Radian Group Inc. Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

 


(Mark One)

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

For the quarterly period ended March 31, 2006

OR

 

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

For the transition period from                      to                     

Commission File Number 1-11356

 


Radian Group Inc.

(Exact name of registrant as specified in its charter)

 


 

Delaware   23-2691170
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
1601 Market Street, Philadelphia, PA   19103
(Address of principal executive offices)   (Zip Code)

(215) 231-1000

(Registrant’s telephone number, including area code)

 


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

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

Large accelerated filer  x            Accelerated filer  ¨            Non-accelerated filer  ¨

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 82,408,140 shares of common stock, $0.001 par value per share, outstanding on May 1, 2006.

 



Table of Contents

Radian Group Inc.

INDEX

 

         Page
Number

Forward Looking Statements—Safe Harbor Provisions

   i

PART I—FINANCIAL INFORMATION

  

Item 1.

 

Financial Statements

  
 

Condensed Consolidated Balance Sheets

   1
 

Condensed Consolidated Statements of Income

   2
 

Condensed Consolidated Statement of Changes in Common Stockholders’ Equity

   3
 

Condensed Consolidated Statements of Cash Flows

   4
 

Notes to Unaudited Condensed Consolidated Financial Statements

   5

Item 2.

 

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

  

28

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

   72

Item 4.

 

Controls and Procedures

   74

PART II—OTHER INFORMATION

  

Item 1.

 

Legal Proceedings

   75

Item 1A.

 

Risk Factors

   75

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

   75

Item 6.

 

Exhibits

   76

SIGNATURES

   77

EXHIBIT INDEX

   78


Table of Contents

Forward Looking Statements—Safe Harbor Provisions

All statements in this report that address events, developments or results that we expect or anticipate may occur in the future are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934 and the U.S. Private Securities Litigation Reform Act of 1995. In most cases, forward-looking statements may be identified by words such as “may,” “will,” “should,” “expect,” “intend,” “plan,” “goal,” “contemplate,” “believe,” “estimate,” “predict,” “project,” “potential,” “continue” or the negative or other variations on these words and other similar expressions. These statements are made on the basis of management’s current views and assumptions with respect to future events. The forward-looking statements, as well as our prospects as a whole, are subject to risks and uncertainties, including the following:

 

    changes in general financial and political conditions, such as extended national or regional economic recessions, changes in housing values, population trends and changes in household formation patterns, changes in unemployment rates, changes or volatility in interest rates, changes in the way investors perceive 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 our insurance;

 

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

 

    the loss of a customer for whom we write a significant amount of our mortgage insurance or financial guaranty insurance;

 

    increased severity or frequency of losses associated with certain of our products that are riskier than traditional mortgage insurance or financial guaranty insurance policies;

 

    changes in persistency rates of our 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;

 

    downgrades of, or other ratings actions with respect to, our credit ratings or the insurance financial strength ratings assigned by the major rating agencies to any of our rated operating subsidiaries at any time, which actions have occurred in the past;

 

    heightened competition for our mortgage insurance business from others such as the Federal Housing Administration and the Veterans Administration or other private mortgage insurers, from alternative products such as “80-10-10” loans or other forms of simultaneous second loan structures used by mortgage lenders, and from investors using forms of credit enhancement other than mortgage insurance as a partial or complete substitution for private mortgage insurance;

 

    changes in the charters or business practices of Fannie Mae and Freddie Mac, the largest purchasers of mortgage loans that we insure;

 

    heightened competition for financial guaranty business from other financial guaranty insurers, 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 and from alternative structures that permit insurers to securitize assets more cost-effectively without the need for other credit enhancement of the types we offer;

 

    the application of existing federal or state consumer, lending, insurance and other applicable laws and regulations, or unfavorable changes in these laws and regulations or the way they are interpreted;

 

   

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

 

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gains and losses on these contracts (See Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies.”);

 

    increases in claim frequency as our mortgage insurance policies age; and

 

    vulnerability to the performance of our strategic investments.

For more information regarding these risks and uncertainties as well as certain additional risks that we face, you should refer to the risks discussed in other documents that we file with the SEC, including the risk factors detailed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2005. We caution you not to place undue reliance on these forward-looking statements, which are current only as of the date on which we filed this report. We do not intend to, and we disclaim any duty or obligation to, update or revise any forward-looking statements made in this report to reflect new information or future events or for any other reason.

 

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PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements.

Radian Group Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

 

(In thousands, except share and per-share amounts)    March 31
2006
    December 31
2005
 

Assets

    

Investments

    

Fixed maturities held to maturity—at amortized cost (fair value $121,584 and $130,227)

   $ 118,267     $ 125,935  

Fixed maturities available for sale—at fair value (amortized cost $4,588,887 and $4,493,789)

     4,678,657       4,608,460  

Trading securities—at fair value (cost $79,812 and $68,078)

     115,786       89,440  

Equity securities—at fair value (cost $226,113 and $258,768)

     292,331       325,117  

Short-term investments

     430,504       361,937  

Other invested assets

     2,616       2,825  
                

Total investments

     5,638,161       5,513,714  

Cash

     16,916       7,847  

Investment in affiliates

     436,685       446,151  

Deferred policy acquisition costs

     209,524       208,325  

Prepaid federal income taxes

     639,704       585,514  

Provisional losses recoverable

     11,905       25,388  

Accrued investment income

     59,438       60,124  

Accounts and notes receivable

     49,943       59,136  

Property and equipment, at cost (less accumulated depreciation of $69,362 and $61,285)

     47,966       52,062  

Other assets

     300,352       272,349  
                

Total assets

   $ 7,410,594     $ 7,230,610  
                

Liabilities and Stockholders’ Equity

    

Unearned premiums

   $ 874,733     $ 849,360  

Reserve for losses and loss adjustment expenses

     791,690       801,002  

Long-term debt

     747,540       747,466  

Deferred federal income taxes

     1,008,119       961,993  

Accounts payable and accrued expenses

     217,292       207,909  
                

Total liabilities

     3,639,374       3,567,730  
                

Commitments and Contingencies (Note 13)

    

Stockholders’ equity

    

Common stock: par value $.001 per share; 200,000,000 shares authorized; 97,440,198 and 97,373,169 shares issued at March 31, 2006 and December 31, 2005, respectively; 82,440,466 and 83,032,456 shares outstanding at March 31, 2006 and December 31, 2005, respectively

     97       97  

Treasury stock: 14,999,732 and 14,340,713 shares in 2006 and 2005, respectively

     (737,068 )     (688,048 )

Additional paid-in capital

     1,328,135       1,318,910  

Deferred compensation

     —         (1,843 )

Retained earnings

     3,075,683       2,913,649  

Accumulated other comprehensive income

     104,373       120,115  
                

Total stockholders’ equity

     3,771,220       3,662,880  
                

Total liabilities and stockholders’ equity

   $ 7,410,594     $ 7,230,610  
                

See notes to unaudited condensed consolidated financial statements.

 

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Radian Group Inc.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

 

     Three Months Ended
March 31
 
(In thousands, except per-share amounts)    2006     2005  

Revenues:

    

Premiums written:

    

Direct

   $ 282,779     $ 255,385  

Assumed

     24,275       (16,010 )

Ceded

     (27,449 )     (24,535 )
                

Net premiums written

     279,605       214,840  

(Increase) decrease in unearned premiums

     (25,908 )     32,185  
                

Net premiums earned

     253,697       247,025  

Net investment income

     54,260       50,862  

Net gains on securities

     22,854       11,526  

Change in fair value of derivative instruments

     17,630       (8,960 )

Other income

     5,211       6,108  
                

Total revenues

     353,652       306,561  
                

Expenses:

    

Provision for losses

     78,634       109,500  

Policy acquisition costs

     27,364       29,356  

Other operating expenses

     60,277       51,670  

Interest expense

     11,840       8,958  
                

Total expenses

     178,115       199,484  
                

Equity in net income of affiliates

     58,340       51,296  
                

Pretax income

     233,877       158,373  

Provision for income taxes

     70,179       42,761  
                

Net income

   $ 163,698     $ 115,612  
                

Basic net income per share

   $ 1.97     $ 1.29  
                

Diluted net income per share

   $ 1.96     $ 1.24  
                

Average number of common shares outstanding—basic

     82,937       89,488  
                

Average number of common and common equivalent shares outstanding—diluted

     83,707       94,258  
                

Dividends per share

   $ 0.02     $ 0.02  
                

See notes to unaudited condensed consolidated financial statements.

 

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Radian Group Inc.

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN COMMON STOCKHOLDERS’ EQUITY

(UNAUDITED)

 

   

Common

Stock

 

Treasury
Stock

   

Additional
Paid-in
Capital

   

Deferred
Compensation

   

Retained
Earnings

    Accumulated Other
Comprehensive
Income (Loss)
   

Total

 
(In thousands)             Foreign
Currency
Translation
Adjustment
  Unrealized
Holding
Gains
(Losses)
   

Balance, January 1, 2006

  $ 97   $ (688,048 )   $ 1,318,910     $ (1,843 )   $ 2,913,649     $ 2,135   $ 117,980     $ 3,662,880  

Comprehensive income:

               

Net income

    —       —         —           163,698       —       —         163,698  

Unrealized foreign currency translation adjustment, net of tax of $274

    —       —         —         —         —         540     —         540  

Unrealized holding losses arising during the period, net of tax benefit of $1,131

    —       —         —         —         —         —       (2,099 )     —    

Less: Reclassification adjustment for net gains included in net income, net of tax of $7,637

    —       —         —         —         —         —       (14,183 )     —    
                     

Net unrealized loss on investments, net of tax benefit of $8,768

    —       —         —         —         —         —       (16,282 )     (16,282 )
                     

Comprehensive income

    —       —         —         —         —         —       —         147,956  

Issuance of common stock under incentive plans

    —       11,215       8,887       —         —         —       —         20,102  

Issuance of restricted stock

    —       —         (1,109 )     —         —         —       —         (1,109 )

Amortization of restricted stock

    —       —         311       —         —         —       —         311  

Reclassification of deferred compensation (a)

    —       —         (1,843 )     1,843       —         —       —         —    

Stock-based compensation expense-options

    —       —         2,979       —         —         —       —         2,979  

Treasury stock purchased

    —       (60,235 )     —         —         —         —       —         (60,235 )

Dividends paid

    —       —         —         —         (1,664 )     —       —         (1,664 )
                                                           

Balance, March 31, 2006

  $ 97   $ (737,068 )   $ 1,328,135     $ —       $ 3,075,683     $ 2,675   $ 101,698     $ 3,771,220  
                                                           

(a) See “Restricted Stock” in Note 8 for information related to the reclassification of the amount in deferred compensation.

See notes to unaudited condensed consolidated financial statements.

 

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Radian Group Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

    

Quarter Ended

March 31

 
(In thousands)    2006     2005  

Cash flows from operating activities

   $ 127,321     $ 111,353  
                

Cash flows from investing activities:

    

Proceeds from sales of fixed-maturity investments available for sale

     322,294       49,038  

Proceeds from sales of equity securities available for sale

     56,419       9,704  

Proceeds from redemptions of fixed-maturity investments available for sale

     38,055       39,630  

Proceeds from redemptions of fixed-maturity investments held to maturity

     8,968       8,946  

Purchases of fixed-maturity investments available for sale

     (422,311 )     (162,999 )

Purchases of equity securities available for sale

     (736 )     (10,213 )

(Purchases) sales of short-term investments, net

     (67,921 )     234,562  

Purchase of other invested assets

     —         (28 )

Purchases of property and equipment

     (4,403 )     (2,033 )

Other

     365       748  
                

Net cash (used in)/provided by investing activities

     (69,270 )     167,355  
                

Cash flows from financing activities:

    

Dividends paid

     (1,664 )     (1,769 )

Proceeds from issuance of common stock under incentive plans

     11,811       13,874  

Excess tax benefits from stock-based awards

     1,261       —    

Purchase of treasury stock

     (60,235 )     (298,346 )

Redemption of long-term debt

     —         (663 )
                

Net cash used in financing activities

     (48,827 )     (286,904 )
                

Effect of exchange rate changes on cash

     (155 )     —    

Increase (decrease) in cash

     9,069       (8,196 )

Cash, beginning of period

     7,847       30,680  
                

Cash, end of period

   $ 16,916     $ 22,484  
                

Supplemental disclosures of cash flow information:

    

Income taxes paid

   $ 24,126     $ 29,675  
                

Interest paid

   $ 7,502     $ 9,637  
                

Supplemental disclosures of non-cash items:

    

Stock-based compensation

   $ 3,926     $ 2,151  
                

See notes to unaudited condensed consolidated financial statements.

 

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Radian Group Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

1—Condensed Consolidated Financial Statements—Basis of Presentation

Our condensed consolidated financial statements include the accounts of Radian Group Inc. and its subsidiaries, including its principal mortgage guaranty operating subsidiaries, Radian Guaranty Inc. (“Radian Guaranty”), Amerin Guaranty Corporation (“Amerin Guaranty”) and Radian Insurance Inc. (“Radian Insurance”), and its principal financial guaranty operating subsidiaries, Radian Asset Assurance Inc. (“Radian Asset Assurance”) and Radian Asset Assurance Limited (“RAAL”). We refer to Radian Group Inc. together with its consolidated subsidiaries as “we,” “us” or “our,” unless the context requires otherwise. We generally refer to Radian Group Inc. alone, without its consolidated subsidiaries, as the “parent company.” We also have a 46.0% interest in Credit-Based Asset Servicing and Securitization LLC (“C-BASS”) and a 34.58% interest in Sherman Financial Group LLC (“Sherman”), each of which are active credit-based asset businesses.

We have presented our condensed consolidated financial statements on the basis of accounting principles generally accepted in the United States of America (“GAAP”). We have condensed or omitted certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with GAAP pursuant to the SEC’s rules and regulations.

The financial information presented for interim periods is unaudited; however, such information reflects all adjustments that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations, and cash flows for the interim periods. These interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005. 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 may differ from these estimates and assumptions.

Basic net income per share is based on the weighted average number of common shares outstanding, while diluted net income per share is based on the weighted average number of common shares outstanding and common share equivalents that would be issuable upon the exercise of stock options, the vesting of restricted stock and phantom stock and the conversion of our senior convertible debentures. We redeemed all of the principal amount outstanding of our senior convertible debentures on August 1, 2005, as discussed in Note 7.

The current period presentation includes changes from the prior period presentation that are consistent with clarification of GAAP rules regarding presentation in the statement of cash flows. In particular, the prior period presentation of the cash flows from investing activities section of the condensed consolidated statements of cash flows has been conformed to the current period presentation by reclassifying distributions from equity affiliates of $60.4 million into the cash flows from operating activities section. This reclassification affects the presentation of the condensed consolidated statements of cash flows, but does not affect the change in cash balance for the period. On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123R “Share-Based Payment” (“SFAS No. 123R”) using a modified prospective application as permitted by SFAS No. 123R. Accordingly, prior period amounts have not been restated. Certain other prior period balances have been reclassified to conform to the current period presentation.

 

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Radian Group Inc.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

2—Derivative Instruments and Hedging Activities

We account for derivatives under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted (“SFAS No. 133”). In general, SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at their respective fair values. All derivative instruments are recognized in our condensed consolidated balance sheets as either assets or liabilities depending on the rights or obligations under the contracts. Transactions that we have entered into that are accounted for under SFAS No. 133 include investments in convertible debt securities, interest rate swaps, selling 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 our overall business strategy of offering mortgage credit enhancement and financial guaranty protection to our customers. The interest rate swaps that we have entered into qualify as hedges and are accounted for as fair value hedges. The embedded equity derivatives contained within our investments in fixed-maturity securities, the forward foreign currency contracts and credit protection in the form of credit default swaps do not qualify as hedges under SFAS No. 133, so changes in their fair value are included in current earnings in our condensed consolidated statements of income. Net unrealized gains and losses on credit default swaps and certain other financial guaranty contracts are included in assets or liabilities, as appropriate, on our condensed consolidated balance sheets. We do not recognize a reserve for losses on derivative financial guaranty contracts. Any equivalent reserve would be embedded in the unrealized gains and losses on derivative financial guaranty contracts. Settlements under derivative financial guaranty contracts are charged to assets or liabilities, as appropriate, on the condensed consolidated balance sheets. During the first quarter of 2006, we received $1.4 million as recoveries of previous default payments and paid $68.0 million in connection with the termination of a derivative financial guaranty contract. See below for further discussion. We received $2.2 million of recoveries of previous default payments on derivative financial guaranty contracts in the corresponding period of 2005.

SFAS No. 133 requires that we split the convertible fixed-maturity securities in our investment portfolio into their 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 our condensed 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 recorded value of the fixed-maturity security increases or decreases. A change in the fair value of the derivative component is recorded as a gain or loss in our condensed consolidated statements of income.

In February 2006, the Financial Accounting Standards Board (the “FASB”) issued Statement No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS No. 155”), an amendment of FASB Statements No. 133 and 140. SFAS No. 155 (i) permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, (ii) clarifies which interest-only strips and principal-only strips are not subject to the requirements of FASB Statement No. 133, (iii) establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, (iv) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and (v) amends FASB Statement No. 140 to eliminate the exemption from applying the requirements of FASB Statement No. 133 on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006 (the fiscal year beginning January 1, 2007 for us). Management is considering the impact, if any, that may result from the adoption of SFAS No. 155.

 

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Radian Group Inc.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

With respect to our direct derivative financial guaranty contracts, estimated fair value amounts are determined by us using market information to the extent available, and appropriate valuation methodologies. For collateralized debt obligations (“CDOs”), credit spreads on individual names in our collateral pool are used to determine an equivalent risk tranche on an industry standard credit default swap index. We then estimate the price of our equivalent risk tranche based on observable market prices of standard risk tranches on the industry standard credit default swap index. When credit spreads on individual names are not available, the average credit spread on the credit rating of the name is used. For certain structured transactions, dealer quotes on similar structured transactions are used. Significant differences may exist with respect to the available market information and assumptions used to determine gains and losses on derivative financial guaranty contracts. Considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates are not necessarily indicative of amounts we could realize in a current market exchange due to the lack of a liquid market. The use of different market assumptions and/or estimation methodologies may have a significant effect on the estimated fair value amounts.

In the fourth quarter of 2005, we refined our mark-to-market model to use actual credit spreads by individual name, when available as discussed above, as compared to our previous version of the model, which used average spreads for similarly rated names. While application of the new model resulted in immaterial changes for most of our derivative transactions, one synthetic CDO showed a large difference due to greater spread volatility in the underlying high-yield corporate names included in this transaction. At December 31, 2005, our refined model indicated that a $50.8 million loss should be recognized on this transaction. On March 2, 2006, Radian Asset Assurance paid $68.0 million to its counterparty in consideration for the termination of this transaction.

A summary of our derivative information, as of and for the periods indicated, is as follows:

 

Balance Sheets (In millions)

   March 31
2006
   December 31
2005
   March 31
2005

Trading Securities

        

Cost

   $ 79.8    $ 68.1    $ 72.3

Fair value

     115.8      89.4      95.1

Derivative financial guaranty contracts

        

Notional value

   $ 36,509.0    $ 30,208.0    $ 12,593.0

Gross unrealized gains

   $ 118.3    $ 98.3    $ 66.7

Gross unrealized losses

     22.7      72.1      55.4
                    

Net unrealized gains

   $ 95.6    $ 26.2    $ 11.3
                    

The components of the change in fair value of derivative instruments are as follows:

 

     Three Months Ended
March 31
 

Statements of Income (In millions)

     2006        2005    

Trading Securities

   $ 14.8    $ 1.8  

Gain on termination of Treasury rate lock

     —        1.0  

Derivative financial guaranty contracts

     2.8      (11.8 )
               

Net gains (losses)

   $ 17.6    $ (9.0 )
               

 

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Radian Group Inc.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

The following table presents information at March 31, 2006 and December 31, 2005 related to net unrealized gains or losses on derivative financial guaranty contracts (included in other assets or accounts payable and accrued expenses on our condensed consolidated balance sheets).

 

     March 31
2006
    December 31
2005
 
     (In millions)  

Balance at January 1

   $ 26.2     $ 25.3  

Net unrealized gains recorded

     2.8       8.4  

Defaults

    

Recoveries

     (1.4 )     (7.6 )

Payments

     —         0.1  

Early termination payments

     68.0       —    
                

Balance at end of period

   $ 95.6     $ 26.2  
                

The application of SFAS No. 133, as amended, could result in volatility from period to period in gains and losses as reported on our condensed consolidated statements of income. These gains and losses result primarily from changes in corporate credit spreads, changes in the creditworthiness of underlying corporate entities, and the equity performance of the entities’ underlying convertible investments. Any incurred gains or losses on such contracts would be recognized as a change in the fair value of derivatives. We are unable to predict the affect this volatility may have on our financial position or results of operations.

In accordance with our risk management policies, we enter into derivatives to hedge the interest rate risk related to our long-term debt. As of March 31, 2006, we were a party to two interest rate swap contracts relating to our 5.625% unsecured senior notes. These interest rate swaps are designed as fair value hedges that hedge the change in fair value of our long-term debt arising from interest rate movements. During 2006 and 2005, the fair value hedges were 100% effective. Therefore, the changes in fair value of derivative instruments in our condensed consolidated statements of income were offset by the change in the fair value of the hedged debt. These interest rate swap contracts mature in February 2013.

Terms of the interest rate swap contracts at March 31, 2006 were as follows (dollars in thousands):

 

Notional amount

   $ 250,000  

Rate received—Fixed

     5.625 %

Rate paid—Floating (a)

     6.174 %

Maturity date

     February 15, 2013  

Unrealized loss

   $ 9,125  

(a) The March 31, 2006 six-month London Interbank Offered Rate (“LIBOR”) forward rate at the next swap payment date plus 87.4 basis points.

In October 2004, we entered into transactions to lock in treasury rates that would have served as a hedge if we had issued long-term debt. The notional value of the hedges was $120 million at a blended rate of 4.075%. In January 2005, we discontinued the hedge arrangements and received payments from our counterparties. We realized a gain of $1.0 million at termination in 2005.

 

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Radian Group Inc.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

3—Comprehensive income

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

 

    

Three Months Ended

March 31

 
     2006     2005  

Net income

   $ 163,698     $ 115,612  

Other comprehensive income (net of tax):

    

Net unrealized losses on investments

     (16,282 )     (65,397 )

Unrealized foreign currency translation adjustment

     540       (4,362 )
                

Comprehensive income

   $ 147,956     $ 45,853  
                

At March 31, 2006, accumulated other comprehensive income of $104.4 million included $16.3 million of net unrealized losses on investments and $0.5 million related to foreign currency translation adjustments. At December 31, 2005, accumulated other comprehensive income of $120.1 million included $52.8 million of net unrealized losses on investments and $12.3 million related to unrealized foreign currency translation adjustments.

4—Investments

We are required to group assets in our investment portfolio into three categories: held to maturity, available for sale or trading securities. Fixed-maturity securities for which we have the positive intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost. Investments classified as available for sale are reported at fair value, with unrealized gains and losses (net of tax) reported as a separate component of stockholders’ equity as accumulated other comprehensive income. Investments classified as trading securities are reported at fair value, with unrealized gains and losses (net of tax) reported as separate component of income. During the first quarter of 2006, we elected to classify certain new security purchases as trading securities. Similar securities were classified as available for sale for periods prior to the first quarter of 2006. For securities classified as either available for sale or held to maturity, we conduct a quarterly evaluation of declines in market value of the investment portfolio asset basis to determine whether the decline is other-than-temporary. This evaluation includes a review of (i) the length of time and extent to which fair value is below amortized cost; (ii) issuer financial condition, and (iii) our intent and ability to retain our investment over a period of time to allow recovery in fair value. We use a 20% decline in price over four continuous quarters as a guide in identifying those securities that should be evaluated for impairment. For securities that have experienced rapid price declines or unrealized losses of less than 20% over periods in excess of four consecutive quarters, classification as other-than-temporary is considered. Factors influencing this consideration include an analysis of the security issuer’s financial performance and financial condition and general economic conditions.

If the decline in fair value is judged to be other-than-temporary, the cost basis of the individual security is written down to fair value through earnings as a realized loss and the fair value becomes the new basis. At March 31, 2006 and 2005, there were no investments held in the portfolio that met these criteria. 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 forward foreign currency contracts and are carried at fair value.

In March 2004, the FASB Emerging Issues Task Force (“EITF”) reached a consensus regarding EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The

 

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Radian Group Inc.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

consensus provides guidance for recognizing other-than-temporary impairments on several types of investments, including debt securities classified as held to maturity and available for sale under SFAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities.”

On November 3, 2005, the FASB issued FASB Staff Position (“FSP”) Nos. FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. This FSP addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary and the measurement of an impairment loss. This FSP also includes accounting considerations subsequent to the recognition of other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. This FSP nullifies certain requirements of EITF Issue 03-1 and supersedes EITF Topic No. D-44, “Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value”. The guidance in this FSP also amends FASB No. 115. We adopted this FSP in the beginning of 2006. Accordingly, we are now required to assess our investments for impairment in each reporting period and to use existing guidance, prior to the issuance of EITF Issue 03-1, in assessing whether an impairment is other than temporary. The impact from the adoption of this guidance was not material.

The following table shows the gross unrealized losses and fair value of our investments with unrealized losses that are not deemed to be other-than-temporarily impaired (in thousands), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2006.

 

     Less Than 12 Months    12 Months or Greater    Total

Description of Securities

   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses

U.S. government securities

   $ 74,201    $ 1,522    $ 2,971    $ 70    $ 77,172    $ 1,592

U.S. government-sponsored enterprises

     27,099      689      2,523      172      29,622      861

State and municipal obligations

     799,503      7,747      32,085      858      831,588      8,605

Corporate bonds and notes

     56,391      1,750      8,460      206      64,851      1,956

Asset-backed securities

     142,433      3,772      66,775      2,309      209,208      6,081

Private placements

     20,077      821      4,927      193      25,004      1,014

Foreign governments

     82,856      1,540      2,644      25      85,500      1,565

Redeemable preferred stock

     52,872      2,164      7,540      366      60,412      2,530

Convertible securities

     133,998      4,084      15,978      825      149,976      4,909

Equity securities

     12,576      3,026      —        —        12,576      3,026
                                         

Total

   $ 1,402,006    $ 27,115    $ 143,903    $ 5,024    $ 1,545,909    $ 32,139
                                         

U.S. government securities

The unrealized losses of 12 months or greater duration as of March 31, 2006 on our investments in U.S. Treasury obligations were caused by interest rate increases. During the twelve-month period ending March 31, 2006, the Federal Reserve (the “Fed”) raised the federal funds rates eight times for a total of 200 basis points. A majority of the securities remained at an unrealized loss position due to the rate increases. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at March 31, 2006.

 

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Radian Group Inc.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

U.S. government-sponsored enterprises

The unrealized losses of 12 months or greater duration as of March 31, 2006 on our investment in U.S. agency mortgage-backed securities were also caused by interest rate increases. The contractual cash flows of these investments are guaranteed by an agency of the U.S. government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of our investment. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at March 31, 2006.

State and municipal obligations

The unrealized losses of 12 months or greater duration as of March 31, 2006 on our investments in tax-exempt state and municipal securities were caused by interest rate increases. During the twelve-month period ending March 31, 2006, the tax-exempt municipal bond yield curve ranged from a 1.23% increase in the shortest maturity sectors to a 0.10% increase in the 15-year sector. Our securities in this maturity range experienced severe price declines. We believe that credit quality did not impact security pricing due to the relative high quality of the holdings (i.e., the majority of the securities were either insured, pre-refunded or escrowed to maturity). Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at March 31, 2006.

Corporate bonds and notes

The unrealized losses of 12 months or greater duration as of March 31, 2006 on the majority of the securities in this category were caused by market interest rate movement. A majority of the securities remained at an unrealized loss position due to these rate increases. Unrealized losses for the remaining securities in this category are attributable to changes in business operations, resulting in widened credit spreads. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at March 31, 2006.

Asset-backed securities

The unrealized losses of 12 months or greater duration as of March 31, 2006 on the securities in this category were caused by market interest rate movement. A majority of the securities remained at an unrealized loss position due to the rate increases. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider the investment in these securities to be other-than-temporarily impaired at March 31, 2006.

Private placements

The unrealized losses of 12 months or greater duration as of March 31, 2006 on the majority of the securities in this category were caused by market interest rate movement. A majority of the securities remained at an unrealized loss position due to the rate increases. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider the investment in these securities to be other-than-temporarily impaired at March 31, 2006.

Foreign governments

The unrealized losses of 12 months or greater duration as of March 31, 2006 on the majority of the securities in this category were caused by market interest rate movement and/or foreign currency exchange rate

 

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Radian Group Inc.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

changes. We believe that credit quality did not impact security pricing due to the relative high quality of the holdings (i.e., the majority of the securities were highly-rated governments and government agencies or corporate issues with minimum ratings of single-A). Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at March 31, 2006.

Redeemable preferred securities and convertible securities

The unrealized losses of 12 months or greater duration as of March 31, 2006 on the majority of the securities in this category were caused by market interest rate movement. We believe that while interest rate changes contributed to a decline in investment value in almost all cases, credit quality, whether industry or company specific, did not have a significant or irrecoverable impact on security pricing. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider the investment in these securities to be other-than-temporarily impaired at March 31, 2006.

For all investment categories, unrealized losses of less than 12 months in duration are generally attributable to interest rate movements or changes in foreign currency exchange rates. All securities are evaluated in accordance with our impairment recognition policy covering various time and price decline scenarios. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider the investment in these securities to be other-than-temporarily impaired at March 31, 2006.

The contractual maturity of securities in an unrealized loss position at March 31, 2006 was as follows:

 

(In millions)

   Fair Value   

Amortized

Cost

  

Unrealized

Loss

2006

   $ 26.7    $ 26.8    $ 0.1

2007 – 2010

     194.5      197.4      2.9

2011 – 2015

     198.4      202.0      3.6

2016 and later

     844.1      858.0      13.9

Mortgage-backed and other asset-backed securities

     209.2      215.3      6.1

Redeemable preferred stock

     60.4      62.9      2.5

Equity securities

     12.6      15.6      3.0
                    

Total

   $ 1,545.9    $ 1,578.0    $ 32.1
                    

5—Segment Reporting

We have three reportable segments: mortgage insurance, financial guaranty and financial services. Our reportable segments are strategic business units that are managed separately because each business segment requires different marketing and sales expertise. We allocate corporate income and expenses to each of the segments.

The mortgage insurance segment provides credit-related insurance coverage principally through private mortgage insurance, and risk management services to mortgage lending institutions located throughout the United States and select countries overseas. Private mortgage insurance primarily protects lenders from all or part of default-related losses on residential first-mortgage loans made mostly to homebuyers who make down payments of less than 20% of the home’s purchase price. Private mortgage insurance also facilitates the sale of these mortgages in the secondary market. Our mortgage insurance business, through Radian Guaranty, offers

 

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Radian Group Inc.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

primary and pool private mortgage insurance coverage on residential first-lien mortgages. We use Radian Insurance to provide credit enhancement for mortgage-related capital market transactions and to write credit insurance on mortgage-related assets that monoline mortgage guaranty insurers are not permitted to insure, including net interest margin securities (“NIMs”), international insurance and reinsurance transactions, second-lien mortgages, home equity loans and credit default swaps. We also insure second-lien mortgages through Amerin Guaranty.

Our 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. Our insurance businesses within the financial guaranty segment include the assumption of reinsurance from monoline financial guaranty insurers for both public finance bonds and structured finance obligations and direct financial guaranty insurance for public finance bonds and structured finance obligations. In 2005, we decided to exit the trade credit reinsurance line of business. We expect that our existing trade credit reinsurance business will take several years to run-off, although the bulk of the remaining premiums will be earned over the next two years.

The financial services segment includes the credit-based businesses conducted through our affiliates, C-BASS and Sherman. We own a 46% interest in C-BASS and a 34.58% interest in Sherman. See Note 6 for more information regarding our ownership interest in Sherman. C-BASS is a mortgage investment and servicing firm specializing in non-prime, single-family residential mortgage assets and residential mortgage-backed securities. By using sophisticated analytics, C-BASS essentially seeks to take advantage of what it believes to be the mispricing of credit risk for certain assets in the marketplace. Sherman is a consumer asset and servicing firm specializing in charged-off and bankruptcy plan consumer assets and charged-off high loan-to-value mortgage receivables that it generally purchases at deep discounts from national financial institutions and major retail corporations and subsequently collects upon these receivables. In March 2005, Sherman acquired CreditOne, providing Sherman with the ability to originate non-prime credit card receivables.

For each of the quarters ended March 31, 2006 and 2005, our domestic net premiums earned from all of our businesses were $239.2 million and $229.2 million, respectively, and our net premiums earned attributable to foreign countries were approximately $14.5 million and $17.8 million, respectively. Because a significant amount of our trade credit reinsurance business line, which we placed in run-off during the fourth quarter of 2005, is written internationally, we anticipate that international net premiums earned from the trade credit reinsurance line of business will decline over the next few years as existing business runs off and new business is not originated. In addition, long-lived assets located in foreign countries were immaterial for the periods presented.

In the mortgage insurance segment, the highest state concentration of primary risk in force at March 31, 2006, was Florida at 9.5%, compared to 9.4% at March 31, 2005. However, California still had the highest state concentration of total direct primary and pool insurance in force at March 31, 2006. The percentage of risk in California has been falling over the past few years due to the high cancellation rate and the lower percentage of new business written. At March 31, 2006, California accounted for 10.7% of the mortgage insurance segment’s total direct primary insurance in force, compared to 10.9% at March 31, 2005, and 11.6% of the mortgage insurance segment’s total pool risk in force, compared to 12.2% for March 31, 2005. California also accounted for 16.8% of the mortgage insurance segment’s direct primary new insurance written in the first quarter of 2006 compared to 8.0% in the first quarter of 2005. The largest single customer of our mortgage insurance segment (including branches and affiliates of such customer), measured by new insurance written, accounted for 7.2% of new insurance written in the first quarter of 2006 compared 10.8% in the first quarter of 2005.

 

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Radian Group Inc.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

The financial guaranty segment derives a substantial portion of its premiums written from a small number of direct primary insurers. In the first quarter of 2006, two primary insurers accounted for approximately $17.7 million of the financial guaranty segment’s gross written premiums. In the first quarter of 2005, two primary insurers accounted for approximately $10.6 million of the financial guaranty segment’s gross written premiums. No other primary insurer accounted for more than 10% of the financial guaranty segment’s gross written premiums during the first quarter of 2006 or 2005. Gross written premiums and net written premiums are not materially different because we do not cede a material amount of business to reinsurers.

We evaluate operating segment performance based principally on net income. Summarized financial information concerning our operating segments, as of and for the periods indicated, is as follows:

 

     March 31, 2006
(In thousands)    Mortgage
Insurance
   Financial
Guaranty
   Financial
Services
   Total

Net premiums written (1)

   $ 223,766    $ 55,839    $ —      $ 279,605
                           

Net premiums earned

   $ 202,706    $ 50,991    $ —      $ 253,697

Net investment income

     31,665      22,518      77      54,260

Net gains on securities

     13,577      7,178      2,099      22,854

Change in fair value of derivative instruments

     9,121      8,509      —        17,630

Other income

     3,634      214      1,363      5,211
                           

Total revenues

     260,703      89,410      3,539      353,652
                           

Provision for losses

     71,097      7,537      —        78,634

Policy acquisition costs

     13,345      14,019      —        27,364

Other operating expenses

     44,267      14,756      1,254      60,277

Interest expense

     6,701      4,026      1,113      11,840
                           

Total expenses

     135,410      40,338      2,367      178,115
                           

Equity in net income of affiliates

     —           58,340      58,340
                           

Pretax income

     125,293      49,072      59,512      233,877

Provision for income taxes

     37,149      12,200      20,830      70,179
                           

Net income

   $ 88,144    $ 36,872    $ 38,682    $ 163,698
                           

Total assets

   $ 4,504,282    $ 2,456,875    $ 449,437    $ 7,410,594

Deferred policy acquisition costs

     68,619      140,905      —        209,524

Reserve for losses and loss adjustment expenses

     587,114      204,576      —        791,690

Unearned premiums

     233,364      641,369      —        874,733

Stockholders’ equity

     2,186,177      1,278,432      306,611      3,771,220

 

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Radian Group Inc.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

     March 31, 2005  
(In thousands)    Mortgage
Insurance
   Financial
Guaranty
    Financial
Services
    Total  

Net premiums written (1)

   $ 200,237    $ 14,603     $ —       $ 214,840  
                               

Net premiums earned

   $ 192,465    $ 54,560     $ —       $ 247,025  

Net investment income

     28,793      22,059       10       50,862  

Net gains on securities

     7,119      3,573       834       11,526  

Change in fair value of derivative instruments

     3,186      (11,957 )     (189 )     (8,960 )

Other income

     4,592      316       1,200       6,108  
                               

Total revenues

     236,155      68,551       1,855       306,561  
                               

Provision for losses

     97,927      11,573       —         109,500  

Policy acquisition costs

     14,678      14,678       —         29,356  

Other operating expenses

     33,669      14,394       3,607       51,670  

Interest expense

     5,124      3,099       735       8,958  
                               

Total expenses

     151,398      43,744       4,342       199,484  
                               

Equity in net income of affiliates

     —        —         51,296       51,296  
                               

Pretax income

     84,757      24,807       48,809       158,373  

Provision for income taxes

     22,036      3,641       17,084       42,761  
                               

Net income

   $ 62,721    $ 21,166     $ 31,725     $ 115,612  
                               

Total assets

   $ 3,972,942    $ 2,354,209     $ 395,446     $ 6,722,597  

Deferred policy acquisition costs

     70,873      129,070       —         199,943  

Reserve for losses and loss adjustment expenses

     571,128      226,543       —         797,671  

Unearned premiums

     149,258      586,510       —         735,768  

Stockholders’ equity

     1,900,760      1,246,876       298,956       3,446,592  

(1) With the exception of trade credit reinsurance products, net premiums written in our financial guaranty reinsurance business are recorded using actual information received from cedants on a one month lag basis. Accordingly, the net premiums written for any given period exclude those from the last month of that period and include those from the last month of the immediately preceding period. The use of information from cedants does not require us to make significant judgments or assumptions because historic collection rates and counterparty strength make collection of all assumed premiums highly likely. Net premiums written for the three month periods ended March 31, 2006 and 2005 include $3.0 million and $13.3 million, respectively, of assumed premiums related to trade credit reinsurance products. Included in these amounts are estimates based on quarterly projections provided by ceding companies. Over the life of the reinsured business, these projections are replaced with actual results and, historically, the difference between the projections and actual results has not been material. Accordingly, we do not record any related provision for doubtful accounts with respect to our trade credit reinsurance products.

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

 

     Three Months Ended
March 31
Consolidated (In thousands)    2006    2005

Net income:

     

Mortgage Insurance

   $ 88,144    $ 62,721

Financial Guaranty

     36,872      21,166

Financial Services

     38,682      31,725
             

Total

   $ 163,698    $ 115,612
             

 

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Radian Group Inc.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

On April 27, 2005, Fitch Ratings (“Fitch”) affirmed the “AA” insurance financial strength rating of Radian Asset Assurance and RAAL, a subsidiary of Radian Asset Assurance that is authorized to conduct insurance business in the United Kingdom, but revised its Ratings Outlook for the two entities to Negative from Stable. Fitch’s ratings for the parent company of “A” and its other rated subsidiaries of “AA” are unchanged, and Fitch’s Ratings Outlook for these other entities remains Stable. None of the primary insurance customers of our financial guaranty business have any recapture rights as a result of this ratings action by Fitch.

In May 2004, Moody’s Investor Service (“Moody’s”) provided Radian Asset Assurance with an initial insurer financial strength rating of Aa3. Concurrently, and in anticipation of the merger of Radian Reinsurance Inc. (“Radian Reinsurance”) with and into Radian Asset Assurance, Moody’s downgraded the insurance financial strength rating of Radian Reinsurance from Aa2 to Aa3. As a result of this downgrade, two of the primary insurer customers of our financial guaranty reinsurance business had the right to recapture previously written business ceded to our financial guaranty reinsurance business. One of these customers agreed, without cost to or concessions by us, to waive its recapture rights. Effective February 28, 2005, the remaining primary insurer customer with recapture rights recaptured approximately $7.4 billion of par in force that it had ceded to us, including $54.7 million of net premiums written, $4.5 million of which already had been treated as earned under GAAP and was required to be recorded as an immediate reduction of net premiums earned at the time of the recapture. Also in connection with the recapture in the first quarter of 2005, we were reimbursed for policy acquisition costs of approximately $17.1 million for which the carrying value under GAAP was $18.8 million. This required us to write off policy acquisition costs of $1.7 million. The aggregate result of the recapture was a reduction in pre-tax income of $6.2 million, or approximately $0.04 per share after tax. In March 2005, without cost to or concessions by us, the customer that exercised these recapture rights waived all of its remaining recapture rights with respect to the May 2004 downgrade by Moody’s.

None of the primary insurer customers of our financial guaranty reinsurance business have any remaining recapture rights as a result of prior downgrades of Radian Asset Assurance’s or Radian Reinsurance’s financial strength ratings from any of the three primary ratings agencies.

6—Investment in Affiliates

We have a 46.0% equity interest in C-BASS and a 34.58% equity interest in Sherman. On June 24, 2005, we entered into agreements to restructure our ownership interest in Sherman. Before the restructuring, Sherman was owned 41.5% by us, 41.5% by Mortgage Guaranty Insurance Corporation (“MGIC”) and 17% by an entity controlled by Sherman’s management team.

As part of the restructuring, we and MGIC each agreed to sell a 6.92% interest in Sherman to a new entity controlled by Sherman’s management team, thereby reducing our ownership interest and MGIC’s ownership interest to 34.58% for each of us. In return, the new entity controlled by Sherman’s management team paid approximately $15.65 million (which resulted in a $3.3 million loss in 2005) to us and the same amount to MGIC. Regulatory approval for this transaction was received in August 2005, and our ownership interest was reduced to 34.58%, retroactive to May 1, 2005. Effective June 15, 2005, Sherman’s employees were transferred to the new entity controlled by Sherman’s management team, and this entity agreed to provide management services to Sherman. Sherman’s management team also agreed to reduce significantly its maximum incentive payout under its annual incentive plan for periods beginning on or after May 1, 2005. This has resulted in Sherman’s net income now being greater than it would have been without a reduction in the maximum incentive payout. Following the restructuring, we expect that our and MGIC’s share of Sherman’s net income will continue to be similar to our respective shares before the restructuring because, although our percentage interest in Sherman is smaller than it was before the restructuring, Sherman’s net income is greater than it would have been if the restructuring had not occurred.

 

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In connection with the restructuring, we and MGIC each also paid $1 million for each of us to have the right to purchase, on July 7, 2006, a 6.92% interest in Sherman from the new entity controlled by Sherman’s management team for a price intended to approximate current fair market value. If either we or MGIC exercise our purchase right but the other fails to exercise its purchase right, the exercising party also may exercise the purchase right of the non-exercising party. Our and MGIC’s representation on Sherman’s Board of Managers will not change regardless of which party or parties exercise the purchase right.

During the fourth quarter of 2005, we recorded a complete write-down of our investment in SBF Participacoes Ltda., recording a $3.2 million loss. We account for our investment in affiliates in accordance with the equity method of accounting, because we lack control of these affiliates and since the other shareholders of these entities have substantial participating rights.

The following table shows the components that make up the investment in affiliates balance:

 

(In thousands)    March 31
2006
    December 31
2005
 
        

C-BASS

   $ 387,043     $ 364,364  

Sherman

     49,608       81,753  

Other

     34       34  
                

Total

   $ 436,685     $ 446,151  
                
    

Three Months Ended

March 31

 
(In thousands)    2006     2005  

Investment in Affiliates-Selected Information:

    

C-BASS

    

Balance, beginning of period

   $ 364,364     $ 290,073  

Share of net income for period

     30,026       28,117  

Dividends received

     (7,347 )     (8,500 )
                

Balance, end of period

   $ 387,043     $ 309,690  
                

Sherman

    

Balance, beginning of period

   $ 81,753     $ 101,492  

Share of net income for period

     28,315       23,179  

Dividends received

     (60,515 )     (51,875 )

Other comprehensive income

     55       1,153  

Warrant repurchase

     —         (2,075 )
                

Balance, end of period

   $ 49,608     $ 71,874  
                

Portfolio Information:

    

C-BASS

    

Servicing portfolio

   $ 53,340,000     $ 36,530,000  

Total assets

     4,704,015       3,617,911  

Sherman

    

Total assets

   $ 1,010,930     $ 740,604  

 

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Three Months Ended

March 31

(In thousands)    2006     2005

Summary Income Statement:

    

C-BASS

    

Income

    

(Loss) gain on securitization

   $ (1,844 )   $ 9,029

Transaction gains

     24,964       31,855

Servicing and subservicing fees

     74,069       59,794

Net interest income

     65,040       41,252

Other income

     8,895       5,370
              

Total revenues

     171,124       147,300
              

Expenses

    

Compensation and benefits

     47,064       41,924

Total other expenses

     58,597       44,749
              

Total expenses

     105,661       86,673
              

Net income

   $ 65,463     $ 60,627
              

Sherman

    

Income

    

Revenues from receivable portfolios—net of amortization

   $ 237,672     $ 148,625

Other revenues

     2,730       7,312
              

Total revenues

     240,402       155,937
              

Expenses

    

Operating and servicing expenses

     127,368       89,028

Interest

     10,036       3,745

Other

     21,117       7,311
              

Total expenses

     158,521       100,084
              

Net income

   $ 81,881     $ 55,853
              

7—Long-Term Debt

On June 7, 2005, we issued $250 million of unsecured senior notes. These notes bear interest at the rate of 5.375% per annum, payable semi-annually on June 15 and December 15, beginning on December 15, 2005. The notes mature on June 15, 2015. We have the option to redeem some or all of the notes at any time with not less than 30 days’ notice at a redemption price equal to the greater of the principal amount of the notes or the sum of the present values of the remaining scheduled payments of principal and interest on the notes to be redeemed. We used a portion of the proceeds from the sale of the notes to redeem at par, on August 1, 2005, all $219.3 million in aggregate principal amount of our outstanding 2.25% Senior Convertible Debentures due 2022. We used the balance of the proceeds for general corporate purposes.

In February 2003, we 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. These notes mature in February 2013. We have the option to redeem some or all of the notes at any time with not less than 30 days’ notice at a redemption price equal to the greater of the principal amount of the notes or the present values of the remaining

 

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scheduled payments of principal and interest on the notes to be redeemed. In April 2004, we entered into interest-rate swap contracts that effectively converted the interest rate on this fixed-rate debt to a variable rate based on a spread over the six-month LIBOR for the remaining term of the debt.

In January 2002, we issued $220 million of 2.25% senior convertible debentures due 2022. Approximately $125 million of the proceeds from the offering were used to increase capital at Radian Asset Assurance. The remainder was used to redeem our preferred stock, to buy back our common stock and for general corporate purposes. On January 3, 2005, $663,000 in principal amount of the debentures was redeemed by holders, leaving $219.3 million in principal amount outstanding. We redeemed the remaining $219.3 million in principal amount outstanding on August 1, 2005.

The composition of our long-term debt at March 31, 2006 and December 31, 2005 was as follows:

 

(In thousands)

   March 31
2006
   December 31
2005

5.625% Senior Notes due 2013

   $ 248,546    $ 248,503

7.75% Debentures due 2011

     249,411      249,388

5.375% Senior Notes due 2015

     249,583      249,575
             
   $ 747,540    $ 747,466
             

On December 16, 2004, we replaced a $250 million Revolving Credit Facility that expired in December 2004 with a $400 million unsecured facility, comprised of a $100 million 364-day facility and a $300 million five-year facility. On December 15, 2005, we amended the facility to extend the expiration date of the 364-day facility from December 15, 2005, to December 14, 2006. The five-year facility expires on December 16, 2009. There were no drawdowns on the expired facility, and we have not drawn down any amounts under the new facility through March 31, 2006. This facility bears interest on any amounts drawn at a rate dependent on our credit rating at the time of such borrowing and will be calculated according to, at our option, a base rate or a Eurocurrency rate, plus an applicable margin and utilization fee. If necessary, this facility will be used for working capital and general corporate purposes.

8—Stock-Based Compensation

We have an equity compensation plan, the Radian Group Inc. Equity Compensation Plan (the “Plan”), under which we may provide grants of incentive stock options, non-qualified stock options, restricted stock, stock appreciation rights (referred to as “SARs”), performance shares and phantom stock. To date, all awards granted under the Plan have been in the form of non-qualified stock options, restricted stock and phantom stock. The Plan provides for the grant of all options principally at an option price per share equal to 100% of the market price of our common stock on the date of grant. The Plan authorizes the issuance of up to 9,400,000 shares of our common stock, of which there are approximately 2,300,000 shares remaining available for grants under the Plan as of March 31, 2006. Officers and other employees (of Radian or its affiliates) are eligible to participate in the Plan. Non-employee directors are also eligible to participate in the Plan, but are not permitted to receive grants of incentive stock options.

On February 7, 2006, our board of directors approved an amendment to the Plan to extend the expiration date of the Plan from December 31, 2006 to December 31, 2008. We intend to submit this amendment to our stockholders for approval at our 2006 annual meeting of stockholders. If the amendment is not approved, the Plan will expire as scheduled on December 31, 2006.

 

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In December 2004, the FASB issued SFAS No. 123R that requires compensation cost related to share-based payment transactions to be recognized in an issuer’s financial statements. The compensation cost, with limited exceptions, is measured based on the grant-date fair value of the equity or liability instrument issued. In October 2005, the FASB issued Staff Position No. FAS 123(R)-2 “Practical Accommodation to the Application of Grant Date as Defined in FASB Statement No. 123(R),” to provide guidance on the application of the term “grant date” in SFAS No. 123R. In accordance with this Staff Position, the grant date of an award shall be the date the award is approved by our board of directors if, at such time, (i) the recipient of the award does not have the ability to negotiate the key terms and conditions of the award and (ii) the key terms of the award are expected to be communicated to the recipients within a relatively short time period after the date of approval. SFAS No. 123R replaces SFAS No. 123 and supersedes Accounting Principles Board (“APB”) Opinion No. 25. Before the adoption of SFAS No. 123R, we applied APB 25 to account for our stock-based compensation.

On January 1, 2006, we adopted SFAS No. 123R using a modified prospective application as permitted by SFAS No. 123R. Accordingly, prior period amounts have not been restated. Under this application, we are required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption. Compensation cost is recognized over the periods that an employee provides service in exchange for the award.

We use the Black-Scholes model in determining the fair value of stock-based compensation issued to employees and directors. The fair value of the stock options granted was estimated using this model on the date of grant using the assumptions noted in the following table:

 

     March 31
2006
    March 31
2005
 

Expected life (years) (1)

   4.75     5.50  

Risk-free interest rate (2)

   4.43 %   3.65 %

Volatility

   24.78 %   32.23 %

Dividend yield

   0.14 %   0.16 %

(1) Beginning in 2006, with the adoption of SFAS No. 123R, the expected life of stock options granted was based on the simplified method. Stock options have historically been granted with a vesting period of four years, expiring over seven or ten years.
(2) The risk-free rate is based on the U.S. treasury yield curve in effect at the time of grant.

In the first quarter of 2006, the adoption of SFAS No. 123R resulted in incremental stock-based compensation of $3.0 million, of which $1.4 million was deferred as policy acquisition costs. The incremental stock-based compensation expense caused income before income taxes and net income to decrease by $1.6 million and $1.0 million, respectively, and basic and diluted earnings per share to decrease by $0.01 per share. In computing the pro-forma expense in prior years, there was no assumption that any compensation expense related to stock options would be deferred, therefore pro-forma adjustments in prior periods do not include adjustments related to acquisition costs. Cash provided by operating activities decreased and cash provided by financing activities increased by $1.3 million related to excess tax benefits from stock-based payment arrangements.

 

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The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123R to stock-based employee compensation prior to 2006.

 

(In thousands, except per share amounts)   

Three Months Ended

March 31 2005

 

Net income, as reported

   $ 115,612  

Add: Stock-based employee compensation expense included in reported net income, net of tax

     1,398  

Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of tax

     (4,074 )
        

Pro forma net income

   $ 112,936  
        

Pro forma net income available to common stockholders

   $ 113,738  
        

Earnings per share

  

Basic—as reported

   $ 1.29  
        

Basic—pro forma

   $ 1.26  
        

Diluted—as reported

   $ 1.24  
        

Diluted—pro forma

   $ 1.21  
        

Stock Options

Unless otherwise specified, each option vests ratably over four years, beginning one year after the date of grant. As long as the grantee is still with Radian, if not sooner vested by its terms, each option fully vests upon the earliest of:

 

    the grantee’s normal retirement date;

 

    five years from the date of the grant;

 

    the grantee’s death or disability;

 

    the occurrence of a change of control of Radian; or

 

    the grantee’s early retirement date if early retirement election is made by the grantee upon reaching the age of 55 and 10 years of service.

A grantee may pay the option price in cash or, with the consent of the Compensation and Human Resources Committee of our board of directors (the “Compensation Committee”), shares of our common stock, or by making other arrangements satisfactory to us.

Information with regard to stock options for the period ended March 31, 2006, is as follows:

 

    

Number of

Shares

   

Weighted Average

Exercise Price

Per Share

Outstanding, January 1, 2006

   3,873,738     $ 39.37

Granted

   1,030,650       56.03

Exercised

   (303,296 )     38.94

Forfeited

   (123,862 )     43.67

Expired

   (8,906 )     39.12
        

Outstanding, March 31, 2006

   4,468,324       43.12
        

Exercisable, March 31, 2006

   2,423,548       36.45
        

Available for grant, March 31, 2006

   2,237,489    
        

 

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Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

The amount of cash received from the exercise of stock options in the first quarter of 2006 was approximately $11.8 million and the related tax benefit was approximately $4.5 million. The total intrinsic value of options exercised, at the date of exercise, during the three months ended March 31, 2006 was $5.7 million.

We generally issue shares from unissued reserved shares for exercises with an exercise price less than the treasury stock repurchase price and from treasury stock when the exercise price is greater than the treasury stock repurchase price.

The table summarizes information regarding fully vested share options as of March 31, 2006:

 

($ in millions, except per-share amount)

    

Number of options vested

     2,423,548

Fair value of options vested

   $ 146.0

Weighted-average exercise price per share

   $ 36.45

Aggregate intrinsic value (excess market price over exercise price)

   $ 57.7

Weighted-average remaining contractual term of options (in years)

     5.09

The weighted average fair values of the stock options granted during the three months ended March 31, 2006 and 2005 were $16.62 and $17.47, respectively.

The following table summarizes information concerning outstanding and exercisable options at March 31, 2006:

 

     Options Outstanding    Options Exercisable

Range of Exercise Prices

  

Number

Outstanding

  

Weighted Average

Remaining

Contractual Life

(Years)

  

Weighted Average

Exercise Price

   Number Exercisable   

Weighted Average

Exercise Price

$16.25–$23.38    399,050    3.18    $ 20.27    399,050    $ 20.27
$26.47–$39.34    1,459,966    5.35      33.36    1,324,369      33.11
$41.48–$56.68    2,478,394    6.56      51.34    569,215      48.84
$65.48–$68.18    130,914    1.82      65.82    130,914      65.82
                  
   4,468,324          2,423,548   
                  

Restricted Stock

The Compensation Committee may issue shares of our common stock under a grant of restricted stock under the Plan. The shares underlying a grant are issued in consideration for cash or services rendered having a value, as determined by our board of directors, at least equal to the par value of the common stock. If a grantee’s relationship with us terminates while the shares are subject to restrictions imposed by the Compensation Committee, the restricted stock grant will terminate with respect to all shares that are subject to restrictions, and such shares must be immediately returned to us. While shares are subject to restrictions, a grantee may not sell, assign, transfer, pledge or otherwise dispose of the shares of our common stock, except to a successor grantee in the event of the grantee’s death. All restrictions imposed under a restricted stock grant lapse after the applicable restriction period or as the Compensation Committee may determine.

We granted, under the Plan, 50,000 shares of restricted stock during 2005 and 19,800 shares of restricted stock in February 2006, each vesting over three years.

 

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Under the provisions of SFAS No. 123R, the recognition of deferred compensation as a separate line item on the condensed consolidated balance sheets is no longer required. Therefore, in the first quarter of 2006, the amount that had been included in “deferred compensation” in the condensed consolidated balance sheets at December 31, 2005 was reclassified to additional paid-in-capital. The amount recorded as stock-based compensation expense related to restricted stock for the three months ended March 31, 2006 was $0.3 million.

Changes in our restricted stock were as follows:

 

    

Number of

Shares

  

Weighted Average

Grant-Date Fair

Value Per Share

Unvested, January 1, 2006

   50,000    $ 46.67

Granted

   19,800      56.03

Vested

   —        —  

Forfeited

   —        —  

Expired

   —        —  
       

Unvested, March 31, 2006

   69,800    $ 49.33
       

Phantom Stock

The Compensation Committee may grant phantom stock awards under the Plan, which entitle grantees to receive shares of our common stock on a vesting date (referred to in the Plan as the conversion date) established by the Compensation Committee. The phantom stock may be subject to further vesting restrictions, as the Compensation Committee determines. Unless otherwise provided in a grant letter, if a grantee’s relationship with us terminates during any period in which vesting restrictions apply, the phantom stock grant terminates as to all shares covered by the grant as to which vesting restrictions have not lapsed and such shares will be forfeited. Our practice to date has been to grant phantom stock to directors with a vesting date upon the termination of the director’s relationship with us. In addition, we are also using phantom stock to fund awards issued under our Performance Share Plan adopted in 2005. See “Performance Shares” below. Each share of phantom stock is granted at full value with no exercise price. All phantom stock will be paid in whole shares of our common stock, with fractional shares paid in cash. The amount recorded as stock-based compensation expense related to phantom stock for the three months ended March 31, 2006 was $1.4 million.

Changes in our phantom stock were as follows:

 

    

Number of

Shares

   

Weighted Average

Grant-Date Fair

Value Per Share

Unvested, January 1, 2006

   97,633     $ 42.31

Granted

   18,468       56.03

Vested

   (10,000 )     47.13

Forfeited

   —         —  

Expired

   —         —  
        

Unvested, March 31, 2006

   106,101     $ 44.24
        

Employee Stock Purchase Plan

We have an Employee Stock Purchase Plan (the “ESPP”). A total of 200,000 shares of our authorized non-issued common stock have been made available under the ESPP. The ESPP allows eligible employees to

 

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purchase shares of our 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 us and eligible employees are limited to a maximum contribution of $400 per payroll period toward the purchase of our stock. Under the ESPP, we sold 8,382 and 8,482 shares to employees during the three months ended March 31, 2006 and 2005, respectively. Beginning in 2006, we applied SFAS No. 123R in accounting for the ESPP. The effect of the issuance of shares under the ESPP on our net income and earnings per share was immaterial in 2005. The amount recorded as stock-based compensation related to the ESPP for the three months ended March 31, 2006 was $44.7 thousand.

The following are weighted average assumptions used in our calculation of ESPP compensation expense:

 

     March 31 2006  

Expected life

   6 months  

Risk-free interest rate

   4.35 %

Volatility

   21.15 %

Dividend yield

   0.07 %

Performance Shares

Effective May 10, 2005, our stockholders approved the 2005 Performance Share Plan (the “Program”). The Program is intended to motivate our executive officers by focusing their attention on critical financial indicators that measure our success. The performance share awards granted pursuant to the Program are funded by equity awards under the Plan. We are currently using phantom stock grants to fund awards under the Program. The Compensation Committee grants performance share awards to eligible participants with respect to performance periods of overlapping durations. Both the first and second performance periods under the Program are three-year periods that began on January 1, 2005 and January 1, 2006, respectively. The Compensation Committee expects that future performance periods will cover additional three-year periods beginning on January 1 of each year.

At the establishment of each performance period, a target number of performance shares are established for each participant in the Program. The performance shares are denominated in shares of common stock and are settled in common shares. The maximum payout under any performance share award is 250,000 shares of common stock. The amount of stock-based compensation related to performance shares at March 31, 2006 was $0.7 million.

Each performance share award becomes payable at the target amount multiplied by a factor (between 0% and 200%) depending on our growth in earnings per share, growth in adjusted book value and return on equity over the performance period. For the first and second performance periods, one third of each award is based on each of the three metrics, and each metric is measured both on an absolute basis and relative to a group of our peers.

As of March 31, 2006, unrecognized compensation expense related to the unvested portion of our stock-based awards was approximately $41.3 million. This cost is expected to be recognized over a weighted average period of 3.5 years.

9—Recent Accounting Pronouncements

In March 2006, the FASB issued FASB Staff Position (“FSP”) No. FTB 85-4-1 “Accounting for Life Settlement Contracts by Third-Party Investors,” which provides initial and subsequent measurement guidance and financial statement presentation and disclosure guidance for investments by third-party investors in life

 

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settlement contracts. This FSP also amends certain provisions of FASB Technical Bulletin No. 85-4, “Accounting for Purchases of Life Insurance,” and SFAS No. 133. Management has not yet determined the impact, if any, that will result from the adoption of this FSP.

In April 2006, the FASB issued FSP No. FIN 46(R)-6 “Determining the Variability to Be Considered in Applying FASB Interpretation No. 46(R),” which addresses how a reporting enterprise should determine the variability to be considered in applying FASB Interpretation No. 46 (R) (“FIN 46R”). The variability that is considered in applying FIN 46R affects the determination of (i) whether the entity is a variable interest entity, (ii) which interests are variable interests in the entity, and (iii) which party, if any, is the primary beneficiary of the variable interest entity. That variability will affect any calculation of expected losses and expected residual returns, if such a calculation is necessary. Management has not yet determined the impact, if any, that will result from the adoption of this FSP.

10—Other Information

Since September 2002, our board of directors has authorized five separate repurchase programs for the repurchase, in the aggregate, of up to 19.5 million shares of our common stock on the open market. At March 31, 2004, we had repurchased all 2.5 million shares under the initial program (announced September 24, 2002) at a cost of approximately $87.0 million. At March 31, 2005, we had repurchased an additional 5.0 million shares under the second program (announced May 11, 2004, and extended on September 8, 2004) at a cost of approximately $235.9 million, and at June 30, 2005, we had repurchased all 5.0 million shares under the third program (announced February 15, 2005) at a cost of approximately $240.0 million. At December 31, 2005, we had repurchased all 3.0 million shares authorized under the fourth repurchase program (announced August 9, 2005) at a cost of approximately $160.0 million. All share repurchases made to date were funded from available working capital, and were made from time to time depending on market conditions, share price and other factors.

On February 8, 2006, we announced that our board of directors had authorized a fifth repurchase program of up to 4.0 million shares of our common stock on the open market. At March 31, 2006, we had repurchased 1.0 million of the 4.0 million shares at a cost of approximately $60.2 million. Stock purchases under this program are funded from available working capital and are made from time to time, depending on market conditions, stock price and other factors. The board did not set an expiration date for this program.

We also may purchase shares on the open market to meet option exercise obligations and to fund 401(k) matches and purchases under our Employee Stock Purchase Plan and may consider additional stock repurchase programs in the future.

Until September 30, 2004, our financial guaranty business also included our ownership interest in Primus Guaranty, Ltd. (“Primus”), a Bermuda holding company and parent to Primus Financial Products, LLC, a provider of credit risk protection to derivatives dealers and credit portfolio managers on individual investment-grade entities. In September 2004, Primus issued shares of its common stock in an initial public offering. We sold a portion of our shares in Primus as part of this offering. As a result of our reduced ownership and influence over Primus after the initial public offering, we reclassified our investment in Primus to our equity securities portfolio. Accordingly, beginning with the fourth quarter of 2004, we began recording changes in the fair value of the Primus securities as other comprehensive income rather than recording income or loss as equity in net income of affiliates. In 2005 and during the first quarter of 2006, we sold all of our remaining interest in Primus, recording a pre-tax gain of $2.8 million in 2005 and a pre-tax gain of $21.4 million in the first quarter of 2006.

 

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11—Benefit Plans

We maintain a noncontributory defined benefit pension plan (the “Pension Plan”) covering substantially all of our full-time employees. Retirement benefits under the Pension Plan are a function of the years of service and the level of compensation of eligible participants. Participants vest in their plan benefits after five years of service or, if sooner, when they reach age 65. Assets of the Pension Plan are allocated in a balanced fashion with approximately 40% in fixed income securities and 60% in equity securities.

We also provide a nonqualified supplemental executive retirement plan (the “SERP”) for selected senior officers. The SERP is intended to provide these officers with retirement benefits supplemental to the Pension Plan. Under the SERP, 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 of eligible participants and are reduced by any benefits paid under the Pension Plan. We fund the SERP through the purchase of variable life insurance policies pursuant to a split-dollar life insurance program called the Executive Life Insurance Program. Under this arrangement, we purchase a life insurance policy, which we own and pay for, on the lives of executive officers who are participants in the SERP. We endorse to the participant a portion of the death benefit, for which the participant is imputed income each year. We own the remainder of the death benefit and all of the cash values in the policy. At the participant’s retirement age, the policy’s cash value is projected to be sufficient for us to pay the promised SERP benefit to the participant. Non-executive officers who were participants in the Executive Life Insurance Program before the issuance in 2003 of regulations under the Internal Revenue Code regarding split-dollar plans, continue under the collateral assignment split-dollar policies that were in force at that time. Under this arrangement, the participant owns the policy, and assigns a portion of the death benefits and cash value to us in amounts sufficient to reimburse us for all of our premium outlays. The eventual cash values above the aggregate premium amounts are designed, as in the endorsement method, to be sufficient to provide payment of the participant’s promised SERP benefit. The participant has imputed income each year for the value of the death benefit provided to him or her, and also for any incidental benefits as provided under applicable tax law.

The discount rate is established by comparing the projection of expected benefit payments based on the assumptions used for the actuarial valuation to the Citigroup Pension Discount Curve (published monthly) as of December 31, of the fiscal year. The expected benefit payments are discounted by each corresponding discount rate on the yield curve. Once the present value of the string of benefit payments is established, we solve for the single spot rate to apply to all obligations of the plan that will exactly match the previously determined present value. This result is rounded to the nearest 25 basis points.

The Citigroup Pension Discount Curve is constructed beginning with a U.S. Treasury par curve that reflects the entire Treasury and STRIPS market. From the Treasury curve, Citibank produces a double–A corporate par curve by adding option-adjusted spreads that are drawn from the double-A corporate sector of the Citigroup Broad Investment-Grade Bond Index. Finally, from the double-A corporate par curve, Citigroup derives the spot rates that constitute the Pension Discount Curve. For payments beyond 30 years we extend the curve assuming that the discount rate derived in year 30 is extended to the end of the plan’s payment expectations.

We disclosed in our financial statements for the year ended December 31, 2005 that we expected to contribute $3.0 million to the Pension Plan and SERP in 2006. As of March 31, 2006, $1.5 million of contributions had been made. We presently anticipate contributing an additional $1.5 million to fund the Pension Plan and SERP by the end of 2006.

 

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Radian Group Inc.

Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)

 

The components of the Pension Plan/SERP benefit and net periodic postretirement benefit costs are as follows (in thousands):

 

    

Pension Plan/SERP

Three Months Ended

March 31

 
     2006     2005  

Service cost

   $ 1,321     $ 1,151  

Interest cost

     542       472  

Expected return on plan assets

     (377 )     (270 )

Amortization of prior service cost

     63       63  

Recognized net actuarial loss

     94       70  
                

Net periodic benefit cost

   $ 1,643     $ 1,486  
                

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

The following is selected financial information for the parent company:

 

(In thousands)    March 31
2006
   December 31
2005

Investment in subsidiaries, at equity in net assets

   $ 4,402,043    $ 4,257,682

Total assets

     4,623,752      4,491,911

Long-term debt

     747,540      747,466

Total liabilities

     852,532      829,031

Total stockholders’ equity

     3,771,220      3,662,880

Total liabilities and stockholders’ equity

     4,623,752      4,491,911

13—Commitments, Contingencies and Off-Balance-Sheet Arrangements

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

We guarantee the payment of up to $25.0 million of a revolving credit facility issued to Sherman. On December 22, 2005, the facility was extended until December 21, 2006. There are no amounts outstanding under this facility at March 31, 2006.

We have committed to invest $10 million in a fund sponsored and managed by C-BASS. The fund invests in real estate related securities and had total assets of $274.0 million at March 31, 2006. C-BASS is also a co-investor in the fund. We had $5.2 million invested in the fund at March 31, 2006.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following analysis of our consolidated financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the notes thereto included elsewhere in this report and the risks and uncertainties detailed in the section immediately preceding Part I of this report.

Overview

We provide credit protection products and financial services to mortgage lenders and other global financial institutions. As a holder of credit risk, our results are subject to macroeconomic conditions and specific events that impact the credit performance of the underlying insured assets. We experienced good results for the first quarter of 2006, although the business production environment for mortgage insurance and financial guaranty insurance continued to present some challenges.

The results of our mortgage insurance business were excellent in the first quarter of 2006. Revenues increased from the prior year due mostly to improvements in persistency and a significant amount of structured new insurance written. In addition, credit performance was strong as mortgage insurance claims were lower than anticipated in the first quarter of 2006, which was coupled with a decrease in delinquencies, a leading indicator of future claims. Those delinquencies that remained did migrate to the latter stages of the delinquency cycle, indicating that such loans have moved closer to foreclosure and therefore, require a higher loss reserve. The mortgage insurance mix of business has continued to include a higher percentage of lower credit profile business such as Alternative A (“Alt-A”) and A minus mortgages and new unproven products such as interest-only loans and pay option ARMs. These products are a growth area of the market as some of the prime mortgage market continues to be absorbed by “80-10-10” arrangements and other hybrid mortgage products that do not typically include mortgage insurance. However, it is expected that higher interest rates and saturated bank portfolios of home equity loans will shift some of the prime mortgage market back to the mortgage insurance industry. We expect to continue to increase our insurance of new and emerging products that we have less experience with both domestically and internationally, which adds to the uncertainty of future credit performance. However, premiums received for these products are usually higher than more traditional products and often have structuring features such as deductibles that benefit our risk position. We have also protected the extreme downside to some of this risk by reinsuring it through Smart Home transactions. As has been the case for the last several years, much of our business has not yet reached its peak claim period.

In the financial guaranty business, new business production generally continued to be challenged by tight credit spreads, which impacted premium rates more than it did our ability to close transactions. Direct public finance production remained good and credit performance also was generally good, although we paid $68.0 million during the quarter to terminate one of our derivative financial guaranty contracts that was on our intensified surveillance list. See “Results of Operations—Financial Guaranty—Three Months Ended March 31, 2006 Compared to Three Months Ended March 31, 2005—Provision for Losses.” We also continued to write more of our structured business in a super senior, more remote risk position. For the first quarter of 2006, the financial services segment showed another period of strong earnings and return on investment, which was, in part, a result of the relatively low interest rate and favorable credit environment and a strong demand from investors in asset-backed securities.

We believe that our diversified credit enhancement and prudent capital management strategies are sound, and we intend to continue to implement these strategies. We see an intersection between the mortgage insurance and financial guaranty markets, with an emphasis on structured credit enhancement products, including credit default swaps, becoming more common in the mortgage credit enhancement market. In the mortgage insurance business, we are hopeful that stability in the housing and job markets can continue to positively impact credit performance and that modestly rising interest rates will help to continue to reduce cancellation rates, although these macroeconomic factors remain outside of our control. We will continue to be challenged to solidify our unique AA financial guaranty business platform by demonstrating the ability to diversify our products, and to

 

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grow and write quality business, which will in turn solidify our franchise. This may be difficult in a competitive, tight credit-spread environment. We have begun to see some success in our efforts to increase our presence in the global markets for both mortgage and financial guaranty business. This will allow us to take advantage of our core competencies of credit risk analysis and capital allocation to write profitable business in Europe and Asia, although we do not expect this to be a significant source of earnings for several years. We will also look for opportunities to expand in ways that leverage our core competencies of credit risk analysis and mortgage market expertise.

Since August 29, 2005, the date that Hurricane Katrina first struck and caused extensive property damage to the U.S. Gulf Coast, we have paid approximately $7.7 million in claims on mortgage insurance written in areas damaged by Hurricanes Katrina and Rita (as designated by Federal Home Loan Mortgage Corp. (“Freddie Mac”) as of March 1, 2006, the “designated areas”), including approximately $4.5 million for claims received after August 29, 2005. In addition, we have paid a total of approximately $70 thousand in claims received after August 29, 2005 on financial guaranty insurance written in the designated areas. This amount relates to a single default that was subsequently cured and for which we were reimbursed.

While we have experienced an increase in defaults in mortgage insurance in designated areas as a result of the hurricanes—approximately 5,044 defaults as of March 31, 2006, which is down from 6,208 defaults as of December 31, 2005—we believe it is still too early to tell how many claims we ultimately may have to pay on these defaults. There are many factors that are contributing to the uncertainty surrounding these defaults. The organizations servicing these loans are reporting defaults, in some cases, despite the existence of forbearance agreements that permit homeowners to defer mortgage payments on these loans. In addition, we anticipate, but cannot be certain, that aid (both from private organizations and from federal, state and local governments) and payments from property and casualty insurers will help to reduce the number of potential claims in these areas by providing a direct source of cash to homeowners and also serving as an economic stimulus in these areas. Limitations also exist in our master policy of insurance that could prevent us from paying all or part of a claim. For example, we are permitted to adjust a claim where the property underlying a mortgage in default is subject to unrestored physical damage. The level of damage being reported in the areas where the defaulting loans are located varies significantly from region to region. Until we have a better understanding of how many of the hurricane-related defaults are likely to result in claims, we intend to reserve for these mortgage insurance defaults as we would for any other non-hurricane-related delinquencies. We therefore, have not taken a view that these loans will perform better or worse than any other delinquencies. As of March 31, 2006, we had established a related mortgage insurance loss reserve of $44.0 million related to the 5,044 Hurricane Katrina- and Rita-related defaults, including a reserve of $16.4 million for approximately 1,800 defaults associated with heavily-damaged areas.

For our financial guaranty business, we believe that certain public finance obligations in the designated areas will require principal and interest advances although the ultimate losses, if any, from such obligations are uncertain. As of March 31, 2006, there has been one default in our public finance obligations in designated areas. As discussed above, this default was subsequently cured and we were reimbursed for this claim payment. We also have exposure in the damaged areas to direct pooled corporate obligations and/or obligations of asset-backed securities; however, we believe there is significant diversification of assets, both as to type and geographical dispersion of the collateral in these pools, and as a result, we view our exposure in these structures to the designated areas as immaterial. We also reinsure pooled corporate obligations that include corporate credits affected by the hurricanes. Defaults of these credits would not likely result in a material claim against us given the degree of credit protection beneath our exposure. As of March 31, 2006, there have been no defaults in structured finance transactions in the designated areas.

As part of our own comprehensive relief program initiated in response to these hurricanes, we are supporting more flexible mortgage payment terms in order to accommodate the financial needs of homeowners in affected areas.

 

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Business Summary

Our principal business segments are mortgage insurance, financial guaranty and financial services. The following table shows the percentage contributions to net income and equity allocated to each business for the three months ended March 31, 2006:

 

     Net Income     Equity  

Mortgage Insurance

   54 %   58 %

Financial Guaranty

   22 %   34 %

Financial Services

   24 %   8 %

Mortgage Insurance

Our mortgage insurance business provides credit-related insurance coverage, principally through private mortgage insurance, and risk management services to mortgage lending institutions located throughout the United States and select countries overseas. We provide these products and services through our wholly-owned subsidiaries, Radian Guaranty Inc., Amerin Guaranty Corporation and Radian Insurance Inc. (which we refer to as “Radian Guaranty,” “Amerin Guaranty” and “Radian Insurance”). Private mortgage insurance protects mortgage lenders from all or a portion of default-related losses on residential first mortgage loans made mostly to home buyers who make down payments of less than 20% of the home’s purchase price. Private mortgage insurance also facilitates the sale of these mortgage loans in the secondary mortgage market, some of which are sold to Freddie Mac and Federal National Mortgage Association (“Fannie Mae”). We sometimes refer to Freddie Mac and Fannie Mae collectively as “Government Sponsored Enterprises” or “GSEs”.

Our mortgage insurance business, through Radian Guaranty, offers primary and pool private mortgage insurance coverage on residential first-lien mortgages. At March 31, 2006, primary insurance on first-lien mortgages made up 90% of our total domestic first-lien mortgage insurance risk in force, and pool insurance on domestic first-lien mortgages made up 10% of our total first-lien mortgage insurance risk in force. We use Radian Insurance to provide credit enhancement for mortgage-related capital market transactions and to write credit insurance on mortgage-related assets that monoline mortgage guaranty insurers are not permitted to insure, including net interest margin securities (“NIMs”), international insurance and reinsurance transactions, second-lien mortgages, home equity loans and credit default swaps (collectively, we refer to the risk associated with these transactions as “other risk in force”). We also insure second-lien mortgages through Amerin Guaranty. At March 31, 2006, other risk in force was approximately 26% of our total mortgage insurance risk in force, although much of the other risk in force was written in two large international deals and financial guaranty wraps.

We carefully review and assess international markets for opportunities to expand our mortgage insurance operations. During 2005, we increased the level of mortgage insurance business that we have been writing internationally. We provide credit protection on pools of mortgages in the United Kingdom (“U.K.”) and in the Netherlands, and we have received authorization to conduct mortgage insurance operations in the U.K., subject to compliance with European passporting rules, and several other European Union jurisdictions. In 2004 and early in 2005, we entered into two mortgage reinsurance transactions in Australia, and in the fourth quarter of 2005, we wrote $7.3 billion in notional value of credit protection in credit default swap form on two large AAA tranches of mortgage-backed securities, one in Germany and one in Denmark. We have entered into a relationship with one of the largest mortgage lenders in Hong Kong to serve as its exclusive provider of mortgage insurance. We are in the process of applying for branch authorization in Hong Kong.

Premium rates for the mortgage insurance business are determined on a risk-adjusted basis that includes borrower, loan and property characteristics. We use proprietary default and prepayment models to project the premiums we should charge, the losses and expenses we should expect to incur and the capital we need to hold in support of our risk. Pricing is established in an amount that we expect will allow a reasonable return on allocated capital. We generally cannot cancel or elect not to renew the mortgage insurance that we provide and, because

 

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we generally establish premium rates for the life of the policy when issued, we cannot adjust renewal premiums or otherwise adjust premiums over the life of the policy to mitigate the effect of adverse developments.

Premium rates for our pool insurance business, which typically includes an aggregate exposure limit for each pool of loans, are generally lower than primary mortgage insurance rates. Because of the generally lower premium rates and lack of exposure limits on individual loans associated with much of our pool insurance, the rating agency capital requirements for this product are generally more restrictive than for primary insurance. In the first quarter of 2006, we wrote $61 million of pool insurance risk, compared to $56 million of pool insurance risk written in the first quarter of 2005.

During the first quarter of 2006, the average premium rates for our primary and pool structured transactions were much lower than our average premium rates on our traditional business due to our writing policies with deductibles and some policies with a very low coverage percentage.

Our mortgage insurance business depends on a small number of lenders for a substantial portion of its business. The top 10 customers were responsible for 21.4% of primary new insurance written in the first quarter of 2006 compared to 46.1% in the first quarter of 2005. The largest single mortgage insurance customer (including branches and affiliates of such customer), measured by new insurance written, accounted for 7.2% of new insurance written during the first quarter of 2006, compared to 10.8% for the same period of 2005. The concentration of business with our mortgage insurance customers may increase or decrease as a result of many factors. These customers may reduce the amount of business currently done with us or cease doing business with us altogether. The volume of structured transaction business also has a significant impact on business concentrations. Our master policies and related lender agreements do not, and by law cannot, require lenders to do business with us. The loss of business from a major lender could have a material adverse effect on our business and financial results. We expect customer concentration to continue as a result of the ongoing consolidation in the financial services industry in general and the mortgage industry in particular.

We and other companies in the mortgage insurance industry participate in reinsurance arrangements with mortgage lenders commonly referred to as “captive reinsurance arrangements.” Under captive reinsurance arrangements, a mortgage lender typically establishes a reinsurance company that assumes part of the risk associated with that lender’s mortgages that are insured by a mortgage insurer on an individual, mortgage-by-mortgage basis (as compared to mortgages insured in structured transactions, which typically are not eligible for captive reinsurance arrangements). In return for the reinsurance company’s assumption of a portion of the risk, the mortgage insurer cedes a portion of its mortgage insurance premiums to the reinsurance company. 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, such as losses brought on by significant national or regional downturns in the real estate market.

We believe that all of our captive reinsurance arrangements transfer risk to the captive reinsurer at a premium rate that is commensurate with the risk. The presence of captive reinsurance on much of our prime book protects us if there is a significant downturn in the housing market. For the three months ended March 31, 2006, premiums ceded under captive reinsurance arrangements were $25.5 million or 12.7% of total premiums earned during the period, compared to $23.8 million or 12.2% of total premiums earned for the same period of 2005. New primary insurance written under captive reinsurance arrangements for the three months ended March 31, 2006 was $2.8 billion or 21.7% of total primary new insurance written during this period, compared to $2.3 billion or 37.8% of total primary new insurance written for the three months ended March 31, 2005. These percentages can be volatile as a result of increases or decreases in structured transactions, which are not typically eligible for captive reinsurance arrangements. We and other mortgage insurers have faced private lawsuits alleging, among other things, that our captive reinsurance arrangements constitute unlawful payments to mortgage lenders under the anti-referral fee provisions of the Real Estate Settlement Practices Act of 1974. We also have been subject to inquiries from the New York insurance department relating to our captive reinsurance arrangements.

 

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In 2004, we developed an approach for reinsuring our non-prime risk. The arrangement, which we refer to as “Smart Home,” effectively transfers risk from our portfolio to investors in the capital markets. Each transaction begins with the formation of an unaffiliated, offshore reinsurance company. We then enter into an agreement with the Smart Home reinsurer pursuant to which we agree to cede to the reinsurer a portion of the risk (and premium) associated with a portfolio of non-prime residential mortgage loans insured by us. The Smart Home reinsurer is funded in the capital markets through the issuance to investors of a series of separate classes of credit-linked notes. Each class relates to the loss coverage levels on the reinsured portfolio and is assigned a rating by one or more of the three major rating agencies. We typically retain the risk associated with the first-loss coverage levels, and we may retain or sell, in a separate risk transfer agreement, the risk associated with the AAA-rated or most remote coverage level. Holders of the Smart Home credit-linked notes bear the risk of loss from losses paid to us under the reinsurance agreement. The Smart Home reinsurer invests the proceeds of the notes in high-quality short-term investments approved by the rating agencies. Income earned on those investments and a portion of the reinsurance premiums that we pay are applied to pay interest on the notes as well as certain of the Smart Home reinsurer’s expenses. The rate of principal amortization of the credit-linked notes approximates the rate of principal amortization of the underlying mortgages.

Ceded premiums written for the first quarter of 2006 and 2005 include $2.2 million and $0.7 million, respectively, related to the Smart Home transactions. As of March 31, 2006, there have been no ceded losses as a result of the Smart Home transactions.

Since August 2004, we have completed three “Smart Home” arrangements. Details of these transactions (aggregated) as of the initial closing of each transaction and as of March 31, 2006 are as follows:

 

     Initial    As of March 31, 2006

Pool of non-prime mortgages (par value)

   $ 8.83 billion    $ 6.69 billion

Risk in force (par value)

   $ 2.52 billion    $ 1.85 billion

Notes sold to investors/risk ceded (principal amount)

   $ 489.1 million    $ 461.9 million

Smart Home protects us against catastrophic loss as we continue to take on more non-prime risk and to generate the higher premiums associated with insuring these types of products. As a result, we consider Smart Home arrangements to be important to our ability to effectively manage our risk profile in the non-prime market. Approximately 23% of our primary non-prime risk in force is currently included in Smart Home arrangements, although we retain a portion of this risk as discussed above. We intend to increase this percentage substantially in 2006. Because the Smart Home arrangement ultimately depends on the willingness of investors to invest in Smart Home securities, we cannot be certain that Smart Home will always be available to us or will be available on terms that are acceptable to us. If we are unable to continue to use Smart Home arrangements, our ability to participate in the non-prime mortgage market could be limited, which could have an adverse effect on our business, financial condition and operating results.

We have delegated underwriting programs with a significant number of our customers. Our delegated underwriting programs allow lenders to commit us to insure loans that meet agreed-upon underwriting guidelines. Our delegated underwriting programs currently include only lenders that are approved by our risk management area, and we routinely audit loans submitted under this program. Once we accept a lender into our delegated underwriting program, however, we generally insure all loans submitted to us by that lender even if the lender has not followed our specified underwriting guidelines. Although we have not experienced this to date, a lender could commit us to insure a material number of loans with unacceptable risk profiles before we discover the problem and terminate that lender’s delegated underwriting authority. We mitigate this risk through periodic, on-site reviews of selected delegated lenders.

Our mortgage insurance business also utilizes its underwriting skills to provide an outsourced underwriting service to its customers known as contract underwriting. For a fee, we underwrite loan files for secondary market compliance, while concurrently assessing the file for mortgage insurance if applicable. For the three months

 

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ended March 31, 2006, the percentage of loans written on a flow basis via contract underwriting accounted for 12.4% of applications, 12.2% of commitments, and 11.8% of certificates issued by our mortgage insurance business, compared to 22.3%, 21.7% and 20.3%, respectively, for the three months ended March 31, 2005. We give recourse to our customers on loans we underwrite for compliance. If we make a material error in underwriting a loan, we agree to provide a remedy of placing mortgage insurance coverage on the loan or purchasing the loan. During the three months ended March 31, 2006, we processed requests for remedies on less than 1% of the loans underwritten. From time to time, we sell, on market terms, loans we have purchased under contract underwriting remedies to our affiliate, Credit-Based Asset Servicing and Securitization LLC (“C-BASS”). There were no loans sold to C-BASS during the first quarter of 2006 or 2005.

Financial Guaranty

Our financial guaranty business mainly insures and reinsures credit-based risks. Financial guaranty insurance provides an unconditional and irrevocable guaranty to the holder of a financial obligation of full and timely payment of principal and interest when due.

Our financial guaranty business offers the following products:

 

    insurance of public finance obligations, including tax-exempt and taxable indebtedness of states, counties, cities, special service districts and other political subdivisions, and for enterprises such as airports, public and private higher education and health care facilities. The issuers of public finance obligations we insure are typically rated investment grade (BBB-/Baa3 or higher);

 

    insurance of structured finance transactions, including collateralized debt obligations and asset-backed securities, consisting of funded and non-funded (“synthetic”) executions that are payable from or tied to the performance of a specific pool of assets. Examples of structured finance transactions include residential and commercial mortgages, a variety of consumer loans, corporate loans and bonds, equipment receivables, real and personal property leases and collateralized corporate debt obligations, including obligations of counterparties under derivative transactions and credit default swaps. Our insured structured finance transactions are generally rated investment-grade without the benefit of our insurance;

 

    financial solutions products, including guaranties of securities exchanges, excess-Securities Investor Protection Corporation (“SIPC”) insurance for brokerage firms and excess-Federal Deposit Insurance Corporation (“FDIC”) insurance for banks; and

 

    reinsurance of public finance obligations, including those issued by sovereign and sub-sovereign entities, as well as structured finance, financial solutions and trade credit obligations. We generally rely on the underwriting performed by the primary insurer for our reinsurance obligations.

The financial guaranty segment derives a substantial portion of its premiums written from a small number of direct primary insurers. In the first quarter of 2006, two primary insurers accounted for approximately $17.7 million of the financial guaranty segment’s gross written premiums compared to $10.6 million in the first quarter of 2005. No other primary insurer accounted for more than 10% of the financial guaranty segment’s gross written premiums during the first quarter of 2006 or 2005. Gross written premiums and net written premiums are not materially different because we do not cede a material amount of business to reinsurers.

In October 2005, we announced that we would be exiting the trade credit reinsurance line of business. Accordingly, this line of business has been placed into run-off and we have ceased initiating new trade credit reinsurance contracts going forward. We expect that our existing trade credit reinsurance business, including claims paid, will take several years to run off, although we expect that the bulk of the remaining premiums will be earned and losses incurred over the next two years. Management does not consider the trade credit line of business to be core to our financial guaranty business, and we do not expect that our move to exit the trade credit reinsurance line of business will materially impact the overall profitability or business position of our financial guaranty business. However, in the short-term, our decision to exit the trade credit reinsurance line of business

 

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will likely have an impact on certain financial measures for our financial guaranty business as this business line continues to run off. Trade credit insurance protects sellers of goods under certain circumstances against non-payment of their receivables, and covers receivables where the buyer and seller are in the same country, as well as cross-border receivables. In the latter instance, the coverage sometimes extends to certain political risks (foreign currency controls, expropriation, etc.) that potentially could interfere with the payment from the buyer. In the first quarter of 2006, trade credit reinsurance accounted for 5.3% of financial guaranty’s net premiums written, down from 91.2% of financial guaranty’s net premiums written in the first quarter of 2005 (19.2% excluding the impact of the recapture of business by one of the primary insurer customers of our financial guaranty business as discussed below).

In our financial guaranty business, the issuer of an insured obligation generally pays the premiums for our insurance either in full at the inception of the policy as is typical for public finance transactions or, in the case of most structured finance transactions, in monthly, quarterly, semi-annual or annual installments from the cash flow of the related collateral. Premiums for synthetic credit protection are generally paid in monthly, quarterly, semi-annual or annual installments, but occasionally all or a portion of the premium is paid upfront at the inception of the protection. However, in synthetic credit protection transactions, payment is due directly from our counterparty and is generally not restricted to the cash flows from the underlying obligation or collateral supporting the obligation. Since we depend on the corporate creditworthiness of our counterparty rather than the cash flows from the insured collateral for payment, we generally have a right to terminate synthetic credit protection without penalty to us if our counterparty fails to pay amounts owed to us when due under the terms of the synthetic credit protection.

For public finance transactions, premium rates typically are stated as a percentage of debt service, which includes total principal and interest. For structured finance transactions, premium rates typically are stated as a percentage of the total principal. Premiums are generally non-refundable. Premiums paid in full at inception are recorded as revenue “earned” over the life of the insured obligation (or the coverage period for such obligation if shorter). Premiums paid in installments are generally recorded as revenue in the accounting period in which coverage is provided. This long and relatively predictable premium earnings pattern from our public finance transactions provides us with a relatively predictable source of future revenues.

The establishment of a premium rate for our financial guaranty transactions reflects some or all of the following factors:

 

    issuer-related factors, such as the issuer’s credit strength and sources of income;

 

    servicer-related factors, such as the ability of our counterparty or third-party servicer to manage the underlying collateral and the servicer’s credit strength and sources of income;

 

    obligation-related factors, such as the type of issue, the type and amount of collateral pledged, the revenue sources and amounts, the existence of structural features designed to provide additional credit enhancement should collateral performance not meet original expectations, the nature of any restrictive covenants and the length of time until the obligation’s stated maturity; and

 

    insurer-and market-related factors, such as rating agency capital charges, competition, if any, from other insurers and the credit spreads in the market available to pay premiums.

The majority of insured public finance and structured finance transactions are guaranteed by triple-A rated financial guaranty insurers. As a AA/Aa3-rated company, our financial guaranty business mainly targets distinct niches in the capital markets. There is generally a greater interest cost savings to an issuer by using triple-A rated credit enhancement as compared to our AA/Aa3 rated credit enhancement. However, financial guaranty insurance provided by a lower-rated provider also can provide significant value over uninsured executions in markets where the triple-A rated financial guaranty insurance is unavailable or uneconomical. In some markets, issuers and other counterparties receive no additional rating agency credit or regulatory relief from triple-A rated enhancement than they do with our AA/Aa3 enhancement, so our enhancement in these markets may be more economical.

 

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On April 27, 2005, Fitch Rating Service (“Fitch”) affirmed the “AA” insurance financial strength rating of Radian Asset Assurance Inc. (“Radian Asset Assurance”), our principal financial guaranty operating subsidiary, and Radian Asset Assurance Limited (“RAAL”), a subsidiary of Radian Asset Assurance that is authorized to conduct insurance business in the U.K., but revised its ratings outlook for the two entities to Negative from Stable. Fitch’s ratings for us and our other rated subsidiaries are unchanged. None of the primary insurance customers of our financial guaranty business have any recapture rights as a result of this ratings action by Fitch.

Effective June 1, 2004, we merged our two main financial guaranty operating subsidiaries, Radian Asset Assurance and Radian Reinsurance Inc. (“Radian Reinsurance”), with Radian Asset Assurance as the surviving company. Through this merger, the financial guaranty reinsurance business formerly conducted by Radian Reinsurance was combined with the direct financial guaranty business conducted by Radian Asset Assurance. The merger also combined the assets, liabilities and stockholders’ equity of the two companies. Prior to the merger, in May 2004, Moody’s Investor Service (“Moody’s”) downgraded the insurance financial strength rating of Radian Reinsurance from Aa2 to Aa3.

As a result of this downgrade, two of the primary insurer customers of our financial guaranty reinsurance business had the right to recapture previously written business ceded to our financial guaranty reinsurance business. Effective February 28, 2005, one of these customers recaptured approximately $7.4 billion of par in force that it had ceded to us, including $54.7 million of written premiums as of February 28, 2005, $4.5 million of which was recorded as an immediate reduction of premiums earned at the time of the recapture, which represents the difference between statutory accounting requirements (“STAT”) and accounting principles generally accepted in the United States of America (“GAAP”) unearned premiums. This return of unearned premiums resulted in an increase in policy acquisition costs of $1.7 million. The aggregate result was a reduction in pre-tax income of $6.2 million, or approximately $0.04 per share after tax on a GAAP basis. We refer to the recapture of business as a result of the May 2004 Moody’s downgrade as the “2005 recapture.”

The sum of the above adjustments related to this recapture is summarized as follows:

 

    

Cash Paid

(Received)

   

GAAP

Book Basis

   

Initial

Gain (Loss)

 
     (In thousands)  

Unearned Premiums

   $ 54,742     $ 50,204     $ (4,538 )

Acquisition Costs

     (17,097 )     (18,791 )     (1,694 )
                        

Total

   $ 37,645     $ 31,413     $ (6,232 )
                        

Despite the recapture, this primary insurer customer renewed its reinsurance treaty with us for 2005 and 2006 on substantially the same terms as in 2004 prior to the May 2004 downgrade. In March 2005, without cost to or concessions by us, this customer waived all of its remaining recapture rights with respect to the May 2004 downgrade by Moody’s. The other customer with recapture rights as a result of the May 2004 downgrade agreed, without cost to or concessions by us, to waive its recapture rights. There are no remaining recapture rights with respect to the May 2004 Moody’s downgrade of Radian Reinsurance. The combined company is now rated Aa3 (with a stable outlook) by Moody’s, AA (with a negative outlook) by Standard and Poor’s Insurance Rating Service (“S&P”) and AA (with a negative outlook) by Fitch.

In October 2002, S&P downgraded the insurer financial strength rating of Radian Reinsurance from AAA to AA. As a result of this downgrade, effective January 31, 2004, one of the primary insurer customers of our financial guaranty reinsurance business exercised its right to recapture approximately $16.4 billion of par in force ceded to our financial guaranty reinsurance business.

Without cost to or concessions by us, the remaining primary insurer customers with recapture rights agreed not to exercise those rights with respect to the October 2002 downgrade by S&P. None of the primary insurer customers of our financial guaranty reinsurance business have any remaining recapture rights as a result of the October 2002 S&P downgrade of Radian Reinsurance.

 

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Through RAAL, we have additional opportunities to write financial guaranty insurance in the U.K. and, subject to compliance with the European passporting rules, in other countries in the European Union. In particular, we expect that RAAL will continue to build its structured finance products business in the U.K. and throughout the European Union. RAAL accounted for $2.0 million of direct premiums written in the first quarter of 2006 (or 6.4% of financial guaranty’s total direct premiums written in the first quarter of 2006), which is a $1.8 million increase from the $0.2 million of direct premiums written in the first quarter of 2005 (or 0.7% of financial guaranty’s total direct premiums written in the first quarter of 2005).

In September 2004, the Financial Services Authority (the “FSA”) authorized Radian Financial Products Limited (“RFPL”), a subsidiary of Radian Asset Assurance, to transact as a Category A Securities and Futures Firm permitting it to act as a principal on credit default swap risk. In the latter half of 2005, we decided that RFPL should re-focus on arranging non-U.S. credit default swap risk for RAAL, Radian Asset Assurance and other affiliates authorized to insure such risk. As a result, we are in the process of repositioning RFPL with a view to seeking a lower category of authorization commensurate with this more limited purpose.

Financial Services

The financial services segment includes the credit-based businesses conducted through our affiliates, C-BASS and Sherman Financial Services Group LLC (“Sherman”). We own a 46% interest in C-BASS and a 34.58% interest in Sherman. C-BASS is a mortgage investment and servicing firm specializing in non-prime, single-family residential mortgage assets and residential mortgage-backed securities. By using sophisticated analytics, C-BASS essentially seeks to take advantage of what it believes to be the mispricing of credit risk for certain of these assets in the marketplace. Sherman is a consumer asset and servicing firm specializing in charged-off and bankruptcy plan consumer assets and charged-off high LTV mortgage receivables that it generally purchases at deep discounts from national financial institutions and major retail corporations and subsequently collects upon these receivables. In March 2005, Sherman acquired CreditOne, a credit card bank that provides Sherman with the ability to originate subprime credit card receivables.

On June 24, 2005, we entered into agreements to restructure our ownership interest in Sherman. Before the restructuring, Sherman was owned 41.5% by us, 41.5% by Mortgage Guaranty Insurance Corporation (“MGIC”) and 17% by an entity controlled by Sherman’s management team. As part of the restructuring, we and MGIC each agreed to sell a 6.92% interest in Sherman to a new entity controlled by Sherman’s management team, thereby reducing our ownership interest and MGIC’s ownership interest to 34.58% for each of us. In return, the new entity controlled by Sherman’s management team paid approximately $15.65 million (which resulted in a $3.3 million loss) to us and the same amount to MGIC. Regulatory approval for this transaction was received in August 2005, retroactive to May 1, 2005. Effective June 15, 2005, Sherman’s employees were transferred to the new entity controlled by Sherman’s management team, and this entity agreed to provide management services to Sherman. Sherman’s management team also agreed to reduce significantly its maximum incentive payout under its annual incentive plan for periods beginning on or after May 1, 2005. This has resulted in Sherman’s net income now being greater than it would have been without a reduction in the maximum incentive payout. Following the restructuring, we expect that our and MGIC’s share of Sherman’s net income will continue to be similar to our respective shares before the restructuring because, although our percentage interest in Sherman is now smaller than it was before the restructuring, Sherman’s net income is greater than it would have been if the restructuring had not occurred.

In connection with the restructuring, we and MGIC each also paid $1 million for each of us to have the right to purchase, on July 7, 2006, a 6.92% interest in Sherman from the new entity controlled by Sherman’s management team for a price intended to approximate current fair market value. If either we or MGIC exercise our purchase right but the other fails to exercise its purchase right, the exercising party also may exercise the purchase right of the non-exercising party. Our and MGIC’s representation on Sherman’s board of managers would not change regardless of which party or parties exercise the purchase right.

 

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Results of Operations—Consolidated

Three Months Ended March 31, 2006 Compared to Three Months Ended March 31, 2005

The following table summarizes our consolidated results of operations for the quarters ended March 31, 2006 and 2005 (in thousands):

 

     Three Months Ended
March 31
    % Change  
     2006    2005     2006 vs. 2005  

Net income

   $ 163,698    $ 115,612     41.6 %

Net premiums written

     279,605      214,840     30.1  

Net premiums earned

     253,697      247,025     2.7  

Net investment income

     54,260      50,862     6.7  

Net gains on securities

     22,854      11,526     98.2  

Change in fair value of derivative instruments

     17,630      (8,960 )   n/m  

Other income

     5,211      6,108     (14.7 )

Provision for losses

     78,634      109,500     (28.2 )

Policy acquisition costs and other operating expenses

     87,641      81,026     8.2  

Interest expense

     11,840      8,958     32.2  

Equity in net income of affiliates

     58,340      51,296     13.7  

Provision for income taxes

     70,179      42,761     64.1  

n/m- not meaningful

Net Income.    Net income for the first quarter of 2006 was $163.7 million or $1.96 per share (diluted), compared to $115.6 million or $1.24 per share (diluted) for the first quarter of 2005. Diluted net income per share for 2005 reflects the inclusion of 3.8 million shares underlying our contingently convertible debt, which we redeemed in its entirety on August 1, 2005. Including these shares in the calculation resulted in a reduction in diluted net income per share of $0.04 for the first quarter of 2005. The results for the first quarter of 2005 also reflect an immediate reduction in net income of $4.1 million or $0.04 per share related to the 2005 recapture. The increase in net income for 2006 was primarily due to an increase in net gains on securities, an increase in change in fair value of derivative instruments, a decrease in the provision for losses and higher equity in net income of affiliates, partially offset by an increase in other operating expenses and interest expense.

Net Premiums Written and Earned.    Consolidated net premiums written for the first quarter of 2006 were $279.6 million, a $64.8 million or 30.1% increase from $214.8 million written in the first quarter of 2005. Consolidated net premiums earned of $253.7 million for the first quarter of 2006 were up slightly from $247.0 million earned in the first quarter of 2005. The amount of net premiums written reported in the first quarter of 2005 reflects a reduction of $54.7 million in financial guaranty written premiums related to the 2005 recapture, which also reduced earned premiums by $4.5 million. Our mortgage insurance business experienced an increase in structured transactions written during the first quarter of 2006, for which premium rates fluctuate significantly depending upon the coverage type and structure. Our financial guaranty business experienced an increase in premiums written and earned in structured finance products, which was offset by a lower level of trade credit reinsurance written, a decrease in insurance written on public finance products and decreased reinsurance.

Net Investment Income.    Net investment income increased to $54.3 million for the first quarter of 2006 from $50.9 million in the first quarter of 2005. This increase was mainly due to an increase in the yield on bonds in our investment portfolio as a result of a net increase in average investable funds and higher interest rates, partially offset by a liquidation of investments in the portfolio to fund the repurchase of 1.0 million shares of our common stock at a purchase price of $60.2 million.

Net Gains on Securities and Change in Fair Value of Derivative Instruments.    Net gains on securities in the first quarter of 2006 were $22.8 million (pre-tax), compared to $11.5 million (pre-tax) for the first quarter of 2005.

 

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This increase was mainly due to the $21.4 million pre-tax gain as a result of the sale of our remaining interest in Primus Guaranty, Ltd. (“Primus”). For the quarter ended March 31, 2006, the change in fair value of derivative instruments was a net gain of $17.6 million (pre-tax), compared to a net loss of $9.0 million (pre-tax) for the quarter ended March 31, 2005. This increase was mainly a result of positive performance in the equity market and further tightening of credit spreads, which increased the fair value of derivatives in the financial guaranty segment. Offsetting this increase is a $17.2 million charge related to a financial guaranty contract terminated in March 2006. See “Results of Operations—Financial Guaranty—Three Months Ended March 31, 2006 Compared to Three Months Ended March 31, 2005—Provision for Losses.”

Other Income.    Other income decreased to $5.2 million in the first quarter of 2006 from $6.1 million for the first quarter of 2005, mainly due to a lower level of income from contract underwriting.

Provision for Losses.    The provision for losses for the first quarter of 2006 was $78.6 million, a decrease of $30.9 million or 28.2% from the $109.5 million reported for the first quarter of 2005. Our mortgage insurance business experienced a decrease in claims paid and required reserves for defaults during the first quarter of 2006. Our financial guaranty business experienced a lower level of incurred losses due to a lower level of trade credit reinsurance business.

Policy Acquisition Costs and Other Operating Expenses.    Policy acquisition costs were $27.4 million in the first quarter of 2006, a decrease of $2.0 million or 6.8% from the $29.4 million reported for the first quarter of 2005. The decrease in 2006 reflects the impact of the $5.1 million acceleration of deferred policy acquisition cost amortization in the mortgage segment in 2005 and the $11.6 million acceleration in 2004, which decreased the balance of the asset to be amortized. The amortization of policy acquisition costs in 2006 includes $2.4 million related to the termination of one derivative financial guaranty contract. The policy acquisition costs for this one policy were deferred prior to our adoption of the policy of expensing policy acquisition costs associated with originating derivative financial guaranty products. The amortization of policy acquisition costs reported in the first quarter of 2005 reflects an increase of $1.7 million related to the 2005 recapture. Other operating expenses were $60.3 million in the first quarter of 2006 compared to $51.7 million for the first quarter of 2005. The 2006 amount includes $1.6 million related to the implementation of Statement of Financial Accounting Standards No. 123R (“SFAS No. 123R”). Other increases were noted in employee costs, office equipment depreciation and software depreciation.

Interest Expense.    Interest expense of $11.8 million in the first quarter of 2006 increased $2.8 million or 32% from $9.0 million in the first quarter of 2005, mainly due to an increase in long-term debt at higher interest rates and a lower positive impact from interest rate swaps that we entered into in 2004. The interest rate swaps effectively convert the interest rate on our 5.625% Senior Notes due 2013 to a variable rate based on a spread over the London Interbank Offered Rate (“LIBOR”). In 2005, we redeemed $220 million of convertible long-term debt with an interest rate of 2.25% and replaced it with $250 million of long-term debt with an interest rate of 5.375%.

Equity in Net Income of Affiliates.    Equity in net income of affiliates increased to $58.3 million in the first quarter of 2006, up 13.7% from $51.3 million in the first quarter of 2005. This resulted from continued strong earnings at C-BASS and Sherman. See “Results of Operations—Financial Services” below.

Provision for Income Taxes.    The consolidated effective tax rate was 30.0% for the first quarter of 2006, compared to 27.0% for the first quarter of 2005, mainly reflecting an increase in operating income compared to income generated from tax-advantaged securities.

Insurance in Force/Net Debt Service Outstanding.    Insurance in force for our primary mortgage insurance business increased to $113.9 billion at March 31, 2006 from $110.1 billion at March 31, 2005. Total net debt service outstanding (par plus interest) on transactions insured by our financial guaranty business was $117.9 billion at March 31, 2006, compared to $94.6 billion at March 31, 2005.

 

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Results of Operations—Mortgage Insurance

Three Months Ended March 31, 2006 Compared to Three Months Ended March 31, 2005

Home purchase transactions have remained at strong levels, and although the mortgage insurance industry did not fully benefit from this in 2005 due to a loss of business to alternative mortgage executions that exclude mortgage insurance, we are optimistic that increases in interest rates and other factors will lead to a cyclical recovery of business for the mortgage insurance industry in 2006. Refinance activity, which often results in the elimination of the need for mortgage insurance on the refinanced loan, remained high during the first quarter of 2006, which reduced the overall percentage of loans requiring mortgage insurance. Positively, there is a continued increase in demand for structured transactions and non-traditional products. Primary new insurance written by our mortgage insurance business during the first quarter of 2006 was $12.8 billion, a $6.8 billion or 113.3% increase from $6.0 billion written in the first quarter of 2005. For the first quarter of 2006, our mortgage insurance business wrote $5.2 billion in flow business and $7.6 billion in structured transactions, compared to $5.6 billion in flow business and $0.4 billion in structured transactions for the first quarter of 2005. Also in the first quarter of 2006, our mortgage insurance business wrote $61 million of pool risk compared to $56 million in the first quarter of 2005.

Our participation in structured transactions is likely to vary significantly from period to period because we compete with other mortgage insurers, as well as capital market executions, for these transactions. However, the overall level is expected to rise over time. In the first quarter of 2006, other risk written decreased to $0.3 billion compared to $0.6 billion in the first quarter of 2005. Most of the risk written in the first quarter of 2006 was second-lien insurance. Included in the approximate $0.6 billion of other risk written in the first quarter of 2005 is $0.5 billion of risk written related to a single transaction that is an AAA wrap on a large portfolio.

The highest state concentration of risk in force at March 31, 2006 was Florida at 9.5%, compared to 9.4% at March 31, 2005. However, California still had the highest state concentration of total direct primary and pool insurance in force at March 31, 2006. The percentage of risk in California has been falling due to a high cancellation rate as compared to new business written. At March 31, 2006, California accounted for 10.7% of the mortgage insurance segment’s total direct primary insurance in force, compared to 10.9% at March 31, 2005, and 11.6% of the mortgage insurance segment’s total direct pool risk in force at March 31, 2006, compared to 12.2% at March 31, 2005. California accounted for 16.8% of the mortgage insurance segment’s direct primary new insurance written in the first quarter of 2006, compared to 8.0% in the first quarter of 2005.

Despite the higher interest rate environment in the first quarter of 2006, refinancing activity continued at a high level. Refinancing activity, as a percentage of our primary new insurance written, was 39% for the first quarter of 2006, compared to 37% for the first quarter of 2005. The persistency rate, which is defined as the percentage of insurance in force that remains on our books after any 12-month period, was 58.6% for the twelve months ended March 31, 2006, compared to 58.4% for the twelve months ended March 31, 2005. However, persistency during the first quarter of 2006 increased as interest rates rose. We expect persistency rates to continue to slowly rise throughout the remainder of 2006, influenced by relatively stable or slowly rising interest rates.

In addition to insuring prime mortgages, we also insure non-prime mortgages, including mainly Alt-A and A minus loans. Alt-A borrowers generally have a similar credit profile to the borrowers under the prime loans that we insure, with FICO credit scores of 620 and higher, but Alt-A loans are underwritten with reduced documentation and verification of information. We consider Alt-A business to be riskier than prime business because of the reduction or elimination of documentation supporting the loans. Alt-A loans also tend to have higher balances than other loans that we insure. We typically charge a higher premium rate for Alt-A business, particularly Alt-A loans to borrowers with FICO credit scores below 660, and we have measures in place to limit our exposure to these lower-FICO Alt-A loans. We previously had disclosed our intent to reduce our insurance in force for lower FICO Alt-A business and we have done so, but we continually re-evaluate this decision and will only increase our participation in this business if we believe we can do so at acceptable levels of risk and return.

 

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The A minus loans that we insure typically have non-traditional credit standards that are less stringent than standard credit guidelines and include loans to borrowers with FICO scores ranging from 575 to 619. We receive a significantly higher premium for insuring A minus loans, and we use Smart Home reinsurance to protect against catastrophic risk on some of this business.

During the first quarter of 2006, non-prime business accounted for $6.8 billion or 52.9% of new primary insurance written by our mortgage insurance business, compared to $1.8 billion or 29.1% for the first quarter of 2005. Of the $6.8 billion of non-prime business written for the first quarter of 2006, $5.0 billion or 73.5% was Alt-A. The relatively high amount of non-prime business is a result of the high level of structured business written in the first quarter of 2006, which tends to be more concentrated in non-prime loans.

Direct primary insurance in force was $113.9 billion at March 31, 2006, compared to $109.7 billion at December 31, 2005 and $110.1 billion at March 31, 2005. At March 31, 2006 non-prime insurance in force was $37.8 billion or 33.2% of total primary mortgage insurance in force, compared to $33.1 billion or 30.0% at March 31, 2005. Of the $37.8 billion of non-prime insurance in force at March 31, 2006, $23.8 billion or 63.0% was Alt-A. We anticipate that the mix of non-prime mortgage insurance business and non-traditional insurance products could continue to fluctuate as a result of structural changes, competitive pricing differentials and competitive products in the mortgage lending and mortgage insurance business.

Pool risk in force was $2.8 billion at March 31, 2006, compared to $2.7 billion at December 31, 2005. In 2006, we wrote a significant amount of pool risk where we are in a second-loss position, and will therefore only pay claims if pool losses are greater than any applicable deductible or stop-loss.

Other risk in force was $9.9 billion at March 31, 2006, compared to $9.7 billion at December 31, 2005 and $1.7 billion at March 31, 2005. Other risk in force at March 31, 2006 included a higher level of second-lien mortgage insurance and an increase in net interest margin securities (“NIMs”). Other risk in force at March 31, 2006 and December 31, 2005, included two large international mortgage securitizations comprising a total of $7.6 billion and $7.5 billion of risk, respectively, in which we provided credit enhancement at a AAA level in credit default swap form. Also included in other risk in force at March 31, 2006, was a single structured transaction that is a AAA wrap that was done in credit default swap form. Because of the remote nature of the risk associated with these transactions, premiums are low as a percentage of exposure.

The default and claim cycle in the mortgage insurance business begins with our receipt of a default notice from the insured. Generally, our master policy of insurance requires the insured to notify us of a default within 15 days after the loan has become 60 days past due. The total number of loans in default decreased from 57,088 at December 31, 2005 to 56,853 at March 31, 2006. The average loss reserve per default decreased from $10,444 at the end of 2005 to $10,327 at March 31, 2006. The number of loans in default at March 31, 2006 included 5,044 defaults related to Hurricanes Katrina and Rita as compared to 6,208 defaults at December 31, 2005. As discussed above, it is too early to tell how many claims we may ultimately have to pay on these defaults. Primary and pool defaults also included approximately 439 and 9,019 defaults, respectively, on loans where reserves have not been established because no claim payment is currently anticipated. Excluding those defaults without a related reserve, the average loss reserve per default was $12,388 for the first quarter of 2006. The loss reserve as a percentage of risk in force was 1.5% at March 31, 2006, compared to 1.6% at December 31, 2005. We do not establish reserves on our derivative financial guaranty products.

The non-prime mortgage insurance business experienced an increase in the number of defaults in the first quarter of 2006 from the first quarter of 2005, but defaults are down from December 31, 2005. Although the default rate on this business is higher than on prime business, higher premium rates charged for non-prime business are expected to compensate for the increased level of expected losses associated with this business. However, we cannot be certain that the increased premiums charged on non-prime business will compensate for the ultimate losses on this business.

 

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The number of non-prime loans in default at March 31, 2006 was 21,651, which represented 55% of the total primary loans in default, compared to 23,525 non-prime loans in default at December 31, 2005, which represented 53% of the total primary loans in default. The default rate on the Alt-A business was 5.4% at March 31, 2006, compared to 6.4% at December 31, 2005. The default rate on the A minus and below loans was 14.1% at March 31, 2006, compared to 15.8% at December 31, 2005. The default rate on the prime business was 3.1% at March 31, 2006, compared to 3.6% at December 31, 2005. The combined default rate on non-prime business decreased 139 basis points to 9.3% at March 31, 2006 from 10.7% at December 31, 2005, with the default rate on the prime business down 56 basis points from December 31, 2005. A strong economy, particularly employment and housing, generally results in lower default rates and a decrease in the overall level of losses. A weakening of the economy could negatively impact our overall default rates, which would result in an increase in the provision for losses.

Claim activity is not spread evenly throughout the coverage period of a book of business. Relatively few claims on prime business are received during the first two years following issuance of a policy and on non-prime business during the first year. Historically, claim activity on prime loans has reached its highest level in the third through fifth years after the year of policy origination, and on non-prime loans this level is expected to be reached in the second through fourth years. Approximately 73.3% of the primary risk in force and approximately 34.0% of the pool risk in force at March 31, 2006 had not yet reached its highest claim frequency years. Because it is difficult to predict both the timing of originating new business and the cancellation rate of existing business, it also is difficult to predict, at any given time, the percentage of risk in force that will reach its highest claim frequency years on any future date. The combined default rate for both primary and pool insurance, excluding second-lien insurance coverage, was 3.8% at March 31, 2006 and at December 31, 2005, compared to 3.2% at March 31, 2005, while the default rate on the primary business was 4.9% at March 31, 2006, compared to 5.6% at December 31, 2005 and 4.7% at March 31, 2005.

Direct claims paid for the quarter ended March 31, 2006 were $79.8 million down from $85.7 million for the first quarter of 2005. The average claim paid has fluctuated over the past few years mostly due to deeper coverage amounts and larger loan balances. In addition, change in real estate values may also affect the amount of the average claim paid. Alt-A loans have a higher average claim payment due to higher loan balances and greater coverage percentages. Claims paid on second-lien mortgages decreased for the three months ended March 31, 2006 compared to the three months ended March 31, 2005 as a result of an increase in recoveries, partially offset by the increase in the volume of second-lien business written over the past few years on which we have begun paying claims. For the majority of risk written on second-lien business in the first quarter of 2006, we are in a second loss position. In reviewing our claims inventory, we expect that paid claims will increase modestly in 2006 with the largest increase occurring towards the end of the year.

A disproportionately higher incidence of claims in Georgia is directly related to what our risk management department believes to be questionable property value estimates in that state. Several years ago, our risk management department put into place several property valuation checks and balances to mitigate the risk of this issue recurring, and now applies these same techniques to all mortgage insurance transactions. We expect this higher incidence of claims in Georgia to continue until loans originated in Georgia before the implementation of these preventive measures become sufficiently seasoned. A higher level of claim incidence in Texas resulted, in part, from unemployment levels that were higher than the national average and from lower home price appreciation. We believe that claims in the Midwest and Southeast have been rising and will continue to rise due to the weak industrial sector of the economy. We also believe that increased claims in Michigan and North Carolina are a result of declining economic conditions in those areas, and that in Colorado, increased claims are a result of a significant decline in property values in that area.

 

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The following table summarizes our mortgage insurance segment’s results of operations for the quarters ended March 31, 2006 and 2005 (in thousands):

 

    

Three Months Ended

March 31

   % Change  
     2006    2005    2006 vs. 2005  

Net income

   $ 88,144    $ 62,721    40.5 %

Net premiums written

     223,766      200,237    11.8  

Net premiums earned

     202,706      192,465    5.3  

Net investment income

     31,665      28,793    10.0  

Net gains on securities

     13,577      7,119    90.7  

Change in fair value of derivative instruments

     9,121      3,186    n/m  

Other income

     3,634      4,592    (20.9 )

Provision for losses

     71,097      97,927    (27.4 )

Policy acquisition costs and other operating expenses

     57,612      48,347    19.2  

Interest expense

     6,701      5,124    30.8  

Provision for income taxes

     37,149      22,036    68.5  

n/m = not meaningful

Net Income.    Our mortgage insurance segment’s net income for the first quarter of 2006 was $88.1 million, an increase of $25.4 million or 40.5% compared to $62.7 million for the first quarter of 2005. This increase was primarily due to a decrease in the provision for losses and increases in net gains on securities and change in fair value of derivative instruments, partially offset by increases in operating expenses and interest expense.

Net Premiums Written and Earned.    Net premiums written for the first quarter of 2006 were $223.8 million, a $23.6 million or 11.8% increase from $200.2 million for the comparable period of 2005. Net premiums earned for the first quarter of 2006 were $202.7 million, a $10.2 million or 5.3% increase compared to $192.5 million for the first quarter of 2005. Net premiums earned reflect an increase of $6.7 million in premiums earned from non-traditional products such as second-lien mortgages, NIMs and international business. Premiums earned from non-traditional products were $29.5 million in the first quarter of 2006, compared to $22.8 million in the first quarter of 2005. Earned premiums also increased as a result of a $3.5 million increase in premiums earned from the primary insurance business as a result of a change in the product mix to higher premium rate products. Premiums earned will fluctuate as the mix of premiums written changes. For the first quarter of 2006, the mix included a higher percentage of structured business, in which premium rates fluctuate greatly from very low rates on business with deductibles to very high rates for coverage on non-prime loans. We expect that the increases in primary insurance in force and other risk in force from non-traditional products will lead to modest increases in earned premiums over the balance of 2006.

Net Investment Income.    Net investment income attributable to our mortgage insurance business in the first quarter of 2006 was $31.7 million, an increase of $2.8 million or 10.0%, compared to $28.8 million in the first quarter of 2005. Investment income in the first quarter of 2006 reflects an increase in interest income on bonds due to higher overall interest rates.

Net Gains on Securities and Change in Fair Value of Derivative Instruments.    Net gains on securities in our mortgage insurance business were $13.6 million for the first quarter of 2006, compared to $7.1 million for the first quarter of 2005. Included in the first quarter of 2006 is an allocation of net gains on securities to the mortgage insurance segment, most of which came from the sale of our remaining interest in Primus. The change in the fair value of derivatives was a gain of $9.1 million for the first quarter of 2006, compared to a gain of $3.2 million for the first quarter in 2005, mainly due to changes in the fair value of embedded options in convertible securities held in the investment portfolio due to market conditions.

 

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Other Income.    Other income for the first quarter of 2006 was $3.6 million, a $0.9 million or 20.9% decrease from $4.6 million in the first quarter of 2005. Other income mostly includes income related to contract underwriting services, which was lower in the first quarter of 2006.

Provision for Losses.    The provision for losses for the first quarter of 2006 was $71.1 million, a $26.8 million or 27.4% decrease from $97.9 million for the first quarter of 2005. Our mortgage insurance business experienced a significant decrease in claims paid in the first quarter of 2006 and a substantial decline in primary delinquencies at March 31, 2006, compared to December 31, 2005, some of which we attribute to seasonality. Although primary delinquencies declined 11.4% from December 31, 2005, the remaining delinquencies are now closer to a foreclosure event, and therefore, require a greater loss reserve per default.

Policy Acquisition Costs and Other Operating Expenses.    Policy acquisition costs represent the amortization of expenses that relate directly to the acquisition of new business. The amortization of these expenses is related to the recognition of gross profits over the life of the policies and is influenced by such factors as persistency and estimated loss rates. Policy acquisition costs were $13.3 million for the first quarter of 2006, compared to $14.7 million for the first quarter of 2005. This decrease was mainly the result of the acceleration of the amortization of policy acquisition costs in 2005. This acceleration related to prior years’ books of business that had canceled more quickly than anticipated due to repayments and pay-offs of the underlying mortgages and resulted in a reduction in the base asset.

Other operating expenses consist mostly of contract underwriting expenses, overhead and administrative costs, some of which are allocated to our various business segments. Other operating expenses were $44.3 million for the first quarter of 2006, an increase of $10.6 million or 31.5% compared to $33.6 million for the first quarter of 2005. For the first quarter of 2006, other operating expenses included significant increases in software depreciation as well as increases in office equipment depreciation and employee costs. Contract underwriting expenses for the quarters ended March 31, 2006 and 2005, including the impact of reserves for remedies included in other operating expenses, were $6.7 million and $7.6 million, respectively.

Interest Expense.    Interest expense attributable to our mortgage insurance business for the first quarter of 2006 was $6.7 million compared to $5.1 million for the first quarter of 2005. Both periods include interest on our long-term debt that was allocated to the mortgage insurance segment as well as the impact of interest-rate swaps.

Provision for Income Taxes.    The effective tax rate for the first quarter of 2006 was 29.6% compared to 26.0% in the first quarter of 2005. The difference between the effective tax rate and the statutory rate of 35% reflects our significant investment in tax-advantaged securities. The increase in the rate for 2006 is due to a larger proportion of income from operations as compared to investment income.

The following tables provide selected information as of and for the periods indicated for our mortgage insurance segment:

 

     Three Months Ended
($ in thousands, unless specified otherwise)   

March 31

2006

  

December 31

2005

  

March 31

2005

Provision for losses

   $ 71,097    $ 99,413    $ 97,927

Reserve for losses

   $ 587,114    $ 596,210    $ 571,128

Reserves for losses by category:

        

Prime

   $ 181,001    $ 179,152    $ 164,847

Alt-A

     135,336      137,430      161,102

A minus and below

     195,246      190,312      150,802

Pool insurance

     36,199      44,135      42,800

Seconds

     30,144      35,876      45,611

Other

     9,188      9,305      5,966
                    

Total

   $ 587,114    $ 596,210    $ 571,128
                    

 

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Certain statistical information included in the following tables is recorded based on information received from lenders and other third-parties.

 

     Three Months Ended  
    

March 31

2006

   

December 31

2005

   

March 31

2005

 

Default Statistics

      

Primary Insurance:

      

Flow

      

Prime

      

Number of insured loans

   501,632     508,117     540,847  

Number of loans in default

   15,117     18,045     15,816  

Percentage of total loans in default

   3.01 %   3.55 %   2.92 %

Alt-A

      

Number of insured loans

   64,555     67,339     78,682  

Number of loans in default

   4,468     4,946     5,453  

Percentage of total loans in default

   6.92 %   7.34 %   6.93 %

A minus and below

      

Number of insured loans

   52,700     54,066     57,637  

Number of loans in default

   6,833     7,543     6,342  

Percentage of total loans in default

   12.97 %   13.95 %   11.00 %

Total Flow

      

Number of insured loans

   618,887     629,522     677,166  

Number of loans in default

   26,418     30,534     27,611  

Percentage of total loans in default

   4.27 %   4.85 %   4.08 %

Structured

      

Prime

      

Number of insured loans

   67,353     59,457     51,125  

Number of loans in default

   2,414     2,640     1,934  

Percentage of total loans in default

   3.58 %   4.44 %   3.78 %

Alt-A

      

Number of insured loans

   63,800     50,997     40,326  

Number of loans in default

   2,491     2,564     2,373  

Percentage of total loans in default

   3.90 %   5.03 %   5.88 %

A minus and below

      

Number of insured loans

   51,277     47,348     41,269  

Number of loans in default

   7,859     8,472     6,149  

Percentage of total loans in default

   15.33 %   17.89 %   14.90 %

 

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Table of Contents
     Three Months Ended  
($ in thousands, unless specified otherwise)   

March 31

2006

   

December 31

2005

   

March 31

2005

 

Total Structured

      

Number of insured loans

     182,430       157,802       132,720  

Number of loans in default

     12,764       13,676       10,456  

Percentage of total loans in default

     7.00 %     8.67 %     7.88 %

Total Primary Insurance

      

Prime

      

Number of insured loans

     568,985       567,574       591,972  

Number of loans in default

     17,531       20,685       17,750  

Percentage of total loans in default

     3.08 %     3.64 %     3.00 %

Alt-A

      

Number of insured loans

     128,355       118,336       119,008  

Number of loans in default

     6,959       7,510       7,826  

Percentage of total loans in default

     5.42 %     6.35 %     6.58 %

A minus and below

      

Number of insured loans

     103,977       101,414       98,906  

Number of loans in default

     14,692       16,015       12,491  

Percentage of loans in default

     14.13 %     15.79 %     12.63 %

Total Primary

      

Number of insured loans

     801,317       787,324       809,886  

Number of loans in default

     39,182 (1)     44,210 (1)     38,067  

Percentage of loans in default

     4.89 %     5.62 %     4.70 %

Direct claims paid:

      

Prime

   $ 29,965     $ 33,156     $ 31,871  

Alt-A

     18,707       19,968       22,332  

A minus and below

     23,263       23,762       20,884  

Seconds

     7,865       7,044       10,607  
                        

Total

   $ 79,800     $ 83,930     $ 85,694  
                        

Average claim paid:

      

Prime

   $ 26.8     $ 25.7     $ 24.5  

Alt-A

     40.2       38.4       37.0  

A minus and below

     29.0       28.1       26.4  

Seconds

     22.8       20.5       25.3  

Total

   $ 29.2     $ 28.0     $ 27.5  

(1) Includes approximately 439 and 452 defaults at March 31, 2006 and December 31, 2005, respectively, where reserves have not been established because no claim payment is currently anticipated.

 

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Table of Contents
     Three Months Ended  
($ in thousands, unless specified otherwise)   

March 31

2006

   

December 31

2005

   

March 31

2005

 

States with highest claims paid:

      

Texas

   $ 8,124     $ 9,041     $ 8,667  

Ohio

     7,783       7,088       6,253  

Georgia

     7,133       8,561       7,808  

Michigan

     7,033       6,348       4,738  

Colorado

     5,447       5,812       5,395  

Percentage of total claims paid:

      

Texas

     10.2 %     10.8 %     10.1 %

Ohio

     9.7       8.4       7.3  

Georgia

     8.9       10.2       9.1  

Michigan

     8.8       7.6       5.5  

Colorado

     6.8       6.9       6.3  

Risk in force: ($ in millions)

      

Florida

   $ 2,470     $ 2,437     $ 2,432  

California

     2,418       2,408       2,768  

Texas

     1,602       1,558       1,494  

New York

     1,439       1,433       1,524  

Georgia

     1,235       1,226       1,233  

Total risk in force:

   $ 26,076     $ 25,729     $ 25,863  

Percentage of total risk in force:

      

Florida

     9.5 %     9.5 %     9.4 %

California

     9.3       9.4       10.7  

Texas

     6.1       6.1       5.8  

New York

     5.5       5.7       5.9  

Georgia

     4.7       4.8       4.8  

 

     Three Months Ended  
    

March 31

2006

   

December 31

2005

   

March 31

2005

 

Primary new insurance written (“NIW”)
($ in millions)

               

Flow

   $ 5,234    40.9 %   $ 6,740    61.7 %   $ 5,662    93.7 %

Structured

     7,569    59.1       4,188    38.3       382    6.3  
                                       

Total Primary

   $ 12,803    100.0 %   $ 10,928    100.0 %   $ 6,044    100.0 %
                                       

Flow

               

Prime

   $ 3,771    72.1 %   $ 5,025    74.6 %   $ 4,155    73.4 %

Alt-A

     1,105    21.1       1,159    17.2       944    16.7  

A minus and below

     358    6.8       556    8.2       563    9.9  
                                       

Total Flow

   $ 5,234    100.0 %   $ 6,740    100.0 %   $ 5,662    100.0 %
                                       

Structured

               

Prime

   $ 2,264    29.9 %   $ 1,676    40.0 %   $ 128    33.5 %

Alt-A

     3,917    51.8       1,707    40.8       199    52.1  

A minus and below

     1,388    18.3       805    19.2       55    14.4  
                                       

Total Structured

   $ 7,569    100.0 %   $ 4,188    100.0 %   $ 382    100.0 %
                                       

Total

               

Prime

   $ 6,035    47.2 %   $ 6,701    61.3 %   $ 4,283    70.9 %

Alt-A

     5,022    39.2       2,866    26.2       1,143    18.9  

A minus and below

     1,746    13.6       1,361    12.5       618    10.2  
                                       

Total Primary

   $ 12,803    100.0 %   $ 10,928    100.0 %   $ 6,044    100.0 %
                                       

 

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Table of Contents
     Three Months Ended  
     March 31
2006
    December 31
2005
    March 31
2005
 

Total Primary New Insurance Written by FICO (a) Score ($ in millions)

            

Flow

            

<=619

   $ 278     5.3 %   $ 327     4.8 %   $ 387     6.8 %

620-679

     1,547     29.6       2,000     29.7       1,782     31.5  

680-739

     1,991     38.0       2,505     37.2       2,043     36.1  

>=740

     1,418     27.1       1,908     28.3       1,450     25.6  
                                          

Total Flow

   $ 5,234     100.0 %   $ 6,740     100.0 %   $ 5,662     100.0 %
                                          

Structured

            

<=619

   $ 1,388     18.3 %   $ 808     19.3 %   $ 56     14.7 %

620-679

     2,181     28.8       1,369     32.7       168     44.0  

680-739

     2,505     33.1       1,337     31.9       101     26.4  

>=740

     1,495     19.8       674     16.1       57     14.9  
                                          

Total Structured

   $ 7,569     100.0 %   $ 4,188     100.0 %   $ 382     100.0 %
                                          

Total

            

<=619

   $ 1,666     13.0 %   $ 1,135     10.4 %   $ 443     7.3 %

620-679

     3,728     29.1       3,369     30.8       1,950     32.3  

680-739

     4,496     35.1       3,842     35.2       2,144     35.5  

>=740

     2,913     22.8       2,582     23.6       1,507     24.9  
                                          

Total Primary

   $ 12,803     100.0 %   $ 10,928     100.0 %   $ 6,044     100.0 %
                                          
     Three Months Ended  
     March 31
2006
    December 31
2005
    March 31
2005
 

Percentage of primary new insurance written

            

Monthlies

     85 %       94 %       93 %  

Refinances

     39 %       37 %       37 %  

95.01% LTV (b) and above

     8 %       10 %       14 %  

ARMS

            

Less than 5 years

     41 %       31 %       23 %  

5 years and longer

     19 %       17 %       13 %  

Primary risk written ($ in millions)

            

Flow

   $ 1,329     55.9 %   $ 1,702     70.0 %   $ 1,414     96.0 %

Structured

     1,050     44.1       729     30.0       60     4.0  
                                          

Total

   $ 2,379     100.0 %   $ 2,431     100.0 %   $ 1,474     100.0 %
                                          

Primary insurance in force ($ in millions)

            

Flow

   $ 81,597     71.6 %   $ 82,700     75.4 %   $ 87,308     79.3 %

Structured

     32,316     28.4       26,984     24.6       22,838     20.7  
                                          

Total Primary

   $ 113,913     100.0 %   $ 109,684     100.0 %   $ 110,146     100.0 %
                                          

Prime

   $ 76,141     66.8 %   $ 74,940     68.3 %   $ 77,048     70.0 %

Alt-A

     23,767     20.9       21,223     19.4       20,377     18.5  

A minus and below

     14,005     12.3       13,521     12.3       12,721     11.5  
                                          

Total Primary

   $ 113,913     100.0 %   $ 109,684     100.0 %   $ 110,146     100.0 %
                                          

Primary risk in force ($ in millions)

            

Flow

   $ 20,073     77.0 %   $ 20,330     79.0 %   $ 21,367     82.6 %

Structured

     6,003     23.0       5,399     21.0       4,496     17.4  
                                          

Total Primary

   $ 26,076     100.0 %   $ 25,729     100.0 %   $ 25,863     100.0 %
                                          

 

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Table of Contents
     Three Months Ended  
     March 31
2006
    December 31
2005
    March 31
2005
 

Flow

            

Prime

   $ 15,595     77.7 %   $ 15,630     76.9 %   $ 15,999     74.9 %

Alt-A

     2,948     14.7       3,131     15.4       3,701     17.3  

A minus and below

     1,530     7.6       1,569     7.7       1,667     7.8  
                                          

Total Flow

   $ 20,073     100.0 %   $ 20,330     100.0 %   $ 21,367     100.0 %
                                          

Structured

            

Prime

   $ 2,379     39.6 %   $ 2,208     40.9 %   $ 1,903     42.3 %

Alt-A

     1,623     27.1       1,358     25.1       1,044     23.2  

A minus and below

     2,001     33.3       1,833     34.0       1,549     34.5  
                                          

Total Structured

   $ 6,003     100.0 %   $ 5,399     100.0 %   $ 4,496     100.0 %
                                          

Total

            

Prime

   $ 17,974     68.9 %   $ 17,838     69.3 %   $ 17,902     69.3 %

Alt-A

     4,571     17.5       4,489     17.5       4,745     18.3  

A minus and below

     3,531     13.6       3,402     13.2       3,216     12.4  
                                          

Total Primary

   $ 26,076     100.0 %   $ 25,729     100.0 %   $ 25,863     100.0 %
                                          
     Three Months Ended  
     March 31
2006
    December 31
2005
    March 31
2005
 

Total Primary Risk in Force by FICO Score
($ in millions)

            

Flow

            

<=619

   $ 1,281     6.4 %   $ 1,321     6.5 %   $ 1,492     7.0 %

620-679

     6,224     31.0       6,352     31.2       6,828     31.9  

680-739

     7,383     36.8       7,459     36.7       7,862     36.8  

>=740

     5,185     25.8       5,198     25.6       5,185     24.3  
                                          

Total Flow

   $ 20,073     100.0 %   $ 20,330     100.0 %   $ 21,367     100.0 %
                                          

Structured

            

<=619

   $ 2,002     33.3 %   $ 1,833     34.0 %   $ 1,552     34.5 %

620-679

     2,170     36.2       1,957     36.2       1,610     35.8  

680-739

     1,268     21.1       1,111     20.6       896     19.9  

>=740

     563     9.4       498     9.2       438     9.8  
                                          

Total Structured

   $ 6,003     100.0 %   $ 5,399     100.0 %   $ 4,496     100.0 %
                                          

Total

            

<=619

   $ 3,283     12.6 %   $ 3,154     12.3 %   $ 3,044     11.8 %

620-679

     8,394     32.2       8,309     32.3       8,438     32.7  

680-739

     8,651     33.2       8,570     33.3       8,758     33.8  

>=740

     5,748     22.0       5,696     22.1       5,623     21.7  
                                          

Total Primary

   $ 26,076     100.0 %   $ 25,729     100.0 %   $ 25,863     100.0 %
                                          

Percentage of primary risk in force

            

Monthlies

     90 %       91 %       91 %  

Refinances

     36 %       37 %       37 %  

95.01% LTV and above

     14 %       14 %       13 %  

ARMs

            

Less than 5 years

     24 %       23 %       22 %  

5 years and longer

     9 %       9 %       8 %  

 

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Table of Contents
     Three Months Ended  
     March 31
2006
    December 31
2005
    March 31
2005
 

Total primary risk in force by LTV
($ in millions)

               

95.01% and above

   $ 3,680    14.1 %   $ 3,599    14.0 %   $ 3,416    13.2 %

90.01% to 95.00%

     8,473    32.5       8,616    33.5       9,408    36.4  

85.01% to 90.00%

     9,476    36.3       9,551    37.1       9,872    38.2  

85.00% and below

     4,447    17.1       3,963    15.4       3,167    12.2  
                                       

Total Primary

   $ 26,076    100.0 %   $ 25,729    100.0 %   $ 25,863    100.0 %
                                       

Total primary risk in force by policy year ($ in millions)

               

2002 and prior

   $ 4,275    16.4 %   $ 4,658    18.1 %   $ 6,700    26.0 %

2003

     5,013    19.2       5,511    21.4       8,103    31.3  

2004

     6,407    24.6       7,091    27.6       9,627    37.2  

2005

     8,015    30.7       8,469    32.9       1,433    5.5  

2006

     2,366    9.1       —      —         —      —    
                                       

Total Primary

   $ 26,076    100.0 %   $ 25,729    100.0 %   $ 25,863    100.0 %
                                       

 

     Three Months Ended  
     March 31
2006
    March 31
2005
 

Alt-A Information

          

Primary new insurance written by FICO score ($ in millions)

          

<=619

   $ 6    0.1 %   $ 6    0.5 %

620-659

     709    14.1       143    12.5  

660-679

     634    12.6       199    17.4  

680-739

     2,324    46.3       520    45.5  

>=740

     1,349    26.9       275    24.1  
                          

Total

   $ 5,022    100.0 %   $ 1,143    100.0 %
                          

Primary risk in force by FICO score ($ in millions)

          

<=619

   $ 34    0.7 %   $ 62    1.3 %

620-659

     937    20.5       982    20.7  

660-679

     766    16.8       849    17.9  

680-739

     1,961    42.9       2,004    42.2  

>=740

     873    19.1       848    17.9  
                          

Total

   $ 4,571    100.0 %   $ 4,745    100.0 %
                          

Primary risk in force by LTV ($ in millions)

          

95.01% and above

   $ 161    3.5 %   $ 324    6.8 %

90.01% to 95.00%

     1,360    29.8       1,683    35.5  

85.01% to 90.00%

     1,930    42.2       2,051    43.2  

85.00% and below

     1,120    24.5       687    14.5  
                          

Total

   $ 4,571    100.0 %   $ 4,745    100.0 %
                          

Primary risk in force by policy year ($ in millions)

          

2002 and prior

   $ 448    9.8 %   $ 847    17.8 %

2003

     758    16.6       1,500    31.6  

2004

     1,180    25.8       2,134    45.0  

2005

     1,538    33.6       264    5.6  

2006

     647    14.2       —      —    
                          

Total

   $ 4,571    100.0 %   $ 4,745    100.0 %
                          

 

49


Table of Contents
     Three Months Ended  
     March 31
2006
    December 31
2005
    March 31
2005
 

Pool risk written ($ in millions)

   $ 61       $ 102       $ 56    

Pool risk in force ($ in millions)

            

Prime

   $ 2,098     76.3 %   $ 2,098     77.4 %   $ 1,971     82.7 %

Alt-A

     272     9.9       272     10.0       238     10.0  

A minus and below

     380     13.8       341     12.6       174     7.3  
                                          

Total Pool

   $ 2,750     100.0 %   $ 2,711     100.0 %   $ 2,383     100.0 %
                                          

Pool insurance

            

Number of insured loans

     627,815         651,051         589,934    

Number of loans in default

     15,072 (2)       10,194 (2)       6,249    

Percentage of loans in default

     2.40 %       1.57 %       1.06 %  

Other risk written ($ in millions)

            

Seconds

            

1st loss

   $ 24       $ 40       $ 4    

2nd loss

     132         247         6    

NIMs

     89         33         28    

International

            

1st loss-Hong Kong primary mortgage insurance

     17         27         50    

Reinsurance

     2         2         10    

Credit default swaps

     —           7,303         —      

Other

            

Domestic credit default swaps

     20         30         —      

Financial guaranty wrap

     —           —           511    
                              

Total other risk written

   $ 284       $ 7,682       $ 609    
                              

(2) Includes approximately 9,019 and 3,699 defaults at March 31, 2006 and December 31, 2005, respectively, where reserves have not been established because no claim payment is currently anticipated.

 

50


Table of Contents
     Three Months Ended
     March 31
2006
   December 31
2005
   March 31
2005

Other risk in force (in millions)

        

Seconds

        

1st loss

   $ 594    $ 591    $ 586

2nd loss

     756      638      73

NIMs

     303      261      315

International

        

1st loss-Hong Kong primary mortgage insurance

     288      271      50

Reinsurance

     29      29      28

Credit default swaps

     7,581      7,469      181

Other

        

Domestic credit default swaps

     200      180      —  

Financial guaranty wrap

     205      270      511
                    

Total other risk in force

   $ 9,956    $ 9,709    $ 1,744
                    

Net premiums written (in thousands)

        

Primary and Pool Insurance

   $ 187,971    $ 179,658    $ 176,874

Seconds