risk in force
grew to $1.6 billion from $1.5 billion at the end of 2000.
For 2001, premiums ceded under captive reinsurance arrangements were
$52.8 million, or 8.4% of total premiums earned during 2001, as compared to
$39.6 million, or 7.6% of total premiums earned for the same period of 2000. New
primary insurance written under captive reinsurance arrangements was $14.7
billion, or 32.9% of total new primary insurance written in 2001 as compared to
$8.1 billion, or 32.6% of total new primary insurance written in 2000.
Net investment income was $97.1 million, a $14.2 million or 17.1%
increase over the $82.9 million reported for 2000. This increase was a result of
continued growth in invested assets primarily due to positive operating cash
flows and the allocation of interest income from net financing activities.
58
Net realized gains on sales of investments were $5.8 million for the
year ended December 31, 2001 compared to $4.2 million for the comparable period
of 2000. Net realized losses from the change in the fair value of the Company's
derivative instruments were $1.3 million for 2001.
The provision for losses was $179.1 million for 2001, an increase of
$24.8 million or 16.1% from $154.3 million in 2000. In addition to increases in
business volumes, this increase reflects an increase in the number of delinquent
loans as a result of the maturation of the books 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. Approximately 66.9% of the primary
risk in force and 59.3% of the pool risk in force at December 31, 2001 had not
yet reached its anticipated highest claim frequency years.
The overall delinquency rate at December 31, 2001 was 3.5% compared to
2.4% at December 31, 2000. The increase in the overall delinquency rate was
primarily a result of the slowing economy, which produced higher levels of
unemployment. The number of delinquencies rose from 26,520 at December 31, 2000
to 41,147 at December 31, 2001 and the average loss reserve per delinquency
declined from $14,707 at the end of 2000 to $11,291 at December 31, 2001,
although the reserve as a percentage of risk in force rose to 169 basis points
at December 31, 2001 from 148 basis points at the end of 2000. The delinquency
rate in California was 1.9% (including pool) at December 31, 2001 as compared to
1.5% at year end 2000 and claims paid in California during 2001 were $7.1
million, representing approximately 7.7% of the total claims as compared to
16.1% for the same period of 2000. California represented approximately 16.4% of
primary risk in force at December 31, 2001 as compared to 16.8% at December 31,
2000. The delinquency rate in Florida was 3.3% (including pool) at December 31,
2001 as compared to 2.7% at December 31, 2000 and claims paid in Florida during
2001 were $6.5 million, representing approximately 7.0% of total claims as
compared to 13.6% for 2000. Florida represented approximately 7.4% of primary
risk in force at December 31, 2001 the same as at year-end 2000. No other state
represented more than 6.4% of Mortgage Insurance's primary risk in force at
December 31, 2001.
The number of delinquent non-prime loans at December 31, 2001 was
7,704, which represented 24.8% of the total number of delinquent primary loans,
as compared to 2,690 or 13.1% of delinquent primary loans at December 31, 2000.
The delinquency rate on this business rose from 4.1% at December 31, 2000 to
5.5% at December 31, 2001. The delinquency rate on prime business was 3.1% and
2.3% at December 31, 2001 and 2000, respectively. At December 31, 2001, the
delinquency rate on the Alternative A business was 4.5% as compared to 2.9% at
December 31, 2000 and Alternative A delinquencies represented 34.6% of the total
number of non-prime delinquent loans. The delinquency rate on A-minus business
was 6.3% at December 31, 2001 as compared to 6.0% at December 31, 2000. Direct
losses paid during 2001 increased to $97.7 million as compared to $93.3 million
during 2000.
Underwriting and other operating expenses were $154.4 million for
2001, an increase of $45.8 million or 42.1% from the $108.6 million reported in
2000.
Policy acquisition costs were $62.4 million in 2001, an increase of
$10.9 million from 2000. This reflects an increase in expenses to support the
higher new insurance written volume during 2001 and the continued development of
marketing and e-commerce efforts undertaken by the Company. Other operating
expenses of $92.0 million for 2001 increased by $34.8 million, representing a
60.9% increase from 2000. This amount reflects an increase in expenses related
to contract underwriting. Contract underwriting expenses for 2001 were $44.6
million, a 120.2% increase from the $20.3 million reported in 2000. This
increase in contract underwriting expenses reflected the increasing demand for
this service as mortgage origination volume increased. Consistent with the
increase in contract underwriting expenses, other income, including income
related to contract underwriting services, also increased to $20.4 million in
2001, up from $7.4 million in 2000. During 2001, loans underwritten via contract
underwriting accounted for 34.5% of applications, 32.0% of commitments, and
25.8% of certificates issued by Mortgage Insurance as compared to 30.1%, 26.2%
and 19.4%, respectively, in 2000.
59
Interest expense for 2001 was $10.5 million, which primarily
represented allocation of interest on the $250 million of long-term debt issued
during 2001.
The effective tax rate for 2001 was 27.9% compared to 29.4% in 2000.
Financial Guaranty - Results of Operations
The Company's consolidated results of operations include 10 months of
operating results from EFSG, since its acquisition occurred at the end of
February, 2001. As such, comparative information is not included in the
discussion.
Radian Reinsurance derives substantially all of its reinsurance
premium revenues from the four monolines. Approximately, 42.0% of the total
financial guaranty gross premiums were derived from these four monolines in
2001.
Net income for 2001 was $56.1 million. Net premiums written and earned
during 2001 were $143.2 million and $106.5 million, respectively. Net premiums
written consisted of $73.2 million of reinsurance premiums, $47.7 million of
premiums from the direct financial guaranty of municipal and structured
obligations, and $22.4 million of trade credit insurance and reinsurance. Net
premiums earned for 2001 include $58.5 million of reinsurance, $25.9 million in
direct financial guaranty, and $22.0 million of trade credit. Included in net
premiums earned for the year were refundings of $6.7 million. Net investment
income was $50.3 million for the year. The provision for losses was $29.0
million for 2001, which represented 27.2% of earned premium. Policy acquisition
costs were $21.8 million for 2001 and other operating expenses were $21.6
million for the same period. Acquisition and other operating expenses together
resulted in an expense ratio of 40.8%. Interest expense of $6.0 million for 2001
represented interest allocated on the Company's debt financings as well as on
the $75.0 million of long-term debt and on $173.7 million of short-term debt
that was retired in May 2001. Net realized gains on sales of investments were
$2.0 million for 2001. Net realized losses from the change in the fair value of
derivative instruments, primarily credit default swaps were $4.4 million for
2001. The effective tax rate for 2001 was 27.7%.
Mortgage Services - Results of Operations
Net income for 2001 was $24.3 million. Equity in net income of
affiliates (pre-tax) was $42.5 million. C-BASS accounted for $38.1 million
(pre-tax) of the total income from affiliates in 2001. These results could vary
from period to period due to a significant portion of C-BASS's income being
generated from sales of mortgage-backed securities in the capital markets.
RadianExpress contributed $16.0 million of other income and $17.4
million of operating expenses for 2001. RadianExpress processed approximately
402,000 applications during 2001 with approximately 37,000 of the transactions
processed related to net funding services, whereby RadianExpress receives and
disburses mortgages funded on behalf of its customers.
Other
Singer is currently operating on a run-off basis. Its operations
consist of servicing the prior originations of non-consolidated special purpose
vehicles and the results of these subsidiaries are not expected to be material
to the financial results of the Company.
Another insurance subsidiary, Van-American Insurance Company, Inc., 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 material to the financial results of the
Company.
60
At December 31, 2001, the Company, through its ownership of EFSG,
owned an indirect 36.5% equity interest in Exporters. Financial Guaranty
provides significant reinsurance capacity to this joint venture on a
quota-share, surplus share and excess-of-loss basis.
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 year ended December 31,
2002 were $586.8 million as compared to $481.1 million for the same period of
2001. This increase consisted of a reduction in income taxes paid, an increase
in net premiums written and investment income received partially offset by
increases in claims paid and operating expenses. Positive cash flows are
invested pending future payments of claims and other expenses; excess cash flow
needs, if any, are funded through sales of short-term investments and other
investment portfolio securities.
Stockholders' equity increased to $2.8 billion at December 31, 2002
from $2.3 billion at December 31, 2001. The 2001 amount includes $40.0 million
of redeemable preferred stock, which was redeemed in August 2002. This increase
in stockholders' equity resulted from net income of $427.2 million, proceeds
from the issuance of common stock of $28.6 million and an increase in the market
value of securities available for sale of $47.1 million net of tax, offset by
dividends of $9.6 million, the redemption of $40 million of redeemable preferred
stock at a $3.0 million premium (described below) and the purchase of 1.4
million shares of the Company's stock, net of reissues, for approximately $44.0
million pursuant to the Company's repurchase also described below.
In August 2002, the Company redeemed its $4.125 Preferred Stock, par
value $.001 per share. Pursuant to the Company's sinking fund redemption
obligation, 72,000 shares were redeemed at $50.00 per share, and the remaining
728,000 shares were redeemed at $54.125 per share. Accrued and unpaid dividends
on the shares to the date of redemption were also paid as part of the redemption
price.
On September 24, 2002, the Company announced that its board of
directors had authorized the repurchase of up to 2.5 million shares of its
common stock on the open market. Shares will be purchased from time to time
depending on the market conditions, share price, and other factors. These
purchases will be funded from available working capital. At December 31, 2002,
approximately 1.4 million shares had been repurchased at a cost of $45.1
million.
On October 4, 2002, Standard & Poor's Ratings Services lowered the
financial strength rating of Radian Reinsurance to "AA" from "AAA," as further
described above, under "2002 COMPARED TO 2001 - Financial Guaranty - Results of
Operations." Radian Reinsurance's outlook was also improved to stable from
negative.
At December 31, 2002, the Company and its subsidiaries had plans to
continue investing in significant information technology and infrastructure
upgrades over the next two years at an estimated total cost of $40 million to
$50 million. The Company plans to move the majority of its Data Center to
Dayton, Ohio in the coming months and expects to be in full service by mid-2003.
Cash flows from operations are being used to fund these expenditures, which are
intended to benefit all of the Company's business segments.
EFSG was party to a credit agreement (as amended, the "Credit
Agreement") with major commercial banks providing EFSG with a borrowing facility
aggregating up to $175.0 million, the proceeds of which were used for general
corporate purposes. The outstanding principal balance under the Credit Agreement
of $173.7 million was retired on May 29, 2001 and the credit facility was
terminated.
The Company owns a 46% interest in C-BASS. The Company did not make
any capital contributions to C-BASS since the Company acquired its interest in
C-BASS in connection with the
61
acquisition of EFSG in February 2001. C-BASS paid $20.1 million of dividends to
the Company during 2002 and $12.8 million during 2001.
The Company owns a 41.5% interest in Sherman as a result of the
acquisition of EFSG. The Company did not make any capital contributions to
Sherman in 2002, but made $15.0 million of contributions during 2001. In
conjunction with the acquisition of its interest in Sherman, the Company
guaranteed payment of up to $25.0 million of a revolving credit facility issued
to Sherman. There was $1.0 million outstanding under this facility as of
December 31, 2002.
In January 2002, the Company issued $220 million of unsecured Senior
Convertible Debentures. Approximately $125 million of the proceeds from the
offering was used to increase capital at Radian Asset Assurance. Some of the
remainder was used to redeem the preferred stock, to buy back the Company's
common stock, as described above, and for other general corporate purposes. The
debentures bear interest at the rate of 2.25% per year and interest is payable
semi-annually on January 1 and July 1. The Company will also pay contingent
interest on specified semi-annual periods, if the sale price of its common stock
for specified period of time is less than 60% of the conversion price. The
debentures are convertible, at the purchaser's option, into shares of common
stock at prices and on dates specified in the offering memorandum. At that time,
the shares would become common shares for the purposes of calculating earnings
per share. The Company may redeem all or some of the debentures on or after
January 1, 2005.
In February 2002, the Company closed on a $50 million Senior Revolving
Credit Facility. The facility is unsecured and expires in May 2003. The facility
will be used for working capital and general corporate purposes. The facility
bears interest on any amounts drawn at either the Borrower's Base rate as
defined in the agreement, or at a rate above LIBOR based on certain
debt-to-capital ratios. There have been no drawdowns on this facility.
In March 2002, the Company made a $20 million investment in Primus
Guaranty, Ltd., a Bermuda holding company and parent company to Primus Financial
Products, LLC. ("Primus"), a Triple A rated company that provides credit risk
protection to derivatives dealers and credit portfolio managers on individual
investment-grade entities. In connection with the capitalization and Triple A
rating of Primus, Radian Reinsurance has provided Primus with an excess of loss
insurance policy, which is expiring March 30, 2003. The Company accounts for the
Primus investment under the equity method of accounting. The results of Primus
for 2002 were immaterial to the Company's consolidated financial statements.
In February 2003, the Company sold $250 million of unsecured Senior
Notes. These notes bear interest at the rate of 5.625% per year, payable
semi-annually on February 15 and August 15, beginning August 15, 2003. These
notes mature in February 2013. The Company intends to use a portion of the
proceeds to repay the $75.0 million in principal on the 6.75% debentures due
March 1, 2003. The remainder will be used for general corporate purposes,
including potential acquisitions.
The Company believes that Radian Guaranty 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 Mortgage Insurance and Financial Guaranty. As a holding company,
the Company conducts its principal operations through Mortgage Insurance and
EFSG. In connection with obtaining approval from the New York insurance
department for the change of control of EFSG when the Company acquired EFSG,
EFSG agreed not to declare or pay dividends for a period of two years following
consummation of the acquisition. The agreement for Radian Reinsurance and Radian
Asset Assurance to refrain from paying dividends to the Company expired on
February 28, 2003. Based on the Company's current intention to pay quarterly
common stock dividends of approximately $0.02 per share, the Company will
require approximately $7.6 million in 2003 to pay the dividends on the
outstanding shares of common stock. The Company will also require $37.6 million
in 2003 to pay the debt service on its long-term and short-term debt financing
and $75 million to redeem the debentures due in March 2003. The Company utilized
approximately $43.0 million to redeem its preferred stock. The Company believes
that it has the resources to meet these cash requirements for the next twelve
months. There are regulatory and contractual
62
limitations on the payment of dividends or other distributions from its
insurance subsidiaries. The Company does not believe that any of these
restrictions will prevent the payment by its subsidiaries or the Company of
these anticipated dividends or distributions in the foreseeable future.
Quantitative and Qualitative Disclosures about Market Risk
The Company manages its investment portfolio to achieve safety and
liquidity, while seeking to maximize total return. The Company believes it can
achieve these objectives by active portfolio management and intensive monitoring
of investments. Market risk represents the potential for loss due to adverse
changes in the fair value of financial instruments. The market risk related to
financial instruments primarily relates to the investment portfolio, which
exposes the Company to risks related to interest rates, default, prepayments,
and declines in equity prices. Interest rate risk is the price sensitivity of a
fixed income security to changes in interest rates. The Company views these
potential changes in price within the overall context of asset and liability
management. The Company's analysts estimate the payout pattern of the mortgage
insurance loss reserves to determine their duration, which is the weighted
average payments expressed in years. The Company sets duration targets for fixed
income investment portfolios that it believes mitigates the overall effect of
interest rate risk. As of December 31, 2002, the average duration of the fixed
income portfolio was 5.5 years. Based upon assumptions the Company uses in its
duration calculations, increases in interest rates of 100 and 150 basis points
would cause decreases in the market value of the fixed maturity portfolio
(excluding short-term investments) of approximately 5.6% and 8.5%, respectively.
Similarly, a decrease in interest rates of 100 and 150 basis points would cause
increases in the market value of the fixed maturity portfolio of approximately
5.1% and 7.6%, respectively. At December 31, 2002, the Company had no material
foreign investments and its investment in non-investment grade fixed income
securities was $14.8 million. At December 31, 2002, the market value and cost of
the Company's equity securities were $168.5 million and $196.8 million,
respectively. In addition, the market value and cost of the Company's short-term
and long-term debt at December 31, 2002 were $587.4 million and $544.1 million,
respectively.
During 2002, 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 $47.1 million. The
accumulated net unrealized gain at December 31, 2002 was $58.1 million compared
to $11.0 million at December 31, 2001. This increase in value was primarily a
result of changes in market interest rates and not a result of changes in the
composition of the Company's investment portfolio.
At December 31, 2002, the fair value of the Company's derivative
instruments, classified as trading securities, was $37.6 million, as compared to
an amortized value of $39.3 million, and the Company recognized $0.5 million,
net of tax, of loss on changes in the fair value of trading securities in the
Consolidated Statements of Income for 2002. The notional value of the Company's
credit default swaps and certain other financial guaranty contracts accounted
for under SFAS No. 133 was $7.3 billion at December 31, 2002 and the Company
recognized $8.0 million, net of tax, of losses on these instruments. Net
unrealized losses on credit default swaps and certain other financial guaranty
contracts of $17.5 million at December 31, 2002 were composed of gross
unrealized gains of $52.4 million and gross unrealized losses of $69.9 million.
Critical Accounting Policies
Critical accounting policies comprise those policies that require the
Company's most difficult, subjective, and complex judgments. These policies
require estimates of matters that are inherently uncertain. The accounting
policies that the Company believes meet the criteria of critical accounting
policies are described below.
Reserve for Losses
As described in notes 1 and 5 of the Notes to Consolidated Financial
Statements, the Company establishes reserves to provide for the estimated costs
of settling claims in both the mortgage insurance and
63
financial guaranty businesses. Setting loss reserves in both businesses involves
the significant use of estimates with regard to the likelihood, magnitude and
timing of a loss.
In the mortgage insurance business, the incurred loss process is
initiated by a borrower's missed payment. The Company uses historical models
based on a variety of loan characteristics, including the status of the loan as
reported by the servicer of the loan, the economic conditions, and the estimated
foreclosure period in the area where the default exists to help determine the
appropriate loss reserve at any point in time. As the delinquency proceeds
toward foreclosure, there is more certainty around these estimates and
adjustments are made to loss reserves to reflect this updated information.
The process for establishing financial guaranty loss reserves is
similar; however, the remote probability of losses and the dearth of historical
losses in this business makes it more difficult to estimate the appropriate loss
reserve. Policies are monitored by the Company or the primary insurers over the
life of the policy. When the policy's performance deteriorates below
underwriting expectations, or if the circumstances dictate, it is placed on a
Watch List. Once a transaction is placed on a Watch List, the transaction is
actively monitored, which may include communication with the borrower, site
inspection or the engagement of a third party consultant. If the transaction
continues to deteriorate to a point where a default is probable and estimable,
the Company will establish a loss reserve. Financial Guaranty has a regular case
reserve committee meeting where experts in the risk management and surveillance
area provide input to the finance area before any case reserves are determined,
and the surveillance team actively monitors any problem deals and notifies the
committee if a change in the loss reserve is necessary. Financial Guaranty
establishes a reserve based on the estimated loss, including expenses associated
with the settlement of the loss.
Setting the loss reserves in both business segments involves
significant reliance upon estimates with regard to the likelihood, magnitude and
timing of a loss. The models and estimates the Company uses to establish loss
reserves may not prove to be accurate, especially during an extended economic
downturn. There can be no assurance that the Company has correctly estimated the
necessary amount of reserves or that the reserves established will be adequate
to cover ultimate losses on incurred defaults.
If the Company's estimates are inadequate, it may be forced by
insurance and other regulators or rating agencies to increase its reserves.
Unanticipated increases to its reserves could lead to a reduction in the
Company's and its subsidiaries' ratings. Such a reduction in ratings could have
a significant negative impact on the Company's ability to attract and retain
business.
Derivative Instruments and Hedging Activity
As described in note 1 of the Notes to Consolidated Financial
Statements, the Company adopted SFAS No. 133 on January 1, 2001. The two areas
where gains and losses on derivative contracts are recognized are in the
convertible debt securities contained in the Company's investment portfolio and
in certain financial guaranty contracts. The value of the derivative position of
convertible debt securities is calculated by the Company's outside convertible
debt portfolio manager by determining the value of the readily ascertainable
comparable debt securities and assigning a value to the equity (derivative)
portion by subtracting the value of the comparable debt security from the total
value of the convertible instrument. Changes in such values from period to
period represent the gains and losses recorded. The gains and losses on
derivative financial guaranty contracts are derived from internally generated
models. The estimated fair value amounts have been determined by the Company
using available market information and appropriate valuation methodologies.
However, considerable judgment is necessarily required to interpret market data
to develop the estimates of fair value. Accordingly, the estimates are not
necessarily indicative of amounts the Company could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have an effect on the estimated fair value amounts.
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DIRECTORS AND OFFICERS
RADIAN GROUP INC.
Directors
Frank P. Filipps
Chairman and Chief Executive Officer
Roy J. Kasmar
President and Chief Operating Officer
Herbert Wender
Lead Director
Retired Vice Chairman
LandAmerica Financial Group, Inc.
David C. Carney
Chairman
ImageMax, Inc.
Howard B. Culang
President
Laurel Corporation
Stephen T. Hopkins
President
Hopkins and Company LLC
James W. Jennings
Retired Senior Partner
Morgan, Lewis & Bockius LLP
Ronald W. Moore
Adjunct Professor of Business Administration
Harvard University, Graduate School of Business Administration
Robert W. Richards
Retired Chairman of the Board
Source One Mortgage Services Corporation
Anthony W. Schweiger
President
The Tomorrow Group LLC
Officers
Frank P. Filipps
Chairman and Chief Executive Officer
Roy J. Kasmar
President and Chief Operating Officer
Martin A. Kamarck
President
65
Radian Asset Assurance Inc. and Radian Reinsurance Inc.
C. Robert Quint
Executive Vice President and Chief Financial Officer
Howard S. Yaruss
Executive Vice President, Secretary, General Counsel and Corporate
Responsibility Officer
John J. Calamari
Senior Vice President and Corporate Controller
Mark A. Casale
Senior Vice President
Strategic Investments
Elizabeth A. Shuttleworth
Senior Vice President and Chief Information Officer
Scott C. Stevens
Senior Vice President
Human Resources and Administration
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STOCKHOLDERS' INFORMATION
ANNUAL MEETING
The annual meeting of stockholders of Radian Group Inc. will be held
on Tuesday, May 13, 2003, at 9:00 a.m. at 1601 Market Street, 11th floor,
Philadelphia, Pennsylvania.
10-K REPORT
Copies of the Company's Annual Report on Form 10-K filed with the
Securities and Exchange Commission will be available without charge on or about
March 21, 2003, to stockholders upon written request to: Secretary,
Radian Group Inc., 1601 Market Street, Philadelphia, PA 19103
TRANSFER AGENT AND REGISTRAR
Bank of New York, P.O. Box 11002, Church Street Station, New York, NY
10286, 212 815.2286
CORPORATE HEADQUARTERS
1601 Market Street, Philadelphia, PA 19103, 215 564.6600
INVESTOR RELATIONS
Mona Zeehandelaar, 1601 Market Street, Philadelphia, PA 19103, 215
564.6600
COMMON STOCK
Radian Group Inc. common stock is listed on The New York Stock
Exchange under the symbol RDN. At December 31, 2002, there were 93,552,290
shares outstanding and approximately 13,100 holders of record. The following
table sets forth the high and low sales prices of the Company's common stock on
The New York Stock Exchange Composite Tape for the financial quarters indicated:
2001 2002
------------- -------------
High Low High Low
----- ----- ----- -----
1st Quarter 37.53 26.91 49.80 40.48
2nd Quarter 43.87 32.48 55.56 47.60
3rd Quarter 42.62 30.10 49.82 30.85
4th Quarter 43.38 32.25 42.00 29.49
67