Radian Group Inc. Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

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

For the fiscal year ended December 31, 2008

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)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, $.001 par value per share   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  ¨    NO  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    YES  ¨    NO  x

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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

 

Large accelerated filer  ¨   Accelerated filer  x   Non-accelerated filer  ¨   Smaller reporting company  ¨
  (Do not check if a smaller reporting company)

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

State the aggregate market value of the voting and non-voting common equity held by non-affiliates, computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. As of June 30, 2008, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $116,587,797 based on the closing sale price as reported on the New York Stock Exchange. Excluded from this amount is the value of all shares beneficially owned by executive officers and directors of the registrant. These exclusions should not be deemed to constitute a representation or acknowledgement that any such individual is, in fact, an affiliate of the registrant or that there are not other persons or entities who may be deemed to be affiliates of the registrant.

(APPLICABLE ONLY TO CORPORATE REGISTRANTS)

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: 81,420,871 shares of common stock, $.001 par value per share, outstanding on March 4, 2009.

DOCUMENTS INCORPORATED BY REFERENCE

List hereunder the following documents if incorporated by reference and the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is incorporated: (1) Any annual report to security holders; (2) Any proxy or information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933. The listed documents should be clearly described for identification purposes (e.g., annual report to security holders for fiscal year ended December 24, 1980).

 

     Form 10-K Reference Document

Definitive Proxy Statement for the Registrant’s 2009 Annual Meeting of Stockholders

   Part III

(Items 10 through 14)

 

 

 


Table of Contents

TABLE OF CONTENTS

 

               Page
Number
     

Forward Looking Statements—Safe Harbor Provisions

   3

PART I

        
   Item 1   

Business

   5
     

General

   5
     

Mortgage Insurance Business

   5
     

Financial Guaranty Business

   11
     

Financial Services Business

   17
     

Risk in Force/Net Par Outstanding

   18
     

Defaults and Claims

   37
     

Loss Management

   41
     

Risk Management

   46
     

Customers

   50
     

Sales and Marketing

   51
     

Competition

   51
     

Ratings

   52
     

Investment Policy and Portfolio

   54
     

Regulation

   58
     

Employees

   69
   Item 1A   

Risk Factors

   69
   Item 1B   

Unresolved Staff Comments

   91
   Item 2   

Properties

   91
   Item 3   

Legal Proceedings

   92
   Item 4   

Submission of Matters to a Vote of Security Holders

   93

PART II

        
   Item 5   

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   94
   Item 6   

Selected Financial Data

   95
   Item 7   

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

   97
   Item 7A   

Quantitative and Qualitative Disclosures About Market Risk

   166
   Item 8   

Financial Statements and Supplementary Data

   169
   Item 9   

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   261
   Item 9A   

Controls and Procedures

   261
   Item 9B   

Other Information

   262

PART III

        
   Item 10   

Directors, Executive Officers and Corporate Governance

   263
   Item 11   

Executive Compensation

   263
   Item 12   

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   263
   Item 13   

Certain Relationships and Related Transactions, and Director Independence

   263
   Item 14   

Principal Accounting Fees and Services

   263

PART IV

        
   Item 15   

Exhibits and Financial Statement Schedules

   264

SIGNATURES

   265

INDEX TO FINANCIAL STATEMENT SCHEDULES

   266

INDEX TO EXHIBITS

   267

 

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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 “anticipate,” “may,” “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, which include, without limitation, projections regarding our future performance and financial condition are made on the basis of management’s current views and assumptions with respect to future events. Any forward-looking statement is not a guarantee of future performance and actual results could differ materially from those contained in the forward-looking information. 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 a deepening of the existing national economic recession, further decreases in housing demand, mortgage originations or housing values (in particular, further deterioration in the housing, mortgage and related credit markets, which would harm our future consolidated results of operations and could cause losses for our businesses to be worse than expected), a further reduction in the liquidity in the capital markets and further contraction of credit markets, further increases in unemployment rates, changes or volatility in interest rates or consumer confidence, changes in credit spreads, changes in the way investors perceive the strength of private mortgage insurers or financial guaranty providers, investor concern over the credit quality and specific risks faced by the particular businesses, municipalities or pools of assets covered by our insurance;

 

   

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

 

   

our ability to successfully execute upon our internally sourced capital plan, (which depends, in part, on the performance of our financial guaranty portfolio) and if necessary, to obtain additional capital to support new business writings in our mortgage insurance business and our long-term liquidity needs and to protect our credit ratings and the financial strength ratings of Radian Guaranty Inc., our principal mortgage insurance subsidiary, from further downgrades;

 

   

a further decrease in the volume of home mortgage originations due to reduced liquidity in the lending market, tighter underwriting standards and the on-going deterioration in housing markets throughout the U.S.;

 

   

our ability to maintain adequate risk-to-capital ratios and surplus requirements in our mortgage insurance business in light of on-going losses in this business;

 

   

the concentration of our mortgage insurance business among a relatively small number of large customers;

 

   

disruption in the servicing of mortgages covered by our insurance policies;

 

   

the aging of our mortgage insurance portfolio and changes in severity or frequency of losses associated with certain of our products that are riskier than traditional mortgage insurance or financial guaranty insurance policies;

 

   

the performance of our insured portfolio of higher risk loans, such as Alternative-A (“Alt-A”) and subprime loans, and of adjustable rate products, such as adjustable rate mortgages and interest-only mortgages, which have resulted in increased losses in 2007 and 2008 and are expected to result in further losses;

 

   

reduced opportunities for loss mitigation in markets where housing values fail to appreciate or continue to decline;

 

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changes in persistency rates of our mortgage insurance policies;

 

   

an increase in the risk profile of our existing mortgage insurance portfolio due to mortgage refinancing in the current housing market;

 

   

further downgrades or threatened downgrades of, or other ratings actions with respect to, our credit ratings or the ratings assigned by the major rating agencies to any of our rated insurance subsidiaries at any time (in particular, the credit rating of Radian Group Inc. and the financial strength ratings assigned to Radian Guaranty Inc.);

 

   

heightened competition for our mortgage insurance business from others such as the Federal Housing Administration and the Veterans’ Administration or other private mortgage insurers (in particular those that have been assigned higher ratings from the major rating agencies);

 

   

changes in the charters or business practices of Federal National Mortgage Association (“Fannie Mae”) and Freddie Mac, the largest purchasers of mortgage loans that we insure, and our ability to remain an eligible provider to both Freddie Mac and Fannie Mae;

 

   

the application of existing federal or state consumer, lending, insurance, securities and other applicable laws and regulations, or changes in these laws and regulations or the way they are interpreted; including, without limitation: (i) the outcome of existing investigations or the possibility of private lawsuits or other formal investigations by state insurance departments and state attorneys general alleging that services offered by the mortgage insurance industry, such as captive reinsurance, pool insurance and contract underwriting, are violative of the Real Estate Settlement Procedures Act and/or similar state regulations, (ii) legislative and regulatory changes affecting demand for private mortgage insurance, or (iii) legislation and regulatory changes limiting or restricting our use of (or requirements for) additional capital, the products we may offer, the form in which we may execute the credit protection we provide or the aggregate notional amount of any product we may offer for any one transaction or in the aggregate;

 

   

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 the premium deficiencies for our first- and second-lien mortgage insurance business, or to estimate accurately the fair value amounts of derivative contracts in our mortgage insurance and financial guaranty businesses in determining gains and losses on these contracts;

 

   

volatility in our earnings caused by changes in the fair value of our derivative instruments and our need to reevaluate the premium deficiencies in our mortgage insurance business on a quarterly basis;

 

   

changes in accounting guidance from the Securities and Exchange Commission (“SEC”) or the Financial Accounting Standards Board;

 

   

legal and other limitations on amounts we may receive from our subsidiaries as dividends or through our tax- and expense-sharing arrangements with our subsidiaries; and

 

   

the performance of our investment in Sherman Financial Group LLC.

For more information regarding these risks and uncertainties as well as certain additional risks that we face, you should refer to the Risk Factors detailed in Item 1A of Part I of this report. 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

 

Item 1. Business.

I. General

We are a credit enhancement company with a primary strategic focus on domestic, first-lien residential mortgage insurance.

We have three business segments—mortgage insurance, financial guaranty and financial services:

 

   

Our mortgage insurance business provides credit protection for mortgage lenders and other financial services companies on residential mortgage assets.

 

   

Our financial guaranty business, which is not currently writing any new business, has provided insurance and reinsurance of municipal bonds, structured finance transactions and other credit-based risks, and has provided credit protection on various asset classes through financial guarantees and credit default swaps (“CDS”).

 

   

Our financial services business consists mainly of our ownership interest in Sherman Financial Group LLC (“Sherman”)—a consumer asset and servicing firm specializing in credit card and bankruptcy-plan consumer assets.

A summary of financial information for each of our business segments and a discussion of net premiums earned attributable to our domestic and international operations for each of the last three fiscal years is included in “Segment Reporting” in Note 3 of Notes to Consolidated Financial Statements.

Background. We began conducting business as CMAC Investment Corporation, a Delaware corporation, following our spin-off from Commonwealth Land Title Insurance Company through an initial public offering on November 6, 1992. On June 9, 1999, we merged with Amerin Corporation, an Illinois based mortgage insurance company, and were renamed Radian Group Inc. (“Radian Group”). On February 28, 2001, we entered the financial guaranty insurance and financial services businesses through our acquisition of Enhance Financial Services Group Inc. (“EFSG”), a New York-based holding company that owned our principal financial guaranty subsidiaries, Radian Asset Assurance Inc. (“Radian Asset Assurance”) and Radian Asset Assurance Limited (“RAAL”) and our interests in two financial services companies—Sherman and Credit-Based Asset Servicing and Securitization LLC (“C-BASS”), a mortgage investment and servicing company that specialized in the credit risk of subprime, single-family residential mortgages. In the third quarter of 2008, we decided to discontinue, for the foreseeable future, writing any new financial guaranty business, including accepting new financial guaranty reinsurance, other than as may be necessary to commute, restructure, hedge or otherwise mitigate losses or reduce exposure in our existing financial guaranty portfolio. Our principal executive offices are located at 1601 Market Street, Philadelphia, Pennsylvania 19103, and our telephone number is (215) 231-1000.

Additional Information. We maintain a website with the address www.radian.biz. We are not including or incorporating by reference the information contained on our website into this report. We make available on our website, free of charge and as soon as reasonably practicable after we file with, or furnish to, the Securities and Exchange Commission (“SEC”), copies of our most recently filed Annual Report on Form 10-K, all Quarterly Reports on Form 10-Q and all Current Reports on Form 8-K, including all amendments to those reports. In addition, copies of our guidelines of corporate governance, code of business conduct and ethics (which includes the code of ethics applicable to our chief executive officer, principal financial officer and principal accounting officer) and the governing charters for each committee of our board of directors are available free of charge on our website, as well as in print to any stockholder upon request.

A. Mortgage Insurance Business (General)

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 (“U.S.”) and in limited countries outside the U.S. We provide these products and services mainly

 

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through our wholly-owned subsidiaries, Radian Guaranty Inc. (“Radian Guaranty”), Radian Insurance Inc. (“Radian Insurance”) and Amerin Guaranty Corporation (“Amerin Guaranty”). Of these subsidiaries, only Radian Guaranty is currently originating a significant amount of new business.

Private mortgage insurance protects mortgage lenders from all or a portion of default-related losses on residential 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, most of which are sold to Freddie Mac and Federal National Mortgage Association (“Fannie Mae”). We refer to Freddie Mac and Fannie Mae together as “Government Sponsored Enterprises” or “GSEs.”

Our mortgage insurance segment, through Radian Guaranty, offers private mortgage insurance coverage on first-lien residential mortgages (“first-lien”). We have used Radian Insurance to provide credit enhancement for mortgage-related capital market transactions and to write credit insurance on mortgage-related assets such as international insurance transactions. We also insured net interest margin securities (“NIMS”) and second-lien mortgages (“second-lien”) through Radian Insurance and second-lien in Amerin Guaranty, although we have discontinued writing new insurance for these and other products written in the capital markets. We refer to the risk associated with products other than first-lien as “non-traditional” or “other risk in force.” In 2008, we wrote $113 million of other risk in force, compared to $604 million in 2007. At December 31, 2008, our other risk in force was 11.9% of our total mortgage insurance risk in force.

Premiums written and earned by our mortgage insurance segment for the last three fiscal years were as follows:

 

     Year Ended December 31
     2008    2007    2006
     (In thousands)

Net premiums written—insurance (1)

        

Primary and Pool Insurance

   $ 759,943    $ 835,961    $ 723,213

Second-lien

     11,458      27,236      57,935

International

     15,831      35,306      20,375
                    

Net premiums written—insurance

   $ 787,232    $ 898,503    $ 801,523
                    

Net premiums earned—insurance (1)

        

Primary and Pool Insurance

   $ 768,723    $ 730,966    $ 715,136

Second-lien

     18,727      32,744      52,588

International

     21,331      15,549      7,028
                    

Net premiums earned—insurance

   $ 808,781    $ 779,259    $ 774,752
                    

 

(1) Excludes premiums written and earned on credit derivatives. These premiums are reported within the change in fair value of derivative instruments. Premiums written on credit derivatives for the year ended December 31, 2008 were $18.7 million, compared to $56.6 million and $47.6 million, for 2007 and 2006, respectively. Premiums earned on credit derivatives for the year ended December 31, 2008 were $26.1 million, compared to $64.3 million and $37.3 million, for 2007 and 2006, respectively.

1. Traditional Types of Coverage (General—Mortgage Insurance)

Primary Mortgage Insurance. Primary mortgage insurance provides protection against mortgage defaults on prime and non-prime mortgages (non-prime mortgages include Alternative-A (“Alt-A”), A minus and B/C mortgages, each of which are discussed below under “Risk in Force/Net Par Outstanding—Mortgage Insurance—Lender and Mortgage Characteristics”) at a specified coverage percentage. When there is a claim, the coverage percentage is applied to the claim amount—which consists of the unpaid loan principal, plus past due interest and certain expenses associated with the default—to determine our maximum liability. We provide primary mortgage insurance on a flow basis (which is loan-by-loan) and we have also provided primary mortgage insurance on a structured basis (in which we insure a group of individual loans).

 

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Some of our structured business has been written in a “second-to-pay” or “second-loss” position, meaning that we are not required to make a payment until a certain amount of losses have already been recognized. See “Types of Transactions” below.

In 2008, we wrote $32.5 billion of primary mortgage insurance, of which 96.2% was originated on a flow basis and 3.8% was originated on a structured basis, compared to $57.1 billion of primary mortgage insurance written in 2007, of which 70.6% was originated on a flow basis and 29.4% was originated on a structured basis. Primary insurance on first-lien mortgages made up 92.2% of our total first-lien mortgage insurance risk in force at December 31, 2008.

Pool Insurance. We offer pool insurance on a limited basis. Pool insurance differs from primary insurance in that our maximum liability is not limited to a specific coverage percentage on each individual mortgage. Instead, an aggregate exposure limit, or “stop loss,” generally between 1% and 10%, is applied to the initial aggregate loan balance on a group or “pool” of mortgages. In addition to a stop loss, many pool policies are written in a second-loss position. We believe the stop loss and second-loss features are important in limiting our exposure on a specified pool.

We write most of our pool insurance in the form of credit enhancement on residential mortgage loans underlying residential mortgage-backed securities, whole loan sales and other structured transactions. An insured pool of mortgages may contain mortgages that are already covered by primary mortgage insurance, and, as such, the pool insurance is secondary to any primary mortgage insurance that exists on mortgages within the pool. Generally, the mortgages we insure with pool insurance are similar to primary insured mortgages.

In 2008, we wrote $60 million of pool insurance risk, compared to $261 million of pool insurance risk written in 2007. Pool insurance on first-lien mortgages made up approximately 7.8% of our total first-lien mortgage insurance risk in force at December 31, 2008.

Modified Pool Insurance. We also write modified pool insurance, which differs from standard pool insurance in that it includes an exposure limit on each individual loan as well as a stop loss feature for the entire pool of loans. Modified pool insurance and the related risk in force is included in our primary mortgage insurance.

2. Types of Transactions (General—Mortgage Insurance)

Our mortgage insurance business has provided credit enhancement mainly through two forms of transactions. We write mortgage insurance on an individual loan basis, which is commonly referred to as “flow” business, and insure multiple mortgages in a single transaction, which is commonly referred to as “structured” business. In flow transactions, mortgages typically are insured as they are originated, while in structured deals, we typically provide insurance on mortgages after they have been originated and closed. For 2008, our mortgage insurance business wrote $31.3 billion of flow business and $1.2 billion in structured transactions, compared to $40.3 billion of flow business and $16.8 billion in structured transactions in 2007.

In structured mortgage insurance transactions, we typically insure the individual mortgages included in a structured portfolio up to specified levels of coverage. Most of our structured mortgage insurance transactions involve non-prime mortgages and mortgages with higher than average balances. A single structured mortgage insurance transaction may include primary insurance or pool insurance, and many structured transactions have both primary and pool insured mortgages.

In the past, we also have written insurance on mortgage-related assets, such as residential mortgage-backed securities (“RMBS”), in structured transactions. In these transactions, similar to our financial guaranty insurance business, we insured the timely payment of principal and interest to the holders of debt securities, the payment of which is backed by a pool of residential mortgages. Unlike our traditional flow and structured transactions, in our residential mortgage-backed securities transactions, we do not insure the payment of the individual loans in the

 

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pool, but insure that aggregate payments on the pool of loans will be sufficient to meet the principal and interest payment obligations to the holders of the debt securities. Some structured transactions include a risk-sharing component under which the insured or a third-party assumes a first-loss position or shares in losses in some other manner. Given market conditions, we stopped originating this type of business in 2007.

3. Non-Traditional Forms of Credit Enhancement (General—Mortgage Insurance)

In addition to traditional mortgage insurance, in the past, we provided other forms of credit enhancement on residential mortgage assets. Although we do not anticipate writing this type of business again in the future (other than possibly international mortgage insurance as discussed below), we maintain a sizeable insured portfolio involving these products.

Second-Lien Mortgages. In addition to insuring first-lien mortgages, we also provided primary or modified pool insurance on second-lien mortgages. Beginning in 2004, we began limiting our participation in these transactions to situations (1) where there was a loss deductible or other first-loss protection that preceded our loss exposure or (2) where a lender otherwise was required to share in a significant portion of any losses. Despite these measures, our second-lien business was largely susceptible to the disruption in the housing market and the subprime mortgage market that began in 2007, and we significantly reduced the amount of our new second-lien business written in 2007. We did not write any new second-lien business in 2008. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview of Business Results—Mortgage Insurance—Discontinued Non-Traditional Products—Second-Lien Mortgages” below for information regarding our recent loss experience and total loss expectations with respect to second-lien mortgages.

Credit Enhancement on Net Interest Margin Securities. In the past, we provided credit enhancement on NIMS bonds. A NIMS bond represents the securitization of a portion of the excess cash flow and prepayment penalties from a mortgage-backed security comprised mostly of subprime mortgages. The majority of this excess cash flow consists of the spread between the interest rate on the mortgage-backed security and the interest generated from the underlying mortgage collateral. Historically, issuers of mortgage-backed securities would have earned this excess interest over time as the collateral aged, but market efficiencies enabled these issuers to sell a portion of their residual interests to investors in the form of NIMS bonds. Typically, the issuer retained a significant portion of the residual interests, which was subordinated to the NIMS bond in a first-loss position, so that the issuer would suffer losses associated with any shortfalls in residual cash flows before the NIMS bond experienced any losses.

On the NIMS bonds for which we have provided credit protection, our policy covers any principal and interest shortfalls on the insured bonds. For certain deals, we only insured a portion of the NIMS bond that was issued. The NIMS transactions that we have insured were typically rated BBB or BB at inception based on the amount of subordination and other factors, although the poor performance of the bonds has led to significant downgrades. As of December 31, 2008, we had $438 million of risk in force associated with NIMS in 34 deals. The average remaining term of our existing NIMS transactions is approximately three years.

At December 31, 2008, our risk in force related to NIMS had decreased by approximately $166 million from December 31, 2007, reflecting both normal paydowns as well as our purchase of some of the NIMS bonds that we insure. Beginning in the fourth quarter of 2007, as a risk mitigation initiative, we began purchasing, at a discount to par, some of our insured NIMS bonds, thereby contributing to the reduction in our overall risk on NIMS. The NIMS purchased are accounted for as derivative assets and are recorded at fair value in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), as amended and interpreted. Upon purchase, our liability representing the unrealized loss on the guarantee associated with the purchased NIMS is eliminated. The difference between the amount we pay for the NIMS and the sum of the fair value of the NIMS and the eliminated liability represents the net impact to earnings. The overall net impact to our financial statements as a result of these purchases has been immaterial.

 

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NIMS are a relatively unproven product with volatile performance history, particularly in the current declining housing market. Like second-liens, NIMS bonds have largely been susceptible to the disruption in the housing market and the subprime mortgage market during 2007 and 2008. We stopped writing insurance on NIMS bonds during the second quarter of 2007. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview of Business Results—Mortgage Insurance—Discontinued Non-Traditional Products—NIMS” below for information regarding our total loss expectations with respect to NIMS.

Domestic CDSs. In our mortgage insurance business, we sold protection on residential mortgage-backed securities through CDSs. A CDS is an agreement to pay our counterparty should an underlying security or the issuer of such security suffer a specified credit event, such as nonpayment, downgrade or a reduction of the principal of the security as a result of defaults in the underlying collateral. A CDS operates much like a financial guaranty insurance policy in that our obligation to pay is absolute. Unlike with most of our non-derivative mortgage insurance and financial guaranty products, however, our ability to engage in loss mitigation is generally limited. Further, in a CDS structure, there is no requirement that our counterparty hold the security for which credit protection is provided. We stopped writing this type of protection in our mortgage insurance business in 2006. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview of Business Results—Mortgage Insurance—Discontinued Non-Traditional Products—Credit Default Swaps” below for information regarding our loss expectations with respect to credit default swaps.

International Mortgage Insurance Operations. Through Radian Insurance, we wrote (i) credit protection in the form of CDSs, (ii) traditional mortgage insurance with Standard Chartered Bank in Hong Kong, and (iii) several mortgage reinsurance transactions in Australia. We terminated one large CDS transaction (representing approximately $4.0 billion of notional value) in the fourth quarter of 2008. Our exposure to international mortgage insurance CDS at December 31, 2008 consists of two CDSs referencing RMBS bonds related to mortgage loans in Germany and the Netherlands. The first CDS contains prime, low “loan to value” or “LTV” mortgages originated in Germany. Our exposure to this transaction, which is rated AAA, was $3.3 billion as of December 31, 2008 with remaining subordination of approximately $247 million. The second transaction contains prime, low LTV mortgages originated in the Netherlands. Our exposure to this transaction was $125 million as of December 31, 2008 with remaining subordination of $16 million. We have insured several tranches in the Netherlands transaction which are rated between BBB and AAA, with over half of our exposure in the AAA category. Both of these transactions are performing well and we currently do not expect to pay claims on either of these transactions.

Ratings downgrades of Radian Insurance have significantly reduced our ability to write international mortgage insurance business. In addition, as a result of these downgrades, the counterparties to each of our active international transactions have the right to terminate these transactions, which could require us to return unearned premiums or transfer unearned premiums to a replacement insurer. On March 4, 2008, Standard Chartered Bank in Hong Kong informed us that they wished to terminate their contract for new business with Radian Insurance. There is a possibility that Radian Insurance could be required to return unearned premiums related to this transaction to Standard Chartered Bank, or to transfer such unearned premiums to another insurer. In addition, we have used Radian Guaranty to assume or reinsure most of our Australian transactions.

 

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4. Premium Rates (General—Mortgage Insurance)

We cannot change our premium rates after we issue coverage. Accordingly, we determine premium rates in our mortgage insurance business 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. We establish pricing in an amount that we expect will allow a reasonable return on allocated capital.

Premiums for our mortgage insurance may be paid by the lender, which will in turn charge a higher interest rate to the borrower, or directly by the borrower. We price our borrower-paid flow business based on rates that we have filed with the various state insurance departments. We generally price our structured business and some lender-paid business based on the specific characteristics of the insured portfolio, which can vary significantly from portfolio to portfolio depending on a variety of factors, including the quality of the underlying loans, the credit history of the borrowers, the amount of coverage required and the amount, if any, of credit protection or subordination in front of our risk exposure.

Premium rates for our pool insurance business are generally lower than primary mortgage insurance rates due to the aggregate stop loss. As a result of these lower premium rates, the lack of exposure limits on individual loans, and the greater concentration of risk in force associated with much of our pool insurance, the rating agency capital requirements per dollar of risk for this product are generally more restrictive than for primary insurance.

5. Underwriting (General—Mortgage Insurance)

Delegated Underwriting. We have a delegated underwriting program with a number of our customers. Our delegated underwriting program enables us to meet lenders’ demands for immediate insurance coverage by having us commit to insure loans that meet agreed-upon underwriting guidelines. Our delegated underwriting program currently involves only lenders that are approved by our risk management group, 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, without our knowledge, not followed our specified underwriting guidelines. A lender could commit us to insure a number of loans with unacceptable risk profiles before we discover the problem and terminate that lender’s delegated underwriting authority. We mitigate this risk by screening for compliance with our underwriting guidelines and through periodic, on-site reviews of selected delegated lenders. As of December 31, 2008, approximately 49% of our total first-lien mortgage insurance in force had been originated on a delegated basis, compared to 43% as of December 31, 2007.

Contract Underwriting. In our mortgage insurance business, we also utilize our underwriting skills to provide an outsourced underwriting service to its customers known as contract underwriting. For a fee, we underwrite our customers’ loan files for secondary market compliance (i.e., for sale to GSEs), while concurrently assessing the file for mortgage insurance, if applicable. Contract underwriting continues to be a popular service to our mortgage insurance customers. During 2008, loans underwritten via contract underwriting accounted for 12.4% of applications, 11.5% of commitments for insurance and 10.7% of insurance certificates issued for our flow business.

We give recourse to our customers on loans that we underwrite for compliance. Typically, we agree that if we make a material error in underwriting a loan, we will provide a remedy to the customer by purchasing or placing additional mortgage insurance on the loan, or by indemnifying the customer against loss. Providing these remedies means we assume some credit risk and interest-rate risk if an error is found during the limited remedy period, which may be up to seven years, but typically is only two years. Rising mortgage interest rates or an economic downturn may expose our mortgage insurance business to an increase in such costs. During 2008, we processed requests for remedies on less than 1% of the loans underwritten and sold a number of loans previously acquired as part of the remedy process. We expect the request for remedies may increase in 2009 due to the increase in delinquent loans and mortgage foreclosures throughout the mortgage industry. We closely monitor this risk and negotiate our underwriting fee structure and recourse agreements on a client-by-client basis. We also routinely audit the performance of our contract underwriters to ensure that customers receive quality underwriting services.

 

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B. Financial Guaranty Business (General)

Our financial guaranty business has mainly provided direct insurance and reinsurance on credit-based risks through Radian Asset Assurance, a wholly-owned subsidiary of Radian Guaranty, and through Radian Asset Assurance’s wholly-owned subsidiary, RAAL, located in the United Kingdom.

Financial guaranty insurance typically provides an unconditional and irrevocable guaranty to the holder of a financial obligation of full and timely payment of principal and interest when due. Financial guaranty insurance may be issued at the inception of an insured obligation or may be issued for the benefit of a holder of an obligation in the secondary market. Historically, financial guaranty insurance has been used to lower an issuer’s cost of borrowing when the insurance premium is less than the value of the spread (commonly referred to as the “credit spread”) between the market yield required to be paid on the insured obligation (carrying the credit rating of the insurer) and the market yield required to be paid on the obligation if sold on the basis of its uninsured credit rating. Financial guaranty insurance also has been used to increase the marketability of obligations issued by infrequent or unknown issuers and/or obligations with complex structures. Until recently, investors generally have benefited from financial guaranty insurance through increased liquidity in the secondary market, reduced exposure to price volatility caused by changes in the credit quality of the underlying insured issue, and added protection against loss in the event of default on the insured obligation. Recent market developments, including ratings downgrades of most financial guaranty insurance companies (including our own), have significantly reduced the perceived benefits of financial guaranty insurance.

We provide financial guaranty credit protection either through the issuance of a financial guaranty insurance policy or through CDSs. Either form of credit enhancement can provide the purchaser of such credit protection with a guaranty of the timely payment of interest and scheduled principal when due on a covered financial obligation. By providing credit default swaps, we have been able to participate in transactions with superior collateral quality involving asset classes (such as corporate collateralized debt obligations (“CDOs”)) that may not have been available to us through the issuance of a traditional financial guaranty insurance policy. Either form of credit enhancement requires substantially identical underwriting and surveillance skills.

We have traditionally offered the following financial guaranty products:

 

   

Public Finance—Insurance of public finance obligations, including tax-exempt and taxable indebtedness of states, counties, cities, special service districts, other political subdivisions, for enterprises such as airports, public and private higher education and health care facilities, and for project finance and private finance initiative assets in sectors such as schools, healthcare and infrastructure projects. The issuers of our insured public finance obligations were generally rated investment-grade at the time we issued our insurance policy, without the benefit of our insurance;

 

   

Structured Finance—Insurance of structured finance obligations, including CDOs and asset-backed securities (“ABS”), consisting of funded and non-funded (referred to herein as “synthetic”) executions that are payable from or tied to the performance of a specific pool of assets or covered reference entities. Examples of the pools of assets that underlie structured finance obligations include corporate loans, bonds or other borrowed money, residential and commercial mortgages, diversified payment rights, a variety of consumer loans, equipment receivables, real and personal property leases or a combination of asset classes or securities backed by one or more of these pools of assets. We have also guaranteed excess clearing losses of securities exchange clearinghouses. The structured finance obligations we insure were generally rated investment-grade at the time we issued our insurance policy, without the benefit of our insurance; and

 

   

Reinsurance—Reinsurance of domestic and international public finance obligations, including those issued by sovereign and sub-sovereign entities, and structured finance obligations.

 

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In October 2005, we exited the trade credit reinsurance line of business which insured the collectibility of cross border payable obligations. Accordingly, this line of business was placed into run-off and we have ceased initiating new trade credit reinsurance contracts. We have also been novating or cancelling several of the trade credit agreements that were in place.

In March 2008, we discontinued writing new insurance on synthetic CDOs and reduced significantly our structured products operations. This action was based on the deterioration and uncertainties in the credit markets in which we and other financial guarantors participate, which significantly reduced the volume of CDOs and other structured products available for our insurance. Subsequent to this action, in June 2008, both Standard & Poor’s Ratings Service (“S&P”) and Moody’s Investor Service (“Moody’s”) downgraded the financial strength ratings of our financial guaranty insurance subsidiaries and in August 2008, S&P again downgraded the financial strength ratings on our financial guaranty insurance subsidiaries. See “Ratings—Recent Ratings Actions” below. These downgrades, combined with the difficult market conditions for financial guaranty insurance, severely limited our ability to write profitable new direct financial guaranty insurance and reinsurance both domestically and internationally. Accordingly, in the third quarter of 2008, we decided to discontinue, for the foreseeable future, writing any new financial guaranty business, including accepting new financial guaranty reinsurance, other than as may be necessary to commute, restructure, hedge or otherwise mitigate losses or reduce exposure in our existing portfolio. We initiated plans to reduce our financial guaranty operations, including a reduction of our workforce, commensurate with this decision. We also contributed the outstanding capital stock of Radian Asset Assurance to Radian Guaranty, strengthening Radian Guaranty’s statutory capital. We continue to maintain a large insured financial guaranty portfolio, including a portfolio of insured CDOs.

As a result of the downgrade of our financial guaranty subsidiaries by S&P in June 2008, four reinsurance customers took back or recaptured all of their business ceded to us and we agreed to allow another reinsurance customer to take back a portion of its business (the “2008 FG Recaptures”).

As a result of a further downgrade of the financial strength ratings of our financial guaranty insurance subsidiaries’ by S&P in August 2008, counterparties in four of our synthetic credit default swap transactions obtained the right to terminate these transactions with settlement on a mark-to-market basis, meaning that if, based on third-party bids received, a replacement counterparty would require amounts in addition to the payments we are entitled to receive under the transaction in order to take over our position in the transaction, we would be required to pay such amounts to our counterparty. In September 2008, we voluntarily terminated one of these credit default swap transactions and novated a second transaction to an unaffiliated third party before our counterparty’s right to terminate on a mark-to-market basis vested. This termination and novation did not have a material impact on our consolidated financial statements.

In addition, an additional $75.6 billion of our financial guaranty net par outstanding remains subject to recapture or termination due to these downgrades. See “Risk in Force/Net For Outstanding—Financial Guaranty Exposure Currently Subject to Recapture or Termination” below for additional information regarding the rights of our primary insurance customers, CDS counterparties and other insured parties to recapture risks assumed by us or to terminate credit protection provided by us, and the potential impact of such recaptures or terminations on us.

 

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The following table summarizes the net premiums written and earned by our financial guaranty business’s various products for the last three fiscal years:

 

     Year Ended December 31
     2008     2007    2006
     (In thousands)

Net premiums written (1):

       

Public finance direct

   $ 15,558     $ 60,117    $ 79,655

Public finance reinsurance

     34,066       86,821      81,065

Structured finance direct

     12,151       16,594      18,772

Structured finance reinsurance

     18,735       21,933      18,676

Trade credit reinsurance

     177       1,264      4,599
                     
     80,687       186,729      202,767

Impact of 2008 FG recaptures

     (51,050 )     —        —  
                     

Total net premiums written—insurance

   $ 29,637     $ 186,729    $ 202,767
                     

Net premiums earned (1):

       

Public finance direct

   $ 56,191     $ 45,770    $ 32,517

Public finance reinsurance

     89,227       44,667      37,765

Structured finance direct

     14,418       17,325      19,446

Structured finance reinsurance

     19,690       22,957      21,086

Trade credit reinsurance

     657       2,303      21,476
                     
     180,183       133,022      132,290

Impact of 2008 FG recaptures

     (17,144 )     —        —  
                     

Total net premiums earned—insurance

   $ 163,039     $ 133,022    $ 132,290
                     

 

(1) Excludes premiums written and earned on credit derivatives. These premiums are reported within the change in fair value of derivative instruments. Premiums written on credit derivatives for the year ended December 31, 2008 were $50.1 million, compared to $43.0 million and $60.1 million, for 2007 and 2006, respectively. Premiums earned on credit derivatives for the year ended December 31, 2008 were $54.1 million, compared to $62.1 million and $71.5 million, for 2007 and 2006, respectively.

In our financial guaranty business, the issuer of an insured obligation generally pays the premiums for our insurance either, in the case of most public finance transactions, in full at the inception of the policy or, in the case of most non-synthetic structured finance transactions, in regular monthly, quarterly, semi-annual or annual installments from the cash flows of the related collateral. Premiums for synthetic CDSs are generally paid in periodic installments (i.e. monthly, quarterly, semi-annually or annually) directly from our counterparty, and not from the cash flows of the insured obligation or the collateral supporting the obligation. On occasion, all or a portion of the premium for structured products transactions is paid at the inception of the protection. 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 our synthetic transactions without penalty if our counterparty fails to pay us, or is financially unable to make timely payments to us under the terms of the CDS transaction.

For public finance transactions, premium rates typically have been stated as a percentage of debt service, which includes total principal and interest. For structured finance obligations, premium rates are typically stated as a percentage of the total par outstanding. Premiums are generally non-refundable. Premiums paid in full at inception are recorded initially as unearned premiums and “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. The long and relatively predictable premium earnings pattern from our public finance and structured products transactions provides us with a relatively predictable source of future “earned” revenues.

 

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The premium rate we establish for a transaction may reflect 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, the servicer’s credit strength and sources of income and the availability of one or more replacement servicers should the need arise;

 

   

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, the length of time until the obligation’s stated maturity, and our ability to mitigate potential losses; and

 

   

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

1. Public Finance (General—Financial Guaranty)

Our public finance business provides credit enhancement of bonds, notes and other evidences of indebtedness issued by states and their political subdivisions (e.g. counties, cities or towns), school districts, utility districts, public and private non-profit universities and hospitals, public housing and transportation authorities, and authorities and other public and quasi-public entities such as airports, public and private higher education and healthcare facilities. Public finance transactions may also include project finance and public finance initiatives, which are transactions in which public or quasi-public infrastructure projects are financed through the issuance of bonds which are to be repaid from the expected revenues from the projects being built. These bonds may or may not be backed by governmental guarantees or other support.

Municipal bonds can be categorized generally into tax-backed bonds and revenue bonds. Tax-backed bonds, which include general obligation bonds, are backed by the taxing power of the governmental agency that issues them, while revenue bonds are backed by the revenues generated by a specific project such as bridge or highway tolls, or by rents or hospital revenues. Credit enhancement of public finance obligations can also take the form of CDSs, where we provide credit protection on a pool of public finance obligations or credit protection on the timely payment of principal and interest on a specified public finance or project finance obligation.

2. Structured Finance (General—Financial Guaranty)

The structured finance market traditionally has included asset-backed securities and other asset-backed or mortgage-backed obligations, including funded and synthetic CDOs. Each asset in a CDO pool typically is of a different credit quality or possesses different characteristics with respect to interest rates, amortization and level of subordination.

Funded asset-backed obligations usually take the form of a secured interest in a pool of assets, often of uniform credit quality, such as credit card or auto loan receivables, commercial or residential mortgages or life insurance policies. Funded asset-backed securities also may be secured by a few specific assets such as utility mortgage bonds and multi-family housing bonds. In addition, we have insured future flow diversified payment rights transactions, where our insured obligations are backed by electronic payment orders intended for third-party beneficiaries (e.g. trade-related payments, individual remittances, and foreign direct investment).

The performance of synthetic transactions is tied to the performance of pools of assets, but is not secured by those assets. Most of the synthetic transactions we insure are CDOs. In many of these transactions, including our corporate CDOs and CDOs of trust preferred securities, we generally are required to make payments to our counterparty upon the occurrence of credit-related events related to the borrowings or bankruptcy of obligors contained within pools of investment-grade corporate obligations or, in the case of pools of mortgage or other asset-backed obligations, upon the occurrence of credit-related events related to the specific obligations in the pool. When we provide synthetic credit protection on a specific credit, our payment obligations to our

 

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counterparties are generally the same as those we have when we insure credits through a financial guaranty insurance policy. However, unlike most of our financial guaranty insurance policy obligations, where we have subrogation and other rights and remedies, we generally do not have recourse or other rights and remedies against the issuer and/or any related collateral for amounts we may be obligated to pay under these transactions. Even in those cases where we have such rights and remedies, they are generally much more limited than the rights and remedies we generally have in our more traditional financial guaranty transactions, and oftentimes need to be exercised indirectly, through our counterparty.

We primarily have provided credit protection in our synthetic CDO portfolio with respect to the following types of collateral: corporate debt obligations, trust preferred securities (“TruPs”), commercial mortgage-backed securities (“CMBS”), ABS (which includes RMBS), collateralized loan obligations (“CLOs”) and a combination of collateral types. In our corporate CDO transactions, we provide credit protection for certain specified credit-related events related to the borrowings or bankruptcy of obligors contained within pools of corporate obligations that were predominantly rated investment-grade at inception. TruPs are subordinated debt obligations or preferred equity issued by banks, insurance companies, Real Estate Investment Trusts and other financial institutions to supplement their capital needs. TruPs are subordinated to substantially all of such institutions debt obligations, but are senior to payments on equity securities of such issuer. In our CDO of CMBS transactions, we insure the timely payment of current interest and the ultimate payment of principal on securities whose payment obligations are secured by pools of CMBS securities. In our CDO of ABS transactions, we insure the timely payment of current interest and the ultimate payment of principal on a senior class of notes whose payment obligations are secured by pools of ABS, predominantly highly-rated (at inception) mezzanine-tranches of RMBS securities. CDOs of CLOs are similar to our corporate CDOs except that the obligations for which we are providing credit protection are backed by loans rather than other corporate debt securities.

In some circumstances, we have provided credit protection for “second-to-pay” corporate CDOs, TruPs and CLOs in which we are not required to pay a claim unless another financial guarantor defaults on its primary insurance obligation to pay such claim. Other structured finance transactions include diversified payment rights, clearinghouse soft capital, collateralized guaranteed investment contracts or letters of credit, foreign commercial assets and life insurance securitizations.

The following table shows the gross par amounts (principal) of structured finance obligations originated in each of the years presented:

 

Type

   2008    2007    2006
     (In millions)

Collateralized debt obligations

   $ 141    $ 13,470    $ 22,362

Asset-backed obligations

     221      2,025      1,305

Other structured

     274      198      1,436
                    

Total structured finance

   $ 636    $ 15,693    $ 25,103
                    

The following table shows the gross par outstanding on structured finance obligations at the end of each of the years presented:

 

Type

   2008    2007
     (In millions)

Collateralized debt obligations

   $ 45,649    $ 46,961

Asset-backed obligations

     3,554      5,275

Other structured

     2,108      2,656
             

Total structured finance

   $ 51,311    $ 54,892
             

The net par originated and outstanding on our structured finance obligations is not materially different from the gross par originated and outstanding for each period because we do not cede a material amount of business to reinsurers.

 

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3. Reinsurance (General—Financial Guaranty)

We reinsure direct financial guarantees written by other primary insurers or “ceding companies.” Reinsurance allows a ceding company to write larger single risks and larger aggregate risks while remaining in compliance with the risk limits and capital requirements of applicable state insurance laws, rating agency guidelines and internal limits. State insurance regulators allow ceding companies to reduce the liabilities appearing on their balance sheet to the extent of reinsurance coverage obtained from licensed reinsurers or from unlicensed reinsurers meeting certain solvency and other financial criteria. Similarly, the rating agencies may permit a reduction in both exposures and liabilities ceded under reinsurance agreements, with the amount of credit permitted dependent on the financial strength rating of the insurer and reinsurer.

Our financial guaranty insurance business has entered into reinsurance agreements with various ceding companies. These reinsurance agreements generally are subject to termination (i) upon written notice by either party (ranging from 90 to 120 days) before the specified deadline for renewal, (ii) at the option of the ceding company if we fail to maintain applicable ratings or certain financial, regulatory and rating agency criteria, or (iii) upon certain changes of control. Upon termination under the conditions set forth in (ii) and (iii) above, we may be required (under some of our reinsurance agreements) to return to the ceding company all unearned premiums, less ceding commissions, attributable to reinsurance ceded pursuant to such agreements. Upon the occurrence of the conditions set forth in (ii) above, regardless of whether or not an agreement is terminated, we may be required to obtain a letter of credit or alternative form of security to collateralize our obligation to perform under such agreement or we may be obligated to increase the level of ceding commission paid.

As a result of S&P’s downgrades of our financial guaranty insurance subsidiaries in June 2008, all of our financial guaranty reinsurance treaties have been terminated on a “run-off” basis, which means that none of our reinsurance customers may cede additional business to us under our reinsurance agreements with them. The business they previously ceded to us under these agreements currently remains outstanding (and a part of our risk in force) unless the applicable primary insurer has exercised its right to recapture business previously ceded to us under the applicable reinsurance agreement. See “Risk in Force/Net Par Outstanding—Financial Guaranty Exposure Currently Subject to Recapture or Termination” below for information regarding the ability of our reinsurance customers to recapture business previously ceded to us.

Treaty and Facultative Agreements. The principal forms of reinsurance agreements are treaty and facultative. Under a treaty agreement, the ceding company is obligated to cede to us, and we are obligated to assume, a specified portion of all risks, within ranges, of transactions deemed eligible for reinsurance by the terms of a negotiated treaty. Limitations on transactions deemed eligible for reinsurance typically focus on the size, security and ratings of the insured obligation. Each treaty is entered into for a defined term, generally one year, with renewals upon mutual consent and rights to early termination (subject to the existing reinsured risk extending upon termination of the treaty for the life of the respective underlying obligations) under certain circumstances. The termination rights described above under “Reinsurance” also are typical provisions for the termination of a treaty reinsurance agreement.

In treaty reinsurance, there is a risk that the ceding company may select weaker credits or proportionally larger amounts to cede to us. We mitigated this risk by requiring the ceding company to retain a sizable minimum portion of each ceded risk, and we included limitations on individual transactions and on aggregate amounts within each type of transaction.

Under a facultative agreement, the ceding company has the option to offer to us, and we have the option to accept, a portion of specific risks, usually in connection with particular obligations. Unlike under a treaty agreement, where we generally rely on the ceding company’s credit analysis, under a facultative agreement, we often perform our own underwriting and credit analysis to supplement the primary insurer’s analysis in order to determine whether to accept the particular risk. The majority of our financial guaranty reinsurance was provided under treaty arrangements.

 

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Proportional or Non-Proportional Reinsurance. We typically have accepted our reinsurance risk on either a proportional or non-proportional basis. Proportional relationships are those in which we and the ceding company share a proportionate amount of the premiums and the losses of the risk subject to reinsurance. In addition, we generally pay the ceding company a commission, which typically is related to the ceding company’s underwriting and other expenses in connection with obtaining the business being reinsured. Non-proportional relationships are those in which the losses, and consequently the premiums paid, are not shared by the ceding company and us on a proportional basis. Non-proportional reinsurance can be based on an excess-of-loss or first-loss basis. Under excess-of-loss reinsurance agreements, we provide coverage to a ceding company up to a specified dollar limit for losses, if any, incurred by the ceding company in excess of a specified threshold amount. A first-loss reinsurance agreement provides coverage to the ceding company on the first dollar of loss up to a specified dollar limit of losses. Generally, we do not pay a commission for non-proportional reinsurance. However, the same factors that affect the payment of a ceding commission in proportional agreements also may be taken into account with respect to non-proportional reinsurance to determine the proportion of the aggregate premium paid to us. The majority of our financial guaranty reinsurance business was originated on a proportional basis.

4. European Operations (General—Financial Guaranty)

Through RAAL, we have written financial guaranty insurance in the United Kingdom, France, the Netherlands and the Republic of Ireland. RAAL primarily has insured synthetic CDSs which have been substantially reinsured (at least 90% of the risk) by Radian Asset Assurance.

C. Financial Services Business (General)

Our financial services segment mainly consists of our 28.7% equity interest in Sherman, a consumer asset and servicing firm. Our financial services segment also includes our 46% interest in C-BASS, a mortgage investment company which we have written off completely and whose operations are currently in run-off.

1. Sherman (General—Financial Services)

Sherman is a consumer asset and servicing firm specializing in charged-off and bankruptcy plan consumer assets, which are generally unsecured, that Sherman typically purchases at deep discounts from national financial institutions and major retail corporations and subsequently seeks to collect. In addition, Sherman originates subprime credit card receivables through its subsidiary CreditOne and has a variety of other similar ventures related to consumer assets.

In August 2008, our equity interest in Sherman increased to 28.7% from 21.8% as a result of a reallocation of the equity ownership of Sherman following a sale by Mortgage Guaranty Insurance Corporation (“MGIC”) of its remaining interest in Sherman back to Sherman. As a result of Sherman’s repurchase of MGIC’s interests, which reduced Sherman’s equity, our investment in affiliates decreased by $25.8 million ($16.8 million after taxes) and is reflected as a reduction in our equity.

2. C-BASS (General—Financial Services)

C-BASS is an unconsolidated, less than 50%-owned investment that is not controlled by us. Historically, C-BASS was engaged as a mortgage investment and servicing company specializing in the credit risk of subprime single-family residential mortgages. As a result of the disruption in the subprime mortgage market during 2007, C-BASS ceased purchasing mortgages and mortgage securities and its securitization activities in the third quarter of 2007 and sold its loan-servicing platform in the fourth quarter of 2007. The run-off of C-BASS’s business is dictated by an override agreement to which we and all of C-BASS’s other owners and creditors are parties. This non-bankruptcy restructuring agreement provides the basis for the orderly run-off of C-BASS’s business through the collection and distribution of cash generated from C-BASS’s whole loans and securities

 

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portfolio, as well as the sale of certain assets, including the loan-servicing platform. We recorded a full write-off of our equity interest in C-BASS in the third quarter of 2007 and wrote-off our $50 million credit facility with C-BASS in the fourth quarter of 2007. See Note 8 of Notes to Consolidated Financial Statements.

As a consequence of the complete write-off of our investment in C-BASS in 2007, we have no continuing interest of value in C-BASS. The effect of C-BASS on our financial position and results of operations as of and for the year ended December 31, 2008, was negligible. We have no contractual obligations to C-BASS or its creditors to fund C-BASS’s shareholders’ deficit as of December 31, 2007 or continuing losses in 2008 or thereafter. All of C-BASS’s business is currently in run-off and we anticipate that all future cash flows of C-BASS will be used to service the outstanding debt. Given its approximate $1 billion shareholders’ deficit as of December 31, 2007, the likelihood that we will recoup any of our investment is extremely remote. Accordingly, we believe that the chance that our investments in C-BASS will have anything more than a negligible impact on our financial position, results of operation or cash flows at any time in the future is extremely remote.

II. Risk in Force/Net Par Outstanding

Our business has traditionally involved taking credit risk in various forms across various asset classes, products and geographies. Credit risk is measured in our mortgage insurance business as risk in force, which represents the maximum exposure that we have at any point in time, and as net par outstanding in our financial guaranty business, which represents our proportionate share of the aggregate outstanding principal exposure on insured obligations. We are also responsible for the timely payment of interest on insured financial guaranty obligations. Our total mortgage insurance risk in force and financial guaranty net par outstanding was $143.7 billion as of December 31, 2008, compared to $161.2 billion as of December 31, 2007. Of the $143.7 billion of total risk in force/net par outstanding as of December 31, 2008, approximately 70.1% consists of financial guaranty risk and 29.9% consists of mortgage insurance risk.

A. Mortgage Insurance (Risk in Force/Net Par Outstanding)

The following table shows the risk in force outstanding associated with our mortgage insurance segment as of December 31, 2008 and 2007:

 

     December 31
2008
   December 31
2007
     (In millions)

Primary

   $ 34,951    $ 31,622

Pool

     2,950      3,004

Seconds

     622      925

NIMS

     438      604

International and domestic CDS

     3,493      8,414

Other International

     566      568
             

Total Mortgage Insurance Risk in Force

   $ 43,020    $ 45,137
             

The following discussion mainly focuses on our primary risk in force. For additional information regarding our pool and non-traditional mortgage insurance risk in force, see “General—Mortgage Insurance” above.

Our primary mortgage insurance risk in force was $35.0 billion as of December 31, 2008, compared to $31.6 billion as of December 31, 2007. We analyze our portfolio in a number of ways to identify any concentrations or imbalances in risk dispersion. We believe the performance of our mortgage insurance portfolio is affected significantly by:

 

   

general economic conditions (in particular interest rates and unemployment);

 

   

the age of the loans insured;

 

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the geographic dispersion of the properties securing the insured loans;

 

   

the quality of loan originations; and

 

   

the characteristics of the loans insured (including LTV, purpose of the loan, type of loan instrument and type of underlying property securing the loan).

The persistency rate, defined as the percentage of insurance in force that remains on our books after any 12-month period, is a key indicator for the mortgage insurance industry. Because most of our insurance premiums are earned over time, higher persistency rates enable us to recover more of our policy acquisition costs and generally result in increased profitability. At December 31, 2008, the persistency rate of our primary mortgage insurance was 85.8%, compared to 75.4% at December 31, 2007.

1. Primary Risk in Force by Policy Year (Risk in Force/Net Par Outstanding—Mortgage Insurance)

The following table shows the amount and percentage of our primary mortgage insurance risk in force by policy origination year as of December 31, 2008:

 

     December 31, 2008  
     ($ in millions)  

2003 and prior

   $ 4,530    13.0 %

2004

     2,767    7.9  

2005

     4,229    12.1  

2006

     5,196    14.9  

2007

     10,711    30.6  

2008

     7,518    21.5  
             

Total

   $ 34,951    100.0 %
             

 

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2. Geographic Dispersion (Risk in Force/Net Par Outstanding—Mortgage Insurance)

The following tables show the percentage of our direct primary mortgage insurance risk in force by location of property for the top 10 states and top 15 metropolitan statistical areas (“MSAs”) in the U.S. as of December 31, 2008 and 2007:

 

     December 31  

Top Ten States

   2008     2007  

California

   10.8 %   8.8 %

Florida

   8.8     9.0  

Texas

   6.5     6.5  

Georgia

   4.6     4.8  

Illinois

   4.5     4.4  

Ohio

   4.4     4.7  

New York

   4.1     4.4  

New Jersey

   3.5     3.4  

Michigan

   3.4     3.6  

Arizona

   3.2     3.1  
            

Total

   53.8 %   52.7 %
            

 

     December 31  

Top Fifteen MSAs

   2008     2007  

Chicago, IL

   3.4 %   3.3 %

Atlanta, GA

   3.4     3.4  

Phoenix/Mesa, AZ

   2.4     2.3  

New York, NY

   2.2     2.2  

Houston, TX

   2.1     2.0  

Los Angeles—Long Beach, CA

   2.0     1.5  

Riverside—San Bernardino, CA

   1.8     1.6  

Washington, DC—MD—VA

   1.7     1.6  

Minneapolis—St. Paul, MN—WI

   1.5     1.6  

Dallas, TX

   1.4     1.4  

Tampa—St. Petersburg—Clearwater, FL

   1.3     1.4  

Las Vegas, NV

   1.3     1.3  

Denver, CO

   1.3     1.2  

Orlando, FL

   1.2     1.2  

Philadelphia, PA

   1.2     1.2  
            

Total

   28.2 %   27.2 %
            

The following table shows the amount and percentage of our international mortgage insurance risk in force by location of property as of December 31, 2008 and 2007:

 

     December 31  

International

   2008     2007  
     ($ in millions)  

Germany

   $ 3,237    82.4 %   $ 3,870    44.1 %

Hong Kong

     413    10.5       465    5.3  

Australia

     153    3.9       103    1.2  

Netherlands

     124    3.2       130    1.5  

Denmark

     —      —         4,202    47.9  
                          

Total

   $ 3,927    100.0 %   $ 8,770    100.0 %
                          

 

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3. Lender and Mortgage Characteristics (Risk in Force/Net Par Outstanding—Mortgage Insurance)

Although geographic dispersion is an important component of our overall risk diversification, the quality of the risk in force should be considered in conjunction with other elements of risk diversification such as product distribution and our risk management and underwriting practices. In the recent past, we faced increased competition for traditional prime mortgage credit enhancement. As a result, non-prime mortgages and products such as adjustable rate mortgages (“ARMs”), negative amortizing loans and interest-only loans grew to represent a greater percentage of our total risk profile. Given current market conditions in which traditional prime mortgages are the predominant mortgage product being originated, we expect that non-prime and other non-traditional products will represent a negligible percentage of our overall mortgage insurance risk written in 2009.

In response to current market conditions, we implemented changes to our underwriting criteria in the fourth quarter of 2007 and throughout 2008, and have increased our pricing.

Loan to Value. One of the most important indicators of claim incidence is the relative amount of a borrower’s equity or down payment that exists in a home. Generally, loans with higher LTVs are more likely to result in a claim than lower LTV loans. For example, claim incidence on mortgages with LTVs between 90.01% and 95% (“95s”) is significantly higher than the expected claim incidence on mortgages with LTVs between 85.01% and 90% (“90s”). We, along with the rest of the industry, had been insuring loans with LTVs between 95.01% and 97% (“97s”) since 1995 and loans with an LTV of between 97.01% and 100% (“100s”) since 2000. These loans are expected to have a higher claim incidence than 95s. We have also insured a small amount of loans having an LTV over 100%. We charge a premium for higher LTV loans commensurate with the additional risk and the higher expected frequency and severity of claims. We are no longer writing business on loans with LTV ratios in excess of 95%.

Loan Grade. The risk of claim on non-prime loans is significantly higher than that on prime loans. We generally define prime loans as loans where the borrower’s Fair Isaac and Company (“FICO”) score is 620 or higher and the loan file meets “fully documented” standards of our credit guidelines and/or the GSE’s guidelines for fully documented loans. Prime loans made up 94.1% of our primary new insurance written in 2008, compared to 58.2% of primary new insurance written in 2007. Prime loans comprised 77.8% of our primary risk in force at December 31, 2008 compared to 71.9% at December 31, 2007. We expect that prime loans will constitute all but a negligible part of our primary new insurance written in 2009.

Within our non-prime mortgage insurance program, we have three defined categories of loans that we insure: Alt-A, A minus and B/C loans. During 2008, non-prime business accounted for 5.9% of our primary new insurance written in our mortgage insurance business (61.4% of which was Alt-A), compared to 41.8% in 2007 (81.0% of which was Alt-A). Non-prime loans comprised 22.2% of our primary risk in force at December 31, 2008 compared to 28.1% at December 31, 2007. We expect that non-prime loans will represent a negligible part of our primary new insurance written in 2009.

We define Alt-A loans as loans where the borrower’s FICO score is 620 or higher and where the loan documentation has been reduced or eliminated. Because of the reduced documentation, we consider Alt-A business to be more risky than prime business, particularly Alt-A loans to borrowers with FICO scores below 660. We insure Alt-A loans with FICO scores ranging from 620 to 660 and we charge a significantly higher premium for the increased default risk associated with these loans. Alt-A loans tend to have higher balances than other loans that we insure because they are often more heavily concentrated in high-cost areas. Alt-A loans made up 3.6% of our primary new insurance written in 2008, compared to 33.9% of primary new insurance written in 2007.

We generally define A minus loans as loans where the borrower’s FICO score ranges from 575 to 619. We also classify loans with certain characteristics originated within the GSE’s automated underwriting system as A

 

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minus loans, regardless of the FICO score. Our pricing of A minus loans is tiered into levels based on the FICO score, with increased premiums at each descending tier of FICO score. We receive a significantly higher premium for insuring this product commensurate with the increased default risk. A minus loans made up 2.3% of our primary new insurance written in 2008, compared to 7.9% of primary new insurance written in 2007.

We define B/C loans as loans where the borrower’s FICO score is below 575. Certain structured transactions that we insure contain a small percentage of B/C loans. We price these structured transactions to reflect a higher premium on B/C loans due to the increased default risk associated with these types of loans. B/C loans made up a negligible amount of total primary new insurance written during 2008 and 2007.

Adjustable-Rate Mortgages (“ARMs”). Our claim frequency on insured ARMs has been higher than on fixed-rate loans due to monthly payment increases that occur when interest rates rise. We consider a loan an ARM if the interest rate for that loan will reset at any point during the life of the loan. It has been our experience that loans subject to reset five years or later from origination are less likely to result in a claim than shorter term ARMs, and our premium rates for these longer term reset loans are lower to reflect the lower risk profile of such loans.

We have also insured Option ARMs, a product that, until recently, was popular in the mortgage market. Option ARMs offer a number of different monthly payment options to the borrower. One of these options is a minimum payment that is below the full amortizing payment, which results in interest being capitalized and added to the loan balance and the loan balance continually increasing. This process is referred to as negative amortization. As a result, additional premiums are charged for these Option ARMs. As of December 31, 2008, Option ARMs represented approximately 4.1% of our primary mortgage insurance risk in force compared to 4.9% at December 31, 2007. We are no longer writing insurance on this product. As of December 31, 2008, approximately 6% of the ARMs and approximately 2% of the Option ARMs and interest-only loans we insure are scheduled to reset during 2009. Within our existing Option ARMs and interest-only insurance portfolio, approximately 43% of these loans have first time resets in 2010 or later.

We have also insured an ARM type product called interest-only mortgages, where the borrower pays only the interest charge on a mortgage for a specified period of time, usually five to ten years, after which the loan payment increases to include principal payments. These loans may have a heightened propensity to default because of possible “payment shocks” after the initial low-payment period expires and because the borrower does not automatically build equity as payments are made. At December 31, 2008, interest-only mortgages represented approximately 10.2% of our primary mortgage insurance risk in force compared to 10.5% at December 31, 2007. We are no longer insuring interest-only mortgages.

Loan Size. The average size of loans that we insure has been increasing as a result of our having insured in the recent past a larger percentage of non-prime loans, in particular Alt-A loans, which tend to have larger loan balances relative to our other loans, and as a result of a general increase in the size of borrowings during the recent past. The increase in average loan size has resulted in a corresponding increase in the average size of loans in default, primarily and most significantly, with respect to Alt-A loans. At December 31, 2008, the average size of loans subject to our primary mortgage insurance was $168,175, compared to $159,844 at December 31, 2007.

Amortization Periods. We believe that 15-year mortgages are less risky than 30-year mortgages, mainly as a result of the faster amortization and the more rapid accumulation of borrower equity in the property. Premium rates for 15-year mortgages are lower to reflect the lower risk. Mortgages with amortization periods beyond 30 years recently have grown in the mortgage market. Our current exposure to these loans is minimal.

Property Type. The risk of claim also is affected by the type of property securing the insured loan. Loans on single-family detached housing are less likely to result in a claim than loans on other types of properties.

 

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Conversely, we generally consider loans on attached housing types, particularly condominiums and cooperatives, to be a higher risk due to the higher density of these properties. Our more stringent underwriting guidelines on condominiums and cooperatives reflect this higher expected risk.

We believe that loans on non-owner-occupied homes purchased for investment purposes are more likely to result in a claim and are subject to greater value declines than loans on either primary or second homes. Accordingly, we have underwritten loans on non-owner-occupied investment homes more stringently, and we charge a significantly higher premium rate than the rate charged for insuring loans on owner-occupied homes. We are no longer writing insurance on non-owner occupied homes.

It has been our experience that higher-priced properties experience wider fluctuations in value than moderately priced residences and that the high incomes of many people who buy higher-priced homes are less stable than those of people with moderate incomes. Underwriting guidelines for these higher-priced properties reflect these factors.

 

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The following table shows the percentage of our direct primary mortgage insurance risk in force (as determined on the basis of information available on the date of mortgage origination) by the categories indicated as of December 31, 2008 and 2007:

 

     December 31  
     2008     2007  

Direct Primary Risk in Force ($ in millions)

   $ 34,951     $ 31,622  

Product Type:

    

Primary

     92.2 %     91.3 %

Pool

     7.8       8.7  
                

Total

     100.0 %     100.0 %
                

Lender Concentration:

    

Top 10 lenders (by original applicant)

     50.2 %     47.9 %

Top 20 lenders (by original applicant)

     63.1       61.9  

LTV:

    

95.01% and above

     22.3 %     23.8 %

90.01% to 95.00%

     32.1       30.6  

85.01% to 90.00%

     35.3       33.5  

85.00% and below

     10.3       12.1  
                

Total

     100.0 %     100.0 %
                

Loan Grade:

    

Prime

     77.8 %     71.9 %

Alt-A

     14.3       18.3  

A minus and below

     7.9       9.8  
                

Total

     100.0 %     100.0 %
                

Loan Type:

    

Fixed

     82.2 %     78.4 %

ARM (fully indexed) (1)

    

Less than five years

     5.0       7.6  

Five years and longer

     8.8       9.2  

ARM (potential negative amortization) (2)

    

Less than five years

     3.6       4.3  

Five years and longer

     0.4       0.5  
                

Total

     100.0 %     100.0 %
                

FICO Score:

    

>=740

     30.5 %     26.1 %

680-739

     36.3       35.6  

620-679

     26.9       30.2  

<=619

     6.3       8.1  
                

Total

     100.0 %     100.0 %
                

Mortgage Term:

    

15 years and under

     1.2 %     1.4 %

Over 15 years

     98.8       98.6  
                

Total

     100.0 %     100.0 %
                

Property Type:

    

Non-condominium (principally single-family detached)

     91.0 %     91.8 %

Condominium or cooperative

     9.0       8.2  
                

Total

     100.0 %     100.0 %
                

 

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     December 31  
     2008     2007  

Occupancy Status:

    

Primary residence

   93.0 %   92.6 %

Second home

   3.7     3.7  

Non-owner-occupied

   3.3     3.7  
            

Total

   100.0 %   100.0 %
            

Mortgage Amount:

    

Less than $400,000

   91.2 %   92.1 %

$400,000 and over

   8.8     7.9  
            

Total

   100.0 %   100.0 %
            

Loan Purpose:

    

Purchase

   70.0 %   68.9 %

Rate and term refinance

   15.4     14.9  

Cash-out refinance

   14.6     16.2  
            

Total

   100.0 %   100.0 %
            

 

(1) “Fully Indexed” refers to loans where payment adjustments are the same as mortgage interest-rate adjustments.
(2) Loans with potential negative amortization will not have increasing principal balances unless interest rates increase as contrasted with scheduled negative amortization where an increase in loan balance will occur even if interest rates do not change.

B. Financial Guaranty (Risk in Force/Net Par Outstanding)

Our financial guaranty net par outstanding was $100.7 billion as of December 31, 2008, compared to $116.0 billion as of December 31, 2007. The decline in net par outstanding in 2008 was primarily due to the 2008 FG Recaptures, the amortization of principal, the prepayment or refundings of public finance obligations and the termination or novation of certain transactions. The following table shows the distribution of our financial guaranty net par outstanding by type of issue and as a percentage of our financial guaranty net par outstanding as of December 31, 2008 and 2007:

 

     Net Par Outstanding (1)  
      2008     2007  

Type of Obligation

   Amount    Percent     Amount    Percent  
     ($ in billions)  

Public finance:

          

General obligation and other tax-supported

   $ 21.6    21.4 %   $ 25.6    22.1 %

Healthcare and long-term care

     9.5    9.4       12.4    10.7  

Water/sewer/electric/gas and other investor-owned utilities

     7.7    7.6       10.4    9.0  

Airports/transportation

     4.9    4.9       6.9    6.0  

Education

     3.6    3.6       4.2    3.6  

Housing revenue

     0.5    0.5       0.6    0.5  

Other municipal (2)

     1.6    1.6       1.8    1.5  
                          

Total public finance

     49.4    49.0       61.9    53.4  
                          

Structured finance:

          

Collateralized debt obligations

     45.6    45.3       47.0    40.5  

Asset-backed obligations

     3.6    3.6       4.4    3.8  

Other structured (3)

     2.1    2.1       2.7    2.3  
                          

Total structured finance

     51.3    51.0       54.1    46.6  
                          

Total

   $ 100.7    100.0 %   $ 116.0    100.0 %
                          

 

(1) Represents our exposure to the aggregate outstanding principal on insured obligations.

 

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(2) Represents other types of municipal obligations, none of which individually constitutes a material amount of our financial guaranty net par outstanding.
(3) Represents other types of structured finance obligations, including diversified payment rights, clearinghouse soft capital, collateralized guaranteed investment contracts or letters of credit and foreign commercial assets and life insurance securitizations, none of which individually constitutes a material amount of our financial guaranty net par outstanding.

1. Credit Quality of Insured Portfolio (Risk in Force/Net Par Outstanding—Financial Guaranty)

The following table identifies the internal credit ratings we have assigned to our net par outstanding as of December 31, 2008 and 2007:

 

     December 31  
     2008     2007  

Credit Rating (1)

   Net Par
Outstanding
   Percent     Net Par
Outstanding
   Percent  
     ($ in billions)  

AAA

   $ 41.4    41.1 %   $ 49.1    42.3 %

AA

     17.3    17.2       17.5    15.1  

A

     17.7    17.6       24.6    21.2  

BBB

     20.8    20.7       23.4    20.2  

BIG (2)

     3.5    3.4       1.4    1.2  
                          

Total

   $ 100.7    100.0 %   $ 116.0    100.0 %
                          

 

(1) Represents our internal ratings estimates assigned to these credits utilizing our internal rating system. See “Risk Management—Financial Guaranty” below. Each rating within a letter category includes all rating grades within that letter category (e.g., “A” includes “A+,” “A” and “A-”).
(2) Below investment grade.

2. Geographic Distribution of Insured Portfolio (Risk in Force/Net Par Outstanding—Financial Guaranty)

The following table shows the geographic distribution of our financial guaranty net par outstanding as of December 31, 2008 and 2007:

 

     December 31  

State

   2008     2007  

Domestic Public Finance by State:

    

California

   5.7 %   6.2 %

Texas

   4.0     3.8  

New York

   3.6     5.1  

Pennsylvania

   2.8     2.8  

Florida

   2.5     3.0  

Illinois

   2.4     2.7  

New Jersey

   2.3     2.3  

Washington

   1.7     1.8  

Massachusetts

   1.7     2.1  

Colorado

   1.6     1.6  

Other domestic public finance

   15.5     17.3  
            

Total Domestic Public Finance

   43.8 %   48.7 %

Domestic Structured Finance

   34.6     31.9  

International Public and Structured Finance

   21.6     19.4  
            

Total Public and Structured Finance

   100.0 %   100.0 %
            

For each of the years ended December 31, 2008, 2007 and 2006, financial guaranty premiums written attributable to foreign countries were approximately 30.6% (20.8% excluding the 2008 FG Recaptures), 9.8% and 9.0%, respectively, of total financial guaranty premiums written.

 

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3. Largest Single Insured Risks (Risk in Force/Net Par Outstanding—Financial Guaranty)

The following table represents our 10 largest public finance single risks by net par outstanding (together representing 4.1% of financial guaranty’s total net par outstanding) as of December 31, 2008, along with the credit rating assigned as of that date to each credit:

 

Credit

   Credit
Rating (1)
   Obligation Type    Aggregate
Net Par Outstanding
as of
December 31, 2008
               (In millions)

State of California

   A-    General Obligation    $ 605

State of Washington (2)

   AA    General Obligation      435

City of Chicago, IL

   A+    General Obligation      433

Los Angeles Unified School District, CA (2)

   AA-    General Obligation      421

New Jersey Transportation Trust Fund Authority

   AA-    General Obligation      419

City of New York, NY

   AA-    General Obligation      408

Metropolitan Transportation Authority, NY (2)

   A    Revenue Obligation      370

Massachusetts School Building Authority

   AA    Tax-Backed      359

New Jersey Economic Development Authority School FAC

   AA-    General Obligation      344

Thames Water Utilities Finance PLC, U.K. (2)

   A-    Revenue Obligation      320
            
         $ 4,114
            

 

(1) Represents our internal ratings estimates for each issuer.
(2) We have additional exposure to several credits in the amounts indicated below on a second-to-pay basis, meaning that our obligation to pay timely principal and interest on insured bonds is secondary to another insurer. Therefore, we will not be required to pay claims on all or any portion of the additional exposure referenced below unless both the issuer and the other insurer fail to meet their payment obligations with respect to the insured bonds.
   

State of Washington: $0.7 million

   

Los Angeles Unified School District: $1.4 million

   

Metropolitan Transportation Authority: $0.3 million

   

Thames Water Utilities Finance PLC: $29.8 million

Our 10 largest structured finance single risks by net par outstanding represented $5.8 billion, or 5.8% of financial guaranty’s net par outstanding as of December 31, 2008. We have entered into each of these transactions through the issuance of a CDS. These risks include the following exposures:

 

   

The seven largest structured finance risks are synthetic corporate CDO transactions with non-managed, fixed or “static” portfolios, which means that the reference entities or obligations in the collateral pool cannot be substituted or otherwise replaced. Each of these seven transactions has a net par outstanding of $600.0 million as of December 31, 2008. These transactions are scheduled to mature in 2011 (one transaction), 2014 (one transaction) and 2017 (five transactions);

 

   

The eighth largest structured finance risk is a synthetic, static CDO of CMBS transaction, with a net par outstanding of $598.5 million, which is scheduled to mature in 2049;

 

   

The ninth largest structured finance risk is a synthetic, static corporate CDO transaction with a net par outstanding of $562.5 million, which is scheduled to mature in 2017; and

 

   

The tenth largest structured finance risk is a synthetic, static CDO of ABS transaction (with predominantly RMBS collateral) with a net par outstanding of $479.7 million, which is scheduled to mature in 2046.

 

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The nine largest structured finance single risks are each internally rated AAA, while the tenth largest structured finance single risk is internally rated CCC-, B+ by S&P and Ba2 by Moody’s. For additional information regarding the CDO of CMBS transaction and the CDO of ABS transaction included above, see “Structured Finance Insured CDO Portfolio” below.

4. Structured Finance Insured CDO Portfolio (Risk in Force/Net Par Outstanding—Financial Guaranty)

The following table shows the distribution of our CDO net par outstanding as of December 31, 2008:

 

Asset Class

   Total Exposure
(Net Par)
   % of CDO
Net Par
Outstanding
    % of Total
Net Par
Outstanding
 
     (In billions)             

Corporate CDOs (1)

   $ 38.0    83.3 %   37.7 %

TruPs

     2.2    4.8     2.2  

CDO of CMBS (2)

     1.8    4.0     1.8  

CDO of ABS (3)

     0.6    1.3     0.6  

Other (4)

     1.3    2.9     1.3  
                   

Subtotal

   $ 43.9    96.3 %   43.6 %

Assumed CDOs (5)

     1.7    3.7     1.7  
                   

Total CDOs

   $ 45.6    100.0 %   45.3 %
                   

 

(1) Includes one CDO squared transaction (a transaction of a master CDO with four sub-pools of corporate CDOs) scheduled to terminate in June 2009, in which we have $0.2 million in exposure through the four sub-pools. Also includes one second-to-pay corporate CDO transaction with a net par outstanding of $0.1 billion.
(2) For more information regarding this exposure, see “Directly Insured CDOs of Commercial Mortgage-Backed Securities and Asset-Backed Securities” below.
(3) Includes transactions that are predominantly CDOs of RMBS.
(4) Includes CLOs, second-to-pay trust preferred CDOs and one direct multisector CDO.
(5) Includes four transactions with net par outstanding of $0.2 billion that are not accounted for as derivatives.

The following table sets forth the ratings assigned to our CDO exposures as of December 31, 2008:

 

Ratings (1)

   # of CDO
Contracts/Policies
   Net Par
Outstanding
   % of CDO Net
Par Outstanding
 
          (In billions)       

AAA

   443    $ 38.8    85.0 %

AA

   46      4.4    9.7  

A

   17      0.7    1.6  

BBB

   13      1.1    2.4  

BIG (2)

   19      0.6    1.3  
                  

Total

   538    $ 45.6    100.0 %
                  

 

(1) Represents our internal ratings estimates. Each rating within a letter category includes all rating grades within that letter category (e.g., “A” includes “A+,” “A” and “A-”).
(2) Below investment grade.

 

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Directly Insured Corporate CDO Portfolio (Risk in Force/Net Par Outstanding—Financial Guaranty—Structured Finance Insured CDO Portfolio)

Our aggregate net par outstanding in our directly insured corporate CDO portfolio is $38.0 billion. We have $37.7 billion in aggregate net par outstanding through 102 directly insured corporate CDO transactions, with exposure to an aggregate of 929 corporate names. In addition, we directly insure one CDO squared transaction, with a net par outstanding of $0.2 billion, in which we have exposure to 296 corporate names. We also directly insure one second-to-pay corporate CDO, with a net par outstanding of $0.1 billion. All of our outstanding corporate CDOs are static pools, which means the covered reference entities generally cannot be changed without our consent.

The same corporate obligor may exist in a number of our corporate CDO transactions and may exist in our other structured finance obligations. However, the pool of corporate names in our directly insured corporate CDO portfolio is well diversified with no individual exposure to any corporate name exceeding 0.7% of our notional exposure to corporate entities in our directly insured corporate CDO portfolio as of December 31, 2008. As of December 31, 2008, our exposure to the five largest corporate names represented (measured by notional exposure) approximately 3.3% of our total aggregate notional exposure to corporate entities in our directly insured corporate CDO portfolio, compared to 3.1% as of December 31, 2007.

Because each transaction has a distinct level of subordination, credit events would typically have to occur with respect to numerous entities in a collateral pool before we would have an obligation to pay in respect of any particular transaction, meaning that our risk adjusted exposure to each corporate entity in a CDO pool is significantly less than our notional exposure. In the unlikely event that all of our five largest corporate obligors were to have defaulted at December 31, 2008, absent any other defaults in the CDOs in which these obligors were included, we would not have incurred any losses due to the significant subordination remaining in each transaction in which these entities were included.

The number of corporate entities in our directly insured corporate CDO transactions range between 79 and 151 per transaction, with the concentrations of each corporate entity averaging 1.3% per transaction. No corporate entity represented more than 2.1% of any one transaction. Our exposure to any single corporate name in any one transaction ranges from $2.5 million to $80.0 million, with an average of $26.4 million per transaction.

The following table summarizes the five largest industry concentrations in our financial guaranty directly insured corporate CDO portfolio as of December 31, 2008:

 

Industry Classification (1)

   % of Total
Notional
 

Telecommunications

   8.1 %

Insurance

   6.8  

Retailers (Excluding food and drug)

   6.1  

Financial Intermediaries

   5.9  

Utilities

   5.8  
      

Total of five largest industry concentrations

   32.7 %
      

 

(1) No industry represents more than 18.0% in any one transaction.

Our directly insured corporate CDO portfolio is highly rated with 98.0% of the transactions (representing 98.4% of the aggregate net par exposure of such portfolio), having subordination at or above the level of subordination necessary to warrant a AAA rating from S&P. Approximately one-third of our directly insured corporate CDO transactions (representing 37.5% of the aggregate net par exposure of our directly insured corporate CDO portfolio), has at least two times the subordination necessary to warrant a AAA rating from S&P.

 

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The amount of remaining subordination necessary to warrant a specific rating is determined using the most recent version of the CDO Evaluator tool published by S&P (as of December 31, 2008) to assist in the risk assessment of the CDO transactions. Ratings derived through this tool do not necessarily reflect our internal ratings for transactions or any of the ratings assigned to our insured tranches.

The number of sustainable credit events, which is the number of credit events on different corporate entities that would have to occur before we are obligated to pay a claim (i.e. the remaining subordination in our transaction measured in credit events), is another measure that is helpful in evaluating the credit strength of a transaction. The following table provides this information for our directly insured corporate CDO portfolio as of December 31, 2008, by year of scheduled maturity. In order to determine the number of different corporate entities that would be required to experience a credit event before we pay a claim, we calculate the weighted average net par exposure per corporate entity, then reduce such amount by an assumed recovery value of 30% (except with respect to transactions where we have agreed to a set fixed recovery, in which case we assume such fixed recovery), which then determines the estimated reduction of subordination that would occur for each applicable credit event. We then divide the aggregate subordination for the applicable transaction by the related reduction of subordination per credit to determine the applicable number of corporate entities that need to experience credit events before subordination in the transactions below our position would be reduced to zero.

 

Year of Scheduled
Maturity (1)

   Number of CDO
Contracts/

Policies (2)
   Aggregate Net
Par
Exposure (2)
   Initial Average
# of Sustainable
Credit
Events (3)
   Current Average #
of Sustainable
Credit
Events (4)
   Minimum # of
Sustainable
Credit
Events (5)
   Avg. # of
Current
Remaining
Entities in
Transaction
(2)(6)
          (In billions)                    

2009

   7    $ 1.0    12.1    11.0    4.4    123

2010

   7      1.3    14.8    12.3    5.9    124

2011

   3      1.5    39.1    36.8    28.7    100

2012

   16      5.9    25.5    23.5    10.9    105

2013

   36      15.2    31.9    29.8    13.9    100

2014

   16      6.5    29.6    27.6    11.3    99

2017

   17      6.3    26.0    24.0    13.0    100
                       

Total

   102    $ 37.7            
                       

 

(1) No directly insured corporate CDO transactions are scheduled to mature in 2015 or 2016. All of our directly insured corporate CDO transactions are scheduled to mature in or before December 2017.
(2) Excludes (a) one CDO squared transaction (a transaction of a master CDO with four sub-pools of corporate CDOs), scheduled to terminate in June 2009, with a net par outstanding of $0.2 billion and (b) a second-to-pay corporate CDO transaction, with a net par outstanding of $0.1 billion.
(3) The average number of sustainable credit events at the inception of each transaction. Average amounts presented are simple averages.
(4) The average number of sustainable credit events determined as of December 31, 2008. Average amounts presented are simple averages.
(5) The number of sustainable credit events for the one transaction with the fewest remaining sustainable credit events scheduled to mature in the year of scheduled maturity indicated. For example, for the 7 directly insured corporate CDO transactions scheduled to mature in 2009, our subordination level for one of those transactions would be eroded after 4.4 credit events in that transaction.
(6) The current average number of different corporate entities in each of the transactions.

In 2008, we experienced a decrease in the “Current Average Number of Sustainable Credit Events,” “Minimum Number of Sustainable Credit Events” and the “Average Number of Current Remaining Entities in Transaction,” in each case as described in the table above, primarily due to credit events in the financial services sector. Several notable financial and corporate institutions experienced credit events in the third and fourth quarters of 2008, including Fannie Mae, Freddie Mac, Lehman Brothers Holdings Inc., Washington Mutual,

 

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Glitnir Banki, hf, Kaupthing Bank hf, Landsbanki Island hf and Tribune Company. Despite these credit events, as of December 31, 2008, the Current Average Number of Sustainable Credit Events has declined only slightly. On average, this decline was only 1.9 sustainable credit events, meaning that for all of our outstanding directly insured corporate CDOs as of December 31, 2008, on average, we are only 1.9 credit events closer to paying a claim than we would be had these events not occurred in the third and fourth quarter of 2008. As of December 31, 2008, for any year of scheduled maturity, there remains at least 83.1% of the sustainable credit events existing at the inception of our policies. In light of the significant deterioration in economic conditions during the second half of 2008, we believe this is an indication of the resiliency of our directly insured corporate CDO portfolio.

Our directly insured corporate CDOs are carried at market value, and the credit spreads used in those valuations imply that further credit deterioration should occur. Deterioration beyond those anticipated market levels may decrease the estimated fair value of our directly insured corporate CDO portfolio, which could have a further negative impact on our results of operations. However, given the remaining subordination in our directly insured corporate CDO transactions and the remaining term of those transactions that have experienced the greatest deterioration of subordination, we do not currently expect any material claims with respect to our directly insured corporate CDO portfolio.

Directly Insured Primary Obligation Trust Preferred CDO Portfolio (Risk in Force/Net Par Outstanding—Financial Guaranty—Structured Finance Insured CDO Portfolio)

We provide credit protection on 13 directly insured TruPs CDOs in a first-to-pay position (“Direct TruPs CDOs”) representing an aggregate net par outstanding of $2.2 billion as of December 31, 2008. TruPs are deeply subordinated securities issued by banks and insurance companies, as well as Real Estate Investment Trusts and other financial institutions, to supplement their regulatory capital needs. Generally, the TruPs issued are subordinated to substantially all of an issuers debt obligations, but rank senior to the equity securities of such issuer. Our insurance, however, is generally issued on the senior classes of TruPs, and all of our Direct TruPs CDOs are currently rated investment grade by both S&P and Moody’s, with our weighted average internal rating for these transactions being A-.

Our Direct TruPs CDOs include 709 separate issuers, including 580 banking institutions (comprising 73.8% of the collateral in our Direct TruPs CDOs), 92 insurance companies (comprising 24.2% of the collateral in our Direct TruPs CDOs), and 37 other financial institutions, Real Estate Investment Trusts and CDO tranches (comprising the remaining 2.0% of the collateral in our Direct TruPs CDOs). The banking institutions in our collateral pool are well diversified geographically and are located in 49 states. Our Direct TruPs CDOs include between 59 and 125 issuers per transaction, with the concentrations of each issuer averaging 1.3% per transaction. No issuer concentration in our Direct TruPs CDOs is more than 1.7% in any one transaction. Our exposure to any issuer in any one Direct TruPs CDO transaction ranges from $0.1 million to $42.0 million, with an average per transaction of $13.1 million.

 

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The issuer of a TruPs often has the right to defer interest or dividend payments for up to five years before a failure to pay the expected interest or dividend will result in a default of the underlying bond. Since we believe there is a significant likelihood that TruPs that are currently in deferral status will ultimately result in a default, we closely monitor deferrals as well as defaults. The following table provides additional detail regarding the scheduled maturity, net par outstanding and subordination in each of our Direct TruPs CDOs as of December 31, 2008.

 

Direct
TruPs
CDOs

  

Maturity Date

   Net Par Outstanding    Current Subordination after
Defaults (1)
    Current Subordination after
Defaults and Deferrals (2)
 
          (In millions)             

1

   07/15/2011    $ 213.3    43.0 %   40.2 %

2

   09/21/2011      98.4    39.8     38.2  

3

   10/12/2011      288.0    41.6     38.8  

4

   11/30/2011      215.1    46.3     39.5  

5

   03/15/2012      317.9    47.0     44.8  

6

   08/04/2017      76.6    44.2     40.7  

7

   12/15/2017      189.1    44.6     40.8  

8

   09/26/2034      48.9    46.3     42.5  

9

   09/23/2035      89.2    45.5     42.6  

10

   12/23/2036      144.3    46.8     43.2  

11

   03/22/2037      139.4    44.6     42.6  

12

   12/23/2037      209.2    43.9     39.9  

13

   10/10/2040      164.0    47.1     45.2  
              

Total

      $ 2,193.4     
              

 

(1) Reflects the amount of remaining subordination expressed as a percentage of the collateral pool as of December 31, 2008, after giving effect to paydowns or redemptions (“amortization”) of the collateral and actual defaults assuming a loss for the full par amount of the underlying TruPs in the collateral pool.
(2) Reflects the amount of remaining subordination expressed as a percentage of the collateral pool as of December 31, 2008, after including the effect of amortization and actual defaults on the underlying bonds in the collateral pool and the effect of deferrals of payment on the underlying bonds in the collateral pool, assuming that any such deferral will ultimately result in a loss of the full par amount of the TruPs.

Directly Insured CDOs of Commercial Mortgage-Backed Securities and Asset-Backed Securities (Risk in Force/Net Par Outstanding—Financial Guaranty—Structured Finance Insured CDO Portfolio)

We have directly insured four CDOs of CMBS transactions, containing 127 CMBS tranches that were issued as part of securitizations. Of the 127 CMBS tranches in the collateral for our CDO of CMBS transactions, 22 of them were downgraded by Moody’s in February 2009 from Aaa to between Aa3 and A2. All of the downgraded collateral is contained in one transaction, which is currently rated A+ internally.

The following table provides information regarding our directly insured CDOs of CMBS exposure as of December 31, 2008:

 

Total Size

Of CDO
Collateral
Pool

  Radian
Outstanding
Exposure
  Internal
Rating
  Number of
Obligations
In CDO (1)
  Average Size of
Obligation In
CDO
  Average
Subordination of
Obligation (2)
    Total
Delinquencies
(Average of
Securitizations)
(3)
    Radian
Attachment
Point (4)
    Radian
Detachment
Point (4)
 
(In billions)   (In millions)           (In millions)                        
$2.4   $ 598.5   AAA   30   $ 80.0   21 %   0.9 %   5.1 %   30.0 %
1.9     450.0   AAA   27     72.0   31     1.1     6.8     30.0  
1.5     352.5   AAA   30     50.0   14     1.0     6.5     30.0  
1.0     430.0   A+   40     25.0   13     1.2     7.0     50.0  
                       
$6.8   $ 1,831.0     127          
                       

 

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(1) Represents the number of CMBS tranches that comprise the collateral pool for the applicable CDO of CMBS transaction.
(2) The average subordination incorporates principal paydowns and defaults.
(3) Delinquencies reflect the average percentage (of total notional) of CMBS which are delinquent. Even if all current delinquencies resulted in defaults, substantial subordination would remain.
(4) The “Attachment Point” is the percentage of losses in the collateral pool that must occur before we are obligated to pay a claim. The “Detachment Point” is the point where the percentage of losses reach a level where we cease to have an obligation to pay claims on additional losses. For example, a 7.0% attachment point on a $1.0 billion collateral pool means that we are not obligated to pay claims until there are $70.0 million of losses, and a 50% detachment point on the same obligation means that our obligation to pay claims for losses ceases when the transaction reaches an aggregate of $500 million of losses.

The total balance of the reference obligations in these collateral pools equals $6.8 billion. The loan collateral pool supporting our $1.8 billion of outstanding exposure to the CDOs of CMBS consists of approximately 15,000 loans with a balance of approximately $198 billion. The underlying loan collateral is well diversified both geographically and by property type. While there is some risk in CMBS securitizations that the underlying loan collateral cannot be refinanced when due (particularly in the current economic downturn), we believe that such risk in our portfolio, particularly given our current subordination levels, is limited given that only approximately 21% of the underlying loans will become due before 2014.

We have exposure to RMBS, including exposure to subprime RMBS, through two directly-insured CDOs of ABS as summarized in the following table.

 

    Collateral     Subordination  

Net Par

Outstanding

  RMBS (1)     CMBS     CDO of
ABS (2)
    CDO of
CDO
    Other     Total     Amount     % of
Collateral
(Attachment
Point)
    % of
Collateral
(Detachment
Point)
 
($ in millions)                                       ($ in millions)              
$150.0   64.8 %   0.0 %   0.0 %   0.0 %   35.2 %(3)   100 %   $ 78.0     13.0 %   38.0 %
$479.7   63.5 %   14.4 %   13.5 %   3.5 %   5.1 %   100 %     (4 )   (4 )   100 %

 

(1) Approximately 15.8% of the collateral in the $150 million transaction and 41.6% of the collateral in the $479.7 million transaction represents subprime RMBS.
(2) Includes CDOs which contain RMBS and CMBS.
(3) Includes 25.2% of ABS collateral other than RMBS and CMBS.
(4) Although the current attachment point equals $110.5 million (18.7%), we currently expect to pay claims on this transaction as discussed below.

We provide $479.7 million net par outstanding of credit protection on the senior-most tranche of a CDO of ABS transaction, where the underlying collateral consists of mezzanine tranches of predominately mortgage-backed securities. As of December 31, 2008, 54 RMBS credits and 20 CDOs of ABS credits (collectively representing $342.3 million (or 58.3%) of the $586.9 million collateral pool) had been downgraded by S&P or Moody’s and 30 of these credits, with a notional value of $136.2 million, have defaulted. The transaction, which is accounted for as a derivative, is currently internally rated CCC-, B+ by S&P and Ba2 by Moody’s. Due to substantial deterioration of the underlying collateral, which has accelerated over the past few quarters, and based on available projections, we currently expect that losses from the remaining collateral will exceed the remaining subordination. Based on current anticipated cash flows, we expect to begin paying unreimbursed claims related to interest shortfalls on this transaction in 2017 or later. Due to the structure of this transaction, we do not expect to begin paying claims related to the principal shortfall until sometime between 2036 and the legal final maturity date for the transaction in 2046. We currently believe that the ultimate principal payment with respect to this transaction will be less than the current outstanding par amount, but due to the long remaining life and nature of the collateral in this transaction, losses are difficult to estimate. Deterioration in economic conditions over the

 

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remaining life of the transaction beyond our current projections could have a material impact on the timing and amount of cash available to make interest and principal payments on our insured tranche, and therefore, our ultimate losses on this transaction could be greater than expected.

The $150.0 million CDO of ABS transaction is rated AAA internally as well as by S&P and Moody’s. While there has been some deterioration in the collateral pool for this transaction, 70% of the collateral pool remains rated in one of the two highest ratings categories by S&P and Moody’s and no credits in this transaction had defaulted. This transaction is scheduled to terminate in March 2010.

In addition, we have RMBS exposure in our directly insured CDO portfolio through one multi-sector CDO described below in “Other Directly Insured CDO Exposure.”

Other Directly Insured CDO Exposure (Risk in Force/Net Par Outstanding—Financial Guaranty—Structured Finance Insured CDO Portfolio)

We also have $1.3 billion in exposure related to other directly insured CDOs, including second-to-pay CLOs, second-to-pay TruPs CDOs and one multi-sector CDO. In a second-to-pay transaction, another financial guaranty insurer has insured the same risk for which we have provided credit protection, and we will not be obligated to pay a claim unless this insurer defaults on its insured obligation. The following table provides information regarding our other directly insured CDOs as of December 31, 2008:

 

Type of CDO

   Number of
Transactions
   Net Par
Outstanding
Amount
   Percentage of
CDO Net Par
Outstanding
    Weighted
Average
Rating
          (In billions)           

CLO (Direct) (1)

   1    $ —      —   %   AAA

CLO (Second-to-Pay) (2)

   4      0.8    1.8     AA+
                    

CLO Total

   5      0.8    1.8    

Multisector CDO (3)

   1      0.3    0.8     AAA

Second-to-Pay TruPs (4)

   3      0.2    0.4     A+
                    

Total CDO Other

   9    $ 1.3    3.0 %  
                    

 

(1) Our directly insured CDO transaction has less than $0.1 billion in net par outstanding and represents less than 0.1% of our CDO net par outstanding.
(2) Our internal ratings for these transactions range between AAA and AA-.
(3) This transaction is currently rated AAA internally. The collateral for this transaction consists of 45.1% of CDOs of investment-grade corporate obligations, 32.9% of RMBS (none of which is subprime), 17.0% of non-mortgage related ABS and 5.0% of CDOs of high-yield corporate obligations. None of the ABS in this transaction, including mortgage-backed obligations, have been downgraded or placed on negative watch by S&P or Moody’s as of December 31, 2008, and all of the RMBS collateral is rated at least A3 by Moody’s (or if not rated by Moody’s, A- by S&P). This transaction is scheduled to terminate in June 2009.
(4) Each of these transactions is scheduled to mature in 2033. Two of these transactions are rated AA internally and the third is rated A- internally.

 

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5. Non-CDO ABS Risk (Risk in Force/Net Par Outstanding—Financial Guaranty)

The following table shows the distribution of our $3.6 billion of net par outstanding related to ABS obligations outside of our insured CDO portfolio.

 

Type of Non-CDO Asset-Backed Security

   Net Par
Outstanding
Amount
   Percentage of
ABS Net Par
Outstanding
    Percentage of
Total Net Par
Outstanding
 
     (In billions)             

Consumer Assets

   $ 1.2    34.3 %   1.2 %

Commercial and other

     1.1    31.4     1.1  

RMBS Domestic

     1.0    28.6     1.0  

RMBS International

     0.3    5.7     0.3  
                   

RMBS Total

     1.3    34.3     1.3  
                   

Total ABS

   $ 3.6    100.0 %   3.6 %
                   

At December 31, 2008, our ABS portfolio, both directly insured and assumed as reinsurance, included approximately $1.0 billion of net par outstanding related to non–CDO domestic RMBS exposure, which consists of 272 transactions. Approximately 33.9% of this exposure is subprime RMBS, as indicated in the table below. We have not directly insured any non-CDO RMBS since 2004. We do not have any financial guaranty exposure to CMBS outside of CDOs that we insure.

The following table provides additional information regarding our exposure to domestic RMBS in our non-CDO portfolio as of December 31, 2008.

 

Types of RMBS

Exposure By
Product

  Total Net
Par
Outstanding
  Net Par Outstanding   % of U.S.
Domestic
Non-
CDO RMBS
Portfolio
    2006/2007
Vintage %
  % of Net Par Outstanding by Rating
    Direct   Assumed (1)       AAA *   AA *   A *   BBB *   BIG (2)*
        ($ in millions)                                  

Subprime

  $ 352.2   $ 122.2   $ 230.0   33.9 %   10.5/33.1   16.9   0.3   3.1   0.1   79.6

Prime

    267.6     122.5     145.1   25.8     6.2/33.2   59.3   9.1   7.6   12.9   11.1

Alt-A

    369.6     72.6     297.0   35.6     26.2/33.2   46.6   6.1   3.6   8.3   35.4

Second-to-Pay

    48.5     —       48.5   4.7     4.3/95.7   21.0   5.2   0.0   6.1   67.7
                                   

Total RMBS

  $ 1,037.9   $ 317.3   $ 720.6   100.0 %   14.8/35.7   38.6   4.9   4.3   6.6   45.6
                                   

 

* Ratings are based on our internal ratings estimate for these transactions.
(1) As of December 31, 2008, we had approximately $180 million of exposure to home equity lines of credit (including $40 million to subprime and $60 million to Alt-A), all of which was assumed from our primary financial guaranty reinsurance customers.
(2) Below investment grade. All below investment grade exposure is on our Watch List and reserves have been established for these transactions as necessary.

 

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6. Reinsurance Exposure (Risk in Force/Net Par Outstanding—Financial Guaranty)

As of December 31, 2008, we had assumed approximately $36.9 billion in exposure from our primary reinsurance customers, compared to $49.9 billion as of December 31, 2007. The decline in assumed net par outstanding in 2008 was primarily due to the 2008 FG Recaptures. See the section immediately above for a discussion of assumed ABS exposure. The following table summarizes the distribution of our assumed net par outstanding by type of issue and as a percentage of our assumed net par outstanding as of December 31, 2008:

 

Types of Reinsurance Obligations

   2008  
     Amount    Percent  
     (In millions)       

Public Finance:

     

General obligation and other tax-supported

   $ 14.8    40.1 %

Water/sewer/electric/gas and other investor-owned utilities

     6.8    18.4  

Airports/transportation

     4.3    11.6  

Healthcare and long-term care

     3.6    9.8  

Education

     0.8    2.2  

Housing revenue

     0.5    1.4  

Other municipal (1)

     0.9    2.4  
             

Total public finance

     31.7    85.9  
             

Structured Finance:

     

Asset-backed obligations (2)

     2.8    7.6  

Collateralized debt obligations

     1.7    4.6  

Other structured (3)

     0.7    1.9  
             

Total structured finance

     5.2    14.1  
             

Total

   $ 36.9    100.0 %
             

 

(1) Includes other types of municipal obligations, none of which individually constitutes a material amount of our assumed net par outstanding.
(2) Includes mortgages and mortgage-backed securities, consumer and commercial and other asset-backed securities.
(3) Includes other types of structured finance obligations, none of which individually constitutes a material amount of our assumed net par outstanding.

7. Financial Guaranty Exposure Currently Subject to Recapture or Termination (Risk in Force/Net Par Outstanding—Financial Guaranty)

As a result of S&P’s downgrades of our financial guaranty insurance subsidiaries in June and August 2008, $75.6 billion of our net par outstanding as of December 31, 2008 remains subject to recapture or termination at the option of our primary reinsurance customers, our credit derivative counterparties or other insured parties.

All but one of our reinsurance customers has the right to take back or recapture business previously ceded to us under their reinsurance agreements with us, and in some cases, in lieu of recapture, the right to increase ceding commissions charged to us. As of December 31, 2008, up to $36.7 billion of our total net assumed par outstanding was subject to recapture. If all of this business was recaptured as of December 31, 2008, we estimate that we would have experienced a reduction in (1) written premiums of approximately $312.8 million, (2) earned premiums of approximately $52.2 million, and (3) the net present value of expected future installment premiums of $142.3 million. In addition, we would have experienced a reduction in incurred losses of up to $94.9 million if this business were recaptured. We would be required to return written premiums (less commissions) and possibly a portion of our reserves, if this business were recaptured.

The counterparty in two of our synthetic CDO transactions, with an aggregate net par outstanding of $293.3 million ($243.0 million of which is scheduled to terminate in June 2009), has the right to terminate these

 

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transactions with settlement on a mark-to-market basis, subject to a maximum payment amount as of December 31, 2008 of approximately $34.1 million in the aggregate. In addition, we also have $103.2 million in exposure to another synthetic CDO transaction which is scheduled to terminate in June 2009. This transaction may be terminated on a mark-to-market basis if S&P lowers Radian Asset Assurance’s financial strength rating below investment grade (BBB-).

As of December 31, 2008, the counterparties to 147 of financial guaranty’s transactions currently have the right to terminate these transactions without our having an obligation to settle the transaction on a mark-to-market basis. If all of these counterparties had terminated these transactions as of December 31, 2008, our net par outstanding would have been reduced by $38.6 billion, with a corresponding decrease in unearned premium reserves of $12.0 million (of which only $0.4 million would be required to be refunded to counterparties) and the present value of expected future installment premiums of $168.0 million. If all these transactions were terminated, we do not believe it would have a material impact on our financial condition or results of operations.

III. Defaults and Claims

We establish reserves to provide for losses and the estimated costs of settling claims in both our mortgage insurance and financial guaranty businesses. Setting loss reserves in both businesses involves significant use of estimates with regard to the likelihood, magnitude and timing of a loss. We have determined that the establishment of loss reserves in our businesses constitutes a critical accounting policy. Accordingly, a detailed description of our policies is contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies—Reserve for Losses” included in Item 7 below and in Notes 2 and 10 of Notes to Consolidated Financial Statements.

A. Mortgage Insurance (Defaults and Claims)

The default and claim cycle in our mortgage insurance business begins with our receipt of a default notice from the insured lender. A “default” is defined under our master policy as a borrower’s failure to make a payment equal to or greater than one monthly regular payment under a loan. Generally, our master policy of insurance requires the insured to notify us of a default within 15 days of (1) the loan’s having been in default for three months, or (2) the occurrence of an early default in which the borrower fails to make any one of the initial 12 monthly payments under a loan so that an amount equal to two monthly payments has not been paid.

Defaults, whether voluntary or involuntary, can occur due to a variety of factors, including death or illness, divorce or other family problems, unemployment, inability to manage credit, overall changes in economic conditions, housing value changes that cause the outstanding mortgage amount to exceed the value of the home or other events. Depending on the type of loan, defaults also may be caused by rising interest rates or an accumulation of negative amortization. Involuntary defaults are those that occur due to factors generally outside the control of the borrower (e.g., job loss, unexpected interest rate changes or in the event of death). Voluntary defaults are those where the borrower willingly walks away from his or her mortgage obligation despite the ability to continue to pay. These types of defaults often are caused by significant negative changes in property values where the borrower makes an investment decision not to continue with a mortgage that exceeds the value of the home. This problem is exacerbated by the fact that many borrowers in the recent past were not required to pay closing costs or make a significant down payment on their homes, leaving these borrowers with little incentive to remain in their homes when values have depreciated. In addition, we believe that some borrowers may be voluntarily defaulting on their mortgages to take advantage of many of the loan modification programs that recently have been announced or implemented to help stem the rising number of defaults and foreclosures. Although it is difficult to track and confirm, we believe that voluntary defaults, which are commonly referred to as “moral hazard” defaults, could represent a portion of new defaults in our mortgage insurance business.

 

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The following table shows the number of primary and pool loans that we have insured, the related loans in default and the percentage of loans in default as of the dates indicated:

 

     December 31  
     2008     2007     2006  

Primary Insurance:

      

Prime

      

Number of insured loans in force

   692,135     630,352     563,144  

Number of loans in default (1)

   51,267     25,339     18,441  

Percentage of loans in default

   7.4 %   4.0 %   3.3 %

Alt-A

      

Number of insured loans in force

   149,439     172,085     133,633  

Number of loans in default (1)

   35,706     16,763     7,995  

Percentage of loans in default

   23.9 %   9.7 %   6.0 %

A Minus and below

      

Number of insured loans in force

   81,504     92,600     89,037  

Number of loans in default (1)

   23,580     18,746     16,264  

Percentage of loans in default

   28.9 %   20.2 %   18.3 %

Total Primary Insurance

      

Number of insured loans in force

   923,078     895,037     785,814  

Number of loans in default (1)

   110,553 (2)   60,848 (2)   42,700 (2)

Percentage of loans in default

   12.0 %   6.8 %   5.4 %

Pool Insurance:

      

Number of loans in default (1)

   32,677 (3)   26,526 (3)   18,681 (3)

 

(1) For reporting and internal tracking purposes, we do not consider a loan to be in default until the loan has been in default for 60 days. Accordingly, the amounts represented in this table exclude loans that are 60 or fewer days past due, in each case as of December 31 of each year.
(2) Includes 539, 2,595 and 1,161 defaults at December 31, 2008, December 31, 2007 and December 31, 2006, respectively, where reserves have not been established because no claim payment is currently anticipated on such loans.
(3) Includes 21,719, 20,193 and 13,309 defaults at December 31, 2008, 2007 and 2006, respectively, where reserves have not been established because no claim payment is currently anticipated on such loans.

We generally do not establish reserves for loans that are in default if we do not believe we will be liable for the payment of a claim with respect to that default. For example, for those defaults in which we are in a second-loss position, we calculate what the reserve would have been if there had been no deductible. If the existing deductible is greater than the reserve amount for any given default, we do not establish a reserve for the default.

The default rate in our mortgage insurance business is subject to seasonality. Historically, our mortgage insurance business experiences a fourth quarter seasonal increase in defaults.

Regions of the U.S. may experience different default rates due to varying economic conditions. The following table shows the primary mortgage insurance default rates by our defined regions as of the dates indicated, including prime and non-prime loans:

 

     December 31  
     2008     2007     2006  

South Atlantic

   15.38 %   7.44 %   5.11 %

Pacific

   14.02     5.95     2.81  

New England

   12.74     8.16     6.65  

East North Central

   12.07     8.50     7.72  

Mountain

   11.44     4.79     3.27  

Mid-Atlantic

   10.80     6.80     5.75  

West North Central

   9.40     6.29     5.53  

East South Central

   9.02     6.37     5.82  

West South Central

   7.81     5.58     5.68  

 

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As of December 31, 2008, the two states with the highest primary mortgage insurance default rates were Florida and Nevada, at 23.4% and 19.5%, respectively. We believe that the higher default rates in both of these states are attributable to declining home values which are significantly higher than the national average. These states continue to be challenged by a large inventory of new housing as a result of significant investor speculation during recent periods of home price appreciation in these states.

Mortgage insurance claim volume is influenced by the circumstances surrounding the default. The rate at which defaults cure, and therefore do not go to claim, depends in large part on a borrower’s financial resources and circumstances, local housing prices and housing supply (i.e., whether borrowers may cure defaults by selling the property in full satisfaction of all amounts due under the mortgage), interest rates and regional economic conditions. In our first-lien mortgage insurance business, the insured lender is required to complete foreclosure proceedings and obtain title to the property before submitting a claim. It can take anywhere from three months to five years for a lender to acquire title to a property through foreclosure, depending on the state. On average, we do not receive a request for claim payment until 12 to 18 months following a default on a first-lien mortgage. In our second-lien business, we typically are required to pay a claim much earlier, within approximately 150 days of a borrower’s missed payment.

Claim volume in our mortgage insurance business is not evenly spread throughout the coverage period of our insurance in force. Historically, most claims under mortgage insurance policies on prime loans occurred during the third through fifth year after issuance of the policies, and on non-prime loans during the second through fourth year after issuance of the policies. After those peak years, the number of claims that we receive historically has declined at a gradual rate, although the rate of decline can be affected by macroeconomic factors. Approximately 62.5% of our primary risk in force, including most of our risk in force on non-prime products, and approximately 18.6% of our pool risk in force at December 31, 2008 had not yet reached its historical highest claim frequency years. At December 31, 2007, the comparable amounts were 67.2% and 37.1%, respectively. The business we originated in 2008 and 2007 has experienced claim activity much sooner than has been the case for prior years. Because it is difficult to predict both the timing of originating new business and the run-off 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 following table shows cumulative claims paid by us on our primary insured book of business at the end of each successive year after the year of original policy issuance, referred to as a “year of origination,” expressed as a percentage of the cumulative premiums written by us in each year of origination:

Claims Paid vs. Premiums Written—Primary Insurance

 

Year of Origination

   End of
1st year
    End of
2nd year
    End of
3rd year
    End of
4th year
    End of
5th year
    End of
6th year
    End of
7th year
    End of
8th year
 

2001

   0.4 %   10.7 %   29.5 %   46.9 %   54.2 %   57.8 %   60.0 %   61.5 %

2002

   0.5 %   8.5 %   23.4 %   32.3 %   37.0 %   40.7 %   42.8 %  

2003

   0.4 %   7.3 %   17.1 %   23.0 %   28.0 %   31.1 %    

2004

   0.6 %   6.6 %   15.8 %   28.0 %   38.9 %      

2005

   0.3 %   6.0 %   24.7 %   58.9 %        

2006

   0.9 %   13.1 %   45.4 %          

2007

   0.5 %   9.8 %            

2008

   0.2 %              

Policy year 2001 was negatively impacted by poor credit performance on our structured business, primarily related to one subprime mortgage lending customer. Policy years 2003 and 2004 have developed better than anticipated due to significant home price appreciation and a liquid refinance market during the years following issuance of these policies. Business written in the latter half of 2005 contains a significant amount of poorly underwritten business generated by subprime and Alt-A customers due to the strong demand for mortgage product to populate mortgage-backed securities. The 2006 and 2007 business continued that trend, and also

 

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contains higher LTV loans. The 2005 through 2007 policy years are expected to contain substantially higher ultimate loss ratios than in previous policy years. In light of underwriting guideline changes we made late in 2007 and throughout 2008, we expect policy year 2008 to outperform the previous policy years, despite the uncertainty around future home price appreciation and mortgage credit markets. The 2008 policy year contains predominantly prime borrowers with higher FICO scores and lower LTV ratios than any of the previous policy years.

In addition to claim volume, another significant factor affecting losses is claim severity. The severity of a claim is determined by dividing the claim paid by the original loan amount. The main determinants of the severity of a claim are the size of the loan, the amount of mortgage insurance coverage placed on the loan, and the impact of our loss management activities with respect to the loan. Pre-foreclosure sales, acquisitions and other early workout efforts help to reduce overall claim severity. The average claim severity for loans covered by our primary insurance was 27.6% for 2008, compared to 27.5% in 2007 and 26.4% in 2006.

The following table shows claims paid information for primary mortgage insurance for the periods indicated:

 

     Year Ended December 31
     2008    2007
     (In thousands)

Direct claims paid:

     

Prime

   $ 310,965    $ 166,967

Alt-A

     210,700      107,672

A minus and below

     211,612      152,670

Second-lien

     182,872      90,799
             

Total

   $ 916,149    $ 518,108
             

Average claim paid:

     

Prime

   $ 40.9    $ 31.8

Alt-A

     54.8      45.4

A minus and below

     39.0      33.8

Second-lien

     35.5      32.4

Average claim paid on all products

     41.6      34.7

States with highest claims paid (1st lien):

     

California

   $ 115,947    $ 21,158

Michigan

     68,761      49,806

Florida

     45,649      14,724

Ohio

     44,469      40,689

Georgia

     44,313      30,364

Claims paid in California and Florida have increased significantly as home price depreciation in those states has been at a much higher level than the national average. 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 in those areas. A much higher level of claims exist in Michigan, as problems with the domestic auto industry and related industries have depressed economic growth, employment and housing prices in that state.

B. Financial Guaranty (Defaults and Claims)

The patterns of claim payments in our financial guaranty business tend to fluctuate and may be low in frequency and high in severity. In the event of default, payments under a typical financial guaranty insurance policy that we provide or reinsure may not be accelerated without our or the primary insurer’s approval. Without such approval, the policyholder is entitled to receive payments of principal and interest from us or the primary insurer on their regularly scheduled dates as if no default had occurred. We or the primary insurer often have remedies against other parties to the transaction, which may be exercised both before and after making any necessary payment.

 

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In our direct financial guaranty business, and with respect to some of the mortgage-backed securities insured by our mortgage insurance business, we typically are obligated to pay claims in an amount equal to defaulted payments on insured obligations on their respective due dates. Normally, these defaulted payments consist of current interest and principal upon the legal maturity of the obligation. However, in certain of the mortgage-backed securities we insure, we may become obligated to pay principal on scheduled principal due dates or to the extent the outstanding principal balance of the insured obligation exceeds the value of the collateral insuring such obligations for a specified number of reporting periods.

In our synthetic corporate CDO transactions, losses arise upon the occurrence of a credit event (i.e., bankruptcy, a failure to pay or certain restructuring of debt) set forth in our agreement with respect to a covered corporate entity or money borrowed by such defaulting entity. Once a loss arises, we typically are obligated to pay a claim in an amount equal to the decrease in market value below par (100% of the outstanding principal amount we have agreed to insure) of a senior unsecured corporate bond selected by our counterparty in accordance with specific criteria set forth in our agreement, but only to the extent that the aggregate of all such loss amounts exceeds an agreed upon amount of subordination.

In our financial guaranty reinsurance business, claim payments due to the ceding companies are typically settled net of premiums payable to us.

The following table shows financial guaranty’s incurred losses and claims paid by category for each period indicated:

 

     Year Ended December 31  
     2008     2007  
     (In thousands)  

Incurred losses:

    

Public finance direct

   $ 10,619     $ 4,577  

Public finance reinsurance

     8,907       4,467  

Structured finance direct

     (3,426 )     111,634  

Structured finance reinsurance

     108,203       (6,177 )

Trade credit reinsurance

     (9,808 )     (16,511 )
                

Total

   $ 114,495     $ 97,990  
                

Claims Paid:

    

Public finance direct

   $ 690     $ 2,127  

Public finance reinsurance

     7,667       212  

Structured finance direct

     100,036       9,733  

Structured finance reinsurance

     20,579       12,191  

Trade credit reinsurance

     3,440       8,579  
                

Total

   $ 132,412     $ 32,842  
                

IV. Loss Management

A. Mortgage Insurance (Loss Management)

In 2008, we continued to add significant resources to our mortgage insurance loss management department in order to better manage losses in the uncertain housing market and rising claim environment. Our loss management function consists of approximately 92 full-time employees dedicated to minimizing claim payment, representing a 46% increase in the number of full time loss management employees from 2007. Loss management pursues opportunities to mitigate losses both before and after claims are received.

 

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In our traditional mortgage insurance business, upon receipt of a valid claim, we generally have the following three settlement options:

 

  (1) Pay the maximum liability—determined by multiplying the claim amount (which consists of the unpaid loan principal, plus past due interest and certain expenses associated with the default) by the applicable coverage percentage—and allow the insured lender to keep title to the property;

 

  (2) Pay the amount of the claim required to make the lender whole, commonly referred to as the “deficiency amount” (not to exceed our maximum liability) following an approved sale; or

 

  (3) Pay the full claim amount and acquire title to the property.

In general, we base our selection of a settlement option on the value of the property. In 2008, we settled 92% of claims by paying the maximum liability (compared to 86% of claims in 2007), 7% by paying the deficiency amount following an approved sale (compared to 13% of claims in 2007) and less than 1% by paying the full claim amount and acquiring title to the property (also less than 1% in 2007). Declining property values in many regions of the U.S. during 2007 and 2008 have made our loss management efforts more challenging. If property values continue to further decline, our ability to mitigate losses could be adversely affected, which could have an adverse effect on our business, financial condition and operating results.

For pre-claim default situations, our loss management specialists focus on the following activities to reduce losses:

 

   

Communication with the insured or the insured’s servicer to ensure the timely and accurate reporting of default information;

 

   

Prompt and appropriate responses to all loss mitigation opportunities presented by the mortgage servicer (including short sale requests); and

 

   

Proactive communication with the borrower, realtor or other individuals involved in the loss mitigation process to maximize results and to increase the likelihood of a completed loss mitigation transaction.

After a claim is received and/or paid, our loss management specialists focus on:

 

   

A review to ensure that program compliance and our master policy requirements have been met;

 

   

Analysis and prompt processing to ensure that valid claims are paid in an accurate and timely manner;

 

   

Responses to real estate owned (“REO”) loss mitigation opportunities presented by the insured;

 

   

Aggressive management and disposal of acquired real estate; and

 

   

Post-claim payment activities to maximize recoveries on various products including, when appropriate, the pursuit of deficiencies through subrogation and/or acquired rights.

In addition, in response to market conditions, we have recently launched a strategy where we advance to the servicer 15% of our claim responsibility, up to $15,000, to use as necessary, in order to cure a defaulted loan. We expect to expand this program in 2009.

Another strategy we recently implemented involves utilizing a third party, Consumer Credit Counseling of the Delaware Valley, to provide credit counseling and other services to our defaulted borrowers. We also built and deployed a borrower education website during 2008 and recently expanded it to allow for the collection of borrower financial information in order to allow us to facilitate modifications with servicers on our insured loans.

We are also participating in large scale modification programs being led by Federal Housing Finance Agency (“FHFA”), several top 10 mortgage servicers and numerous borrower outreach campaigns being conducted by HOPE NOW, of which we are a member. See “Regulation—Federal Regulation—Indirect Regulation” below for information regarding recent modification programs.

 

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Other units within our loss management department contribute additional risk management services. One unit is responsible for identifying and investigating insured loans involving non-compliance with the terms of our master policy of insurance (or commitment letter for structured transactions) to ensure that claims are ultimately paid, as agreed, only upon valid and insurable risks. Much of our effort involves the identification, investigation and reporting of mortgage fraud schemes that impact our losses. We coordinate our activities with legal counsel, law enforcement and fraud prevention organizations, and work to promote mortgage fraud awareness, detection and prevention among our personnel and client lenders. If a claim fails to comply with our master policy, fails to comply with our underwriting guidelines or contains misrepresentations (mortgage fraud), we may rescind the insurance policy or deny the claim. During 2008, the number of claims that we rescinded increased significantly.

Another unit manages counterparty risk by examining operational risk, completing underwriting reviews, and performing ongoing surveillance of our lender clients. During 2008, we began placing experienced loss mitigation personnel on-site with our servicing partners to improve communication and workflow, allowing us to act more quickly to reduce loss exposure. We also created a Servicer Advocacy Group which includes field- based representatives of loss management who make regular visits to our servicing partners to improve communication and better implement our programs that could mitigate losses.

B. Financial Guaranty (Loss Management)

The risk management function in our financial guaranty business is responsible for the identification, analysis, measurement and surveillance of credit, market, legal and operational risk associated with our financial guaranty insurance contracts. Risk management is also responsible for claims prevention and loss mitigation strategies. This discipline is applied at both the point of origination of a transaction and during the on-going monitoring and surveillance of each exposure in the portfolio. The risk management function is structured by area of expertise and includes the following areas: risk analytics; public finance; structured finance; and portfolio management (each is more fully described below).

Our public finance and structured finance groups utilize several tools to monitor our directly insured portfolio. For each transaction, we require the regular delivery of periodic financial information and in most cases, covenant compliance reports that are reviewed by the risk manager assigned to the particular credit. Each risk manager prepares regular periodic (usually annually or biennially depending on the continued credit quality of the transaction) written surveillance reports for each credit which contain in depth financial analysis of the credits together with the manager’s internal rating for the transaction. Observed deterioration in the performance of a credit may prompt additional and more frequent review. Upon continued performance deterioration, the risk manager, in consultation with senior management, may downgrade the internal credit rating for a credit or if appropriate, move the credit to the financial guaranty Watch List. All amendments, consents and waivers related to a transaction are also the primary responsibility of the appropriate risk manager. In addition to individual credit analysis, these teams are responsible for following economic, environmental and regulatory trends and for determining their potential impact on the insured portfolio.

We monitor not only the nominal exposure for each obligor for which we provide protection in our corporate CDO transactions, but also risk-adjusted measures, taking into account, among other factors, our assessment of the relative risk that would be represented by direct exposure to the particular obligor and the remaining subordination in the transactions in which we are exposed to a particular obligor. We have $12.5 million of exposure to our affiliate, C-BASS, as collateral under one TruPs CDO, which constitutes an insignificant portion of such collateral pool.

The portfolio management group oversees all portfolio level analysis and reporting of our insured financial guaranty portfolio. This group is also primarily responsible for the analysis of our assumed financial guaranty portfolio and the oversight of the credit risk relationship with our reinsurance customers. The head of the portfolio management team directs the “Watch and Reserve” process (which is more fully described below), and chairs the quarterly Watch and Reserve meetings, at which reserve recommendations are made on the portfolio.

 

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The risk analytics team is responsible for the analysis of market risk factors and their impact on economic capital. Key market risk factors, including interest-rate risk and credit spreads, are assessed on an individual credit and insured portfolio basis. The risk analytics team has developed quantitative tools and models to measure these risks which incorporate the risk assessments and internal ratings assigned by each of the teams within risk management. We use an internal economic capital methodology to attribute economic capital to each individual credit exposure within our insured portfolio. This methodology relies heavily on our ability to quantify the individual risks of default and prepayment underlying each transaction in our insured portfolio. Economic capital is also the basis for calculating risk-adjusted returns on our capital (“RAROC”), which allows us to establish criteria for weighing the credit risk relative to the premium received.

In our financial guaranty reinsurance business, the primary obligation for assessing and mitigating claims rests with our ceding reinsurance customers. To help align the ceding company’s interests with ours, we generally have required that the ceding company retain a portion of the exposure on any single risk that we reinsure. Our portfolio management group is responsible for the periodic diligence and evaluation of the underwriting and surveillance capabilities of the ceding companies. This evaluation includes an in depth review of the following areas: business strategy; underwriting approach and risk appetite; sector specific surveillance strategies; watch and reserve processes and procedures and reinsurance strategies. Each of the ceding companies provides us with quarterly updates to their watch and reserve lists, including reserve information. In the event that we have identified a potential deficiency in the surveillance activities of a ceding company, appropriate personnel in our risk management department may conduct an independent analysis to the extent adequate information is available. We also may have an independent view on assumed credits where we also have direct exposure based on the information obtained through our independent credit review. As a result, we may assess credits and establish reserves based upon information in addition to that received from the ceding company.

Our board of directors has formed a Credit Committee of independent directors to assist the board in its oversight responsibilities for our credit risk management policies and procedures, including heightening board-level awareness of the impact of developing risk trends in our portfolio. Our risk management group updates this committee, no less frequently than on a quarterly basis, on all aspects of risk management, including portfolio/sector analysis, economic capital trends, risk management policy enhancements and Watch and Reserve Committee recommendations and decisions.

The financial guaranty business has a Watch and Reserve Committee that meets quarterly to review under-performing credits and establish reserves for transactions as recommended by the appropriate risk manager. The Committee is chaired by the head of the portfolio management group and includes senior management, credit, legal and finance personnel from both the financial guaranty business and Radian Group. Our risk management processes and procedures address both performing and under-performing transactions. Performing transactions are assigned investment-grade internal ratings, denoting nominal to moderate credit risk. When our risk management department concludes that a directly insured transaction should no longer be considered performing, it is placed in one of three designated categories for deteriorating credits: Special Mention, Intensified Surveillance or Case Reserve. Assumed exposures in financial guaranty’s reinsurance portfolio are generally placed in one of these categories if the primary insurer for such transaction downgrades it to an equivalent watch list classification. However, if our financial guaranty risk management group disagrees with the risk rating assigned by the ceding company, we may assign our own risk rating rather than using the risk rating assigned by the ceding company.

Special Mention. This category includes insured transactions that are internally rated no more than two rating levels below investment grade upon the observation and analysis of financial or asset performance deterioration by the appropriate risk manager. Although these insured transactions typically are not performing as expected, we have determined that such transactions are not expected to have severe, prolonged stress and we do not believe that claim payments are imminent. The credits in this category could have all or some of the following characteristics:

 

   

Speculative grade obligations with increasing credit risk, but with the possibility of recovering and returning to investment grade levels;

 

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Slight probability of payment default due to current adverse economic conditions and operating challenges;

 

   

Limited capacity for absorbing volatility and uncertainty; vulnerability to further downward pressure which could lead to difficulty in covering future debt obligations; and

 

   

Requires additional monitoring by the risk manager to evaluate developing, potentially adverse credit trends.

Once a risk manager detects some or all of these characteristics, the risk manager makes a recommendation to place the credit in this category to the portfolio management group and the respective risk management group. Direct and assumed exposures in this category are typically reviewed annually or more frequently if there is a change to the credit profile.

Due to the additional efforts involved in monitoring Special Mention credits, consultants and/or legal counsel may be engaged to assist in claim prevention or loss mitigation strategies. As a result, loss adjustment expense (“LAE”) reserves are occasionally posted for exposures on this list where such third parties are engaged.

Intensified Surveillance. This category includes transactions in financial guaranty’s insured portfolio that are internally rated below investment grade and indicates a severe and often permanent adverse change in the transaction’s credit profile. Transactions in this category are still performing, meaning they have not yet defaulted on a payment, but our risk management department has determined that there is a substantial likelihood of default. Transactions that are placed in this category may have some or all of the following characteristics:

 

   

Speculative grade transactions with high credit risk and low possibility of recovery back to performing levels;

 

   

Impaired ability to satisfy future payments;

 

   

Debtors or servicers with distressed operations that we believe have a questionable ability to continue operating in the future without external assistance from government and/or private third parties;

 

   

Requires frequent monitoring and risk management action to prevent and mitigate possible claims; and

 

   

Requires the allocation of claim liability reserves.

Insured transactions are generally elevated into this category from the Special Mention list as a result of continuing declining credit trends. Occasionally, however, transactions may enter this category due to an unexpected financial event that leads to rapid and severe deterioration. Direct and assumed exposures in this category are generally reviewed and reported on quarterly.

Consultants and/or legal counsel are regularly engaged in connection with these transactions to assist in claim prevention and loss mitigation strategies due to the remediation efforts necessary to prevent or minimize losses. As a result, LAE reserves are regularly posted for these exposures in addition to claim liability reserves.

Case Reserve. This category consists of insured transactions where a payment default on the insured obligation has occurred. LAE reserves are normally required as remediation efforts often continue for credits classified at this level to mitigate claims. Direct and assumed exposures in this category are generally reviewed and reported on quarterly. Case reserves are established for all non-derivative transactions on this list.

In our directly insured financial guaranty business, we establish loss and LAE reserves on our non-derivative financial guaranty contracts based upon the recommendation by the risk manager responsible for the transaction. Such recommendations are generally made for Intensified Surveillance and Case Reserve credits. For Intensified Surveillance credits, the risk manager may recommend a reserve if he or she has determined a default is likely and if the severity of loss upon default is quantifiable. Once a default occurs, a case reserve is

 

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established that reflects anticipated future claims. The assumptions used to recommend reserves for directly insured credits are based upon the analysis performed by the risk manager as more fully described above. In our financial guaranty reinsurance business, the primary obligation for assessing and mitigating claims rests with the ceding company. We establish reserves for our assumed Watch List credits based upon information provided by the ceding company. Expected losses on derivative financial guaranty contracts are recorded in change in fair value of derivative instruments.

As discussed in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies,” the reserving policies used by the financial guaranty industry will be impacted by the adoption of SFAS No. 163, “Accounting for Financial Guarantee Insurance Contracts, an interpretation of Financial Accounting Standards Board (“FASB”) Statement No. 60” (“SFAS No. 163”).

As soon as our risk management department detects a problem, it works with the appropriate parties in an attempt to avoid a default or to minimize the claims that we may be obligated to pay on our policy. Loss mitigation can consist of:

 

   

restructuring the obligation;

 

   

enforcing available security arrangements;

 

   

working with the issuer to work through or to find alternatives mitigating the impact of management or potential political problems;

 

   

when appropriate, exercising applicable rights to replace problem parties; and

 

   

when appropriate, purchasing the insured obligation.

Issuers typically are under no obligation to restructure insured transactions to prevent losses, but often will cooperate to avoid being associated with an obligation that experiences losses. When appropriate, we discuss potential settlement options, either at our request or that of our counterparties, regarding particular obligations with appropriate parties. On occasion, loss mitigation may include an early termination of our obligations, which could result in payments to or from us. To determine the appropriate loss mitigation approach, we generally consider various factors relevant to such insured transaction, which may include:

 

   

the current and projected performance of the underlying obligation (both on an expected case basis and stressed for more adverse performance and/or market circumstances that we expect);

 

   

the likelihood that we will pay a claim in light of credit deterioration and reductions in available payment reserves and existing subordination;

 

   

our total exposure to the obligation;

 

   

expected future premium payments from the credit; and

 

   

the cost to us of pursuing mitigation remedies.

V. Risk Management

A. Mortgage Insurance (Risk Management)

Our mortgage insurance business has a comprehensive risk management function which includes a Risk Originations group that consists of individual risk managers aligned with our lender customers as well as Portfolio Management and Credit Analytics functions that operate across the mortgage insurance business. The mortgage insurance risk management function is responsible for overall credit policy creation, compliance monitoring, portfolio management, limit setting and communication of credit related issues to management and our board of directors.

 

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1. Risk Origination (Risk Management—Mortgage Insurance)

Understanding our business partners and customers is a key component of managing risk. Individual risk managers are assigned to specific lender accounts and perform ongoing business-level due diligence to understand a lender’s strengths and weaknesses in originating mortgage credit risk. This information allows the individual risk managers to customize credit policy to address lender-specific performance issues.

2. Portfolio Management (Risk Management—Mortgage Insurance)

Portfolio Management oversees the allocation of economic capital within our mortgage insurance business. This group establishes the portfolio limits for product type, loan attributes, geographic concentration and counterparties and also is responsible for distribution of risk using risk transfer mechanisms such as captive reinsurance or the Smart Home arrangements discussed below under “Reinsurance—Ceded.”

Portfolio Management—Surveillance. The Surveillance function is responsible for monitoring the performance of various risks in our mortgage portfolio. The analysis performed by Surveillance is used by the Credit Analytics and Risk Analytics functions where it is incorporated into the development of credit policy and the development of our proprietary default and prepayment models.

Portfolio Management—Valuation. The Valuation function is responsible for analyzing the current composition of our mortgage insurance portfolio and monitoring its compliance with our risk parameters as established by our board of directors. This analysis involves analyzing risks to the portfolio from the market (e.g., the effects of changes in home prices and interest rates) and analyzing risks from particular lenders, products, and geographic locales.

3. Credit Analytics (Risk Management—Mortgage Insurance)

Credit Analytics is responsible for establishing and maintaining all mortgage related credit risk policy involving risk acceptance, counterparty, portfolio, operational and structured risks secured by or involving mortgage collateral. Credit Analytics also is responsible for establishing insurable risk guidelines for product types and loan attributes.

4. Risk Analytics (Risk Management—Mortgage Insurance)

Risk Analytics is responsible for all modeling functions in our mortgage insurance business. Risk Analytics estimates, implements and controls our proprietary Prophet Models® used in pricing our flow rate cards and structured transactions. Our proprietary Prophet Models® jointly estimate default and prepayment risk on all of our major product lines. Risk Analytics also reviews and approves all third party models used to approve loans for delegated mortgage insurance. Risk Analytics is also responsible for the economic capital model and RAROC pricing tools, and builds and updates the reserve model for the mortgage insurance portfolio and oversees economic research.

5. Reinsurance—Ceded (Risk Management—Mortgage Insurance)

We use reinsurance in our mortgage insurance business as a capital and risk management tool.

Smart Home. In 2004, we developed an approach, referred to as “Smart Home,” for reinsuring risk associated with non-prime mortgages and riskier products. These reinsurance transactions effectively transfer 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 to cede to the reinsurer a portion of the risk (and premium) associated with a portfolio of loans, consisting mostly of non-prime residential mortgages, insured by us. The

 

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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 that would be 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 is intended to approximate the rate of principal amortization of the underlying mortgages.

Between August 2004 and May 2006, we completed four Smart Home reinsurance transactions. Details of these transactions (aggregated) as of the initial closing of each transaction and as of December 31, 2008 are as follows:

 

     Initial    As of
December 31, 2008

Pool of mortgages (par value)

   $ 14.7 billion    $ 5.2 billion

Risk in force (par value)

   $ 3.9 billion    $ 1.3 billion

Notes sold to investors/risk ceded (principal amount)

   $ 718.6 million    $ 571.5 million

At December 31, 2008, approximately 3.7% of our primary risk in force was included in Smart Home reinsurance transactions, compared to approximately 5.3% at December 31, 2007. In these transactions, we reinsured the middle layer risk positions, while retaining a significant portion of the total risk comprising the first-loss and most remote risk positions. Ceded premiums written and earned related to Smart Home for 2008 were each $13.0 million, compared to $11.0 million and $11.4 million, respectively, for 2007 and $12.0 million and $12.3 million, respectively, for 2006. Ceded losses related to Smart Home were $91.1 million in 2008 and $9.8 million in 2007. There were no ceded losses in 2006. Ceded losses related to Smart Home are expected to continue to increase in 2009. Most actual cash recoveries are not expected until 2009 and later.

Captive Reinsurance. 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 the portfolio of that lender’s mortgages insured by us on a flow 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, we cede a portion of the mortgage insurance premiums paid to us to the reinsurance company. We currently have 16 “active” captive reinsurance agreements in which new business continues to be placed. We also currently have 45 captive reinsurance arrangements operating on a run-off basis, meaning that no new business is being placed in these captives. This compares to 51 active and 10 run-off captives as of December 31, 2007.

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. Until recently, losses under most captive reinsurance arrangements have not approached a level requiring payment to us. However, during the current housing and related credit market downturn in which losses have increased significantly, many captive reinsurance arrangements have attached, requiring our captive reinsurers to make payments to us. We began recording ceded losses recoverable from such captives in the fourth quarter of 2007, which accelerated throughout 2008, although most cash recoveries are not expected until 2009 and later. We believe that captive reinsurance is likely to serve as a significant source of reinsurance recoveries for us in future periods. Ceded

 

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losses related to captives in 2008 and 2007 were $400.7 million and $3.9 million, respectively. We also offer, on a limited basis, “quota share” captive reinsurance arrangements under which the captive reinsurance company assumes a pro rata share of all losses in return for a pro rata share of the premiums collected.

Because of many factors, including the incentives for mortgage lenders to funnel relatively higher-quality loans through their captive reinsurers due to the risk-sharing feature, we continue to evaluate the level of revenue-sharing to risk-sharing on a customer-by-customer basis as part of our customer profitability analysis. We believe that all of our captive reinsurance arrangements transfer risk to the captive reinsurer. We also believe that captive reinsurance agreements are important in aligning our interests with those of the lenders by providing lenders with an ongoing stake in the outcome of the lending decision. In February 2008, Freddie Mac and Fannie Mae announced that effective June 1, 2008, they would limit the percentage of premiums that mortgage insurers may cede to captives to 25% of the mortgage insurance premiums paid to the mortgage insurer. As a result, the terms of all of our captive reinsurance arrangements that ceded an amount greater than 25% were amended to comply with these limitations.

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 (“RESPA”). We and other mortgage insurers also have been subject to inquiries from the New York insurance department, the Minnesota Department of Commerce and the U.S. Department of Housing and Urban Development (“HUD”) relating to our captive reinsurance arrangements. For more information, see “Regulation—Federal Regulation—RESPA” below.

Premiums ceded to captive reinsurance companies in 2008 on first-lien mortgage insurance were $138.3 million, representing 15.0% of total first-lien mortgage insurance premiums earned, as compared to $121.6 million, or 14.1% in 2007. Primary new insurance written in 2008 on first-lien mortgage insurance that had captive reinsurance associated with it was $11.8 billion or 36.4% of our total first-lien primary new insurance written, as compared to $23.3 billion, or 40.8% of our total first-lien primary new insurance written in 2007. These percentages have been volatile as a result of increases or decreases in the volume of structured transactions, which are not typically eligible for captive reinsurance arrangements.

Some private mortgage insurers have elected not to enter into new captives going forward and have placed their existing captives into run-off. Others, including us, have not yet made this determination, and we continue to evaluate our use of captives in light of our overall mortgage insurance business strategy. However, in light of the significant number of our captives currently in run-off, we expect amounts ceded to captives to decline significantly in 2009.

GSE Arrangements. We also have entered into risk/revenue-sharing arrangements with the GSEs whereby the primary insurance coverage amount on certain loans is recast into primary and pool insurance and our overall exposure is reduced in return for a payment made to the GSEs. Ceded premiums written and earned for the year ended December 31, 2008 were $5.6 million and $5.7 million, respectively, under these programs.

Other Reinsurance. Certain states limit the amount of risk a mortgage insurer may retain on a single loan to 25% of the indebtedness to the insured. Radian Guaranty currently uses reinsurance from affiliated companies to remain in compliance with these insurance regulations. See “Regulation—State Regulation—Reinsurance” below.

B. Financial Guaranty (Risk Management)

In insuring our current financial guaranty portfolio, we employed a comprehensive risk system. This system incorporated the integration of company-wide risk management policies and processes as well as best practices of the financial guaranty industry. All transactions were subject to a thorough underwriting analysis and a comprehensive risk committee decision process.

Transaction underwriting included an analysis of all credit and legal aspects as well as any specific risks that may be inherent in the transaction. Further, we utilized our proprietary internal economic capital model for risk

 

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analysis, valuation and as the basis for calculating RAROC on our financial guaranty business. All transactions were subject to a credit committee decision process embedded in the financial guaranty business.

Our risk management department uses internal ratings in monitoring our insured transactions. We determine our internal ratings for a transaction, by utilizing all relevant information available to us, including: periodic reports supplied by the issuer, trustee or servicer for the transaction; publicly available information regarding the issuer, the transaction, the underlying collateral or asset class of the transaction and/or collateral; communications with the issuer, trustee, collateral manager and servicer for the transaction; and when available, public or private ratings assigned to our insured transactions or to other obligations that have substantially similar risk characteristics to our transactions without the benefit of financial guaranty or similar credit insurance. When we deem it appropriate, we also utilize nationally recognized rating agency models and methodologies to assist in such analysis. We use this information to develop an independent judgment regarding the risk and loss characteristics for our insured transactions. If public or private ratings have been used, our risk management analysts express a view regarding the rating agency opinion and analysis. When our analyses of the transaction results in a materially different view of the risk and loss characteristics of an insured transaction, we will assign a different internal rating than that assigned by the rating agency.

Our rating scale is comparable to that of the nationally recognized rating agencies (S&P and Moody’s). Our use of internal ratings rather than rating agency ratings, results in a decrease in the percentage of our insured obligations rated AAA, an increase in the percentage of our insured obligations rated AA, A and BBB and a slight increase in the percentage of obligations rated below investment grade. Our internal ratings estimates are subject to revision at any time and may differ from the credit ratings ultimately assigned by the rating agencies.

See “Loss Management—Financial Guaranty” above for information regarding our risk management department.

VI. Customers

A. Mortgage Insurance (Customers)

The principal customers of our mortgage insurance business are mortgage originators such as mortgage bankers, mortgage brokers, commercial banks, savings institutions and credit unions. This is the case even though individual mortgage borrowers generally incur the cost of primary mortgage insurance coverage. We also offer lender-paid mortgage insurance, in which the mortgage lender or loan servicer pays the mortgage insurance premiums. The cost of the mortgage insurance is then generally passed through to the borrower in the form of higher interest rates. In 2008, approximately 43% of our mortgage insurance was originated on a lender-paid basis, compared to approximately 57% in 2007. This lender-paid business is highly concentrated among a few large mortgage-lending customers.

To obtain primary mortgage insurance from us, a mortgage lender must first apply for and receive a master policy. Our approval of a lender as a master policyholder is based, among other factors, on our evaluation of the lender’s financial position and demonstrated adherence to sound loan origination practices.

The number of individual primary mortgage insurance policies in force at December 31, 2008, was 923,078, compared to 895,037 at December 31, 2007 and 785,814 at December 31, 2006.

Our mortgage insurance business depends to a significant degree on a small number of lending customers. Our top 10 mortgage insurance customers, measured by primary new insurance written, were responsible for 59.4% of our primary new insurance written in 2008, compared to 64.0% in 2007 and 64.7% in 2006. The largest single mortgage insurance customer (including branches and affiliates), measured by primary new insurance written, accounted for 20.5% of new insurance written during 2008, compared to 19.4% in 2007 and 18.6% in 2006.

 

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Challenging market conditions during 2008 and 2007 have adversely affected, and may continue to adversely affect, the financial condition of a number of our largest lending customers. These customers may become subject to serious liquidity constraints that could jeopardize the viability of their business plans or their access to additional capital, forcing them to consider alternatives such as bankruptcy or, as has occurred recently, consolidation with others in the industry. See “Risk Factors—Because our mortgage insurance business is concentrated among a few significant customers, our new business written and franchise value could decline if we lose any significant customer.”

B. Financial Guaranty (Customers)

We have historically conducted our structured finance business with many of the major global financial institutions that structure, underwrite or trade securities issued in structured finance obligations. These institutions typically are large commercial or investment banks that focus on high-quality deals in the public finance and structured finance markets. While our public finance customers have historically included many of the same financial institutions as our structured finance business, our public finance customers have also included regional financial institutions and issuers that may focus on lower investment-grade obligors or obligations.

As a reinsurer of financial guaranty obligations, we have traditionally maintained close and long-standing relationships with most of the primary financial guaranty insurers. We believe that these relationships have provided us with a comprehensive understanding of the market and of the financial guaranty insurers’ underwriting guidelines and reinsurance needs. Our financial guaranty reinsurance customers have consisted mainly of the largest primary insurance companies licensed to write financial guaranty insurance and their foreign-based affiliates, including Ambac Assurance Corporation (“Ambac”), Financial Security Assurance Inc. (“FSAI”) and Financial Guaranty Insurance Company (“FGIC”).

VII. Sales and Marketing

A. Mortgage Insurance (Sales and Marketing)

We employ six national account managers, who focus on the largest mortgage lenders, as well as a mortgage insurance field sales force of approximately 72 persons, organized into four divisions, that provides local sales representation throughout the U.S. Each of the four divisions is supervised by a divisional sales manager who is directly responsible for several regional sales managers. The divisional sales managers are responsible for managing the profitability of business in their regions, including premiums, losses and expenses. The regional sales managers are responsible for managing a sales force in different areas within the region. In addition, there are several account managers that manage specific accounts within a region that are not national accounts, but that need more targeted oversight and attention.

Mortgage insurance sales personnel are compensated by salary, commissions on new insurance written and an incentive component based on the achievement of various goals.

VIII. Competition

A. Mortgage Insurance (Competition)

We compete directly with six other private mortgage insurers—Genworth Financial Inc., MGIC, PMI Mortgage Insurance Co., Republic Mortgage Insurance Company, CMG Mortgage Insurance Company and United Guaranty Corporation—some of which are subsidiaries of larger companies with stronger financial strength ratings. We also compete against various federal and state governmental and quasi-governmental agencies, principally the Federal Housing Administration (“FHA”), the Veteran’s Administration (“VA”) and state-sponsored mortgage insurance funds. While the mortgage insurance industry has not had new entrants in many years, it is possible that the increased credit quality of new loans being insured in the current market combined with the deterioration of the financial strength ratings of existing mortgage insurance companies, in part due to their legacy books of insured mortgages, could encourage new entrants.

 

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Governmental and quasi-governmental entities typically do not have the same capital requirements that we and other mortgage insurance companies have, and therefore, may have greater financial flexibility in their pricing and capacity that could put us at a competitive disadvantage. In the event that a government-owned or sponsored entity in one of our markets decides to reduce prices significantly or alter the terms and conditions of its mortgage insurance or other credit enhancement products in furtherance of social or other goals rather than a profit motive, we may be unable to compete in that market effectively, which could have an adverse effect on our financial condition and results of operations. We believe the FHA, which until recently was not viewed by us as a significant competitor, substantially increased its market share in 2008, including by insuring loans that would meet our current underwriting guidelines at a cost to the borrower that is lower than the cost of our insurance. Recent federal legislation and programs have provided the FHA with greater flexibility in establishing new products and have increased the FHA’s competitive position against private mortgage insurers. See “Regulation—Federal Regulations—Indirect Regulation” below.

We compete for flow business with other private mortgage insurance companies on the basis of both service and price. The service-based component includes risk management services, timeliness of claims payments, loss mitigation efforts and management and field service organization and expertise. In the past, we have competed for structured transactions with other mortgage insurers and have competed with capital market executions such as senior/subordinated security structures for this business. Competition for this business generally is based both on price and on the percentage of a given pool of loans that we are willing to insure.

In the past, we also have faced competition from a number of alternatives to traditional private mortgage insurance, including:

 

   

mortgage lenders structuring mortgage originations to avoid private mortgage insurance, mostly through “80-10-10 loans” or other forms of simultaneous second loans;

 

   

investors using other forms of credit enhancement such as credit default swaps or securitizations as a partial or complete substitute for private mortgage insurance; and

 

   

mortgage lenders and other intermediaries that forego third-party insurance coverage and retain the full risk of loss on their high-LTV loans.

Recently, competition from these alternatives has significantly diminished as a result of the recent housing market decline and credit market turmoil. In particular, the recent poor performance of subprime loans, which made up a significant portion of capital market securitizations, has all but eliminated the secondary market for mortgage collateral other than with the GSEs.

IX. Ratings

S&P and Moody’s each rate the financial strength of our insurance subsidiaries. The rating agencies mainly focus on the following factors: capital resources; financial strength; franchise value; commitment of management to, and alignment of stockholder interests with the insurance business; demonstrated management expertise in our insurance business; credit analysis; systems development; risk management; marketing; earnings volatility; capital markets and investment operations, including the ability to raise additional capital, if necessary; and capital sufficient to meet projected growth and capital adequacy standards. As part of their ratings process, S&P and Moody’s test our insurance subsidiaries by subjecting them to a “stress level scenario” in which losses over a stress period are tested against our capital level. Determinations of ratings by the rating agencies also are affected by macroeconomic conditions and economic conditions affecting the mortgage insurance and financial guaranty industries in particular, changes in regulatory conditions, competition, underwriting and investment losses.

The financial strength rating assigned by the rating agencies to an insurance company is based on factors relevant to policyholders and is not intended to protect that company’s equity holders or creditors. A financial strength rating is neither a rating of securities nor a recommendation to buy, hold or sell any security. Financial strength ratings are an indication to an insurer’s customers of the insurer’s present financial strength and its capacity to honor its future claims payment obligations.

 

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Our holding company, Radian Group, currently is rated BB (CreditWatch with negative implications) by S&P and B3 (outlook developing) from Moody’s.

The following table sets forth the current financial strength ratings assigned to our principal insurance subsidiaries:

 

     MOODY’S     S&P (2)

Radian Guaranty

   Ba3    BBB+

Radian Insurance

   B1    BB+

Amerin Guaranty

   Ba3    BBB+

Radian Asset Assurance (1)

   A3    BBB+

Radian Asset Assurance Limited (1)

   A3    BBB+

 

(1) Each Moody’s rating for our financial guaranty subsidiaries is currently under review for possible downgrade.
(2) Each S&P rating for our mortgage insurance and financial guaranty subsidiaries is currently on CreditWatch with negative implications.

On May 2, 2008, Fitch Ratings (“Fitch”) withdrew its ratings for Radian Group and all of our insurance subsidiaries, citing a lack of available information regarding these entities. We had requested that Fitch withdraw these ratings in September 2007, following Fitch’s downgrade of Radian Group and our financial guaranty subsidiaries.

Recent Ratings Actions—Moody’s

On June 25, 2008, Moody’s lowered its senior debt rating on Radian Group to Ba1 from A2 and its insurance financial strength ratings on Radian Guaranty and Amerin Guaranty to A2 from Aa3. In downgrading our mortgage insurance subsidiaries, Moody’s cited deterioration in our insured portfolio, including NIMS and second-liens. Moody’s further stated that our ability to retain our status as an eligible mortgage insurer with the GSEs will continue to be an important ratings consideration for our mortgage insurance subsidiaries. Moody’s lowered its insurance financial strength rating on Radian Insurance to Baa1 (two notches below Radian Guaranty) from Aa3 as a result of the higher-risk nature of its insured portfolio of second-liens and NIMS and the fact that Radian Insurance is no longer strategically important to our overall mortgage insurance business.

Also on June 25, 2008, Moody’s lowered its insurance financial strength ratings on Radian Asset Assurance and RAAL to A3 from Aa3, citing the likelihood that Radian Asset Assurance will cease writing new business going forward and the possible diversion of capital from Radian Asset Assurance to support our mortgage insurance business.

On October 10, 2008, Moody’s placed its ratings for Radian Group and each of our mortgage insurance and financial guaranty subsidiaries on review for possible downgrade. In taking this ratings action, Moody’s cited its expectation of further stress on the risk-adjusted capital position of our mortgage insurance business in light of continued deterioration in certain housing market fundamentals.

On February 13, 2009, Moody’s downgraded the insurance financial strength ratings of Radian Guaranty and Amerin Guaranty to Ba3 from A2 and the rating of Radian Insurance to B1 from Baa1. Moody’s also downgraded the senior debt rating of Radian Group to B3 from Ba1. According to Moody’s, these downgrades reflect significant stress on the risk-adjusted capital position of our mortgage insurance subsidiaries due to the weak economic environment and continued deterioration in housing fundamentals, which Moody’s expects to result in significantly higher losses for our mortgage insurance business. Moody’s also considered the continued pressure on our profitability and constraints on our financial flexibility in the current market environment. Moody’s also cited its belief that the mortgage insurance business model has deteriorated due to on-going losses and the relative weakness of the GSEs.

 

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Recent Ratings Actions—S&P

On August 26, 2008, S&P lowered its senior debt rating on Radian Group to BB+ from BBB and its insurance financial strength ratings on Radian Guaranty and Amerin Guaranty to BBB+ from A. In lowering its ratings for Radian Group and our mortgage insurance subsidiaries, S&P cited the significant operating losses incurred by our mortgage insurance business as well as S&P’s reassessment of the mortgage insurance industry’s long-term fundamentals. S&P also cited Radian Group’s financial flexibility as a potential concern. S&P also lowered its insurance financial strength ratings for our financial guaranty subsidiaries to BBB+ from A. S&P stated that it had lowered the ratings for these entities based on the diminished business prospects for our financial guaranty business and our intention to use this business to provide capital support to our mortgage insurance business.

On December 5, 2008, S&P placed its ratings on Radian Group and our mortgage insurance and financial guaranty insurance subsidiaries on CreditWatch with negative implications. S&P has indicated that it will resolve the CreditWatch status of the ratings in two stages. First, it will re-evaluate its estimate of mortgage insurers’ net loss costs for their insured portfolios based on deterioration in macroeconomic conditions, partially offset by greater anticipated benefits of reinsurance. The second stage will be a thorough sector-wide review that incorporates operating results for the fourth quarter of 2008 and developments in macroeconomic conditions, which S&P anticipates completing in March 2009. On December 19, 2008, S&P announced the results of the first stage of its evaluation and Radian Group’s rating was downgraded to BB, but its ratings for the mortgage insurance and financial guaranty insurance subsidiaries were unchanged. The ratings for Radian Group and our mortgage and financial guaranty insurance subsidiaries remain on CreditWatch with negative implications while S&P performs the second stage of its analysis, which it expects to complete in March 2009 and which could result in a substantial downgrade.

Our current ratings and the threat of further ratings actions could have a negative impact on our business and results of operations. See “Risk Factors—We could lose our eligibility status with the GSEs, causing Freddie Mac and Fannie Mae to decide not to purchase mortgages insured by us, which would significantly impair our mortgage insurance franchise.”

X. Investment Policy and Portfolio

Income from our investment portfolio is one of our primary sources of cash flow to support our operations and claim payments.

We follow an investment policy that, at a minimum, requires:

 

   

At least 80% of our investment portfolio, based on amortized cost, to consist of investment securities and instruments that are assigned a “1” rating designating the highest quality ranking by the National Association of Insurance Commissioners (“NAIC”) or equivalent ratings by a Nationally Recognized Statistical Rating Organization (“NRSRO”) (e.g., “A-” or better by S&P and “A3” or better by Moody’s);

 

   

A maximum of 15% of our investment portfolio, based on amortized cost, may consist of investment securities and instruments that are assigned a “2” rating designating a high quality ranking by the NAIC or equivalent ratings by an NRSRO (e.g., “BBB+” to “BBB-” by S&P and “Baa1” to “Baa3” by Moody’s); and

 

   

A maximum of 5% of our investment portfolio, based on amortized cost, may consist of investment securities and instruments that are assigned a “3 or below” rating designating lower quality debt and equity rankings by the NAIC or equivalent ratings by an NRSRO (e.g., “BB+” and below by S&P and “Ba1” and below by Moody’s).

Under our investment policy, which is applied on a consolidated risk and asset allocation basis, we are permitted to invest in equity securities (including convertible debt and convertible preferred stock), provided our

 

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equity component does not exceed 20% of our total investment portfolio and at least 95% of the portfolio is investment grade. We manage our investment portfolio to minimize interest rate volatility through active portfolio management and intensive monitoring of investments to ensure a proper mix of the types of securities held and to stagger the maturities of fixed-income securities. Our investment policy focuses on the generation of optimal after-tax returns, stable tax-efficient current returns, and the preservation and growth of capital. We have increased our percentage of short-term investments in light of the rising claim amounts in the mortgage insurance business.

Our investment policies and strategies are subject to change depending on regulatory, economic and market conditions and our then-existing or anticipated financial condition and operating requirements, including our tax position. The investments held at our insurance subsidiaries are also subject to insurance regulatory requirements applicable to such insurance subsidiaries and are highly liquid.

Oversight responsibility of our investment portfolio rests with management—allocations are set by periodic asset allocation studies, calibrated by risk and return and after-tax considerations, and are approved by the Investment and Finance Committee (the “Investment Committee”) of our board of directors. Manager selection, monitoring, reporting and accounting (including valuation) of all assets are performed by management. We manage over 70% of the portfolio—the portion of the portfolio largely consisting of municipal bonds and short-term investments—internally, with the remainder managed by eight external managers. External managers are selected by management based primarily upon the allocations approved by the Investment Committee of our board of directors as well as factors such as historical returns and stability of management. Management’s selections are presented to and approved by the Investment Committee.

Our investment allocation, asset class percentage targets and actual investment concentration among these asset class targets at December 31, 2008, are as follows:

 

Allocation Strategy

   Target     Actual  

Fixed Income:

    

Short-Term

   2.5 %   17.1 %

Global Bond

   2.5 %   1.7 %

Core Bond

   10.0 %   9.7 %

Municipal Securities

   70.0 %   61.3 %
            

Total Fixed Income

   85.0 %   89.8 %
            

Hybrids (Convertible Securities)

   10.0 %   7.2 %
            

Equity/Other:

    

Large Cap

   2.0 %   1.7 %

Small Cap

   2.0 %   0.8 %

Other

   1.0 %   0.5 %
            

Total Equity/Other

   5.0 %   3.0 %
            

Total All Allocation Strategies

   100.0 %   100.0 %
            

 

The relatively large position of short-term securities at year-end 2008 compared to our allocation target reflects the anticipated funding of mortgage insurance claim payments.

We review our investment portfolio on at least a quarterly basis for declines in the fair value of securities below the amortized cost basis of such securities that are considered to be other-than-temporary. If the fair value of a security is below the cost basis, and it 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. During 2008, we recorded approximately $55.2 million of charges related to declines in the fair value of securities (primarily municipal and taxable bonds, and preferred stocks) considered to be other-than-temporary, compared to $9.4 million of charges related to declines in 2007 and $10.6 million in 2006.

 

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At December 31, 2008, our investment portfolio had a cost basis of $6.4 billion, a carrying value of $5,981.6 million and a market value of $6.0 billion, including $1.0 billion of short-term investments. Our investment portfolio did not include any real estate or mortgage loans at December 31, 2008. The portfolio included 81 privately placed, investment-grade securities with an aggregate carrying value of $58.0 million at December 31, 2008. At December 31, 2008, 96.6% of our investment portfolio was rated investment grade.

During 2008, global financial markets experienced severe dislocations which led the U.S. and other governments to implement financial programs targeted at improving financial institutions liquidity and capitalization. In general, equity markets declined, interest rates decreased and credit spreads widened. These events contributed to volatility in our investment portfolio and realized and unrealized losses.

A. Investment Portfolio Diversification (Investment Policy and Portfolio)

The diversification of our investment portfolio at December 31, 2008, was as follows:

 

     December 31, 2008  
     Cost or
Amortized Cost
   Fair Value    Percent (1)  
     ($ in thousands)  

Fixed-maturities held to maturity:

        

State and municipal obligations

   $ 36,628    $ 37,486    0.6 %
                    

Total

     36,628      37,486    0.6 %
                    

Fixed-maturities available for sale:

        

U.S. government securities (2)

     81,636      93,206    1.6 %

U.S. government-sponsored enterprises

     20,089      21,636    0.4  

State and municipal obligations

     3,235,053      2,977,919    49.8  

Corporate obligations

     176,085      169,510    2.8  

Asset-backed securities (3)

     310,269      307,150    5.1  

Private placements

     13,652      12,992    0.2  

Foreign governments

     62,703      64,856    1.1  
                    

Total

     3,899,487      3,647,269    61.0 %
                    

Equity securities

     212,620      165,099    2.8  

Short-term investments

     1,029,167      1,029,286    17.2  

Trading securities:

        

State and municipal obligations

     625,837      629,084    10.5  

Equity securities

     44,781      25,440    0.4  

Other

     217      175    —    
                    

Total

     670,835      654,699    10.9 %
                    

Hybrid securities

     499,929      426,640    7.1  

Other invested assets

     21,388      21,933    0.4  
                    

Total

   $ 6,370,054    $ 5,982,412    100.0 %
                    

 

(1) Percentage of cost or amortized cost.
(2) Substantially all of these securities are backed by the full faith and credit of the U.S. government.
(3) Primarily comprised of securities issued by the government or government agencies and triple-A rated corporate obligations.

 

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B. Investment Portfolio Scheduled Maturity (Investment Policy and Portfolio)

The weighted average duration of the assets in our investment portfolio as of December 31, 2008, was 5.6 years. The following table shows the scheduled maturities of the securities held in our investment portfolio at December 31, 2008:

 

     December 31, 2008  
     Carrying
Value
   Percent  
     ($ in thousands)  

Short-term investments

   $ 1,029,286    17.2 %

Less than one year (1)

     221,122    3.7  

One to five years (1)

     749,076    12.5  

Five to ten years (1)

     746,087    12.5  

Over ten years (1)

     3,023,511    50.5  

Other investments (2)

     212,471    3.6  
             

Total

   $ 5,981,553    100.0 %
             

 

(1) Actual maturities may differ as a result of calls before scheduled maturity.
(2) No stated maturity date.

C. Investment Portfolio by Rating (Investment Policy and Portfolio)

The following table shows the ratings of our investment portfolio as of December 31, 2008:

 

     December 31, 2008  
     Carrying
Value
   Percent  
     ($ in thousands)  

Rating (1)

     

U.S. government and agency securities

   $ 159,842    2.7 %

AAA (2)

     2,409,545    40.3  

AA

     1,848,579    30.9  

A

     937,304    15.6  

BBB

     425,007    7.1  

BB and below (3)

     22,304    0.4  

Not rated

     5,906    0.1  

Equity securities

     173,066    2.9  
             

Total

   $ 5,981,553    100.0 %
             

 

(1) As assigned by an NRSRO as of December 31, 2008.
(2) Includes $126.2 million in a municipal security money market fund with a credit distribution of 70% A1+ and 30% A1 with an average maturity of 23 days.
(3) Securities in this category have been rated non-investment grade by an NRSRO as of December 31, 2008.

 

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D. Investment Risk Concentration—(Investment Policy and Portfolio)

The following table shows our top ten investment portfolio risk concentrations as of December 31, 2008:

 

              Securities Classifications

($ in thousands)

Issuer Description

  Market Value     U.S. Government Agency &
GSE Securities
  Municipal Securities        
  $   %     Money Market/
Short-Term
  MBS   GSE Notes   Uninsured   Insured   Prerefunded*   Money
Market
  Equity

Northern Institutional Government
Portfolio (1)

  $ 295,378   4.94 %   $ 295,378   $ —     $ —     $ —     $ —     $ —     $ —     $ —  

State of California (2)

    273,040   4.56       —       —       —       215,245     26,413     31,382     —       —  

State of New York (2)

    217,497   3.64       —       —       —       167,340     16,559     33,598     —       —  

Federal National Mortgage Association (Fannie Mae)

    182,447   3.05       20,000     143,757     18,690     —       —       —       —       —  

Vanguard Institutional Prime Portfolio (1)

    176,232   2.95         —       —       —       —       —       176,232     —  

Master Settlement Agreement (MSA) Securitizations (3)

    129,628   2.17       —       —       —       108,066     11,307     10,255     —       —  

Northern Institutional Municipal Portfolio (2)

    126,176   2.11       —       —       —       —       —         126,176     —  

Fidelity Institutional Government Portfolio (1)

    121,172   2.03       121,172     —       —       —       —         —       —  

Commonwealth of Massachusetts (2)

    116,829   1.95       —       —       —       40,087     12,116     64,626     —       —  

Vanguard Institutional Index Fund (4)

    103,100   1.72       —       —       —       —       —         —       103,100
                                                           

Top Investment Portfolio Risk Concentrations

  $ 1,741,499   29.12 %   $ 436,550   $ 143,757   $ 18,690   $ 530,738   $ 66,395   $ 139,861   $ 302,408   $ 103,100
                                                           

 

* Prerefunded bonds are backed by U.S. Treasury and/or agency debt held in escrow, and structured to provide sufficient cash flows to offset the cashflows due on the refunded bonds. At maturity, the issuer will sell the U.S. Treasury securities or agency debt held in escrow and buy back the municipal bonds with the proceeds.
(1) Money Market Funds.
(2) Includes securities with indirect state funding support.
(3) Aggregate investment in securities backed by MSA payments (the MSA obligated participating tobacco companies to compensate various states for health and other tobacco related expenses).
(4) Tracks performance of the S&P 500 Index.

XI. Regulation

A. State Regulation (Regulation)

We and our insurance subsidiaries are subject to comprehensive, detailed regulation principally designed for the protection of policyholders, rather than for the benefit of investors, by the insurance departments in the various states where our insurance subsidiaries are licensed to transact business. Insurance laws vary from state to state, but generally grant broad supervisory powers to agencies or officials to examine insurance companies and enforce rules or exercise discretion affecting almost every significant aspect of the insurance business.

Insurance regulations address, among other things, the licensing of companies to transact business, claims handling, reinsurance requirements, premium rates and policy forms offered to customers, financial statements, periodic reporting, permissible investments and adherence to financial standards relating to surplus, dividends and other criteria of solvency intended to assure the satisfaction of obligations to policyholders.

Our insurance subsidiaries’ premium rates and policy forms are generally subject to regulation in every state in which the insurers are licensed to transact business. These regulations are intended to protect policyholders against the adverse effects of excessive, inadequate or unfairly discriminatory rates and to encourage competition

 

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in the insurance marketplace. In most states, premium rates and policy forms must be filed and, in some states approved, before their use. Changes in premium rates may be subject to justification, generally on the basis of the insurer’s loss experience, expenses and future trend analysis. The general default experience in the mortgage insurance industry also may be considered with regard to mortgage insurers.

Radian Guaranty. Radian Guaranty is domiciled and licensed in Pennsylvania as a stock casualty insurance company authorized to carry on the business of mortgage guaranty insurance as a licensed credit guaranty insurer pursuant to the provisions of the Pennsylvania insurance law and related rules and regulations governing property and casualty insurers. In addition to Pennsylvania, Radian Guaranty is authorized to write mortgage guaranty insurance (or in most states where there is no specific authorization for mortgage guaranty insurance, the applicable line of insurance under which mortgage guaranty insurance is regulated) in each of the other 49 states, the District of Columbia and Guam. Radian Guaranty must maintain both a reserve for unearned premiums and for incurred losses and a special, formulaically derived contingency reserve to protect policyholders against the impact of excessive losses occurring during adverse economic cycles. The contingency reserve may be drawn on under specified but limited circumstances. Radian Guaranty and other mortgage insurers in the U.S. generally are required to be monoline insurers restricted to writing only residential mortgage guaranty insurance.

Radian Insurance. Radian Insurance is domiciled and licensed in Pennsylvania as a stock casualty insurance company authorized to carry on the business of credit insurance pursuant to the provisions of the Pennsylvania insurance law and related rules and regulations governing property and casualty insurers. Radian Insurance must maintain both a reserve for unearned premiums and for incurred losses and a special, formulaically derived contingency reserve to protect policyholders against the impact of excessive losses occurring during adverse economic cycles. The contingency reserve may be drawn on under specified but limited circumstances. Radian Insurance is also authorized in Hong Kong to carry on the business of credit insurance, suretyship and miscellaneous financial loss (including mortgage guaranty insurance) through its Hong Kong branch office.

Amerin. Amerin Guaranty is domiciled and licensed in Illinois as a mortgage guaranty insurer and is subject to the provisions of the Illinois insurance law and related rules and regulations governing property-casualty insurers. In addition to Illinois, Amerin Guaranty is authorized to write mortgage guaranty insurance (or in certain states where there is no specific authorization for mortgage guaranty insurance, the applicable line of insurance under which mortgage guaranty is regulated), in each of the other states except Rhode Island (Amerin operates under an industrial insured exemption in Rhode Island) and the District of Columbia. Amerin Guaranty must maintain both a reserve for unearned premiums and for incurred losses and a special, formulaically derived contingency reserve to protect policyholders against the impact of excessive losses occurring during adverse economic cycles. The contingency reserve may be drawn on under specified but limited circumstances.

Radian Asset Assurance. Radian Asset Assurance is domiciled and licensed in New York as a financial guaranty insurer and is subject to the provisions of the New York insurance law and related rules and regulations governing property-casualty insurers to the extent these provisions are not inconsistent with the New York financial guaranty insurance statute. Radian Asset Assurance is also licensed under the New York insurance law to write some types of surety insurance and credit insurance. In addition to New York, Radian Asset Assurance is authorized to write financial guaranty or surety insurance (or in one state where there is no specific authorization for financial guaranty insurance, credit insurance) in each of the other 49 states, the District of Columbia, Guam, the U.S. Virgin Islands and the Commonwealth of Puerto Rico. Radian Asset Assurance must maintain both a reserve for unearned premiums and for incurred losses and a special, formulaically derived contingency reserve to protect policyholders against the impact of excessive losses occurring during adverse economic cycles. The contingency reserve may be drawn on under specified but limited circumstances with approval of the Superintendent of the New York Insurance Department. Radian Asset Assurance and other financial guaranty insurers in the U.S. are generally restricted to writing financial guaranty insurance.

Each insurance subsidiary is required by its state of domicile and each other jurisdiction in which it is licensed to transact business and to make various filings with those jurisdictions and with the National

 

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Association of Insurance Commissioners, including quarterly and annual financial statements prepared in accordance with statutory accounting practices. In addition, our insurance subsidiaries are subject to examination by the insurance departments of each of the states in which they are licensed to transact business.

Given the recent significant losses incurred by many mortgage and financial guaranty insurers, our insurance subsidiaries have been subject to heightened scrutiny by insurance regulators. We are currently in close communication with certain insurance regulatory authorities, including the Pennsylvania Insurance Department with respect to Radian Guaranty and Radian Insurance, the Illinois Division of Insurance regarding Amerin and the Texas Department of Insurance regarding the Commonwealth Mortgage Assurance Company of Texas (“CMAC of Texas”), which reinsures a portion of Radian Guaranty’s portfolio. Amerin, which insures second-lien mortgages, is not currently writing any new business and is currently prohibited from writing new insurance business in four states without prior approval. Additionally, the Hong Kong Insurance Authority has directed Radian Insurance to continue to maintain sufficient assets in Hong Kong to cover its potential liabilities on insured loans in Hong Kong. In light of current market conditions and on-going deterioration in our financial condition, insurance departments in the jurisdictions noted above or in other jurisdictions could impose restrictions or requirements that could have a material adverse impact on our businesses.

1. Insurance Holding Company Regulation (Regulation—State Regulation)

Radian Group is an insurance holding company and our insurance subsidiaries belong to an insurance holding company system. All states have enacted legislation regulating insurance companies in an insurance holding company system. These laws generally require the insurance holding company to register with the insurance regulatory authority of each state in which its insurance subsidiaries are domiciled and to furnish to this regulator financial and other information concerning the holding company and its affiliated companies within the system that may materially affect the operations, management or financial condition of insurers within the system.

Because we are an insurance holding company, and because Radian Guaranty and Radian Insurance are Pennsylvania insurance companies, Amerin Guaranty is an Illinois insurance company, CMAC of Texas and Radian Mortgage Insurance Inc. (each an operating subsidiary used primarily for intra-company reinsurance) are Texas and Arizona insurance companies, respectively, and Radian Asset Assurance is a New York insurance company, the Pennsylvania, Texas, Arizona, Illinois and New York insurance laws regulate, among other things, certain transactions in our common stock and certain transactions between us, our insurance subsidiaries and other parties affiliated with us. Specifically, no person may, directly or indirectly, offer to acquire or acquire “control” of Radian Group, unless that person files a statement and other documents with the commissioners of insurance of the states in which our insurance subsidiaries are domiciled and each commissioner’s prior approval is obtained. Similarly, no person may directly or indirectly, offer to acquire or acquire “control” of any of our insurance subsidiaries without first obtaining the approval of the commissioner of insurance of the state where the target insurance company is domiciled. The Commissioner may hold a public hearing on the matter. In addition, material transactions between us, our insurance subsidiaries and our affiliates are subject to certain conditions, including that they be “fair and reasonable.” These restrictions generally apply to all persons controlling or who are under common control with us or our insurance subsidiaries. Certain transactions between us or our affiliates and our insurance subsidiaries may not be entered into unless the applicable commissioner of insurance is given 30 days’ prior notification and does not disapprove the transaction during that 30-day period.

2. Dividends (Regulation—State Regulation)

Radian Guaranty and Radian Insurance. Radian Guaranty’s and Radian Insurance’s ability to pay dividends is restricted by certain provisions of the insurance laws of Pennsylvania. Under Pennsylvania’s insurance laws, dividends and other distributions may only be paid out of an insurer’s unassigned surplus, measured as of the end of the prior fiscal year, unless the Pennsylvania Insurance Commissioner approves the payment of dividends or other distributions from another source. Radian Guaranty and Radian Insurance each had negative unassigned

 

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surplus at December 31, 2008 of $697.4 million and $423.5 million, respectively. In addition, in the event a insurer had positive unassigned surplus as of the end of the prior fiscal year, without the prior approval of the Pennsylvania Insurance Commissioner, an insurer only may pay dividends or other distributions during any 12-month period in an aggregate amount less than or equal to the greater of (i) 10% of the preceding year-end statutory policyholders’ surplus, or (ii) the preceding year’s statutory net income. Due to the negative unassigned surplus at the end of 2008, no dividends or other distributions can be paid from Radian Guaranty or Radian Insurance in 2009 without approval from the Pennsylvania Insurance Commissioner. Neither Radian Guaranty nor Radian Insurance paid any dividends in 2008.

Amerin. Amerin Guaranty’s ability to pay dividends is restricted by certain provisions of the insurance laws of Illinois. The insurance laws of Illinois establish a test limiting the maximum amount of dividends that may be paid from unassigned surplus by an insurer without prior approval by the Illinois Insurance Commissioner. Under this test, Amerin Guaranty may only pay dividends during any 12-month period in an aggregate amount less than or equal to the greater of (i) 10% of the preceding year-end statutory policyholders’ surplus, or (ii) the preceding year’s statutory net income. In accordance with this test, Amerin Guaranty was not permitted (absent prior regulatory approval) to pay dividends in 2008 and will not be permitted to pay dividends in 2009 without prior regulatory approval.

Radian Asset Assurance. Radian Asset Assurance’s ability to pay dividends is restricted by certain provisions of the insurance laws of New York. Under the New York insurance laws, Radian Asset Assurance may only pay dividends from earned surplus. Without the prior approval from the New York Superintendent of Insurance, Radian Asset Assurance can only pay a dividend, which when totaled with all other dividends declared or distributed by it during the preceding 12 months, is the lesser of 10% of its surplus to policyholders as shown by its last statement on file with the Superintendent of Insurance, or 100% of adjusted net investment income. Radian Asset Assurance paid $107.5 million in dividends in 2008, which was subsequently contributed to Radian Guaranty in July 2008. At December 31, 2008, Radian Asset Assurance did not have any funds available for dividends that could be paid prior to June 2009 without prior regulatory approval. 

3. Risk-to-Capital (Regulation—State Regulation)

A number of states in which we write mortgage insurance limit a private mortgage insurer’s risk in force to 25 times the total of the insurer’s policyholders’ surplus, plus the statutory contingency reserve. This is commonly known as the “risk-to-capital” requirement. As a result of net losses during 2007 and 2008, Radian Guaranty’s risk-to-capital ratio grew from 8.1 to 1 at December 31, 2006 to 14.9 to 1 as of December 31, 2007 and to 16.4 to 1 at December 31, 2008, even after including the contribution of our financial guaranty business to our mortgage insurance business during the third quarter of 2008. This contribution added approximately $934.6 million in statutory capital to our mortgage insurance business.

Additional losses in our mortgage insurance portfolio without a corresponding increase in new capital or capital relief could further negatively impact this ratio, which could limit Radian Guaranty’s ability to write new insurance and could increase restrictions and requirements placed on Radian Guaranty by the GSE’s or state insurance regulators. See “Risk Factors—Recent losses in our mortgage insurance business have reduced Radian Guaranty’s statutory surplus and increased Radian Guaranty’s risk-to-capital ratio; additional losses in our mortgage insurance portfolio without a corresponding increase in new capital or capital relief could further negatively impact these ratios, which could limit Radian Guaranty’s ability to write new insurance and could increase restrictions and requirements placed on Radian Guaranty by the GSEs or state insurance regulators.”

4. Reserves (Regulation—State Regulation)

For statutory reporting, mortgage insurance companies are required annually to provide for additions to their contingency reserve in an amount equal to 50% of earned premiums. Such amounts cannot be released into surplus for a period of 10 years, except when loss ratios exceed 35%, in which case the amount above 35% can be released under certain circumstances. The contingency reserve, designed to be a reserve against catastrophic

 

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losses, essentially restricts dividends and other distributions by mortgage insurance companies. We classify the contingency reserve as a statutory liability. At December 31, 2008, Radian Guaranty had statutory policyholders’ surplus of $445.0 million and a contingency reserve of $1.3 billion, Amerin Guaranty had a statutory policyholders’ surplus of $19.6 million and Radian Insurance had statutory policyholders’ surplus of $112.4 million. In March 2008, Radian Group contributed $15 million to Amerin Guaranty.

Our financial guaranty business also is required to establish contingency reserves. The contingency reserve on direct financial guaranty business written is established net of reinsurance, in an amount equal to the greater of 50% of premiums written or a stated percentage (based on the type of obligation insured or reinsured) of the net amount of principal guaranteed, ratably over 15 to 20 years depending on the category of obligation insured. The contingency reserve may be released with regulatory approval to the extent that losses in any calendar year exceed a pre-determined percentage of earned premiums for such year, with the percentage threshold dependent upon the category of obligation insured. Such reserves may also be released, subject to regulatory approval in certain instances, upon demonstration that the reserve amount is excessive in relation to the outstanding obligation. The contingency reserve on assumed reinsurance business is provided by the ceding company. At December 31, 2008, Radian Asset Assurance had statutory policyholders’ surplus of $965.4 million and a contingency reserve of $515.0 million.

5. Reinsurance (Regulation—State Regulation)

Restrictions apply under the laws of several states to any licensed company ceding business to an unlicensed reinsurer. Under those laws, if a reinsurer is not admitted, authorized or approved in such state, the company ceding business to the reinsurer cannot take credit in its statutory financial statements for the risk ceded to the reinsurer without compliance with certain reinsurance security requirements.

The State of California and the National Association of Insurance Commissioners Mortgage Guaranty Insurance Model Act limit the amount of risk a mortgage insurer may retain with respect to coverage on an insured loan to 25% of the principal balance of the insured loan. Coverage in excess of 25% (i.e., deep coverage) must be reinsured. Radian Guaranty currently uses reinsurance from affiliated companies such as CMAC of Texas to remain in compliance with these insurance regulations.

6. Accreditation (Regulation—State Regulation)

The National Association of Insurance Commissioners instituted the Financial Regulatory Accreditation Standards Program, known as “FRASP,” in response to federal initiatives to regulate the insurance business. FRASP provides standards intended to establish effective state regulation of the financial condition of insurance companies. FRASP requires states to adopt certain laws and regulations, institute required regulatory practices and procedures, and have adequate personnel to enforce these items in order to become accredited. In accordance with the National Association of Insurance Commissioners’ Model Law on Examinations, accredited states are not permitted to accept certain financial examination reports of insurers prepared solely by the insurance regulatory agencies of non-accredited states. Although the State of New York is not accredited, no state where Radian Asset Assurance is licensed has refused to accept the New York Insurance Department’s Reports on Examination for Radian Asset Assurance. We cannot be certain that, if the New York Insurance Department remains unaccredited, other states that are accredited will continue to accept financial examination reports prepared solely by the New York Insurance Department. We do not believe that the refusal by an accredited state to continue accepting financial examination reports prepared by the New York Insurance Department would have a material adverse affect on our insurance businesses.

 

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B. Federal Regulation (Regulation)

1. Mortgage Insurance Tax Deductibility (Regulation—Federal Regulation)

On December 20, 2006, federal legislation was enacted making mortgage insurance premiums tax deductible with regard to loans closing on or after January 1, 2007. Originally scheduled to expire at the end of 2007, the legislation was extended for three more years in December 2007 as part of the Mortgage Forgiveness Debt Relief Act of 2007. The legislation allows borrowers with adjusted gross incomes of $100,000 or less ($50,000 in the case of a married individual filing a separate return) to deduct the full amount of their mortgage insurance premiums paid in calendar years 2007 through 2010. Borrowers making between $100,000 and $110,000 will be eligible to write off a portion of the premiums paid in those years. As extended, the legislation applies to loans closing on or after January 1, 2007 through December 31, 2010, and to both purchase and refinance transactions.

2. Real Estate Settlement Practices Act—“RESPA” (Regulation—Federal Regulation)

The origination or refinance of a federally regulated mortgage loan is a settlement service, and therefore, subject to RESPA. In December 1992, regulations were issued stating that mortgage insurance also is a settlement service. As a result, mortgage insurers are subject to the anti-referral provisions of Section 8(a) of RESPA, which provide, in essence, that mortgage insurers are prohibited from paying anything of value to a mortgage lender in consideration of the lender’s referral of business to the mortgage insurer. Although many states prohibit mortgage insurers from giving rebates, RESPA has been interpreted to cover many non-fee services as well. HUD, as well as the insurance commissioner or an attorney general of any state, may conduct investigations, levy fines and other sanctions or enjoin future violations of RESPA.

We and other mortgage insurers have faced private lawsuits alleging, among other things, that our captive reinsurance arrangements, as well as pool insurance and contract underwriting services, constitute unlawful payments to mortgage lenders under RESPA. Although to date we have successfully defended against all such lawsuits on the basis that the plaintiffs lacked standing, we cannot be certain that we will have continued success defending against similar lawsuits.

The insurance law provisions of many states, including New York, also prohibit paying for the referral of insurance business and provide various mechanisms to enforce this provision. In February 1999, the New York Insurance Department issued Circular Letter No. 2 that discusses its position concerning various transactions between mortgage guaranty insurance companies licensed in New York and mortgage lenders. The letter confirms that captive reinsurance transactions are permissible if they “constitute a legitimate transfer of risk” and “are fair and equitable to the parties.” The letter also states that “supernotes/performance notes,” “dollar pool” insurance, and “un-captive captives” violate New York insurance law.

In May 2005, we received a letter from the New York Insurance Department seeking information related to all of the captive mortgage reinsurance arrangements that we entered into since January 1, 2000, a list of the lenders associated with each captive along with each captive’s state of domicile and capital/surplus requirements. The letter also included a request for a description of any other arrangements through which we provide any payment or consideration to a lender in connection with mortgage insurance. We submitted our response and affirmed it as true under penalties of perjury to the New York insurance department in June 2005. We are aware that other mortgage insurers received similar requests from the New York insurance department.

In February 2006, we and other mortgage insurers received a second letter from the New York insurance department seeking documentation and a description of the due diligence that we perform in selecting reinsurers for our mortgage insurance risk. The letter indicated that the New York insurance department is seeking evidence from us to rebut the assertion that the premiums we pay under our captive reinsurance arrangements constitute an inducement or compensation to lenders for doing business with us and to bolster a claim that it is difficult or impossible to obtain mortgage reinsurance from non-captive reinsurers. We submitted a response to the New York insurance department for Radian Guaranty in March 2006 and for Amerin Guaranty in May 2006, as requested. We have had no further inquiries from the insurance department about either company with respect to captive reinsurance.

 

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In addition to the New York inquiry, we and other mortgage insurers recently have been subject to inquiries from the Minnesota Department of Commerce relating to our captive reinsurance and contract underwriting arrangements, and we have also received a subpoena from the Office of the Inspector General of HUD, requesting information relating to captive reinsurance. We are in the process of responding to both of these requests. Public reports have indicated that both the Colorado and North Carolina Insurance Commissioners also were considering investigating or reviewing captive mortgage reinsurance arrangements. Insurance departments or other officials in other states may also conduct such investigations or reviews.

We cannot predict whether these inquiries will lead to further inquiries, or further investigations of these arrangements, or the scope, timing or outcome of the present inquiries or any other inquiry or action by these or other regulators. Although we believe that all of our captive reinsurance and contract underwriting arrangements comply with applicable legal requirements, we cannot be certain that we will be able to successfully defend against any alleged violations of RESPA or other laws. See “Risk Factors—Legislation and regulatory changes and interpretations could harm our mortgage insurance business.”

HUD proposed an exemption under RESPA for lenders that, at the time a borrower submits a loan application, give the borrower a firm, guaranteed price for all the settlement services associated with the loan, commonly referred to as “bundling.” In 2004, HUD indicated its intention to abandon the proposed rule and to submit a revised proposed rule to the U.S. Congress. HUD began looking at the reform process again in 2005 and a new rule was proposed in 2008. We do not know what form, if any, this rule will take or whether it will be promulgated. In addition, HUD has also declared its intention to seek legislative changes to RESPA. We cannot predict which changes will be implemented and whether the premiums we are able to charge for mortgage insurance will be negatively affected.

3. Home Mortgage Disclosure Act of 1975 (“HMDA”) (Regulation—Federal Regulation)

Most originators of mortgage loans are required to collect and report data relating to a mortgage loan applicant’s race, nationality, gender, marital status and census tract to HUD or the Federal Reserve under the HMDA. The purpose of the HMDA is to detect possible discrimination in home lending and, through disclosure, to discourage this discrimination. Mortgage insurers are not required pursuant to any law or regulation to report HMDA data, although under the laws of several states, mortgage insurers are currently prohibited from discriminating on the basis of certain classifications.

Several mortgage insurers, through the trade association Mortgage Insurance Companies of America (“MICA”), entered into an agreement with the Federal Financial Institutions Examinations Council (“FFIEC”) to report the same data on loans submitted for insurance as is required for most mortgage lenders under HMDA. Reports of HMDA-type data for the mortgage insurance industry have been submitted by several mortgage insurers through MICA to the FFIEC since 1993. We are not aware of any pending or expected actions by governmental agencies in response to the reports submitted by MICA to the FFIEC. We have been independently reporting HMDA data to the FFIEC since January 2004, but now expect to submit HMDA through MICA as a result of our rejoining this trade group in 2008.

4. Mortgage Insurance Cancellation (Regulation—Federal Regulation)

The Homeowners Protection Act of 1998 (the “HPA”) was signed into law on July 29, 1998. The HPA imposes certain cancellation and termination requirements for borrower-paid private mortgage insurance and requires certain disclosures to borrowers regarding their rights under the law. The HPA also requires certain disclosures for loans covered by lender-paid private mortgage insurance. Specifically, the HPA provides that private mortgage insurance on most loans originated on or after July 29, 1999, may be canceled at the request of the borrower once the LTV reaches 80%, provided that certain conditions are satisfied. Private mortgage insurance must be canceled automatically once the LTV reaches 78% (or, if the loan is not current on that date, on the date that the loan becomes current).

 

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The HPA establishes special rules for the termination of private mortgage insurance in connection with loans that are “high risk.” The HPA does not define “high risk” loans but leaves that determination to Fannie Mae and Freddie Mac for loans up to the conforming loan limit and to the lender for any other loan. For “high risk” loans above the conforming loan limit, private mortgage insurance must be terminated on the date that the LTV is first scheduled to reach 77%. In no case, however, may private mortgage insurance be required beyond the midpoint of the amortization period of the loan if the borrower is current on the payments required by the terms of the mortgage.

5. Freddie Mac and Fannie Mae (Regulation—Federal Regulation)

As the largest purchasers and sellers of conventional mortgage loans, and therefore, the main beneficiaries of private mortgage insurance, the GSEs impose requirements on private mortgage insurers who wish to insure loans sold to the GSEs. The current eligibility requirements impose limitations on the type of risk insured, standards for the geographic and customer diversification of risk, procedures for claims handling, standards for acceptable underwriting practices, standards for certain reinsurance cessions and financial requirements that generally mirror state insurance regulatory requirements. These requirements are subject to change from time to time.

Some of the GSEs’ more recent programs require less insurance coverage than they historically have required, and they have the ability to further reduce coverage requirements. They also have the ability to:

 

   

implement new eligibility requirements for mortgage insurers and to alter or liberalize underwriting standards on low-down-payment mortgages they purchase;

 

   

alter the terms on which mortgage insurance coverage may be canceled before reaching the cancellation thresholds established by law;

 

   

require private mortgage insurers to perform activities intended to avoid or mitigate loss on insured mortgages that are in default; and

 

   

influence a mortgage lender’s selection of the mortgage insurer providing coverage.

In order to maintain the highest level of eligibility with the GSEs, mortgage insurers historically had to maintain an insurer financial strength rating of AA- or Aa3 from at least two of the three rating agencies by which they are customarily rated. If a mortgage insurer were to lose such eligibility, the GSEs could restrict the mortgage insurer from conducting certain types of business with them, or take actions that may include not purchasing loans insured by the mortgage insurer. In light of the housing market downturn that has adversely affected mortgage insurers, both of the GSEs have indicated that loss of eligibility due to such a mortgage insurer downgrade will no longer be automatic and will be subject to review if and when the downgrade occurs.

The GSEs have programs that allow for lower levels of required mortgage insurance coverage for certain low-down-payment, 30-year fixed-rate loans approved through their automated underwriting systems. Under these programs, the GSEs replace a portion of their standard mortgage insurance coverage with a reduced layer of coverage.

The GSEs require that we participate in “affordable housing” programs that they maintain to provide for loans to low- and moderate-income borrowers. These programs usually include 95s, 97s and 100s, and may require the liberalization of certain underwriting guidelines to achieve the programs’ objectives. Our default experience on loans that we insure through these programs has been worse than on non-“affordable housing” loans, but the risk in force attributable to our participation in these programs is immaterial.

In July 2008, an overhaul of regulatory oversight of the GSEs was enacted. The new provisions, contained within the Housing and Economic Recovery Act (“HERA”), encompass substantially all of the GSEs’ operations. This new law abolished the former regulator for the GSEs and created a new, stronger regulator, the FHFA, in addition to other oversight reforms.

 

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In September 2008, the FHFA was appointed as the conservator of the GSEs. As their conservator, the FHFA controls and directs the operations of the GSEs. The appointment of a conservator may increase the likelihood that the business practices of the GSEs will be changed in ways that may have a material adverse effect on us. In particular, if the private mortgage insurance industry does not have the ability, due to capital constraints, to continue to write sufficient business to meet the needs of the GSEs, the GSEs may seek alternatives other than private mortgage insurance to conduct their business. The appointment of a conservator also increases the likelihood that the U.S. Congress will examine the role and purpose of the GSEs in the domestic housing market and potentially make certain structural and other changes to the GSEs. Although we believe that private mortgage insurance will continue to play an important role in any future structure involving the GSEs, there is a possibility that new federal legislation could reduce the level of private mortgage insurance coverage used by the GSEs as credit enhancement or eliminate the requirement altogether.

The GSEs have recently introduced streamlined loan modification programs intended to assist qualifying borrowers whose loans are in default. We have agreed to the terms of these programs with both GSEs. Further, in connection with the recently announced Homeownership Affordability and Stability Plan, the government announced a new program that is intended to provide homeowners who took out conforming loans owned or guaranteed by the GSEs to refinance through these institutions over time. Under this program, the FHFA will allow the GSEs to refinance their own qualifying loans without mortgage insurance if the original loan does not have mortgage insurance. The U.S. Treasury also has developed uniform guidance for loan modifications to be used by all federal agencies and the private sector. The GSEs are now required to use these guidelines for loans that they own or guaranty. See “Indirect Regulation “below”.

6. Indirect Regulation (Regulation—Federal Regulation)

We also are indirectly, but significantly, impacted by regulations affecting originators and purchasers of mortgage loans, such as the GSEs, and regulations affecting governmental insurers such as the FHA and the VA. We and other private mortgage insurers may be significantly impacted by federal housing legislation and other laws and regulations that affect the demand for private mortgage insurance and the housing market generally.

In October 2006, the federal banking regulators (Office of the Comptroller of the Currency, Treasury (“OCC”); Board of Governors of the Federal Reserve System (“Board”); Federal Deposit Insurance Corporation (“FDIC”); Office of Thrift Supervision, Treasury (“OTS”); and National Credit Union Administration (“NCUA”)) issued joint interagency guidance on non-traditional mortgage loans. The guidance was developed to address what the regulators identified as the risks associated with the growing use of mortgage products that allow borrowers to defer payment of principal and, sometimes, interest. While the guidance does not have a legally binding effect on lenders, the provisions are used by federal bank examiners to determine whether regulated institutions are in compliance with recommended underwriting and risk management practices. As a result, lenders often are influenced to adjust their business practices in order to conform to currently prevailing guidance. The guidance includes a focus on tightening underwriting and credit standards for non-traditional loans. Simultaneous second-lien loans (which in the past have been utilized in lieu of mortgage insurance) are among the factors cited in the guidance as a risk factor when used in conjunction with non-traditional loan features. The guidance cites the use of mortgage insurance as a mitigating factor for lenders to reduce risk in non-traditional loan products.

In February 2008, the Economic Stimulus Act of 2008 was enacted, which raised loan limits for FHA-insured loans as well as the limit on GSE conforming loans in certain areas up to a maximum of $729,750. The increase in the GSEs’ conforming loan limits was intended to increase the size of the secondary market for purchasing and securitizing home loans and to encourage the GSEs to continue to provide liquidity to the residential mortgage market, particularly in higher-priced areas, at a time when many banks and similar institutions had seriously curtailed their activities due to the subprime lending crisis that developed and intensified during the latter half of 2007.

 

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The HERA contains provisions intended to provide the FHA with greater flexibility in establishing new products. Under HERA, the maximum loan amount that the FHA can insure was increased and a higher minimum cash down-payment was established. The HERA also contained provisions, called the Hope for Homeownership program, in which the FHA is authorized to refinance distressed mortgages in return for lenders and investors agreeing to write down the amount of the original mortgage.

In October 2008, the Emergency Economic Stabilization Act (“EESA”) was enacted. This Act includes provisions that require the Secretary of the U.S. Treasury to encourage further use of the Hope for Homeowners program. Under EESA, the Secretary is required to “maximize assistance to homeowners and encourage mortgage servicers to take advantage of available programs (including the HOPE for Homeowners program) to minimize foreclosures.” The Secretary also is authorized to use loan guarantees and credit enhancements to facilitate loan modifications to prevent avoidable foreclosures. The recently announced Homeowner Affordability and Stability Plan also includes provisions that encourage further use of the Hope for Homeowners program and further strengthen support for FHA programs by easing restrictions in these programs. We cannot predict with any certainty the long term impact of these changes upon demand for our products. However, we believe the FHA has materially increased its market share in 2009, in part by insuring a number of loans that would meet our current underwriting guidelines, as a result of these recent legislative and regulatory changes. See “Risk Factors—Our mortgage insurance business faces intense competition.”

During 2008, mortgage industry participants implemented programs to modify troubled residential mortgages. In particular, Bank of America and Countrywide Financial Corporation entered into a settlement with various states’ Attorneys General that requires the creation of a proactive home retention program that is intended to systematically modify troubled mortgages to allow for up to $8.4 billion in interest rate and principal reductions for nearly 400,000 Countrywide customers. In addition, the FDIC in its role as conservator for IndyMac Bank, also has implemented broad modification procedures for its servicers. Under the recently announced Homeowner Affordability and Stability Plan, the U.S. Treasury plans to allocate $75 billion to support a Homeowner Stability Initiative aimed at reducing foreclosures and avoiding further depreciation in overall home prices. As part of this program, the U.S. Treasury intends to work with financial institutions to reduce interest rates on qualifying mortgages, including those that are current, to specified affordability levels. As discussed above in this section under “Freddie Mac and Fannie Mae,” the U.S. Treasury also has announced a comprehensive refinancing program through the GSEs.

The various initiatives intended to support homeownership and to mitigate the impact of the current housing downturn could have a significant positive effect on moving the domestic housing towards recovery. However, many of the programs are in their early stages and it is unclear at this point whether they will provide us with a material benefit. See “Risk Factors—Loan modification and other similar programs may not provide us with a material benefit.”

C. Foreign Regulation (Regulation)

We also are subject to certain regulation in various foreign countries, namely the United Kingdom, Hong Kong and Bermuda, as a result of our operations in those jurisdictions. In Australia, our transactions have consisted solely of off-shore reinsurance; consequently, we are not subject to direct regulation by the relevant Australian authorities.

In the United Kingdom, we are subject to regulation by the Financial Services Authority (“FSA”). The FSA periodically performs a formal risk assessment of insurance companies or groups carrying on business in the United Kingdom. After each risk assessment, the FSA will inform the insurer of its views on the insurer’s risk profile. This will include details of any remedial action that the FSA requires. The FSA also supervises the management of insurance companies through the approved persons regime, by which any appointment of persons to perform certain specified “controlled functions” within a regulated entity, must be approved by the FSA.

 

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In addition, the FSA supervises the sale of general insurance, including payment protection insurance and mortgage insurance. Under FSA rules, persons who are involved in the sale of general insurance (including insurers and distributors) are prohibited from offering or accepting any inducement in connection with the sale of general insurance that is likely to conflict materially with their duties to insureds. Although the rules do not generally require disclosure of broker compensation, the insurer or distributor must disclose broker compensation at the insured’s request.

The FSA has extensive powers to intervene in the affairs of an insurance company or authorized person and has the power, among other things, to enforce, and take disciplinary measures in respect of, breaches of its rules. Under FSA rules, insurance companies must maintain a margin of solvency at all times, the calculation of which in any particular case depends on the type and amount of insurance business a company writes.

Our United Kingdom subsidiaries are prohibited from declaring a dividend to their shareholders unless they have “profits available for distribution.” The determination of whether a company has profits available for distribution is based on its accumulated realized profits less its accumulated realized losses.

The acquisition of “control” of any United Kingdom insurance company will require FSA approval. For these purposes, a party that “controls” a United Kingdom insurance company includes any company or individual that (together with its or his associates) directly or indirectly acquires 10% or more of the shares in a United Kingdom authorized insurance company or its parent company, or is entitled to exercise or control the exercise of 10% or more of the voting power in such authorized insurance company or its parent company. In considering whether to approve an application for approval, the FSA must be satisfied that the acquirer is both a fit and proper person to have such “control” and that the interests of consumers would not be threatened by such acquisition of “control.” Failure to make the relevant prior application could result in action being taken against our United Kingdom subsidiaries by the FSA.

By reason of Radian Insurance’s authorization, in September 2006, to conduct insurance business through a branch in Hong Kong, we also are subject to regulation by the Hong Kong Insurance Authority (“HKIA”). The HKIA’s principal purpose is to supervise and regulate the insurance industry, primarily for the protection of policy holders and the stability of the industry. Hong Kong insurers are required by the Insurance Companies Ordinance to maintain minimum capital as well as an excess of assets over liabilities of not less than a required solvency margin, which is determined on the basis of a statutory formula. Foreign-owned insurers are also required to maintain assets in Hong Kong in an amount sufficient to ensure that assets will be available in Hong Kong to meet the claims of Hong Kong policy holders if the insurer should become insolvent. The HKIA also reviews the backgrounds and qualifications of insurance companies’ directors and key local management to ensure that these “controllers” are “fit and proper” to hold their positions, and has the authority to approve or disapprove key appointments.

In Bermuda, we are subject to regulation by the Bermuda Monetary Authority. The Insurance Department within the Monetary Authority is responsible for the supervision, regulation, licensing and inspection of Bermuda’s insurance companies, pursuant to the Insurance Act of 1978, as amended under the Insurance Amendment Act of 2002. The Insurance Department has full licensing and intervention powers, including the authority to obtain information and reports and to require the production of documents from licensed insurers.

We currently conduct reinsurance business as an off-shore reinsurer with Australian-licensed lenders’ mortgage insurers. Because we do not conduct an insurance business in Australia, we are not subject to regulation by the Australian Prudential Regulatory Authority (the “APRA”), the prudential regulator of insurance business in Australia, though our customers are themselves subject to APRA regulation.

 

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D. Basel II Capital Accord (Regulation)

The Basel II Capital Accord represents a proposal by the Basel Committee on Banking Supervision (BCBS), consisting of bank supervisors and central bankers from 13 countries, to revise the international standards for measuring the adequacy of a bank’s capital. The implementation of the Basel II Capital Accord proposal will promote a more forward-looking approach to capital supervision and ensure greater consistency in the way banks and banking regulators approach risk management around the world. The implementation of the Basel II Capital Accord may affect the demand for and capital treatment provided to mortgage insurance and the capital available to large domestic and internationally active banking institutions for their mortgage origination and securitization activities.

Our primary mortgage insurance business and opportunities may be significantly impacted by the implementation of the Basel II Capital Accord in the U.S due to adoption of jurisdiction specific prudential standards, that may lead to change in demand for and acceptance of mortgage insurance by large domestic and internationally active banking institutions. The implementation of the Basel II Capital Accord and adoption of standards is subject to the views and discretion of the local banking supervisors and its implementation is expected to vary across national jurisdictions. We are continuously assessing the impact of Basel II Capital Accord implementation in the countries where we have significant operations.

Basel II was implemented by many banks in the U.S. and many other countries in 2008 and may be implemented by the remaining banks in the U.S. and many other countries in 2009. The Basel II provisions related to residential mortgages and mortgage insurance may provide incentives to certain of our bank customers not to insure mortgages having a lower risk of claim and to insure mortgages having a higher risk of claim. See “Risk Factors—The implementation of the Basel II capital accord may discourage the use of mortgage insurance.”

XII. Employees

At December 31, 2008, we had 835 employees, of which 146 work mainly for Radian Group, while 599 and 90 are employed in our mortgage insurance and financial guaranty businesses, respectively. Approximately 137 of our employees are contract underwriters that are hired on an “as-needed” basis. The number of contract underwriters can vary substantially from period to period, mainly as a result of changes in the demand for these services. Our employees are not unionized and management considers employee relations to be good.

 

Item 1A. Risk Factors.

We incurred significant losses during 2007 and 2008, and we expect to incur significant losses in 2009.

The amount of losses we incur on our insured products is subject to national and regional economic factors, many of which are beyond our control, including extended national or regional economic recessions, home price depreciation and unemployment, interest-rate changes or volatility, deterioration in lending markets and other factors.

Throughout 2008, we experienced increased delinquencies and claims in our mortgage insurance business, primarily driven by the poor performance of our late 2005 through early 2008 books of business. Deterioration in general economic conditions, including a significant increase in unemployment, has increased the likelihood that borrowers will default on their mortgages. In addition, home prices have continued to decline in many regions of the U.S. Falling home prices have increased the likelihood that borrowers with the ability to make their mortgage payments may voluntarily default on their mortgages when their mortgage balances exceed the value of their homes. We also believe that some borrowers may voluntarily default to take advantage of certain loan modification programs currently being offered. Falling home prices also make it more difficult for us to mitigate our losses when a default occurs. See Our loss mitigation opportunities are reduced in markets where housing values fail to appreciate or begin to decline.”

 

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Our financial guaranty portfolio also has been negatively impacted by deterioration in the credit markets and the overall economy. See We have experienced deterioration in our financial guaranty portfolio” below.

The current economic downturn and related disruption in the housing and credit markets is expected to continue during 2009 and possibly beyond. We have incurred increased losses as a result of the deterioration in economic conditions and the amount of our new insurance written has declined, and we expect that these trends will continue to materially affect our results of operations and financial condition.

A large portion of our mortgage insurance risk in force consists of higher risk loans, such as non-prime and high-LTV loans, and non-traditional mortgage products, which have resulted in increased losses and are expected to result in further losses in the future.

Non-Prime Loans. A large percentage of the mortgage insurance we wrote in years 2005 through 2007 and, consequently, our existing mortgage insurance risk in force, is related to non-prime loans. At December 31, 2008, our non-prime mortgage insurance in force, including Alt-A, was $43.7 billion or 28.1% of our total primary insurance in force, compared to $49.5 billion or 34.6% of our primary insurance in force at December 31, 2007 and $37.0 billion or 32.5% of our primary insurance in force at December 31, 2006. Historically, non-prime loans are more likely to result in claims than prime loans. In addition, our non-prime business, in particular Alt-A loans, tends to have larger loan balances relative to other loans, which results in larger claims. Since 2006, we have experienced a significant increase in mortgage loan delinquencies related to Alt-A loans originated in 2005 through 2007. These losses have occurred more rapidly and well in excess of historical loss patterns, and have contributed in large part to the significant increase in our provision for losses since 2006. If delinquency and default to claim rates on non-prime loans continue to increase as is expected, in particular in California, Florida and other states where the Alt-A product is prevalent, our results of operations and financial condition will continue to be negatively affected.

High-LTV Mortgages. We generally provide private mortgage insurance on mortgage products that have more risk than most mortgage products that meet the GSEs’ classification of conforming loans. A portion of our mortgage insurance in force consists of insurance on mortgage loans with LTVs at origination of 97% or greater. In 2008, loans with LTVs in excess of 97% accounted for $2.8 billion or 8.8% of our new primary mortgage insurance written, compared to $13.1 billion or 23.0% in 2007 and $5.7 billion or 14.2% in 2006. At December 31, 2008, our mortgage insurance risk in force related to these loans was $6.7 billion or 19.3% of our total primary risk in force, compared to $6.5 billion or 20.7% of primary insurance risk in force at December 31, 2007 and $3.5 billion or 14.0% of primary insurance risk in force at December 31, 2006. Mortgage loans with LTVs greater than 97% default substantially more often than those with lower LTVs. In addition, when we are required to pay a claim on a higher LTV loan, it is generally more difficult to recover our costs from the underlying property, especially in areas with declining property values. Throughout 2007 and 2008, we experienced a significant increase in mortgage loan delinquencies related to high-LTV mortgages. As a result, we have altered our underwriting criteria to eliminate insuring new loans with LTVs greater than 95%. We also have more stringent guidelines for loans with LTVs greater than 90%. While we believe these changes will improve our overall risk profile, in the near term, we will likely continue to be negatively affected by the performance of our existing insured loans with high-LTVs.

Pool Mortgage Insurance. We offer pool mortgage insurance, which exposes us to different risks than the risks applicable to primary mortgage insurance. Our pool mortgage insurance products generally cover all losses in a pool of loans up to our aggregate exposure limit, which generally is between 1% and 10% of the initial aggregate loan balance of the entire pool of loans. Under pool insurance, we could be required to pay the full amount of every loan in the pool within our exposure limits and upon which a claim is made until the aggregate limit is reached, rather than a percentage of the loan amount, as is the case with traditional primary mortgage insurance. At December 31, 2008, $2.9 billion of our mortgage insurance risk in force was attributable to pool insurance, compared to $3.0 billion at each of December 31, 2007 and December 31, 2006.

 

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NIMS. We have provided credit enhancement on NIMS. NIMS are a relatively unproven product with a volatile performance history, particularly in the current declining housing market. NIMS have been particularly susceptible to the disruption in the mortgage credit markets, and we stopped writing insurance on NIMS in 2007. We expect future principal credit losses on NIMS to be approximately $430 million, with most payments expected to occur in 2011 and 2012. Because our future expected credit losses are greater than our cumulative unrealized loss related to NIMS, we expect an additional negative impact to our results of operations related to NIMS in future periods.

A portion of our mortgage insurance risk in force consists of insurance on adjustable-rate products such as ARMs that have resulted in significant losses and are expected to result in further losses.

At December 31, 2008, approximately 18% of our mortgage insurance risk in force consists of ARMs (9% of our mortgage insurance risk in force relates to ARMs with resets of less than five years from origination), which includes loans with negative amortization features, such as pay option ARMs. We consider a loan an ARM if the interest rate for that loan will reset at any point during the life of the loan. It has been our experience that ARMs with resets of less than five years from origination are more likely to result in a claim than longer-term ARMs. Our claim frequency on ARMs has been higher than on fixed-rate loans due to monthly payment increases that occur when interest rates rise or when the “teaser rate” (an initial interest rate that does not fully reflect the index which determines subsequent rates) expires. At December 31, 2008, approximately 10.2% of our primary mortgage insurance risk in force consists of interest-only mortgages, where the borrower pays only the interest on a mortgage for a specified period of time, usually five to ten years, after which the loan payment increases to include principal payments. Similar to ARMs, these loans have a heightened propensity to default because of possible “payment shocks” after the initial low-payment period expires and because the borrower does not automatically build equity as payments are made.

A lack of liquidity in the mortgage market, tighter underwriting standards, and declining home prices in many regions in the U.S. during 2007 and throughout 2008, have combined to make it more difficult for many borrowers with ARMs and interest-only mortgages to refinance their mortgages into lower fixed rate products. As a result, without available alternatives, many borrowers have been forced into default when their interest rates reset. This has resulted in significant losses during 2007 and 2008 for mortgage lenders and insurers as well as investors in the secondary market. Approximately 35.7% of our total increase in mortgage insurance loss reserves during 2008 was attributable to adjustable rate products, which represented approximately 18.2% of our mortgage insurance risk in force at December 31, 2008. Although there can be no assurance, the historically low level of interest rates in the current mortgage market should help to reduce the size of interest payment increases (and in some cases eliminate any increase) for loans resetting in 2009. In the long-term, however, absent a change in the current lending environment or a positive mitigating effect from recent legislation aimed at reducing defaults from adjustable rate resets (See “Business—Regulation—Federal Regulation—Indirect Regulation” above), we expect that defaults related to these products will likely continue to increase. As of December 31, 2008, approximately 6.0% and 10.0% of the adjustable rate mortgages we insure are scheduled to reset during 2009 and 2010, respectively. If defaults related to adjustable rate mortgages were to continue at their current pace or were to increase as is currently projected, our results of operations will continue to be negatively affected, possibly significantly, which could adversely affect our financial and capital position.

Recent losses in our mortgage insurance business have reduced Radian Guaranty’s statutory surplus and increased Radian Guaranty’s risk-to-capital ratio; additional losses in our mortgage insurance portfolio without a corresponding increase in new capital or capital relief could further negatively impact these ratios, which could limit Radian Guaranty’s ability to write new insurance and could increase restrictions and requirements placed on Radian Guaranty by the GSEs or state insurance regulators.

The GSEs, rating agencies and state insurance regulators impose various capital requirements on our subsidiaries. These capital requirements include risk-to-capital ratios, leverage ratios and surplus requirements that limit the amount of insurance that our subsidiaries may write. Many states limit a mortgage insurer’s

 

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risk-to-capital ratio to 25:1. As a result of net losses during 2007 and 2008, Radian Guaranty’s risk-to-capital ratio grew from 8.1:1 at December 31, 2006 to 16.4:1 at December 31, 2008, even after including the contribution of our financial guaranty business to our mortgage insurance business during the third quarter of 2008. This contribution added approximately $934.6 million in statutory capital to our mortgage insurance business.

Based on current and expected future trends, we believe that we will continue to incur and pay material losses in our mortgage insurance business. The ultimate amount of losses will depend in part on general economic conditions and other factors, including the health of credit markets, home price fluctuations and unemployment rates, all of which are difficult to predict. In the absence of additional new capital or capital relief through reinsurance or otherwise, Radian Guaranty’s risk-to-capital ratio is expected to continue to increase during 2009. As a result, we are actively exploring alternatives for raising additional capital, including raising capital through the issuance of equity in a private or public offering, or by selling our interest in Sherman. Any future equity offerings could be significantly dilutive to our existing stockholders or could result in the issuance of securities that have rights, preferences and privileges that are senior to those of our common stock. We may also consider reinsuring our existing or future books of mortgage insurance business or reducing our volume of new insurance business to effectively reduce our risk in force.

We cannot provide any assurance as to whether we will be successful in obtaining additional capital or capital relief, especially given the limited opportunities for raising capital in the current marketplace. If we are unsuccessful in obtaining new capital or capital relief for Radian Guaranty, Radian Guaranty’s risk-to-capital ratio could increase to the point where state insurance regulators may limit the amount of new insurance business that Radian Guaranty may write or prohibit Radian Guaranty from writing new insurance altogether. In addition, the GSEs and our other customers may decide not to conduct new business with Radian Guaranty (or reduce current business levels) while its risk-to-capital ratio remained at elevated levels. This ultimately could result in a loss of Radian Guaranty’s eligibility with the GSEs. The franchise value of our mortgage insurance business would be significantly diminished if Radian Guaranty was prohibited from writing new business or restricted in the amount of new business it could write. Any restriction on Radian Guaranty’s ability to continue to write new insurance would likely harm our ability to attract new capital.

We and our insurance subsidiaries are subject to comprehensive, detailed regulation, principally designed for the protection of our insured policyholders, rather than for the benefit of investors, by the insurance departments in the various states where our insurance subsidiaries are licensed to transact business. Insurance laws vary from state to state, but generally grant broad supervisory powers to agencies or officials to examine insurance companies and enforce rules or exercise discretion affecting almost every significant aspect of the insurance business, including the power to revoke or restrict an insurance company’s ability to write new business.

Given the recent significant losses incurred by many insurers in the mortgage and financial guaranty industries, our insurance subsidiaries have been subject to heightened scrutiny by insurance regulators. We are currently in close communication with certain insurance regulatory authorities, including the Pennsylvania Insurance Department with respect to Radian Guaranty and Radian Insurance, the Illinois Division of Insurance regarding Amerin Guaranty and the Texas Department of Insurance regarding Commonwealth Mortgage Assurance Company of Texas, which reinsures a portion of Radian Guaranty’s portfolio. Amerin Guaranty, which insured second-lien mortgages and therefore is currently in run-off, currently is prohibited from writing new insurance business in four states. Additionally, the Hong Kong Insurance Authority has directed Radian Insurance to continue to maintain sufficient assets in Hong Kong to cover its potential liabilities on insured loans in Hong Kong. In light of current market conditions and on-going deterioration in our financial condition, insurance departments in the jurisdictions noted above or in other jurisdictions could impose restrictions or requirements that could have a material adverse impact on our businesses.

 

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The long-term capital adequacy of Radian Guaranty is dependent, in part, upon the performance of our financial guaranty portfolio.

During the third quarter of 2008, we implemented an internally-sourced capital plan by contributing our financial guaranty business to our mortgage insurance business. This reorganization provided Radian Guaranty with immediate and substantial regulatory capital credit. Importantly, it also is intended to provide Radian Guaranty with significant cash infusions from dividends over time. The timing and amount of these cash infusions will depend on the dividend capacity of our financial guaranty business, which is governed by New York insurance laws.

As of December 31, 2008, Radian Asset Assurance, our principal financial guaranty subsidiary, maintained a statutory surplus of approximately $965 million and claims paying resources of approximately $2.8 billion. Assuming the credit performance of our financial guaranty business remains stable, we expect our financial guaranty business to issue significant dividends to Radian Guaranty over time as our existing financial guaranty portfolio matures and the exposure is reduced. If the exposure is reduced on an accelerated basis through the recapture of insured business from our primary financial guaranty reinsurance customers or otherwise, we may have the ability to release capital to Radian Guaranty more quickly and in a greater amount. If, however, the performance of our financial guaranty portfolio deteriorated materially, our financial guaranty statutory surplus could be reduced, which in turn would have a negative impact on the regulatory capital of Radian Guaranty. Further, our financial guaranty business would likely have less capacity to issue dividends to Radian Guaranty, and could be restricted from issuing dividends altogether, if our financial guaranty portfolio deteriorates materially. Any perceived or actual decrease in the capital support derived from our financial guaranty business could negatively impact the franchise value of our mortgage insurance business. See “We could lose our eligibility status with the GSEs, causing Freddie Mac and Fannie Mae to decide not to purchase mortgages insured by us, which would significantly impair our mortgage insurance franchise” below.

Our financial guaranty portfolio is exposed to risks associated with the on-going deterioration in the credit markets and the overall economy. See “We have experienced deterioration on our financial guaranty portfolio,” Some of our financial guaranty products may be riskier than traditional guaranties of public finance obligations” and “Our financial guaranty business faces risks associated with our reinsurance of risk from our financial guaranty insurance customers and our second-to-pay liabilities from these entities” below.

We have experienced deterioration in our financial guaranty portfolio.

Our financial guaranty portfolio is exposed to risks associated with the deterioration in the credit markets and the overall economy. As discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview of Business Results—Financial Guaranty—Credit Performance,” in Item 7 of Part II below, we experienced deterioration in our financial guaranty portfolio during 2008, primarily related to deterioration in the consumer finance markets and in public finance. The performance of our reinsurance portfolio of assumed RMBS and ABS credits deteriorated during 2008. As of December 31, 2008, $720.6 million of our exposure to RMBS outside of CDOs that we insure was assumed from our primary reinsurance customers. Of this exposure, $527.0 million was subprime and Alt-A RMBS. While we did not experience material deterioration in our directly insured portfolio, there was ratings deterioration within our corporate CDO portfolio due to the impact of several credit events in the second half of 2008. While we have sought to underwrite our insured credits with levels of subordination designed to protect us from loss in the event of poor performance of the underlying collateral, we cannot be certain that such levels of subordination will protect us from future material losses in light of the significantly higher rates of delinquency, foreclosure and losses currently being observed within our insured credits.

 

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Some of our financial guaranty products may be riskier than traditional guarantees of public finance obligations

Historically, our financial guaranty public finance business has focused on smaller, regionalized, lower-investment grade issuers and structures that were uneconomical for most of the larger, higher-rated financial guarantors to insure. As a result, we have greater exposure than other monoline financial guarantors to sectors such as healthcare and long-term care and education that historically have had higher default rates than other public finance sectors. These risks, which generally cover smaller, more rural and specialized issuers, tend to be lower rated and more susceptible to default in an economic downturn such as the one we currently are facing.

In addition to our public finance business, we have guaranteed structured finance obligations that expose us to a variety of complex credit risks and indirectly to market, political and other risks beyond those that generally apply to financial guaranties of public finance obligations. We have insured and reinsured certain asset-backed transactions and securitizations secured by one or a few classes of assets, such as residential mortgages, auto loans and leases, credit card receivables and other consumer assets, both funded and synthetic, and obligations under credit default swaps, including CDOs of several asset classes, including, corporate debt, TruPs, RMBS, CMBS and other ABS obligations. We continue to have exposure to trade credit reinsurance (which is currently in run-off), which protects sellers of goods under certain circumstances against nonpayment of their accounts receivable. These guaranties expose us to the risk of buyer nonpayment, which could be triggered by many factors, including the failure of a buyer’s business. These guaranties may cover receivables where the buyer and seller are in the same country as well as cross-border receivables. In the case of cross-border transactions, in certain cases, we provide coverage that effectively covers losses that could result from political risks, such as foreign currency controls and expropriation, which could interfere with the payment from the buyer. Losses associated with our structured finance and trade credit reinsurance businesses are difficult to predict accurately and could have a material adverse effect on our financial condition and operating results, especially given the current economic disruption.

Our financial guaranty business faces risks associated with our reinsurance of risk from our financial guaranty insurance customers and our second-to-pay liabilities from these entities.

In June 2008, S&P downgraded our financial guaranty insurance subsidiaries’ financial strength ratings. As a result, all but one of our primary reinsurance customers now has the right to take back or recapture up to an aggregate of $36.8 billion of business previously ceded to us under their reinsurance agreements with us. Approximately two-thirds of this business is subject to recapture by one primary insurance customer. Under our treaties with our primary reinsurance customers, our customers do not have the ability to selectively recapture business previously ceded to us under their treaties. However, because we have entered into multiple treaties with each customer, it is possible that our customers may choose to recapture business only under those treaties that they perceive as covering less risky portions of our reinsurance portfolio.

Our reinsurance customers are primarily responsible for surveillance, loss mitigation and salvage on the risks that they cede to us. Many of these customers are experiencing financial difficulties, and therefore, may be less willing to or capable of performing surveillance to the extent necessary to minimize potential losses and/or maximize potential salvage on the credits we reinsure. We generally do not have direct access to the insured obligation or the right to perform our own loss mitigation or salvage work on these transactions. We also have limited visibility with respect to the performance of many of the obligations we reinsure. See If the estimates we use in establishing loss reserves for our mortgage insurance or financial guaranty businesses are incorrect, we may be required to take unexpected charges to income and our ratings may be downgraded” below. In addition, our primary reinsurance customers may delegate their loss adjustment functions to third parties, the cost of which would then be proportionally allocated to us and any other reinsurers for the insured transaction. Accordingly, the losses and loss adjustment expenses allocated to us on our reinsured risks may be significantly higher than otherwise would have been the case if we were responsible for surveillance, loss mitigation and salvage for these risks. This could have a material adverse effect on our financial condition and operating results.

 

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We have directly insured several transactions on a second-to-pay basis, meaning that we are obligated to pay claims in these transactions only to the extent that another monoline financial guarantor fails to pay such claim. Consequently, if a financial guarantor should become insolvent or the conservator for such financial guarantor rejects payment of all or a portion of a claim, we may be required to pay all or a portion of such claim. Because many monoline financial guarantors are currently experiencing significant financial difficulties, the likelihood of our having to pay a claim on our second-to-pay transactions has increased.

Because most of the mortgage loans that we insure are sold to Freddie Mac and Fannie Mae, changes in their charters or business practices could significantly impact our mortgage insurance business.

Freddie Mac and Fannie Mae are the beneficiaries of the majority of our mortgage insurance policies. Freddie Mac’s and Fannie Mae’s federal charters generally prohibit them from purchasing any mortgage with a loan amount that exceeds 80% of a home’s value, unless that mortgage is insured by a qualified insurer or the mortgage seller retains at least a 10% participation in the loan or agrees to repurchase the loan in the event of a default. As a result, high-LTV mortgages purchased by Freddie Mac or Fannie Mae generally are insured with private mortgage insurance.

Changes in the charters or business practices of Freddie Mac or Fannie Mae could reduce the number of mortgages they purchase that are insured by us and consequently diminish our franchise value. Some of Freddie Mac’s and Fannie Mae’s more recent programs require less insurance coverage than they historically have required, and they have the ability to further reduce coverage requirements, which could reduce demand for mortgage insurance and have an adverse effect on our business, financial condition and operating results. They also have the ability to

 

   

implement new eligibility requirements for mortgage insurers and to alter or liberalize underwriting standards on low-down-payment mortgages they purchase. See “We could lose our eligibility status with the GSEs, causing Freddie Mac and Fannie Mae to decide not to purchase mortgages insured by us, which would significantly impair our mortgage insurance franchise” below;

 

   

alter the terms on which mortgage insurance coverage may be canceled before reaching the cancellation thresholds established by law;

 

   

require private mortgage insurers to perform activities intended to avoid or mitigate loss on insured mortgages that are in default; and

 

   

influence a mortgage lender’s selection of the mortgage insurer providing coverage.

The GSEs business practices may be impacted by their results of operations as well as legislative or regulatory changes governing their operations. In July 2008, an overhaul of regulatory oversight of the GSEs was enacted. The new provisions, contained within the Housing and Economic Recovery Act, encompass substantially all of the GSEs’ operations. This new law abolished the former regulator for the GSEs and created a new, stronger regulator, the FHFA, in addition to other oversight reforms.

In September 2008, the FHFA was appointed as the conservator of the GSEs. As their conservator, the FHFA controls and directs the operations of the GSEs. The appointment of a conservator may increase the likelihood that the business practices of the GSEs will be changed in ways that may have a material adverse effect on us. In particular, if the private mortgage insurance industry does not have the ability, due to capital constraints, to continue to write sufficient business to meet the needs of the GSEs, the GSEs may seek alternatives other than private mortgage insurance to conduct their business. The appointment of a conservator also increases the likelihood that the U.S. Congress will examine the role and purpose of the GSEs in the domestic housing market and potentially make certain structural and other changes to the GSEs. Although we believe that private mortgage insurance will continue to play an important role in any future structure involving the GSEs, there is a possibility that new federal legislation could reduce the level of private mortgage insurance coverage used by the GSEs as credit enhancement or eliminate the requirement altogether. In connection with the recently announced Homeownership Affordability and Stability Plan, the FHFA will allow the GSEs to refinance their own qualifying loans without mortgage insurance if the original loan does not have mortgage insurance.

 

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We could lose our eligibility status with the GSEs, causing Freddie Mac and Fannie Mae to decide not to purchase mortgages insured by us, which would significantly impair our mortgage insurance franchise.

In order to maintain the highest level of eligibility with Freddie Mac and Fannie Mae, mortgage insurers generally must maintain an insurer financial strength rating of AA- or Aa3 from at least two of the three ratings agencies by which they are customarily rated. If a mortgage insurer were to lose such eligibility, Freddie Mac and/or Fannie Mae could restrict the mortgage insurer from conducting certain types of business with them, or take actions that may include not purchasing loans insured by the mortgage insurer. In light of the housing market downturn, both Freddie Mac and Fannie Mae have indicated that loss of mortgage insurer eligibility due to such a downgrade will no longer be automatic and will be subject to review if and when the downgrade occurs.

Our mortgage insurance subsidiaries have been downgraded substantially below AA-/Aa3 by S&P and Moody’s. In response to these ratings actions, we have presented business and financial plans to Freddie Mac and Fannie Mae for how to restore profitability and ultimately regain a higher rating for our mortgage insurance business. These plans recently have focused on our completed internal reorganization in which we contributed our financial guaranty business to our mortgage insurance business, thus providing our mortgage insurance business with substantial regulatory capital credit and potential cash infusions over time. See “The long-term capital adequacy of Radian Guaranty is dependent, in part, upon the performance of our financial guaranty portfolio” above for risks associated with this plan. The amount of capital credit that we may receive as a result of the internal reorganization is uncertain and depends on the rating agencies and GSE’s views of the credit quality of our financial guaranty portfolio and our expected dividend capacity from financial guaranty, among other factors. Our ratings are also driven by the rating agencies’ views of the mortgage insurance industry as a whole. If the capital credit we receive from the rating agencies and GSEs is less than they believe may be required by our mortgage insurance business, we could lose our eligibility with the GSEs and/or be further downgraded by the rating agencies.

Our remediation plans include projections of our future financial performance, including the effect of significant changes to the underwriting and pricing of our business. Although their initial reactions to our plans were favorable, we cannot be certain that either of the GSEs will accept our plans or if we will be able to retain our eligibility status with either of them. Loss of our eligibility status with the GSEs would likely have an immediate and material adverse impact on the franchise value of our mortgage insurance business and our future prospects and could negatively impact our long-term result of operations and financial condition.

Deterioration in regional economic factors in areas where our business is concentrated increases our losses in these areas.

Our results of operations and financial condition are particularly affected by weakening economic conditions, such as depreciating home values and unemployment, in specific regions (including international markets) where our business is concentrated.

Approximately 55.2% of our primary mortgage insurance in force is concentrated in 10 states, with the highest percentages being in California, Florida and Texas. A large percentage of our second-lien mortgage insurance in force also is concentrated in California and Florida. Throughout 2008, deteriorating markets in California and Florida, where non-prime and non-traditional mortgage products such as ARMs (including interest-only loans) are prevalent and where home prices have fallen significantly, have resulted in significant losses in our mortgage insurance business. Approximately 45% of our total increase in primary mortgage insurance loss reserves during 2008 was attributable to these states, which together represented approximately 20% of our primary mortgage insurance risk in force at December 31, 2008. During the prolonged period of rising home prices that preceded the current downturn in the U.S. housing market, very few mortgage delinquencies and claims were attributable to insured loans in California, despite the significant growth during this period of riskier, non-traditional mortgage products in this state. As mortgage credit performance in California and Florida has deteriorated, given the size of these markets, our loss experience has been significantly affected and will continue to be negatively affected if conditions continue to deteriorate as we expect.

 

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In addition to California and Florida, approximately 12.3% of our primary mortgage insurance risk in force at December 31, 2008 was concentrated in the Midwestern states of Michigan, Illinois and Ohio. This region continued to experience higher default rates in 2008, which are largely attributable to the difficult operating environment facing the domestic auto industry. We expect that this trend may continue and could become worse.

Our financial guaranty business also has a significant portion of its insurance in force concentrated in a small number of states, principally including California, Texas, New York, Pennsylvania, and Florida, and could be affected by a weakening of economic conditions in these states.

In addition to the impact of regional housing and credit market deterioration, our results of operations and financial condition could be negatively impacted by natural disasters or other catastrophic events, acts of terrorism, conflicts, event specific economic depressions or other harmful events in the regions, including areas internationally, where our business is concentrated.

A decrease in the volume of home mortgage originations could result in fewer opportunities for us to write new insurance business.

Our ability to write new business depends on a steady flow of high-LTV mortgages that require our mortgage insurance. The deterioration in the credit performance of non-prime and other forms of non-conforming loans during 2007 and 2008 has caused lenders to substantially reduce the availability of non-prime mortgages and most other loan products that are not conforming loans, and to significantly tighten their underwriting standards. Fewer loan products and tighter loan qualifications, while improving the overall quality of new mortgage originations, have in turn reduced the pool of qualified homebuyers and made it more difficult for buyers (in particular first-time buyers) to obtain mortgage financing or to refinance their existing mortgages. In addition, the significant disruption in the housing and related credit markets has led to reduced investor demand for mortgage loans and mortgage-backed securities in the secondary market, which historically has been an available source of funding for many mortgage lenders. This has significantly reduced liquidity in the mortgage funding marketplace, forcing many lenders to retain a larger portion of their mortgage loans and mortgage-backed securities and leaving them with less capacity to continue to originate new mortgages.

The potential negative effect on our business from the decreased volume of mortgage originations has been offset by an increase in the demand for mortgage insurance on conforming loans as the lending industry embraces more prudent risk management measures. However, if the volume of new mortgage originations continues to decrease or persists at low levels for a prolonged period of time, we may experience fewer opportunities to write new insurance business, which could reduce our existing insurance in force and have a significant negative effect on both our ability to execute our business plans and our overall franchise value.

Because our mortgage insurance business is concentrated among a few significant customers, our new business written and franchise value could decline if we lose any significant customer.

Our mortgage insurance business depends to a significant degree on a small number of lending customers. Our top ten mortgage insurance customers are generally responsible for half of both our primary new insurance written in a given year and our direct primary risk in force. Accordingly, maintaining our business relationships and business volumes with our largest lending customers is important to the success of our business. Challenging market conditions during 2007 and 2008 have adversely affected, and may continue to adversely affect, the financial condition of a number of our largest lending customers. Many of these customers have experienced ratings downgrades and liquidity constraints in the face of increasing delinquencies and the lack of a secondary market for mortgage funding. These customers could become subject to serious liquidity constraints that may jeopardize the viability of their business plans or their access to additional capital, forcing them to consider alternatives such as bankruptcy or consolidation with others in the industry. In addition, as a result of current market conditions, our largest lending customers may seek to diversify their exposure to any one or more mortgage insurers or decide to write business only with those mortgage insurers that they perceive to have the

 

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strongest financial position. During 2007 and throughout 2008, we have tightened our underwriting guidelines, which has resulted in our declining to insure some of the loans originated by our larger customers. We’ve also increased our pricing to reflect the increased risk of default in the current economic and housing downturn. The loss of business from even one of our major customers could have a material adverse effect on the amount of new business we are able to write, and consequently, our franchise value. Our master policies and related lender agreements do not, and by law cannot, require our mortgage insurance customers to do business with us, and we cannot be certain that any loss of business from a single lender will be recouped from other lending customers in the industry.

Our mortgage insurance business faces intense competition.

The U.S. mortgage insurance industry is highly dynamic and intensely competitive. Our competitors include other private mortgage insurers and federal and state governmental and quasi-governmental agencies, principally the VA and the FHA, which has significantly increased its competitive position in areas with higher home prices by streamlining its down-payment formula and reducing the premiums it charges.

Governmental and quasi-governmental entities typically do not have the same capital requirements that we and other mortgage insurance companies have, and therefore, have greater financial flexibility in their pricing and capacity that could put us at a competitive disadvantage. In the event that a government-owned or sponsored entity in one of our markets decides to reduce prices significantly or alter the terms and conditions of its mortgage insurance or other credit enhancement products in furtherance of social or other goals rather than a profit motive, we may be unable to compete in that market effectively, which could have an adverse effect on our business, financial condition and operating results.

We believe the FHA has substantially increased its market share in 2008, including by insuring a number of loans that would meet our current underwriting guidelines at a cost to the borrower that is lower than the cost of our insurance. For information regarding certain legislative developments that have enhanced the FHA’s competitive position, see “Legislation and regulatory changes and interpretations could harm our mortgage insurance business below. In light of the capital constraints currently facing most, if not all, private mortgage insurers and the need by private mortgage insurers to tighten underwriting guidelines based on past loan performance, we anticipate that the FHA will continue to maintain a strong market position and could increase its market position to the point that private mortgage insurers may be perceived as less significant to the future of the housing finance market.

While the mortgage insurance industry has not had new entrants in many years, it is possible that the improvement in the credit quality of new loans being insured in the current market combined with the deterioration of the financial strength ratings of the existing mortgage insurance companies, in part due to their legacy books of insured mortgages, could encourage new entrants. Our inability to compete with other providers, including any new entrants, could have a material adverse effect on our business, financial condition and operating results.

In addition, in the recent past, an increasing number of alternatives to traditional private mortgage insurance developed, many of which reduced the demand for our mortgage insurance. These alternatives included:

 

   

mortgage lenders structuring mortgage originations to avoid private mortgage insurance, mostly through “80-10-10 loans” or other forms of simultaneous second loans. The use of simultaneous second loans increased significantly during the recent past to become a competitive alternative to private mortgage insurance, particularly in light of (1) the potential lower monthly cost of simultaneous second loans compared to the cost of mortgage insurance in a low-interest-rate environment and (2) possible negative borrower, broker and realtor perceptions about mortgage insurance;

 

   

investors using other forms of credit enhancement such as credit default swaps or securitizations as a partial or complete substitute for private mortgage insurance; and

 

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mortgage lenders and other intermediaries foregoing third-party insurance coverage and retaining the full risk of loss on their high-LTV loans.

As a result of the on-going turmoil in the housing credit market, many of these alternatives to private mortgage insurance are no longer available in the mortgage market, although simultaneous second loans are still available and their use may grow again. If market conditions were to change, however, we again could likely face significant competition from these alternatives as well as others that may develop.

Our business depends, in part, on effective and reliable loan servicing, which may be negatively impacted by the current disruption in the housing and mortgage credit markets.

We depend on reliable, consistent third-party servicing of the loans that we insure. Dependable servicing generally ensures timely billing and strong loss mitigation opportunities for delinquent or near-delinquent loans. Many of our customers also serve as the servicers for loans that we insure, whether the loans were originated by such customer or another lender. Therefore, the same market conditions affecting our customers as discussed above in “Because our mortgage insurance business is concentrated among a few significant customers, our new business written and franchise value could decline if we lose any significant customer” also will affect their ability to effectively maintain their servicing operations. In addition, current housing trends have led to a significant increase in the number of delinquent mortgage loans requiring servicing. These increases have strained the resources of servicers, reducing their ability to undertake loss mitigation efforts that could help limit our losses. Managing a substantially higher volume of non-performing loans could create operational difficulties that our servicers may not have the resources to overcome. If a disruption occurs in the servicing of mortgage loans covered by our insurance policies, this, in turn, could contribute to a rise in delinquencies and/or claims among those loans and could have a material adverse effect on our business, financial condition and operating results.

Loan modification and other similar programs may not provide us with a material benefit.

Recently, the FDIC, as receiver of IndyMac, the GSEs and lenders have adopted programs to modify loans to make them more affordable to borrowers with the goal of reducing the number of foreclosures. In February 2009, the U.S. Treasury announced the Homeowner Affordability and Stability Plan, which provides certain guidelines for loan modifications and allocates $75 billion for this purpose. All of the programs adopted to date are in their early stages and it is unclear whether they will result in a significant number of loan modifications. Even if a loan is modified, we do not know how many modified loans will subsequently re-default. As a result, we cannot ascertain with confidence whether these programs will provide material benefits to us. In addition, because we do not have information for all of the parameters used to determine which of our insured loans are eligible for modification programs, our estimates of the number of qualifying loans are inherently uncertain. The U.S. Treasury is supporting judicial modifications for home mortgages during bankruptcy proceedings. If legislation is enacted to permit a mortgage balance to be reduced in bankruptcy, we would still be responsible under our master insurance policy to pay the original balance if the borrower re-defaulted on that mortgage after its balance has been reduced. Various government entities have enacted foreclosure moratoriums. A moratorium does not affect the accrual of interest and other expenses on a loan. Unless a loan is modified during a moratorium to cure the default, at the expiration of the moratorium, additional interest and expenses would be due, which could result in our losses on loans subject to the moratorium being higher than if there had been no moratorium.

Mortgage refinancings in the current housing market may increase the risk profile of our existing mortgage insurance portfolio.

Mortgage interest rates currently are at historically low levels, which has led many borrowers to seek to refinance their existing mortgages. However, because most lenders are currently utilizing more restrictive underwriting guidelines, only those borrowers with strong credit profiles are generally able to qualify for the new

 

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loans required to refinance. Consequently, only high quality borrowers are generally able to refinance in the current market. As more of these borrowers refinance (and their existing mortgage insurance with us is canceled), the total percentage of our risk in force related to high-risk borrowers could possibly increase, which could increase the risk profile of our existing mortgage insurance portfolio and potentially reduce the future profitability of our mortgage insurance business.

Our success depends on our ability to assess and manage our underwriting risks.

Our mortgage insurance and financial guaranty premium rates may not be adequate to cover future losses. Our mortgage insurance premiums are based on our long-term expected risk of claims on insured loans, and take into account, among other factors, each loan’s LTV, type (e.g., prime vs. non-prime or fixed vs. variable payments), term, coverage percentage or the existence of a deductible in front of our loss position. Our financial guaranty premiums are based on our expected risk of claim on the insured obligation, and take into account, among other factors, the rating and creditworthiness of the issuer and of the insured obligations, the type of insured obligation, the policy term and the structure of the transaction being insured. In addition, our premium rates take into account expected cancellation rates, operating expenses and reinsurance costs, as well as profit and capital needs and the prices that we expect our competitors to offer.

We generally cannot cancel or elect not to renew the mortgage insurance or financial guaranty insurance coverage we provide, and because we generally fix premium rates for the life of a policy when issued, we cannot adjust renewal premiums or otherwise adjust premiums over the life of a policy. Therefore, even if the risk underlying many of the mortgage or financial guaranty products we have insured develops more adversely than we anticipated, including as a result of the on-going economic recession and housing market downturn, and the premiums our customers are currently paying for similar coverage from us and others has increased, we generally cannot increase the premium rates on this in-force business, or cancel coverage or elect not to renew coverage, to mitigate the effects of such adverse developments. Our premiums earned and the associated investment income on those premiums may ultimately prove to be inadequate to compensate for the losses that we may incur. An increase in the amount or frequency of claims beyond the levels contemplated by our pricing assumptions could have a material adverse effect on our business, financial condition and operating results.

Our delegated underwriting program may subject our mortgage insurance business to unanticipated claims.

In our mortgage insurance business, we enter into agreements with our mortgage lender customers that commit us to insure loans using pre-established underwriting guidelines. Once we accept a lender into our delegated underwriting program, we generally insure a loan originated by that lender even if the lender does not follow our specified underwriting guidelines. Under this program, 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. Even if we terminate a lender’s underwriting authority, we remain at risk for any loans by that lender that we previously insured before termination. The performance of loans insured through programs of delegated underwriting has not been tested over a period of extended adverse economic conditions, and the program could lead to greater losses than we anticipate in light of the current economic downturn. Greater than anticipated losses could have a material adverse effect on our business, financial condition and operating results.

We face risks associated with our contract underwriting business.

We provide contract underwriting services for certain of our mortgage lender customers, including on loans for which we are not providing mortgage insurance. Under the terms of our contract underwriting agreements, we agree that if we make material errors that lead to a default in connection with these services, the mortgage lender may, subject to certain conditions, require us to purchase the loans, issue mortgage insurance on the loans, or indemnify the lender against future loss associated with the loans. Accordingly, we assume some credit risk and interest-rate risk in connection with providing these services. In 2007, we underwrote $21.3 billion in principal

 

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amount of loans through contract underwriting. Depending on market conditions, a significant amount of our underwriting services may be performed by independent contractors hired by us on a temporary basis. If these independent contractors make more material errors than we anticipate, the resulting need to provide greater than anticipated recourse to mortgage lenders could have a material adverse effect on our business, financial condition and operating results.

Our loss mitigation opportunities are reduced in markets where housing values fail to appreciate or begin to decline.

The amount of mortgage insurance loss we suffer depends in part on whether the home of a borrower who has defaulted on a mortgage can be sold for an amount that will cover unpaid principal and interest on the mortgage and expenses from the sale. If a borrower defaults under our standard mortgage insurance policy, we generally have the option of paying the entire loss amount and taking title to a mortgaged property or paying our coverage percentage in full satisfaction of our obligations under the policy. In the past, we have been able to take title to the properties underlying certain defaulted loans and sell the properties quickly at prices that have allowed us to recover some or all of our losses. In the current housing market downturn, our ability to mitigate our losses in such manner has been reduced. If housing values continue to decline, or decline more significantly and/or on a larger geographic basis than is currently anticipated, the frequency of loans going to claim could increase and our ability to mitigate our losses on defaulted mortgages may be significantly reduced, which could have a material adverse effect on our business, financial condition and operating results.

A downgrade or potential downgrade of our credit ratings or the insurance financial strength ratings assigned to any of our mortgage insurance or financial guaranty subsidiaries is possible and could weaken our competitive position and affect our financial condition.

The credit ratings of Radian Group and the insurance financial strength ratings assigned to our subsidiaries were downgraded multiple times during 2008 and again in 2009 and may be further downgraded. In response to current market conditions, the rating agencies are engaged in ongoing monitoring of the mortgage insurance and financial guaranty industries and could take action, including by downgrading or warning of the strong possibility of downgrade, with respect to one or more companies in a specific industry. Although we remain in frequent contact with the rating agencies and have prepared action plans to address rating agency actions, we are generally not provided with much advance notice of an impending rating decision, which could come at any time.

Historically, our ratings have been critical to our ability to market our products and to maintain our competitive position and customer confidence in our products. A downgrade in these ratings or the announcement of the potential of a downgrade, or any other concern relating to the on-going financial strength of our insurance subsidiaries, could (i) make it difficult or impossible for them to continue to write new profitable business, (ii) create a competitive advantage for other industry participants that maintain higher ratings than us, or (iii) give existing customers or counterparties the right to recapture business previously written by us. Further, although we believe the GSEs currently are not as concerned with ratings as they have been in past periods, any additional downgrade of the insurance financial strength ratings for our mortgage insurance business could negatively impact our eligibility status with the GSEs. We may be required to raise additional capital in the event of a downgrade or the likelihood of a downgrade, which we may not be able to do on terms acceptable to us or in an amount that would be sufficient to restore or stabilize our ratings. Additional capital could dilute our existing stockholders and reduce our per-share earnings.

If the estimates we use in establishing loss reserves for our mortgage insurance or financial guaranty businesses are incorrect, we may be required to take unexpected charges to income and our ratings may be downgraded.

We establish loss reserves in both our mortgage insurance and financial guaranty businesses to provide for the estimated cost of future claims. Because our reserves represent our best estimate of claims, these reserves

 

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may be insufficient to satisfy the full amount of claims that we ultimately have to pay. Setting our loss reserves requires significant judgment by management with respect to the likelihood, magnitude and timing of anticipated losses. The models and estimates we use to establish loss reserves may prove to be inaccurate, especially during an extended economic downturn or a period of extreme credit market volatility, as currently exists. If our estimates are inadequate, we may be required to increase our reserves, which would have a material adverse effect on our financial condition, capital position and operating results, as well as our ability to continue to write new business.

In accordance with accounting principles generally accepted in the United States of America (“GAAP”), we generally do not establish reserves in our mortgage insurance business until we are notified that a borrower has failed to make at least two consecutive payments when due. Upon notification that two payments have been missed, we establish a loss reserve by using historical models based on a variety of loan characteristics, including the type of loan, the status of the loan as reported by the servicer of the loan, and the area where the loan is located. Because our mortgage insurance reserving does not account for future losses that we expect to incur with respect to in-force loans that have not defaulted, our obligation for ultimate losses that we expect to incur at any period end is not reflected in our financial statements, except to the extent that a premium deficiency exists.

We also are required under GAAP to establish a premium deficiency reserve for our mortgage insurance products if the amount by which the net present value of expected future losses for a particular product and the expenses for such product exceeds the expected future premiums and existing reserves for such product. We evaluate whether a premium deficiency exists at the end of each fiscal quarter. During the second quarter of 2008, we established a premium deficiency reserve of $421.8 million for our first-lien mortgage insurance business, which was reduced to $0 as of December 31, 2008. A premium deficiency reserve of $86.9 million existed for our second-lien mortgage insurance business as of December 31, 2008. Because our evaluation of premium deficiency is based on our best estimate of future losses, expenses and premiums, the evaluation is inherently uncertain and may prove to be inaccurate. Although no premium deficiency existed on our first-lien mortgage insurance business at December 31, 2008, there can be no assurance that additional premium deficiency reserves will not be required for this product or our other mortgage insurance products in future periods.

It also is difficult to estimate appropriate loss reserves for our financial guaranty business because of the nature of potential losses in that business, which are largely influenced by the particular circumstances surrounding each troubled credit, including the availability of loss mitigation, and therefore, are less capable of being evaluated based on historical assumptions or precedent. In addition, in our reinsurance business, we rely in part on information provided by the primary insurer in order to establish reserves. If this information is incomplete or untimely, our loss reserves may be inaccurate and could require adjustment in future periods as new or corrected information becomes available.

Our success depends, in part, on our ability to manage risks in our investment portfolio.

Income from our investment portfolio is one of our primary sources of cash flow to support our operations and claim payments. If we underestimate our policy liabilities, or if we improperly structure our investments to meet those liabilities, we could have unexpected losses, including losses resulting from forced liquidation of investments before their maturity. Our investments and investment policies and those of our subsidiaries are subject to state insurance laws. We may be forced to change our investments or investment policies depending upon regulatory, economic and market conditions and the existing or anticipated financial condition and operating requirements, including the tax position, of our business segments.

Our investment objectives may not be achieved. Although our portfolio consists mostly of highly-rated investments and complies with applicable regulatory requirements, the success of our investment activity is affected by general economic conditions, which may adversely affect the markets for credit and interest-rate-sensitive securities, including the extent and timing of investor participation in these markets, the level and

 

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volatility of interest rates and, consequently, the value of our fixed-income securities. During the second half of 2008, we experienced modest negative returns in our investment portfolio as a result of the on-going deterioration in the economy. Continued volatility or illiquidity in the markets in which we directly or indirectly hold positions has reduced the market value of many of our investments and has caused other than temporary impairments within our portfolio, which, if this continues, could have a material adverse effect on our liquidity, financial condition and operating results.

As a holding company, Radian Group relies on its operating subsidiaries to fund its dividend payments and to meet its obligations.

Radian Group acts principally as a holding company for our insurance subsidiaries and does not have any significant operations of its own. Radian Group’s principal liquidity demands over the next 12 months include funds for: (i) the payment of dividends on our common stock, (ii) the payment of certain corporate expenses (which are fully reimbursed through expense-sharing arrangements with our subsidiaries), (iii) interest payments on our outstanding long-term debt and borrowings under our credit facility (which are fully reimbursed through expense-sharing arrangements with our subsidiaries), (iv) payments to our insurance subsidiaries under our tax-sharing agreement, and (v) potential capital support for our insurance subsidiaries. Radian Group held directly or through an unregulated direct subsidiary, unrestricted cash and marketable securities of $399.0 million at December 31, 2008.

Dividends from our insurance subsidiaries and Sherman, and permitted payments to Radian Group under tax- and expense-sharing arrangements with our subsidiaries are Radian Group’s principal sources of cash. Our insurance subsidiaries’ ability to pay dividends to Radian Group is subject to various conditions imposed by the GSEs and rating agencies, and by insurance regulations requiring insurance department approval. In general, dividends in excess of prescribed limits are deemed “extraordinary” and require insurance regulatory approval. In light of on-going losses in our mortgage insurance subsidiaries, we do not anticipate that these subsidiaries will be permitted under applicable insurance laws to issue dividends to Radian Group for the foreseeable future. To the extent Radian Asset Assurance is permitted to issue dividends, these dividends will be issued to Radian Guaranty, the direct parent company of Radian Asset Assurance, and not to Radian Group. Dividends from Sherman are not subject to regulatory conditions, but to the extent received, must be used to pay-down outstanding amounts under our credit facility if such amounts exceed our tax obligations resulting from our equity ownership of Sherman. The expense-sharing arrangements between Radian Group and our insurance subsidiaries, as amended, have been approved by applicable state insurance departments, but such approval may be changed at any time. Further, any changes to these expense-sharing arrangements must be approved by the administrative agent to our credit facility.

If the cash Radian Group receives from our subsidiaries pursuant to dividend payment and expense- and tax-sharing arrangements is insufficient for Radian Group to fund its obligations, we may be required to seek additional capital by incurring additional debt, by issuing additional equity or by selling assets, which we may be unable to do on favorable terms, if at all. The need to raise additional capital or the failure to make timely payments on our obligations could have a material adverse effect on our financial condition and operating results.

We have significant payment obligations upcoming in 2010 and 2011.

Under our current tax-sharing agreement between Radian Group and our subsidiaries, our subsidiaries are required to pay to Radian Group on a quarterly basis, amounts representing their estimated separate company tax liability for the current tax year. Radian Group is required to refund to each subsidiary any amount that such subsidiary overpaid to Radian Group for a taxable year as well as any amount that the subsidiary could utilize through existing carry-back provisions of the Code had such subsidiary filed its federal tax return on a separate company basis. We currently believe that Radian Group will be required to pay approximately $154 million to our subsidiaries by October 2009, including approximately $149 million to Radian Guaranty. In addition, based on our current tax loss projections, we believe that Radian Group will be required to pay an additional amount of approximately $300 million to Radian Guaranty in October 2010, which amount could increase up to a maximum of $478 million if actual tax losses are worse than projected. All amounts required to be paid under our tax-

 

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sharing agreement are dependent on the extent of tax losses in current and future periods. A portion of these payments may be funded from refunds that Radian Group receives from the Internal Revenue Service (“IRS”). We currently anticipate receiving approximately $105.2 million refund from the IRS in 2009 or 2010 relating to the carry-back of our 2008 net operating loss. Our tax-sharing agreement may not be changed without the pre-approval of the applicable state insurance departments for certain of the insurance subsidiaries that are party to the agreement.

Our $100 million credit facility expires in February 2011, at which time we will be required to repay all $100 million in outstanding principal as well as any interest then outstanding. In addition, we have $250 million in principal amount of debentures that are due in June 2011 as well as $250 million in principal amount of senior notes due in each of 2013 and 2015.

In light of the on-going turmoil in the housing and related credit markets, we do not expect to be profitable in 2009, and Radian Group does not expect to receive any dividends from our insurance subsidiaries in the foreseeable future. Accordingly, in order to satisfy our payment obligations in 2010 and 2011, we likely will be required to seek additional capital by incurring additional debt or issuing additional equity, which could be significantly dilutive to our stockholders, or by selling assets, including our interest in Sherman, which we may not be able to do on favorable terms, if at all. The current turmoil in the mortgage market has created a situation where it would be difficult to raise capital or refinance our long-term debt on favorable terms if it were due currently. We expect that market conditions will improve by 2010, but cannot provide any assurances that we will be able to access the capital markets on favorable terms, if at all.

Our credit facility was amended in 2008, reducing our liquidity and adding additional restrictions on our ability to operate our business. Our failure to comply with, cure breaches of, or obtain waivers for, covenants could result in an acceleration of the due dates of our credit facility and our publicly-traded debt.

We currently have $100 million in principal amount outstanding under our credit facility, which matures in February 2011. We have no unused commitment that we may draw on. In addition, we have $250 million in 7.75% debentures due in June 2011, $250 million in 5.625% senior notes due in February 2013 and $250 million in 5.375% senior notes due in 2015.

The credit agreement governing our credit facility restricts, among other things, our ability to: incur additional indebtedness; create liens; enter into mergers, consolidations and sales of certain of our assets; make certain investments or other specified restricted payments, including investments in, loans to, or guarantying any obligations of, Radian Asset Assurance (other than with respect to its soft capital program); pay dividends or make distributions in respect of our capital stock in excess of a permitted annual amount (generally equal to our current dividend and subject to certain adjustments); and sell certain of our assets and, in certain circumstances, issue stock.

Although our credit agreement no longer has a ratings trigger or debt to capital requirement, and we have eliminated some other requirements, we also agreed to some new restrictions in recent amendments of the credit agreement. For example, we now are limited in the amount of dividends we may pay even if we are not in default under our credit facility.

Under our credit facility as amended, in addition to our business covenants, we are required to maintain (subject to certain adjustments), a consolidated net worth of at least $1.5 billion through June 30, 2009, $1.25 billion from July 1, 2009 through December 31, 2009 and $1.0 billion at any time thereafter, in each case, subject to upward adjustment if we receive net proceeds from the issuance of certain securities. Our consolidated net worth under the credit facility is determined by excluding mark-to-market adjustments on derivative instruments and investments reflected on our financial statements. At December 31, 2008, our consolidated net worth as determined under the facility was $2.6 billion. We expect to incur a net operating loss in 2009, which would negatively impact our consolidated net worth. In addition, our consolidated net worth would be further reduced if we realize losses in our investment portfolio. Although we do not expect to breach our net worth covenant based on our current loss projections, there can be no assurance that losses in or after 2009 will not reduce our consolidated net worth below the minimum amount required by our covenant, which would cause our default under the credit facility.

 

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We would also be in default under our credit facility if, among other things:

 

   

any of our main insurance subsidiaries: (a) fails to meet or maintain minimum levels of statutory capital or surplus; (b) is prohibited from writing, underwriting, assuming, or reinsuring further business; or (c) is otherwise prohibited by its regulators from writing or materially restricted from performing any of its core business activities; and in such event our shared expense reimbursement payments from our subsidiaries do not cover all of our operating expenses and debt service. We discuss our mortgage insurance statutory surplus and risk-to-capital or leverage ratios above in “Recent losses in our mortgage insurance business have reduced Radian Guaranty’s statutory surplus and increased Radian Guaranty’s risk-to-capital ratio; additional losses in our mortgage insurance portfolio without a corresponding increase in new capital or capital relief could further negatively impact these ratios, which could limit Radian Guaranty’s ability to write new insurance and could increase restrictions and requirements placed on Radian Guaranty by the GSEs or state insurance regulators.

 

   

any of our main insurance subsidiaries fails to pay any shared expense reimbursement payment to Radian Group under our expense-sharing arrangements; or

 

   

an insurance regulatory authority or other governmental authority voids, terminates, prohibits, suspends or otherwise causes to be invalid or ineffective, any of our expense-sharing arrangements with our subsidiaries.

If we default under our credit agreement, the agent or the lenders representing a majority of the debt under our credit agreement would have the right to terminate all commitments under the credit agreement and declare the outstanding debt due and payable. If the debt under our credit agreement were accelerated in this manner and not repaid, the holders of 25% or more of our publicly traded $250 million 7.75% debentures due in June 2011, the holders of 25% or more of our publicly traded $250 million 5.625% senior notes due in February 2013 and the holders of 25% or more of our publicly traded $250 million 5.375% senior notes due in 2015, each would have the right to accelerate the maturity of those debts, respectively. We currently maintain sufficient liquidity to repay amounts outstanding under our credit facility. However, if the amounts due under our credit agreement or any series of our outstanding long-term debt are accelerated, we may not have sufficient funds in the future to repay any such amounts.

Our reported earnings are subject to fluctuations based on changes in our credit derivatives that require us to adjust their fair market value as reflected on our income statement.

We provide credit enhancement in the form of derivative contracts. The gains and losses on these derivative contracts are derived from internally generated models, which may differ from models used by our counterparties or others in the industry. We estimate fair value amounts using market information, to the extent available, and valuation methodologies that we deem appropriate in order to estimate the fair value amounts that would be exchanged to sell an asset or transfer a liability. Considerable judgment is required to interpret available market data to develop the estimates of fair value. Since there currently is no active market for many derivative products, we have had to use assumptions as to what could be realized in a current market exchange. In the event that our investments or derivative contracts were sold or transferred in a forced liquidation, the fair values received or paid could be materially different than those reflected in our financial statements. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies—Derivative Assets and Liabilities” in Item 7 below.

Temporary market or credit spread changes as well as actual credit improvement or deterioration in our derivative contracts are reflected in changes in fair value of derivative instruments. Because the adjustments referenced above are reflected on our statements of income, they affect our reported earnings and create earnings volatility. Additionally, beginning in 2008, in accordance with SFAS No. 157, we made an adjustment to our derivatives valuation methodology to account for our own non-performance risk by incorporating our observable credit default swap spread into the determination of fair value of our credit derivatives. Our five year credit

 

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default swap spread has increased significantly, and was 2,466 basis points as of December 31, 2008. This market perception of our high risk of non-performance has had the effect of reducing our derivative liability valuations by approximately $5.6 billion as of December 31, 2008. If our credit default swap spread were to tighten significantly, and other credit spreads utilized in our fair value methodologies remained constant, our earnings could be significantly reduced.

The performance of our strategic investments could harm our financial results.

Part of our business involves strategic investments in other companies, and we generally do not have control over the way that these companies run their day-to-day operations. Our 28.7% equity interest in Sherman currently represents our most significant strategic investment. Sherman is a consumer asset and servicing firm specializing in charged-off and bankruptcy plan consumer assets that it generally purchases at deep discounts from national financial institutions and major retail corporations and subsequently seeks to collect. In addition, Sherman originates subprime credit card receivables through its subsidiary CreditOne and has a variety of other similar ventures related to consumer assets. Consequently, Sherman’s results could be adversely impacted by:

 

   

Sherman’s ability to obtain or renew financing, most of which is renewable annually with the next renewal required in April of 2009, and its ability to accomplish this on reasonable terms;

 

   

mispricing of the pools of consumer assets it purchases;

 

   

macroeconomic or other factors that could diminish the success of its collection efforts on the variety of consumer assets it owns; and

 

   

the results of its credit card origination business, which are sensitive to interest-rate changes, charge-off losses and the success of its collection efforts, and which may be impacted by macroeconomic factors that affect a borrower’s ability to pay.

As a result of their significant amount of collection efforts, there is a risk that Sherman could be subject to consumer related lawsuits and other investigations related to fair debt collection practices, which could have an adverse effect on Sherman’s income, reputation and future ability to conduct business. In addition, Sherman is particularly exposed to consumer credit risk as a result of its credit card origination business and unsecured lending business through CreditOne. National credit card lenders recently have reported decreased spending by card members and an increase in delinquencies and loan write-offs as a result of the on-going turmoil in the consumer credit markets. A continuation of current economic trends could materially impact the future results of Sherman, which, in turn, could have an adverse effect on our results of operations or financial condition.

Sherman’s principal credit facility, which Sherman uses to fund the consumer assets it purchases, is scheduled to expire in April 2009. Sherman may not be able to renew this facility on reasonable terms, if at all. If Sherman is unable to renew the facility, Sherman could lose access to the funds it needs to continue its purchasing activities and to grow its core servicing businesses.

Our international operations subject us to risks.

We are subject to a number of risks associated with our international mortgage insurance and financial guaranty business activities, including:

 

   

dependence on regulatory and third-party approvals;

 

   

foreign governments’ monetary policies and regulatory requirements;

 

   

economic downturns in targeted foreign mortgage origination markets;

 

   

interest-rate volatility in a variety of countries;

 

   

political risk and risks of war, terrorism, civil disturbances or other events that may limit or disrupt markets;

 

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the burdens of complying with a wide variety of foreign regulations and laws, some of which are materially different than the regulatory and statutory requirements we face in our domestic business, and which may change unexpectedly;

 

   

potentially adverse tax consequences;

 

   

restrictions on the repatriation of earnings; and

 

   

foreign currency exchange rate fluctuations.

Given our current strategic focus on domestic mortgage insurance, we have ceased writing new international business (other than limited mortgage reinsurance transactions in Australia) and are seeking to reduce our existing international exposures. In certain cases, our ability to reduce our exposure depends on our counterparty’s ability to find alternative insurance, which opportunities are limited in the current global economic downturn. Accordingly, we may not be able to recover the capital we invested in our international operations for many years and may not recover all of such capital if losses are worse than expected. Further, any one or more of the risks listed above could limit or prohibit us from effectively running off our international operations.

We may lose business if we are unable to meet our customers’ technological demands.

Participants in the mortgage insurance industry rely on e-commerce and other technologies to provide and expand their products and services. Our customers generally require that we provide aspects of our products and services electronically, and the percentage of our new insurance written and claims processing that we deliver electronically has continued to increase. We expect this trend to continue and, accordingly, we may be unable to satisfy our customers’ requirements if we fail to invest sufficient resources or otherwise are unable to maintain and upgrade our technological capabilities. This may result in a decrease in the business we receive, which could impact our profitability.

Our information technology systems may not be configured to process information regarding new and emerging products.

Many of our information technology systems, which have been in place for a number of years, originally were designed to process information regarding traditional products. As new products with new features emerge or when we modify our underwriting standards as we have done recently, our systems may require modification in order to recognize these features to allow us to price or bill for our insurance of these products appropriately. Our systems also may not be capable of recording, or may incorrectly record, information about these products that may be important to our risk management and other functions. In addition, our customers may encounter similar technological issues that prevent them from sending us complete information about the products or transactions that we insure. Making appropriate modifications to our systems involves inherent time lags and may require us to incur significant expenses. The inability to make necessary modifications to our systems in a timely and cost-effective manner may have adverse effects on our business, financial condition and operating results.

We could be adversely affected if personal information that we maintain on consumers is improperly disclosed.

As part of our business, we and certain of our subsidiaries and affiliates maintain large amounts of personal information on consumers. While we believe we have appropriate information security policies and systems to prevent unauthorized disclosure, there can be no assurance that unauthorized disclosure, either through the actions of third parties or our employees, will not occur. Unauthorized disclosure could adversely affect our reputation and expose us to material claims for damages.

 

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We are subject to the risk of private litigation and regulatory proceedings.

We face litigation risk in the ordinary course of operations, including the risk of class action lawsuits. In August and September 2007, two purported stockholder class action lawsuits, Cortese v. Radian Group Inc. and Maslar v. Radian Group Inc., were filed against Radian Group and individual defendants in the U.S. District Court for the Eastern District of Pennsylvania. The complaints, which are substantially similar, allege that we were aware of and failed to disclose the actual financial condition of C-BASS prior to our declaration of a material impairment to our investment in C-BASS. On January 30, 2008, the Court ordered that the cases be consolidated into In re Radian Securities Litigation and appointed the Institutional Investors Iron Workers Local No. 25 Pension Fund and the City of Ann Arbor Employees’ Retirement System Lead Plaintiffs in the case. In April 2008, a consolidated and amended complaint was filed, adding one additional defendant. On June 6, 2008, we filed a motion to dismiss this case, and on December 19, 2008, oral arguments were held on this motion. We are currently awaiting a final ruling on this motion. While it is still very early in the pleadings stage, we do not believe that the allegations in the consolidated cases have any merit and we intend to defend against this action vigorously.

In April 2008, a purported class action lawsuit was filed against Radian Group, the Compensation and Human Resources Committee of our board of directors and individual defendants in the U.S. District Court for the Eastern District of Pennsylvania. The complaint alleges violations of the Employee Retirement Income Securities Act as it relates to our Savings Incentive Plan. The named plaintiff is a former employee of ours. On July 25, 2008, we filed a motion to dismiss this case. The court heard oral arguments on our motion to dismiss on December 19, 2008, and we are awaiting a final ruling. We believe that the allegations are without merit, and intend to defend against this action vigorously.

In June 2008, we filed a complaint for declaratory judgment in the United States District Court for the Eastern District of Pennsylvania, naming IndyMac, Deutsche Bank National Trust Company, FGIC, AMBAC and MBIA Insurance Corporation as defendants. The suit involves three of our pool policies covering second-lien mortgages, entered into in late 2006 and early 2007 with respect to loans originated by IndyMac. We are in a second loss position behind IndyMac and in front of three defendant financial guaranty companies. We are alleging that the representations and warranties made to us to induce us to issue the policies were materially false, and that as a result, the policies should be void. The total amount of our claim liability is approximately $77 million. IndyMac and the FDIC, which now controls IndyMac, have obtained a stay of this action until March 15, 2009.

Also in June 2008, IndyMac filed a suit against us in California State Court in Los Angeles on the same policies, alleging that we have wrongfully denied claims or rescinded coverage on the underlying loans. This action was subsequently dismissed without prejudice. There are related suits between FGIC and IndyMac in California and the Southern District of New York which may also be consolidated with our suit at a later date.

In addition to the above litigation, 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 condensed consolidated financial position and results of operations. In the future, we cannot predict whether other actions might be brought against us. Any such proceedings could have an adverse effect on our consolidated financial position, results of operations or cash flows.

In October 2007, we received a letter from the staff of the Chicago Regional Office of the SEC stating that the staff is conducting an investigation involving Radian Group and requesting production of certain documents. We believe that the investigation generally relates to our proposed, but now-terminated, merger with MGIC and our investment in C-BASS. We are in the process of providing responsive documents and information to the Securities and Exchange Commission.

 

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See also “Legislation and regulatory changes and interpretations could harm our mortgage insurance business,“Legislation and regulatory changes and interpretations could harm our financial guaranty business” and “The IRS is examining our tax returns for the years 2000 through 2007.”

The IRS is examining our tax returns for the years 2000 through 2007.

We are currently under examination by the IRS for the 2000 through 2007 tax years. The IRS opposes the recognition of certain tax losses and deductions that were generated through our investment in a portfolio of residual interests in Real Estate Mortgage Investment Conduits (“REMICs”) and has proposed adjustments denying the associated tax benefits of these items. We are contesting all such proposed adjustments relating to the IRS’s opposition of the tax benefits in question and are working with tax counsel in our defense efforts. We have received the revenue agent report relating to the 2000 through 2004 tax years which proposes an increase to our tax liability of approximately $121 million and, in response to that report, have made a “qualified deposit” with the U.S. Treasury under Internal Revenue Code (“IRC”) Section 6603 of approximately $85.0 million to avoid the accrual of the above-market-rate interest associated with our estimate of the potentially unsettled adjustment. Although we disagree with and will contest the adjustments proposed by the IRS, and believe that our income and loss from these investments was properly reported on our federal income tax returns in accordance with applicable tax laws and regulations in effect during the periods involved, there can be no assurance that we will prevail in opposing additional tax liability with respect to this investment. The examination process and any appeals we may pursue may take some time, and a final resolution may not be reached until a date many months or years into the future. Additionally, although we believe, after discussions with outside counsel about the issues raised in the examination and the procedures for resolution of the disputed adjustments, that an adequate provision for income taxes has been made for potential liabilities that may result, if the outcome of this matter results in liability that differs materially from our expectations, it could have a material impact on our effective tax rate, results of operations and cash flows.

We have concluded that no valuation allowance is required with regard to our deferred tax asset (“DTA”) which is on our balance sheet at December 31, 2008 at $446.1 million

Statement of Financial Accounting Standards No. 109 requires an enterprise to reduce its DTA by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the DTA will not be realized. At each balance sheet date, we assess the requirement to establish a valuation allowance. This assessment, along with the level of a potential valuation allowance, is made based on all available information, including tax planning strategies and projections of future taxable income. Projections of future taxable income incorporate several assumptions of future business and operations that may differ from actual experience. Based on our analysis at December 31, 2008, we believe that we will ultimately possess sufficient taxable income of the appropriate character so that it is more likely than not that our DTA will be realized. Our analysis in making this determination includes our net operating and capital loss carryback potential, a viable tax planning strategy, the reversal of temporary differences relating to our financial guaranty derivatives and the reversal of temporary differences relating to our unrealized losses in our investment portfolio. If, in the future, our assumptions and estimates that resulted in our forecast of future taxable income prove to be incorrect, or future market events occur that prevent our ability to hold financial instruments with unrealized losses to recovery, a valuation allowance could be required to be recognized. Recognition of a valuation allowance could have a material adverse effect on our financial condition, results of operations, and liquidity.

Legislation and regulatory changes and interpretations could harm our mortgage insurance business.

Our business and legal liabilities are affected by the application of federal or state consumer lending and insurance laws and regulations, or by unfavorable changes in these laws and regulations. For example, the Housing and Economic Recovery Act includes reforms to the FHA, which provide the FHA with greater flexibility in establishing new products and increased the FHA’s competitive position against private mortgage insurers. This new law increased the maximum loan amount that the FHA can insure and established a higher

 

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minimum cash down-payment. The Housing and Economic Recovery Act also contained provisions, called the Hope for Homeownership program, in which the FHA is authorized to refinance distressed mortgages in return for lenders and investors agreeing to write down the amount of the original mortgage. The recently enacted Emergency Economic Stabilization Act and the recently announced Homeowner Affordability and Stability Plan include provisions that encourage further use of the Hope for Homeowners program and further strengthen support for FHA programs by easing restrictions in these programs. We cannot predict with any certainty the long term impact of these changes upon demand for our products. However, we believe the FHA has materially increased its market share in 2009, in part by insuring a number of loans that would meet our current underwriting guidelines, as a result of these recent legislative and regulatory changes. See Our mortgage insurance business faces intense competition” above. Any further increase in the competition we face from the FHA or any other government sponsored entities could harm our business, financial condition and operating results.

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 RESPA and that we have failed to comply with the notice provisions of the Fair Credit Reporting Act (“FCRA”). In addition, class action lawsuits have been brought against a number of large lenders alleging that their captive reinsurance arrangements violated RESPA. While we are not currently a defendant in any case related to RESPA or FCRA, there can be no assurance that we will not be subject to any future litigation under RESPA or FCRA or that the outcome of such litigation will not have a material adverse affect on us.

We and other mortgage insurers have been subject to inquiries from the New York Insurance Department and the Minnesota Department of Commerce relating to our captive reinsurance and contract underwriting arrangements, and we have also received a subpoena from the Office of the Inspector General of HUD, requesting information relating to captive reinsurance. We cannot predict whether these inquiries will lead to further inquiries, or further investigations of these arrangements, or the scope, timing or outcome of the present inquiries or any other inquiry or action by these or other regulators. Although we believe that all of our captive reinsurance and contract underwriting arrangements comply with applicable legal requirements, we cannot be certain that we will be able to successfully defend against any alleged violations of RESPA or other laws.

Proposed changes to the application of RESPA could harm our competitive position. HUD proposed an exemption under RESPA for lenders that, at the time a borrower submits a loan application, give the borrower a firm, guaranteed price for all the settlement services associated with the loan, commonly referred to as “bundling.” In 2004, HUD indicated its intention to abandon the proposed rule and to submit a revised proposed rule to the U.S. Congress. HUD began looking at the reform process again in 2005 and a new rule was proposed in 2008. We do not know what form, if any, this rule will take or whether it will be promulgated. In addition, HUD has also declared its intention to seek legislative changes to RESPA. We cannot predict which changes will be implemented and whether the premiums we are able to charge for mortgage insurance will be negatively affected.

Legislation and regulatory changes and interpretations could harm our financial guaranty business.

The laws and regulations affecting the municipal, asset-backed and trade credit debt markets, as well as other governmental regulations, may be changed in ways that could adversely affect our business. Our regulators are reviewing the laws, rules and regulations applicable to financial guarantors in light of the current market disruptions. These reviews could result in additional limitations on our ability to conduct our financial guaranty business, including additional restrictions and limitations on our ability to declare dividends or more stringent statutory capital requirements for all or certain segments of our financial guaranty businesses. Any of these changes could have a material adverse effect on our business, financial condition and operating results.

 

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The implementation of the Basel II capital accord may discourage the use of mortgage insurance.

In 1988, the Basel Committee on Banking Supervision developed the Basel Capital Accord (the “Basel I”), which set out international benchmarks for assessing banks’ capital adequacy requirements. In June 2005, the Basel Committee issued an update to Basel I (as revised in November 2005, “Basel II”). Basel II was implemented by many banks in the U.S. and many other countries in 2008 and may be implemented by the remaining banks in the U.S. and many other countries in 2009. Basel II affects the capital treatment provided to mortgage insurance by domestic and international banks in both their origination and securitization activities. The Basel II provisions related to residential mortgages and mortgage insurance may provide incentives to certain of our bank customers not to insure mortgages having a lower risk of claim and to insure mortgages having a higher risk of claim.

 

Item 1B. Unresolved Staff Comments.

On May 23, 2008, we received a comment letter from the Staff of the SEC's Division of Corporation Finance pertaining, among other matters, to our accounting and disclosures regarding our valuation of derivative instruments, including credit default swaps. In particular, the Staff requested additional information about our methodology used to estimate the fair values of these derivative instruments and our related disclosures. We responded to the Staff's initial comments and we have continued our discussions with the Staff regarding these issues both by letters and by telephone.

Currently, we still have several outstanding staff comments relating to the issues initially raised in the May 23, 2008 letter, including additional Staff comments stemming from our responses, which involve a number of technical matters regarding our valuation methodologies. Specifically, the Staff has requested that we provide more detailed disclosure of assumptions used to estimate the fair values of our CDS contracts and our put options on our money market committed preferred custodial trust securities.

We believe that our valuation methodologies with respect to these complicated financial instruments are appropriate. We are working with the Staff to revise and expand the disclosures and have responded to the Staff's outstanding comments by providing additional disclosure in this Annual Report on Form 10-K.

The Staff may have additional comments regarding our periodic reports filed with the SEC and how we have responded to their comments in this Annual Report on Form 10-K. It is possible that the SEC could ultimately disagree with our methodology used to determine the fair value of our derivative financial instruments, or require additional or different disclosure, which may require us to amend our Quarterly Reports on Form 10-Q filed with the SEC during 2008, this Annual Report on Form 10-K and our Annual Report on Form 10-K for the year ended December 31, 2007.

 

Item 2. Properties.

At our corporate headquarters in Philadelphia, Pennsylvania, we lease approximately 151,697 square feet of office space and 1,240 square feet of space for data storage under a lease that expires in August 2017. In addition, we also lease the following:

 

   

18,962 square feet of office space (including 3,813 square feet in Atlanta, Georgia which is subleased until the expiration of the lease in November 2009) for our mortgage insurance regional offices, service centers and on-site offices throughout the U.S. The leases for this space expire between 2009 and 2012. We are seeking to sublease or potentially buyout a service center lease in Blue Bell, Pennsylvania. This lease expires March 2012;

 

   

121,093 square feet of office space for our financial guaranty operations in New York City. The lease for this space expires in 2015. We occupy 40,553 square feet of this space and sublease 80,540 square feet, including 36,140 square feet to C-BASS and 3,847 square feet to Sherman;

 

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Approximately 600 square feet of office space for our international financial guaranty operations in London until May 2010, with early termination rights beginning May 2009. The lease of the original space, comprising 6,600 square feet, with a term through June 2012 has been assigned to a third party. Radian Group remains as a guarantor on the lease should the assignee fail to perform;

 

   

Approximately 500 square feet of office space for our mortgage insurance operations in Hong Kong. The lease for this space expires in July 2009;

 

   

4,786 square feet of office space in Boca Raton, Florida for other operations. The lease for this space expires in September 2012; and

 

   

15,269 square feet and 27,360 square feet of office space for our data centers in Philadelphia, Pennsylvania (separate from our corporate headquarters) and Dayton, Ohio, respectively. The leases for these offices expire in August 2015 (Philadelphia) and September 2012 (Dayton). Under the Dayton lease, we have an early termination option that can be exercised anytime, upon 90 days notice. We are currently seeking to terminate the lease for our data center space in Philadelphia.

We cannot be certain that we will be able to obtain satisfactory lease renewal terms for our operations, as necessary. We believe our existing properties are well utilized, suitable and adequate for our present circumstances.

Our two data centers (Dayton and Philadelphia) serve as one another’s disaster recovery sites and support all of our businesses. In addition, we have established business continuity recovery plans for our offices in London, New York and Philadelphia.

 

Item 3. Legal Proceedings.

In August and September 2007, two purported stockholder class action lawsuits, Cortese v. Radian Group Inc. and Maslar v. Radian Group Inc., were filed against Radian Group and individual defendants in the U.S. District Court for the Eastern District of Pennsylvania. The complaints, which are substantially similar, allege that we were aware of and failed to disclose the actual financial condition of C-BASS prior to our declaration of a material impairment to our investment in C-BASS. On January 30, 2008, the Court ordered that the cases be consolidated into In re Radian Securities Litigation and appointed the Institutional Investors Iron Workers Local No. 25 Pension Fund (“Iron Workers”) and the City of Ann Arbor Employees’ Retirement System (“Ann Arbor”) Lead Plaintiffs in the case. On April 16, 2008, a consolidated and amended complaint was filed, adding one additional defendant. On June 6, 2008, we filed a motion to dismiss this case, and on December 19, 2008, oral arguments were held on this motion. We are currently awaiting a final ruling on this motion. While it is still very early in the pleadings stage, we do not believe that the allegations in the consolidated cases have any merit.

In April 2008, a purported class action lawsuit was filed against Radian Group, the Compensation and Human Resources Committee of our board of directors and individual defendants in the U.S. District Court for the Eastern District of Pennsylvania. The complaint alleges violations of the Employee Retirement Income Securities Act as it relates to our Savings Incentive Plan. The named plaintiff is a former employee of ours. On July 25, 2008, we filed a motion to dismiss this case. The court heard our motion to dismiss on December 19, 2008, and we are awaiting a final ruling. We believe that the allegations are without merit, and intend to defend against this action vigorously.

On June 26, 2008, we filed a complaint for declaratory judgment in the United States District Court for the Eastern District of Pennsylvania, naming IndyMac, Deutsche Bank National Trust Company, FGIC, AMBAC and MBIA Insurance Corporation as defendants. The suit involves three of our pool policies covering second-lien mortgages, entered into in late 2006 and early 2007 with respect to loans originated by IndyMac. We are in a second loss position behind IndyMac and in front of three defendant financial guaranty companies. We are alleging that the representations and warranties made to us to induce us to issue the policies were materially

 

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false, and that as a result, the policies should be void. The total amount of our claim liability is approximately $77 million. We have established loss reserves equal to the total amount of our exposure to these transactions. IndyMac and the Federal Deposit Insurance Corporation, which now controls IndyMac, have obtained a stay of this action until March 15, 2009.

Also in June 2008, IndyMac filed a suit against us in California State Court in Los Angeles on the same policies, alleging that we have wrongfully denied claims or rescinded coverage on the underlying loans. This action was subsequently dismissed without prejudice. There are related suits between FGIC and IndyMac in California and the Southern District of New York which may also be consolidated with our suit at a later date.

In addition to the above litigation, 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.

On October 3, 2007, we received a letter from the staff of the Chicago Regional Office of the SEC stating that the staff is conducting an investigation involving Radian Group and requesting production of certain documents. The staff has also requested that certain of our employees provide voluntary testimony in this matter. We believe that the investigation generally relates to the proposed merger with MGIC and Radian Group’s investment in C-BASS. We are cooperating with the requests of the SEC. The SEC staff has informed us that this investigation should not be construed as an indication by the Commission or its staff that any violation of the securities laws has occurred, or as a reflection upon any person, entity or security.

See also “Risk Factors—Legislation and regulatory changes and interpretations could harm our mortgage insurance business” and “The Internal Revenue Service (“IRS”) is examining our tax returns for the years 2000 through 2007” above.

 

Item 4. Submission of Matters to a Vote of Security Holders.

None.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Our common stock is listed on the New York Stock Exchange (“NYSE”) under the symbol “RDN.” At March 4, 2009, there were 81,420,871 shares outstanding and approximately 89 holders of record. The following table shows the high and low sales prices of our common stock on the NYSE for the financial quarters indicated:

 

     2008    2007
     High    Low    High    Low

1st Quarter

   $ 12.43    $ 4.41    $ 67.35    $ 53.17

2nd Quarter

     7.14      1.24      63.95      50.82

3rd Quarter

     7.50      0.70      55.40      15.20

4th Quarter

     5.49      1.31      25.99      8.15

We declared cash dividends on our common stock equal to $0.02 per share in each quarter of 2007 and the first and second quarters of 2008. In the third and fourth quarters of 2008, we reduced our cash dividend to $0.0025 per share. As a holding company, Radian Group relies on our operating subsidiaries to fund its dividend payments. For more information on Radian Group’s ability to pay dividends, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” in Item 7 and Note 15 of Notes to Consolidated Financial Statements.

The following table provides information about repurchases by us during the quarter ended December 31, 2008, of equity securities that are registered by us pursuant to Section 12 of the Exchange Act of 1934, as amended:

Issuer Purchases of Equity Securities

 

Period

   Total Number of
Shares Purchased
   Average Price Paid
per Share
   Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs (1)
   Maximum Number of
Shares that May Yet
Be Purchased Under
the Plans or
Programs (2)

10/01/08 to 10/31/08

   —      $ —      —      1,101,355

11/01/08 to 11/30/08

   —        —      —      1,101,355

12/01/08 to 12/31/08

   —        —      —      1,101,355

 

(1) On February 8, 2006, we announced that our board of directors had authorized the repurchase of up to 4.0 million shares of our common stock on the open market under a share repurchase plan. On November 9, 2006, we announced that our board of directors had authorized the purchase of an additional 2.0 million shares as part of an expansion of the existing stock repurchase program. The board did not set an expiration date for this program.
(2) Amounts shown in this column reflect the number of shares remaining under the 4.0 million share authorization and, effective November 9, 2006, the additional 2.0 million share authorization referenced in Note 1 above.

 

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Item 6. Selected Financial Data.

The following table sets forth our selected financial data. This information should be read in conjunction with our Consolidated Financial Statements and Notes thereto included in Item 8 and the information included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

     2008     2007     2006