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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from_____________________to_____________________
Commission file number 1-11356
RADIAN GROUP INC.
-----------------
(Exact name of registrant as specified in its charter)
DELAWARE 23-2691170
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1601 MARKET STREET, PHILADELPHIA, PA 19103
------------------------------------ -----
(Address of principal executive offices) (zip code)
(215) 564-6600
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or if such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No ____
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Sections 12, 13 or 15 (d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes ____ No ____
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date: 94,822,256 shares of
Common Stock, $0.001 par value, outstanding on August 8, 2002.
1
RADIAN GROUP INC. AND SUBSIDIARIES
INDEX
PAGE NUMBER
-----------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets .......................................... 3
Condensed Consolidated Statements of Income .................................... 4
Condensed Consolidated Statement of Changes in Common Stockholders' Equity ..... 5
Condensed Consolidated Statements of Cash Flows ................................ 6
Notes to Unaudited Condensed Consolidated Financial Statements ................. 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ........................................................12
Item 3. Quantitative and Qualitative Disclosures about Market Risk .....................21
PART II - OTHER INFORMATION
Item 1. Legal Proceedings ...............................................................22
Item 4. Submission of Matters to a Vote of Security Holders .............................22
Item 6. Exhibits and Reports on Form 8-K ................................................22
SIGNATURES ...................................................................................23
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
RADIAN GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
June 30 December 31
2002 2001
----------- -----------
(In thousands, except share amounts)
Assets
Investments
Fixed maturities held to maturity - at amortized cost (fair value $463,368
and $461,962) $ 413,323 $ 442,198
Fixed maturities available for sale - at fair value (amortized cost $3,090,264
and $2,552,930) 3,138,419 2,567,200
Trading securities - at fair value (cost $42,337 and $22,599) 34,823 21,659
Equity securities - at fair value (cost $156,217 and $116,978) 146,111 120,320
Short-term investments 287,282 210,788
Other invested assets 7,733 7,310
----------- -----------
Total Investments 4,027,691 3,369,475
----------- -----------
Cash 20,194 60,159
Investment in affiliates 223,284 177,465
Deferred policy acquisition costs 171,546 151,037
Prepaid federal income taxes 270,150 326,514
Provisional losses recoverable 46,580 47,229
Other assets 335,796 306,747
----------- -----------
$ 5,095,241 $ 4,438,626
=========== ===========
Liabilities and Stockholders' Equity
Unearned premiums $ 552,311 $ 513,932
Reserve for losses 603,221 588,643
Long-term and short-term debt 544,110 324,076
Deferred federal income taxes 478,536 432,098
Accounts payable and accrued expenses 323,554 233,549
----------- -----------
2,501,732 2,092,298
----------- -----------
Redeemable preferred stock, par value $.001 per share; 800,000 shares issued
and outstanding - at redemption value 40,000 40,000
----------- -----------
Common stockholders' equity
Common stock, par value $.001 per share; 200,000,000 shares authorized;
95,001,195 and 94,170,300 shares issued in 2002 and 2001, respectively 95 94
Treasury stock; 188,092 shares in 2002 and 2001 (7,874) (7,874)
Additional paid-in capital 1,235,550 1,210,088
Retained earnings 1,301,006 1,093,580
Accumulated other comprehensive income 24,732 10,440
----------- -----------
2,553,509 2,306,328
----------- -----------
$ 5,095,241 $ 4,438,626
=========== ===========
See notes to unaudited condensed consolidated financial statements.
3
RADIAN GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Quarter Ended Six Months Ended
June 30 June 30
------------------------ ------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
(In thousands, except per-share amounts)
Revenues:
Premiums written:
Direct $ 221,076 $ 182,748 $ 423,940 $ 347,155
Assumed 34,092 33,585 69,494 41,307
Ceded (17,558) (17,130) (31,186) (29,010)
--------- --------- --------- ---------
Net premiums written 237,610 199,203 462,248 359,452
Increase in unearned premiums (26,579) (19,962) (42,028) (24,448)
--------- --------- --------- ---------
Premiums earned 211,031 179,241 420,220 335,004
Net investment income 44,485 39,455 87,238 67,475
Equity in net income of affiliates 26,774 12,760 45,394 24,804
Other income 10,965 9,284 22,247 15,575
--------- --------- --------- ---------
293,255 240,740 575,099 442,858
--------- --------- --------- ---------
Expenses:
Provision for losses 57,576 52,310 115,003 101,582
Policy acquisition costs 25,603 21,996 49,050 39,037
Other operating expenses 44,500 32,942 89,245 56,899
Interest expense 7,239 4,448 14,393 5,849
--------- --------- --------- ---------
134,918 111,696 267,691 203,367
--------- --------- --------- ---------
Gains and losses:
Net gains (losses) on sales of investments 2,462 (662) 3,083 2,762
Change in fair value of derivative instruments (5,764) 1,410 (9,006) (191)
--------- --------- --------- ---------
(3,302) 748 (5,923) 2,571
--------- --------- --------- ---------
Pretax income 155,035 129,792 301,485 242,062
Provision for income taxes 46,113 37,115 88,630 69,228
--------- --------- --------- ---------
Net income 108,922 92,677 212,855 172,834
Dividends to preferred stockholder 825 825 1,650 1,650
--------- --------- --------- ---------
Net income available to common stockholders $ 108,097 $ 91,852 $ 211,205 $ 171,184
========= ========= ========= =========
Basic net income per share $ 1.14 $ 0.99 $ 2.24 $ 1.96
========= ========= ========= =========
Diluted net income per share $ 1.12 $ 0.97 $ 2.20 $ 1.92
========= ========= ========= =========
Average number of common shares outstanding - basic 94,708 93,124 94,466 87,400
========= ========= ========= =========
Average number of common and common equivalent shares
outstanding - diluted 96,387 94,854 96,134 88,946
========= ========= ========= =========
See notes to unaudited condensed consolidated financial statements.
4
RADIAN GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN COMMON STOCKHOLDERS' EQUITY
(UNAUDITED)
Accumulated Other
Comprehensive
Income (Loss)
---------------------------
Foreign Unrealized
Additional Currency Holding
Common Treasury Paid-in Retained Translation Gains
Stock Stock Capital Earnings Adjustment (Losses) Total
----------- ----------- ----------- ----------- ----------- ----------- -----------
(In thousands)
Balance, January 1, 2002 $ 94 $ (7,874) $ 1,210,088 $ 1,093,580 $ (586) $ 11,026 $ 2,306,328
Comprehensive income:
Net income -- -- -- 212,855 -- -- 212,855
Unrealized foreign currency
translation adjustment,
net of tax of $381 -- -- -- -- 707 -- 707
Unrealized holding gains
arising during period, net
of tax of $8,394 -- -- -- -- -- 15,589
Less: Reclassification
adjustment for net gains
included in net income, net
of tax of $1,079 -- -- -- -- -- (2,004)
-----------
Net unrealized gain on
investments, net of tax of
$7,315 -- -- -- -- -- 13,585 13,585
------
Comprehensive income 227,147
Issuance of common stock under
incentive plans 1 -- 25,462 -- -- -- 25,463
Dividends -- -- -- (5,429) -- -- (5,429)
----------- ----------- ----------- ----------- --------- ----------- -----------
Balance, June 30, 2002 $ 95 $ (7,874) $ 1,235,550 $ 1,301,006 $ 121 $ 24,611 $ 2,553,509
=========== =========== =========== =========== ========= =========== ===========
See notes to unaudited condensed consolidated financial statements.
5
RADIAN GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended
June 30
-------------------------------
2002 2001
----------- -----------
(in thousands)
Cash flows from operating activities $ 267,803 $ 213,368
=========== ===========
Cash flows from investing activities:
Proceeds from sales of fixed maturity investments available
for sale 954,337 288,639
Proceeds from sales of equity securities available for sale 7,449 2,253
Proceeds from redemptions of fixed maturity investments
available for sale 44,844 74,068
Proceeds from redemptions of fixed maturity investments
held to maturity 31,069 5,381
Purchases of fixed maturity investments available for sale (1,463,991) (567,614)
Purchases of equity securities available for sale (63,070) (18,143)
Purchases of short-term investments, net (76,476) (27,078)
Payable for securities 51,015 --
Purchases of property and equipment, net (27,997) (3,854)
Sales (Purchases) of other invested assets 1,956 (515)
Acquisitions, net of cash acquired -- 6,788
Investment in affiliates (20,000) (15,020)
Distributions from affiliates 20,095 5,261
Other (2,987) (567)
----------- -----------
Net cash used in investing activities (543,756) (250,401)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock under incentive plans 25,463 20,410
Acquisition costs -- (7,223)
Issuance of long-term debt 215,954 247,100
Repayment of short-term debt -- (173,724)
Dividends paid (5,429) (4,655)
----------- -----------
Net cash provided by financing activities 235,988 81,908
----------- -----------
(Decrease)/Increase in cash (39,965) 44,875
Cash, beginning of period 60,159 2,424
----------- -----------
Cash, end of period $ 20,194 $ 47,299
=========== ===========
Supplemental disclosures of cash flow information:
Income taxes (received) paid ($ 68,428) $ 37,826
=========== ===========
Interest paid $ 12,631 $ 6,439
=========== ===========
See notes to unaudited condensed consolidated financial statements.
6
RADIAN GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. CONSOLIDATED FINANCIAL STATEMENTS - BASIS OF PRESENTATION
The consolidated financial statements included herein, include the
accounts of Radian Group Inc. (the "Company") and its subsidiaries, including
its 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") and its
principal financial guaranty operating subsidiaries, Radian Reinsurance Inc.
("Radian Re") and Radian Asset Assurance Inc. ("Radian Asset Assurance"). The
Company also has a partial equity interest in two active credit-based asset
businesses, Credit-Based Asset Servicing and Securitization LLC ("C-BASS") and
Sherman Financial Group LLC ("Sherman"). The Company has a 46.0% interest in
C-BASS and a 45.5% interest in Sherman. These statements are presented on the
basis of accounting principles generally accepted in the United States of
America ("GAAP"). The Company has condensed or omitted certain information and
footnote disclosures normally included in consolidated financial statements
prepared in accordance with GAAP pursuant to such rules and regulations.
The financial information for the interim periods is unaudited;
however, such information reflects all adjustments, which are, in the opinion of
management, necessary for a fair presentation of the financial position, results
of operations, and cash flows for the interim periods. These financial
statements should be read in conjunction with the financial statements and notes
thereto included in the Company's annual report on Form 10-K for the year ended
December 31, 2001. The results of operations for interim periods are not
necessarily indicative of results to be expected for the full year or for any
other period.
The preparation of financial statements in accordance with GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting periods. Actual results could differ
from these estimates.
Basic net income per share is based on the weighted average number of
common shares outstanding, while diluted net income per share is based on the
weighted average number of common shares outstanding and common share
equivalents that would arise from the exercise of stock options. Preferred stock
dividends are deducted from net income in the net income per share computation.
Certain prior period balances have been reclassified to conform to the
current period presentation.
2 - ACQUISITION OF ENHANCE FINANCIAL
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 2001 results include the results of Financial Guaranty's operations
for the period from the date of the acquisition.
The following unaudited pro forma information presents a summary of the
consolidated operating results of the Company for the six month period ended
June 30, 2001, as if the acquisition of Financial Guaranty had occurred on
January 1, 2001 (in thousands, except per-share information):
Six Months Ended
June 30, 2001
-------------
Total revenues $ 446,863
Net income 77,562
Net income per share-basic $ 0.87
Net income per share-diluted $ 0.85
7
3 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company adopted SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", as amended, on January 1, 2001.
Transactions that the Company has entered into that are accounted for under SFAS
No. 133, as amended, include convertible securities, 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 qualify as hedges under SFAS No. 133.
At June 30, 2002, the fair value of the Company's derivative
instruments, classified as trading securities, was $34.8 million, as compared to
an amortized value of $42.3 million, and the Company recognized $4.3 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 $4.6 billion at June 30, 2002 and the Company
recognized $1.8 million, net of tax, of loss on these instruments. Net
unrealized depreciation on credit default swaps of $7.7 million at June 30, 2002
was comprised of gross unrealized gains of $33.0 million and gross unrealized
losses of $40.7 million.
The application of SFAS 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.
4 - SEGMENT REPORTING
The Company has three reportable segments: mortgage insurance,
financial guaranty and mortgage services. 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 financial guaranty segment provides credit-related
insurance coverage to meet the needs of customers in a wide variety of domestic
and international markets. For the periods presented in this report, revenues
attributable to foreign countries was not material. In addition, long-lived
assets located in foreign countries were not material for periods presented. The
Company's insurance businesses within this segment include the assumption of
reinsurance from the monoline financial guaranty insurers for both municipal
bonds and structured finance obligations. The Company also provides direct
financial guaranty insurance for municipal bonds, structured finance, trade
credit reinsurance and excess Securities Investor Protection Corporation
("SIPC") insurance. The mortgage services segment deals primarily with
credit-based servicing and securitization of assets in underserved markets, in
particular, the purchase and servicing of and securitization of special assets,
including sub-performing/non-performing mortgages, seller financed residential
mortgages and delinquent consumer assets. In addition, mortgage services
includes the results of RadianExpress.com ("RadianExpress"), an internet-based
settlement company that provides real estate information products and services
to the first and second lien mortgage industry. The Company's reportable
segments are strategic business units, which are managed separately, as each
business requires different marketing and sales expertise. Certain corporate
expenses have been allocated to the segments. Prior period information has been
restated to conform with the current year segment definitions.
In the mortgage insurance segment, the highest state concentration of
risk is California at 16.7%. At June 30, 2002, California also accounted for
16.7% of Mortgage Insurance's total direct primary insurance in force and 11.1%
of Mortgage Insurance's total direct pool insurance in force. California
accounted for 19.5% of Mortgage Insurance's direct primary new insurance written
in the first six months of 2002. The largest single customer of Mortgage
Insurance (including branches and affiliates of such customer) measured by new
insurance written, accounted for 16.4% of new insurance written during the first
six months of 2002 compared to 12.6% for full year 2001 and 11.2% for full year
2000. The amount reported in 2002 includes a large structured transaction, for
$3.9 billion, for one customer comprised of prime mortgage loans originated
throughout the United States.
In the financial guaranty segment, the Company derives a substantial
portion of its premiums written from a small number of primary insurers. In the
first six months of 2002, 21.6% of gross written premiums were derived from two
primary insurers. Four primary insurers were responsible for 27.4% of gross
written premiums. This customer concentration results from the small number of
primary insurance companies licensed to write financial guaranty insurance.
8
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:
Quarter Ended Six Months Ended
June 30 June 30
MORTGAGE INSURANCE ------------------------------- ------------------------------
(in thousands) 2002 2001 2002 2001
----------- ----------- ----------- -----------
Net premiums written $ 164,328 $ 159,416 $ 326,390 $ 310,050
=========== =========== =========== ===========
Net premiums earned $ 167,873 $ 148,508 $ 336,912 $ 293,083
Net investment income 26,963 24,507 52,814 47,492
Equity in net income of affiliates -- -- -- --
Other income 4,393 5,802 8,410 9,780
----------- ----------- ----------- -----------
Total revenues 199,229 178,817 398,136 350,355
----------- ----------- ----------- -----------
Provision for losses 47,318 43,506 92,416 89,950
Policy acquisition costs 17,326 15,718 32,898 30,846
Other operating expenses 27,248 24,337 56,054 41,225
Interest expense 4,633 2,386 8,675 3,347
----------- ----------- ----------- -----------
Total expenses 96,525 85,947 190,043 165,368
----------- ----------- ----------- -----------
Net gains (losses) (616) 1,362 (931) 3,211
----------- ----------- ----------- -----------
Pretax income 102,088 94,232 207,162 188,198
Income tax provision 28,439 25,784 57,387 51,548
----------- ----------- ----------- -----------
Net income $ 73,649 $ 68,448 $ 149,775 $ 136,650
=========== =========== =========== ===========
Total assets $ 3,114,928 $ 2,551,219
Deferred policy acquisition costs 79,243 73,573
Reserve for losses 475,288 435,202
Unearned premiums 94,402 94,898
Equity 1,539,185 1,303,944
9
Quarter Ended Six Months Ended
June 30 June 30
FINANCIAL GUARANTY ------------------------------- -------------------------------
(in thousands) 2002 2001 2002 2001
----------- ----------- ----------- -----------
Net premiums written $ 73,282 $ 39,787 $ 135,858 $ 49,402
Net premiums earned $ 43,158 $ 30,733 $ 83,308 $ 41,921
Net investment income 17,511 14,902 34,370 19,905
Equity in net income of affiliates (135) (1,521) (19) (1,322)
Other income 262 391 831 805
----------- ----------- ----------- -----------
Total revenues 60,796 44,505 118,490 61,309
----------- ----------- ----------- -----------
Provision for losses 10,258 8,804 22,587 11,632
Policy acquisition costs 8,277 6,278 16,152 8,191
Other operating expenses 7,791 4,249 16,492 8,215
Interest expense 2,129 1,710 4,733 2,055
----------- ----------- ----------- -----------
Total expenses 28,455 21,041 59,964 30,093
----------- ----------- ----------- -----------
Net gains (losses) (3,543) (539) (5,781) (566)
----------- ----------- ----------- -----------
Pretax income 28,798 22,925 52,745 30,650
Income tax provision 8,014 6,277 14,611 8,395
----------- ----------- ----------- -----------
Net income $ 20,784 $ 16,648 $ 38,134 $ 22,255
=========== =========== =========== ===========
Total assets $ 1,763,462 $ 1,343,429
Deferred policy acquisition costs 92,303 62,907
Reserve for losses 127,933 118,097
Unearned premiums 457,909 378,490
Equity 839,636 665,557
Quarter Ended Six Months Ended
June 30 June 30
MORTGAGE SERVICES --------------------------- ---------------------------
(in thousands) 2002 2001 2002 2001
--------- --------- --------- ---------
Net premiums written -- -- -- --
========= ========= ========= =========
Net premiums earned -- -- -- --
Net investment income $ 11 $ 46 $ 54 $ 78
Equity in net income of affiliates 26,909 14,281 45,413 26,126
Other income 6,310 3,090 13,006 4,990
--------- --------- --------- ---------
Total revenues 33,230 17,417 58,473 31,194
--------- --------- --------- ---------
Provision for losses
Policy acquisition costs
Other operating expenses 9,461 4,356 16,699 7,459
Interest expense 477 351 985 447
--------- --------- --------- ---------
Total expenses 9,938 4,707 17,684 7,906
--------- --------- --------- ---------
Net gains (losses) 857 (75) 789 (74)
--------- --------- --------- ---------
Pretax income 24,149 12,635 41,578 23,214
Income tax provision 9,660 5,054 16,632 9,285
--------- --------- --------- ---------
Net income $ 14,489 $ 7,581 $ 24,946 $ 13,929
========= ========= ========= =========
Total assets $ 216,851 $ 188,859
Deferred policy acquisition costs
Reserve for losses
Unearned premiums
Equity 174,688 144,917
10
The reconciliation of segment net income to consolidated net income is as
follows:
Quarter Ended Six Months Ended
June 30 June 30
CONSOLIDATED ------------------------ ------------------------
(in thousands) 2002 2001 2002 2001
-------- -------- -------- --------
Net income:
Mortgage Insurance $ 73,649 $ 68,448 $149,775 $136,650
Financial Guaranty 20,784 16,648 38,134 22,255
Mortgage Services 14,489 7,581 24,946 13,929
-------- -------- -------- --------
Total $108,922 $ 92,677 $212,855 $172,834
-------- -------- -------- --------
5 - LONG-TERM AND SHORT-TERM DEBT
In January 2002, the Company sold $220 million of Senior Convertible
Debentures. The debentures bear interest at the rate of 2.25% per year and
interest is payable semi-annually on January 1 and July 1, beginning July 1,
2002. The Company will also pay contingent interest on specified semi-annual
periods, if the sale price of its common stock for a specified period of time is
less than 60% of the conversion price. The debentures are convertible, at the
purchaser's option, into shares of common stock at prices and on dates specified
in the offering. At that time, the shares become common shares for the purposes
of calculating earnings per share.
The composition of long-term and short-term debt was as follows:
June 30 December 31
($ in thousands) 2002 2001
-------- --------
2.25% Senior Convertible Debentures due 2022 $220,000 $ --
7.75% debentures due 2011 249,110 249,076
6.75% debentures due 2003 75,000 75,000
-------- --------
$544,110 $324,076
======== ========
6 - SUBSEQUENT EVENTS
In July 2002, the Company issued a notice of redemption for the
Company's $4.125 Preferred Stock, par value $.001 per share. The notice calls
for the redemption of all 800,000 outstanding shares of the Company's preferred
stock on August 15, 2002. Pursuant to the Company's sinking fund redemption
obligation, 72,000 shares will be redeemed at $50.00 per share, and the
remaining 728,000 shares will be redeemed at $54.125 per share. Accrued and
unpaid dividends on the shares to the date of redemption will also be paid as
part of the redemption price. The amount paid over the carrying value of the
preferred stock will result in an approximate $.03 reduction in earnings per
share for the third quarter of 2002.
7 - RECENT ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statements of Financial Accounting Standards ("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 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. Management has determined that the provisions of this statement will have
no 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 activities when they are
incurred rather than at the date of commitment to an exit or disposal
11
plan. Examples of costs covered by the standard include lease termination costs
and certain employee severance costs that are associated with restructuring,
discontinued operations, plant closing, or other exit or disposal activity.
Statement 146 is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following is a "Safe Harbor" Statement under the Private Securities
Litigation Reform Act of 1995:
The statements contained in this Form 10-Q that are not historical
facts are forward-looking statements. Actual results may differ materially from
those projected in the forward-looking statements. These forward-looking
statements involve risks and uncertainties including, but not limited to: the
possibility that interest rates may increase rather than remain stable or
decrease; the possibility that housing demand may decrease for any number of
reasons, some of which may be out of the control of the Company, including
changes in interest rates, adverse economic conditions, or other reasons; the
Company's market share may decrease as a result of changes in underwriting
criteria by the Company or its competitors, or other reasons; performance of the
financial markets generally, changes in the demand for and market acceptance of
the Company's products, increased competition from government programs and the
use of substitutes for mortgage insurance, changes in government regulation or
tax laws that may affect one or more of the Company's businesses, changes in
investor perceptions regarding the strength of financial guaranty providers and
the guaranty offered by such providers, changes in investor concern regarding
the credit quality of municipalities and corporations, including the need or
desirability for financial guaranty insurance at all or as an alternative for
other credit enhancement; and changes in general financial conditions. Investors
are also directed to other risks discussed in documents filed by the Company
with the Securities and Exchange Commission.
RESULTS OF CONSOLIDATED OPERATIONS
Net income for the second quarter of 2002 was $108.9 million or $1.12
per share compared to $92.7 million or $0.97 per share for the second quarter of
2001. Net income for the first six months of 2002 was $212.9 million or $2.20
per share, compared to $172.8 million or $1.92 per share for the six months
ended June 30, 2001. The 17.5% increase in net income for the second quarter was
primarily a result of growth in the Company's business volumes. Insurance in
force for Mortgage Insurance increased from $104.3 billion at June 30, 2001 to
$111.4 billion at June 30, 2002. Total net debt service outstanding for
Financial Guaranty increased from $90.8 billion at June 30, 2001 to $102.4
billion at June 30, 2002. These increases in business volumes produced increases
in written and earned premiums, investment income and other income. In addition,
equity in net income of affiliates increased by $14.0 million in the second
quarter of 2002 from the $12.8 million recorded in the second quarter of 2001
primarily due to strong results at Credit-Based Asset Servicing and
Securitization LLC ("C-BASS") and Sherman Financial Services Group LLC
("Sherman"). Partially offsetting these increases were increases in the
provision for losses, policy acquisition costs, operating expenses and interest
expense to support the higher business volumes. The 23.2% increase in net income
for the six months ended June 30, 2002 was primarily due to the reasons stated
above, as well as the inclusion of Financial Guaranty and much of Mortgage
Services for six months in 2002, compared to four months in 2001, as a result of
the acquisition of Financial Guaranty on February 28, 2001.
Consolidated earned premiums of $211.0 million increased $31.8 million
or 17.7% from $179.2 million in the second quarter of 2001. Mortgage Insurance
contributed $19.4 million of this increase and Financial Guaranty contributed
$12.4 million to this increase. Net investment income for the second quarter of
2002 increased to $44.5 million from $39.5 million in the second quarter of
2001. The $5.0 million or 12.7% increase was primarily due to a large investment
portfolio balance as a result of continued positive operating cash flows. Other
income increased to $11.0 million in the second quarter of 2002 from $9.3
million in the same period of 2001, primarily related to the activities of
RadianExpress, our internet-based settlement company. Consolidated earned
premiums for the first six months of 2002 were $420.2 million, up 25.4% from
$335.0 million for the same period of 2001. Financial Guaranty contributed $41.4
million of this increase, partially due to the inclusion of that segment for six
months during 2002 compared to four months in 2001. The remaining increase came
from Mortgage Insurance. Net investment income of $87.2 million for the six
months ended June 30, 2002 increased $19.7 million or 29.2% from $67.5 million
reported in the comparable period of 2001. Equity in net income of affiliates
increased 83.1% from $24.8 million for the first six months of 2001 to $45.4
million for the same period of 2002. Other income increased 42.3% to $22.2
million for the first six months of 2002 compared to $15.6 million in the
comparable period of 2001.
12
The provision for losses was $57.6 million for the second quarter of
2002, an increase of $5.3 million or 10.1% from the $52.3 million reported for
the second quarter of 2001. Approximately $3.8 million of this was related to
Mortgage Insurance to support an increase in claims payments, and $1.5 million
was due to balance sheet strengthening at Financial Guaranty. Policy acquisition
costs for the second quarter of 2002 were $25.6 million, up from $22.0 million
in the second quarter of 2001. Other operating expenses of $44.5 million
increased $11.6 million or 35.3% from the $32.9 million reported in the second
quarter of 2001. This was primarily due to increases in salaries and benefits
related to an increase in headcount to support higher volumes, increased legal
fees and fees for outside services, and increased depreciation and software
costs due to increased capital expenditures in late 2001 and 2002. Interest
expense of $7.2 million increased from $4.4 million for the second quarter of
2001, as a result of the issuance of $250 million of long-term debt in May 2001
and $220 million of convertible debt in January 2002, combined with the $75
million of debt acquired as a result of the Financial Guaranty acquisition in
February 2001. The provision for losses of $115.0 million for the first six
months of 2002 increased $13.4 million or 13.2% from the same period of 2001.
The increase in the provision for losses for the six month period of 2002 was
primarily related to increased claims and balance sheet strengthening at
Financial Guaranty. Policy acquisition costs were $49.1 million for the six
months ended June 30, 2002 compared to $39.0 million for the first six months of
2001. Other operating expenses were $89.2 million for the first six months of
2002, a $32.3 million or 56.8% increase from the same period of 2001. Interest
expense of $14.4 million increased from $5.8 million for the first six months of
2001, due to the increases in levels of long-term debt to support higher
business volumes discussed above. The consolidated effective tax rate for the
three and six months ended June 30, 2002 was 29.7% and 29.4%, respectively,
compared to 28.6% for both the three and six month periods of 2001.
MORTGAGE INSURANCE - RESULTS OF OPERATIONS
Net income for the second quarter was $73.6 million, up from $68.4
million in the second quarter of 2001. This increase was due to an increase in
earned premiums and investment income partially offset by decreases in other
income and an increase in the provision for losses, policy acquisition costs,
other operating expenses and interest expense.
Primary new insurance written during the second quarter of 2002 was
$10.1 billion, a 6% decrease compared to $10.8 billion for the second quarter of
2001. This decrease in Mortgage Insurance's primary new insurance written volume
for the second quarter of 2002 was primarily due to a decrease in insurance
written through contract underwriting due to a reduction in contract
underwriting staff. The industry experienced a 15% increase in new insurance
written volume for the second quarter of 2002 as compared to the second quarter
of 2001. The Company's market share of the industry based on new insurance
written decreased to 11.7% in the second quarter of 2002, compared to almost 18%
in the first quarter of 2002 and 14.3% in the second quarter of 2001. The
Company's market share of the industry based on new insurance written for the
first six months of 2002 was 14.6%. During the first six months of 2002,
Mortgage Insurance wrote $6.4 billion or 26.7% of new insurance written in
structured transactions as compared to $2.6 billion or 13.4% of new insurance
written in the same period of 2001. Of this amount in 2002, $4.8 million was
written in the first three months of the year. The amount originated in the
first quarter of 2002 includes a large structured transaction for $3.9 billion
for one customer comprised of prime mortgage loans originated throughout the
United States. The Company's participation in the structured transactions market
is likely to vary significantly from quarter to quarter as the Company competes
with other mortgage insurers as well as capital market executions for these
transactions. In the second quarter and year-to-date periods of 2002, Mortgage
Insurance wrote $35 million and $121 million of pool insurance risk as compared
to $55 million and $88 million in the same periods of 2001.
Mortgage Insurance's volume in the second quarter and year-to-date
period of 2002 continued to be positively impacted by relatively lower interest
rates that affected the entire mortgage industry. The continued low interest
rate environment caused refinancing activity at the beginning of 2002 to
continue to remain high and contributed to relatively strong new insurance
volume through the second quarter of 2002. Mortgage Insurance's refinancing
activity as a percentage of primary new insurance written was 44% for the second
quarter of 2002 as compared to 42% for the same period in 2001. The refinancing
percentages for the six months ended June 30, 2002 and 2001, were 40% and 39%,
respectively. The persistency rate, which is defined as the percentage of
insurance in force that is renewed in any given year, was 59.3% for the twelve
months ended June 30, 2002 as compared to 72.6% for the twelve months ended June
30, 2001. This decrease was consistent with the increasing level of refinancing
activity, which caused the cancellation rate to increase. The expectation for
the balance of 2002 is a
13
continuation of strong industry volume and a gradual increase in persistency
rates, influenced by a leveling off of interest rates.
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 typical
insured 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 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
that the Company believes is commensurate with the additional default risk.
During the second quarter and year-to-date period of 2002, non-prime business
accounted for $3.3 billion and $7.8 billion or 32.7% and 32.5%, respectively of
Mortgage Insurance's primary new insurance written. This compared to $3.0
billion and $5.3 billion or 27.8% and 27.3% for the same periods in 2001. Of the
$3.3 billion of non-prime business for the second quarter of 2002 and $7.8
billion year-to-date 2002, $2.3 billion and $5.8 billion, respectively, was
Alternative A.
The Company insures mortgage-related assets in a Pennsylvania domiciled
insurer, Radian Insurance Inc. ("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%. Beginning in October 2001, Radian Insurance
entered into a reinsurance agreement with one of its affiliates, Radian Asset
Assurance, whereby Radian Insurance ceded substantially all of the insurance
business and premium associated with certain obligations secured by
mortgage-backed securities and manufactured housing loans. Because most
Financial Guaranty business on mortgage related assets will be written in Radian
Asset Assurance and Amerin will be the primary writer of second mortgage
insurance in the future, the business written by Radian Insurance will be
substantially reduced in 2002. The second mortgage new insurance written by
Amerin in the second quarter and first six months of 2002 was $139.6 million and
$168.6 million, respectively. The comparable amounts of second mortgage new
insurance written in 2001 were $807.0 million and $1.9 billion, respectively.
This reduction was a result of the tightening of underwriting guidelines. Radian
Insurance originated $10 million par amount of financial guaranty insurance in
the second quarter and first six months of 2002. The business originated by
Radian Insurance related to certain non-investment grade financial guaranty
insurance on mortgage related assets.
Net premiums earned in the second quarter and first six months of 2002
were $167.9 million and $336.9 million, respectively. These amounts represent
increases of 13.1% and 14.9% respectively, compared to the comparable periods of
2001. These increases, which were greater than the increase in insurance in
force, reflected a significant increase in new insurance volume, which are
monthly policies. This increase included a slightly higher percentage of
non-prime business. This type of business has higher premium rates, which are
commensurate with the increased level of risk associated with the insurance. The
insurance in force growth resulting from strong new insurance volume in the
second quarter of 2002 was offset by the decrease in persistency levels. These
lower persistency levels will impact premiums earned in future periods. There
was an increase in direct primary insurance in force for the first six months of
3.2%, from $107.9 billion at December 31, 2001 to $111.4 billion at June 30,
2002. Total pool risk in force was $1.7 billion at June 30, 2002 compared to
$1.6 billion at December 31, 2001.
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 lender
sets up a mortgage reinsurance company that assumes part of the risk associated
with that lender's insured book of business. In most cases, the risk assumed by
the reinsurance company is an excess layer of aggregate losses that would be
penetrated only in a situation of adverse loss development. For the second
quarter of 2002, premiums ceded under captive reinsurance arrangements were
$13.7 million, or 8.2% of total premiums earned during the period, as compared
to $13.4 million, or 9.0% of total premiums earned for the same period of 2001.
For the year-to-date period of 2002, premiums ceded under captive reinsurance
arrangements were $24.9 million, or 7.4% of total premiums earned during the
period, as compared to $25.4 million, or 8.7% of total premiums earned for the
same period of 2001. Primary new insurance written under captive reinsurance
arrangements for the three and six months ended June 30, 2002 was $4.4 billion
and $8.2 billion, respectively, or 42.9% and 34.1%, respectively, of total
primary new insurance written for the second quarter and year to date period of
2002 as compared to $2.9 billion and $5.8 billion,
14
respectively, for the three and six months ended June 30, 2001, or 26.9% and
29.6%, respectively, of total primary new insurance written.
Net investment income for the second quarter of 2002 was $27.0 million,
a 10.2% increase compared to $24.5 million for the same period of 2001. This
increase was a result of continued growth in invested assets primarily due to
positive operating cash flows during the second quarter of 2002 and the
allocation of interest income from net financing activities. 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 intent is to target the common equity
exposure at a maximum of 5% of the investment portfolio's market value while the
investment-grade convertible securities and investment-grade asset-backed
securities exposures are each targeted not to exceed 10% each. Net investment
income was $52.8 million for the six months ended June 30, 2002 compared to
$47.5 million for the same period of 2001, also due to the reasons stated above.
The provision for losses was $47.3 million for the three months ended
June 30, 2002, an increase of 8.7% compared to $43.5 million for the comparable
three months of 2001. Claims activity is not spread evenly throughout the
coverage period of a book of business. Relatively few claims are received during
the first two years following issuance of the policy. Historically, claim
activity has reached its highest level in the third through fifth years after
the year of loan origination. Approximately 67.9% of the primary risk in force
and approximately 43.1% of the pool risk in force at June 30, 2002 had not yet
reached its anticipated highest claim frequency years. The overall default rate
for both primary and pool insurance at June 30, 2002 was 2.3%, compared to 2.2%
at December 31, 2001, while the default rate on the primary business was 3.5% at
June 30, 2002 consistent with December 31, 2001. The change in the primary
default rate resulted from a 43 basis point decline in the delinquency rate on
our prime loans, partially offset by a 190 basis point increase in the non-prime
delinquency rate. 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 number of defaults
increased slightly from 41,147 at December 31, 2001 to 41,275 at June 30, 2002
while the average loss reserve per default increased from $11,291 at the end of
2001 to $11,789 at June 30, 2002. The reserve as a percentage of risk in force
was 1.7% at June 30, 2002 and 1.6% at December 31, 2001. Mortgage Insurance has
reported an increased number of defaults on non-prime business insured beginning
in 1997. Although the default rate for this business is higher than on the prime
book of business, it is within the expected range for this type of business, and
the higher premium rates charged are expected to compensate for the increased
level of risk. The number of non-prime loans in default at June 30, 2002 was
11,643, which represented 36.8% of the total number of primary loans in default
as compared to 7,704 at December 31, 2001, which represented 24.8% of the
primary loans in default. The default rate on this business rose from 5.5% at
December 31, 2001 to 7.4% at June 30, 2002 as compared to the primary default
rate on the prime business of 2.7% at June 30, 2002 and 3.1% at December 31,
2001. Direct losses paid in the second quarter of 2002 increased to $39.3
million as compared to $37.0 million in the first quarter of 2002 and $19.9
million for the second quarter of 2001. Direct paid losses for the first six
months of 2002 were $76.2 million as compared to $41.6 million for the same
period of 2001, an increase of 83.2%. Claims paid for the second mortgage
business for the second quarter and first six months of 2002 were $2.6 million
and $8.5 million, respectively. The severity of loss payments has increased due
to deeper coverage amounts and larger loan balances, and any negative impact on
future property values would most likely increase the loss severity. In
addition, the claims in the six months of 2002 have been impacted by the rise in
delinquencies from 2001 that have proceeded to foreclosure.
The following table provides selected information as of and for the
periods indicated for the Mortgage Insurance segment:
Three Months Ended Six Months Ended
------------------------------------ ----------------------
June 30, March 31, June 30, June 30, June 30,
($ thousands, unless specified otherwise) 2002 2002 2001 2002 2001
-------- -------- -------- -------- --------
Provision for losses $ 47,318 $ 45,098 $ 43,506 $ 92,416 $ 89,950
Reserve for losses $475,288 $471,268 $435,202
15
Three Months Ended Six Months Ended
------------------------------------ ----------------------
June 30, March 31, June 30, June 30, June 30,
2002 2002 2001 2002 2001
-------- -------- -------- -------- --------
PRIMARY INSURANCE:
Prime:
Number of insured loans 749,065 763,990 788,880
Number of loans in default 20,012 20,244 19,448
Percentage of total loans in default 2.67% 2.65% 2.47%
Non-Prime:
Number of insured loans 156,521 144,617 92,065
Number of loans in default 11,643 10,593 4,398
Percentage of total loans in default 7.44% 7.32% 4.78%
Total:
Number of insured loans 905,586 908,607 880,945
Number of loans in default 31,655 30,837 23,846
Percentage of total loans in default 3.50% 3.39% 2.71%
Claims paid:
Georgia $ 2,774 $ 3,686 $ 665 $ 6,460 $ 1,372
California 2,879 2,702 1,705 5,581 3,615
Utah 2,010 2,505 870 4,515 2,001
Texas 2,668 1,611 864 4,279 1,776
Florida 1,926 1,674 1,891 3,600 4,323
Total Claims Paid $ 37,892 $ 31,755 $ 19,504 $ 69,647 $ 42,434
Percentage of total claims paid:
Georgia 7.3% 11.6% 3.4% 9.3% 3.2%
California 7.6 8.5 8.7 8.0 8.5
Utah 5.3 7.9 4.5 6.5 4.7
Texas 7.0 5.1 4.4 6.1 4.2
Florida 5.1 5.3 9.7 5.2 10.2
Risk in Force: ($ millions)
California $ 4,459 $ 4,463 $ 4,031
Florida 2,037 2,008 1,868
New York 1,629 1,643 1,526
Texas 1,401 1,401 1,325
Georgia 1,196 1,203 1,102
Total Risk in Force $ 26,716 $ 26,715 $ 25,072
Percentage of total risk in force:
California 16.7% 16.7% 16.1%
Florida 7.6 7.5 7.5
New York 6.1 6.1 6.1
Texas 5.2 5.2 5.3
Georgia 4.5 4.5 4.4
Reserve for Losses as a % of Risk in Force 1.7% 1.7% 1.6%
16
Three Months Ended Six Months Ended
------------------------------------ ----------------------
June 30, March 31, June 30, June 30, June 30,
2002 2002 2001 2002 2001
-------- -------- -------- -------- --------
New insurance written: ($ millions)
Prime $ 6,838 $ 9,378 $ 7,812 $ 16,216 $ 14,067
Non-Prime 3,309 4,485 3,012 7,794 5,347
-------- -------- -------- -------- --------
Total $ 10,147 $ 13,863 $ 10,824 $ 24,010 $ 19,414
Primary risk written ($ millions) 2,501 3,591 2,641 6,092 4,741
Direct primary insurance in force ($ millions) $111,424 $107,918 $104,257
POOL INSURANCE:
Pool risk written ($ millions) $ 35 $ 86 $ 55 $ 121 $ 88
GSE pool risk in force ($ millions) $ 1,222 $ 1,224 $ 1,212
Total pool risk in force ($ millions) $ 1,745 $ 1,723 $ 1,517
Underwriting and other operating expenses were $44.6 million for the
second quarter of 2002, an increase of 11.2% compared to $40.1 million for the
same period of 2001. For the six months ended June 30, 2002, these expenses were
$89.0 million, an increase of 23.4% compared to $72.1 million for the comparable
period of 2001. These expenses consist of policy acquisition expenses, which
relate directly to the acquisition of new business, and other operating
expenses, which primarily represent contract underwriting expenses, overhead and
administrative costs.
Policy acquisition costs were $17.3 million in the second quarter of
2002, an increase of 10.2% compared to $15.7 million in the second quarter of
2001. While new insurance written volume has not increased, the amortization of
expenses is related to the premium recognition over the life of an account. Much
of the amortization in the current year represents costs that were expended in
2001. Other operating expenses for the second quarter of 2002 were $27.2
million, an increase of 11.9% compared to $24.3 million for the second quarter
of 2001. This reflects an increase in expenses associated with the Company's
technological, administrative and support functions. Contract underwriting
expenses for the second quarter of 2002 included in other operating expenses
were $10.3 million as compared to $11.9 million for the same period in 2001, a
decrease of 13.4%. This $1.6 million decrease in contract underwriting expenses
during the second quarter of 2002 reflected the slightly lower demand for
contract underwriting services. Other income related to contract underwriting
services was $3.4 million for the second quarter of 2002 as compared to $4.1
million for the same period in 2001. During the first six months of 2002, loans
underwritten via contract underwriting accounted for 31.8% of applications,
29.7% of insurance commitments, and 22.6% of certificates issued by the Company
as compared to 31.4% of applications, 30.2% of commitments and 23.4% of
certificates in the first six months of 2001.
The effective tax rate for the quarter and year-to-date period ended
June 30, 2002 was 27.9% and 27.7% as compared to 27.4% for the second quarter
and the year-to-date period of 2001.
The U.S. Department of Housing and Urban Development has proposed a
rule under the Real Estate Settlement Procedures Act ("RESPA") to create a safe
harbor 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
safe harbor 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 could be included as one
of these settlement services. The proposed rule was published in the Federal
Register on July 29, 2002 and is subject to a 90-day comment period. If the rule
is implemented, the premiums charged for mortgage insurance could be affected.
17
FINANCIAL GUARANTY INSURANCE - RESULTS OF OPERATIONS
The financial guaranty insurance operations are conducted through
Financial Guaranty and primarily involve the direct insurance and reinsurance of
municipal bonds and structured finance obligations. Reinsurance is assumed
primarily from the four primary monoline financial guaranty insurers. Radian
Reinsurance Inc., a subsidiary of Financial Guaranty ("Radian Re"), currently
derives substantially all of its reinsurance premium revenues from those four
monolines. Approximately 27.4% of total gross written premiums for Financial
Guaranty were derived from these four monolines in 2002. A substantial reduction
in the amount of insurance ceded by one or more of these four principal clients
could have a material adverse effect on Financial Guaranty's gross written
premiums and, consequently, its results of operations. Financial Guaranty is
also dependent on reinsurance for trade credit insurance written.
The results of operations for the year-to-date period of 2001 include
the results of Financial Guaranty from the date of acquisition, February 28,
2001. Since the acquisition, business volumes in Financial Guaranty 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 the second quarter of 2002 was $20.8 million compared to
$16.6 million in the same period of 2001. Net premiums written and earned for
the second quarter of 2002 were $73.3 million and $43.2 million, respectively,
compared to $39.8 million and $30.7 million, respectively, for the same periods
of 2001. Net income for the six months ended June 30, 2002 was $38.1 million
compared to $22.3 million for the same period of 2001. Net premiums written and
earned for the six month period of 2002 were $135.9 million and $83.3 million,
respectively, compared to $49.4 million and $41.9 million, respectively, for the
comparable period in 2001. For the second quarter of 2002, there was $521.0
million of par insured originated in the municipal bond insurance area including
$225.0 million in the healthcare sector and $225.0 million in the higher
education sector. In the non-municipal or global structured products area,
Financial Guaranty wrote $1.7 billion of par, primarily in the form of credit
protection on synthetic, static pools of investment-grade collateralized debt
obligations. The following table shows the breakdown of premiums written and
earned for each period.
Quarter Ended Six Months Ended
June 30 June 30
--------------------- ---------------------
2002 2001 2002 2001
-------- -------- -------- --------
(in thousands) (in thousands)
Net premiums written:
Muni direct $ 15,956 $ 5,497 $ 30,540 $ 6,678
Muni reinsurance 7,212 14,260 23,194 16,251
Non-muni direct 21,669 2,102 29,684 2,815
Non-muni reinsurance 15,256 10,412 30,970 12,866
Trade credit 13,189 7,516 21,470 10,792
-------- -------- -------- --------
Total net premiums written $ 73,282 $ 39,787 $135,858 $ 49,402
======== ======== ======== ========
Net premiums earned:
Muni direct $ 3,314 $ 3,336 $ 6,833 $ 5,410
Muni reinsurance 10,840 6,891 18,505 9,014
Non-muni direct 8,944 3,323 15,499 4,522
Non-muni reinsurance 12,565 10,114 27,605 13,243
Trade credit 7,495 7,069 14,866 9,732
-------- -------- -------- --------
Total net premiums earned $ 43,158 $ 30,733 $ 83,308 $ 41,921
======== ======== ======== ========
Included in net premiums earned for the second quarter and year-to-date
periods of 2002 were refundings of $3,264,000 and $3,903,000, respectively,
compared to $1,575,000 and $2,805,000 for the same periods of 2001.
Net investment income was $17.5 million and $34.4 million for the
second quarter and year-to-date periods of 2002, compared to $14.9 million and
$19.9 million for the similar periods of 2001. The provision for losses was
$10.3 million for the second quarter of 2002 compared to $8.8 million for the
second quarter of 2001 and the year-to-date 2002 provision was $22.6 million
compared to $11.6 million in 2001. The provision represented 23.8% and 27.1% of
earned premiums for the second quarter and year-to-date periods of 2002 compared
to 28.6% and 27.7% in the same periods of 2001. Financial Guaranty paid one
large claim for approximately $9.0 million in the year-to-
18
date period of 2002. The remaining claims of $9.5 million relate primarily to
trade credit insurance. Policy acquisition and other operating expenses were
$16.1 million and $32.6 million for the three and six month periods of 2002
compared to $10.5 million and $16.4 million for the three and six month periods
of 2001. This resulted in an expense ratio of 37.2% and 38.0% for the second
quarter and year-to-date period of 2002 compared to 34.3% and 39.1% for the 2001
periods. Interest expense for the second quarter of 2002 was $2.1 million
compared to $1.7 million in the second quarter of 2001. For the year-to-date
periods of 2002 and 2001, interest expense was $4.7 million and $2.1 million,
respectively. All periods include interest allocated on the Company's debt
financing. Net losses of $3.5 million and $5.8 million for the second quarter
and year-to-date periods of 2002 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 a derivative instrument.
The effective tax rate was 27.8% and 27.7% for the three and six months
ended June 30, 2002 compared to 27.4% for both periods of 2001.
MORTGAGE SERVICES - RESULTS OF OPERATIONS
The mortgage services results include the operations of
RadianExpress.com Inc. ("RadianExpress") and the asset-based businesses
conducted through Financial Guaranty's minority owned subsidiaries, C-BASS and
Sherman. The Company owns a 46% interest in C-BASS and a 45.5% interest in
Sherman. 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 the second quarter and year-to-date periods of 2002 was
$14.5 and $24.9 million compared to $7.6 million and $13.9 million for the same
periods in 2001. Equity in net income of affiliates (pre-tax) was $26.9 million
for the second quarter of 2002 compared to $14.3 million for the comparable
period in 2001. For the year-to-date periods of 2002 and 2001, equity in net
income of affiliates was $45.4 million and $26.1 million, respectively. C-BASS
accounted for $21.5 million (pre-tax) of the total income from affiliates in the
second quarter of 2002 and $37.6 million (pre-tax) of the year-to-date 2002
amount. 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 $5.8 million of other income and $6.2 million
of operating expenses for the second quarter of 2002 compared to $3.1 million
and $3.6 million, respectively, for the second quarter of 2001. Year-to-date
2002, RadianExpress had revenues of $11.5 million and expenses of $12.6 million,
compared to $5.0 million and $6.3 million, respectively in the year-to-date
period of 2001. RadianExpress processed approximately 105,000 applications
during the second quarter of 2002 and 225,000 applications year-to-date 2002. In
the second quarter and year to date periods of 2001, RadianExpress processed
79,000 and 164,000 applications, respectively. 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. This 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 Company is vigorously appealing this cease and desist order.
OTHER
Two wholly-owned subsidiaries of Financial Guaranty, Singer Asset
Finance Company, L.L.C. ("Singer") and Enhance Consumer Services LLC ("ECS"),
which had been engaged in the purchase, servicing, and securitization of assets
including state lottery awards, structured settlement payments and viatical
settlements, are currently operating on a run-off basis. Their 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. At June 30, 2002, the Company has
approximately $533.0 million and $509.0 million of non-consolidated assets and
liabilities, respectively, associated with the Singer special purpose vehicles.
The Company's investment in these special purpose vehicles is $25.0 million at
June 30, 2002.
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
19
landfill operators. Such business is not expected to be material to the
financial results of the Company.
At June 30, 2002, the Company, through its ownership of Financial
Guaranty, owned an indirect 36.5% equity interest in Exporters Insurance Company
Ltd., an insurer of 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.
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 six months ended June 30,
2002 were $267.8 million as compared to $213.4 million for the same period of
2001. This increase consisted of an increase in net premiums written and
investment income received partially offset by increases in losses 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, plus redeemable preferred stock of $40.0 million,
increased to $2.6 billion at June 30, 2002 from $2.3 billion at December 31,
2001. This resulted from net income of $212.9 million, proceeds from the
issuance of common stock of $25.5 million and an increase in the market value of
securities available for sale of $14.3 million, net of tax, offset by dividends
of $5.4 million.
As of June 30, 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 cost of $25 million to $30
million. The Company plans to move its Data Center to Dayton, Ohio in the coming
year. Cash flows from operations will be used to fund these expenditures.
Financial Guaranty was party to a credit agreement (as amended, the
"Credit Agreement") with major commercial banks providing Financial Guaranty
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.
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 acquisition of Financial Guaranty. C-BASS paid
$20.1 million of dividends to the Company during the first six months of 2002
and $12.8 million during all of 2001.
The Company owns a 45.5% interest in Sherman. The Company did not made
any capital contributions to Sherman in the first six months of 2002, but made
$15.0 million of contributions during full year 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 were no
outstanding drawdowns on the line of credit as of June 30, 2002.
In January 2002, the Company sold $220 million of Senior Convertible
Debentures. Approximately $125 million of the proceeds from the offering was
used to increase capital at Radian Asset Assurance. The remainder will be used
for 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,
beginning July 1, 2002. The Company will also pay contingent interest on
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. At that time, the shares
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 one year. 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
20
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, Inc. ("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 Re has provided Primus with an excess of loss insurance
policy. The Company accounts for the Primus investment under the equity method
of accounting. Their results for the second quarter of 2002 were immaterial to
the consolidated financial statements.
In July 2002, the Company issued a notice of redemption for the
Company's $4.125 Preferred Stock, par value $.001 per share. The notice calls
for the redemption of all 800,000 outstanding shares of the Company's preferred
stock on August 15, 2002. Pursuant to the Company's sinking fund redemption
obligation, 72,000 shares will be redeemed at $50.00 per share, and the
remaining 728,000 shares will be redeemed at $54.125 per share. Accrued and
unpaid dividends on the shares to the date of redemption will also be paid as
part of the redemption price.
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
Financial Guaranty. The Company's ability to pay dividends on the $4.125
Preferred Stock is dependent upon dividends or other distributions from Mortgage
Insurance or Financial Guaranty. In connection with obtaining approval from the
New York Insurance Department for the change of control of Financial Guaranty
when the Company acquired Financial Guaranty, Financial Guaranty agreed not to
declare or pay dividends for a period of two years following consummation of the
acquisition. Consequently, the Company cannot rely upon or expect any dividends
or other distributions from Financial Guaranty. 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 annually to pay the
dividends on the outstanding shares of common stock. The Company will also
require $29.4 million annually to pay the debt service on its long-term and
short-term debt financing and approximately $43.4 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 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
During the first six months of 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 $14.3 million. The accumulated net unrealized gain at June 30, 2002 was $24.7
million compared to $10.4 million at December 31, 2001. This increase in value
was a result of changes in market interest rates and not a result of changes in
the composition of the Company's investment portfolio. The market value of the
Company's long-term and short-term debt at June 30, 2002 was $588.0 million. For
a more complete discussion about the potential impact of interest rate changes
upon the fair value of the financial instruments in the Company's investment
portfolio, see "Quantitative and Qualitative Disclosures about Market Risk" in
the Company's 2001 Form 10-K.
21
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There have been no material developments in legal proceedings involving
the Company or its subsidiaries since those reported in the Company's Annual
Report on Form 10-K for the year ended December 31, 2001.
The Company is involved in certain litigation arising in the normal
course of its business. The Company is contesting the allegations in each such
pending action and believes, based on current knowledge and after consultation
with counsel, that the outcome of such litigation will not have a material
adverse effect on the Company's consolidated financial position and results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 7, 2002, the Annual Meeting of Stockholders of the Company was
held. At the meeting, the following matters were submitted to a vote of the
stockholders of the Company, with the voting results indicated below:
1) The election of four directors to serve for a three-year term
beginning at the 2002 Annual Meeting of Stockholders and
expiring at the 2005 Annual Meeting of Stockholders.
For Withheld
---------- ---------
David C. Carney 83,110,162 1,002,617
Howard B. Culang 83,909,581 203,198
Rosemarie B. Greco 83,910,525 202,254
Ronald W. Moore 83,908,080 204,699
2) The approval of the appointment of Deloitte & Touche LLP as
the Company's independent auditors for the year ending
December 31, 2002.
For Against Abstain
- ---------- --------- ------
79,676,136 4,399,579 37,064
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit No. Exhibit Name
- ----------- ------------
11 Statement Re: Computation of Per Share Earnings.
(b) REPORTS ON FORM 8-K
Current Report on Form 8-K filed with the Securities and
Exchange Commission on July 16, 2002 reporting the Company's
announcement that it has called for redemption all of the
outstanding shares of its $4.125 Preferred Stock, par value
$.001 per share.
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RADIAN GROUP INC.
Date: August 13, 2002 /s/ C. Robert Quint
--------------------
C. Robert Quint
Executive Vice President and
Chief Financial Officer
/s/ John J. Calamari
---------------------
John J. Calamari
Vice President and Corporate Controller
23
EXHIBIT INDEX
Exhibit No. Exhibit Name
- ----------- ------------
11 Statement Re: Computation of Per Share Earnings.
24