RDN.10Q.09.30.2014

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________
FORM 10-Q
_____________________________
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number 1-11356
_______________________________
Radian Group Inc.
(Exact name of registrant as specified in its charter)
_______________________________
 
Delaware
 
23-2691170
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
1601 Market Street, Philadelphia, PA
 
19103
(Address of principal executive offices)
 
(Zip Code)
(215) 231-1000
(Registrant’s telephone number, including area code)
_____________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o
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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  x
 
Accelerated filer  o
 
Non-accelerated filer  o
 
Smaller reporting company  o
 
 
 
 
(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  o    No  x
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 191,051,817 shares of common stock, $0.001 par value per share, outstanding on November 3, 2014.




TABLE OF CONTENTS
 
 
Page
Number

 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
Item 1.
Item 1A.
Item 6.
 
 
 


2



GLOSSARY OF ABBREVIATIONS AND ACRONYMS
The list which follows includes the definitions of various abbreviations and acronyms used throughout this report, including the Condensed Consolidated Financial Statements, the Notes to Unaudited Condensed Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Term
Definition
2013 Form 10-K
Annual Report on Form 10-K for the year ended December 31, 2013
ABS
Asset-backed securities
Alt-A
Alternative-A loan where the borrower’s FICO score is generally lower and there is limited documentation
AOCI
Accumulated other comprehensive income (loss)
Appeals
Internal Revenue Service Office of Appeals
Available Assets
As defined in the proposed PMIERs, these assets generally include only the liquid assets of an insurer and exclude Unearned Premium Reserves and certain subsidiary capital
BofA Settlement Agreement
The Confidential Settlement Agreement and Release dated September 16, 2014, by and among Radian Guaranty and Countrywide Home Loans, Inc. and Bank of America, N.A., as a successor to BofA Home Loan Servicing f/k/a Countrywide Home Loan Servicing LP, in order to resolve various actual and potential claims or disputes as to mortgage insurance coverage on certain Subject Loans
Basel II
The June 2005 update to the Basel Capital Accord
Basel III
The September 2010 update to the Basel Capital Accord
BIG
Below investment grade
Carryforwards
Net operating loss carryforward and tax credit carryforward, collectively
CDO
Collateralized debt obligation
CDS
Credit default swap
CDX
A widely traded, observable credit default swap index based on a standardized, synthetic corporate collateralized debt obligation, used as a benchmark of relevant market data for valuation purposes

CFPB
Consumer Financial Protection Bureau
CLO Transaction
A collateralized loan obligation of middle market loans that we insure in a second-to-pay position through a credit default swap
Claim Severity
The percentage of the total claim amount paid
Clayton
Clayton Holdings LLC, a Delaware domiciled indirect non-insurance subsidiary of Radian Group
CMBS
Commercial mortgage-backed security
Convertible Senior Notes due 2017
Our 3.000% convertible unsecured senior notes due November 2017 ($450 million principal amount)
Convertible Senior Notes due 2019
Our 2.250% convertible unsecured senior notes due March 2019 ($400 million principal amount)
Default to Claim Rate
Rate at which defaulted loans result in a claim
Deficiency Amount
The assessed tax liabilities, penalties and interest associated with a formal Notice of Deficiency
Dodd-Frank Act
Dodd-Frank Wall Street Reform and Consumer Protection Act
DTAs
Deferred tax assets
DTLs
Deferred tax liabilities
Early Stage Default
A default for which the foreclosure sale has not been scheduled or held
EFSG
Enhance Financial Services Group Inc., a New York domiciled non-insurance subsidiary of Radian Group
Exchange Act
Securities and Exchange Act of 1934, as amended


3



Term
Definition
Extraordinary Dividend
A dividend distribution required to be approved by an insurance company’s primary regulator that is greater than would be permitted as an ordinary dividend, which does not require regulatory approval
FASB
Financial Accounting Standards Board
FGIC
Financial Guaranty Insurance Company
FGIC Commutation
The January 2013 commutation of the remaining $822.2 million net par outstanding that had been reinsured by Radian Asset Assurance from FGIC
FHA
Federal Housing Administration
FHFA
Federal Housing Finance Agency
FICO
Fair Isaac Corporation
First-liens
First-lien mortgage loans
Flow business
With respect to mortgage insurance, transactions in which mortgage insurance is provided on mortgages on an individual loan basis as they are originated. Flow business contrasts with Structured Transactions, in which mortgage insurance is provided on a group of mortgages after they have been originated
Foreclosure Stage Default
The Stage of Default indicating that the foreclosure sale has been scheduled or held
Freddie Mac Agreement
The Master Transaction Agreement between Radian Guaranty and Freddie Mac entered into in August 2013
Future Legacy Loans
With respect to the BofA Settlement Agreement, Legacy Loans where a claim decision has been or will be communicated by Radian Guaranty after February 13, 2013
GAAP
Accounting principles generally accepted in the United States of America
GSEs
Government-Sponsored Enterprises (Fannie Mae and Freddie Mac)
HARP
Home Affordable Refinance Program
HARP 2
The FHFA’s extension of and enhancements to the HARP program
HUD
U.S. Department of Housing and Urban Development
IBNR
Incurred but not reported
IIF
Insurance in force
Implementation Date
With respect to the BofA Settlement Agreement, a date to be determined by the parties that is within 90 days of receipt of consent by the GSEs
Initial QSR Transaction
Initial quota share reinsurance agreement entered into with a third-party reinsurance provider in the second quarter of 2012
Insureds
With respect to the BofA Settlement Agreement, Countrywide Home Loans, Inc. and Bank of America, N.A., as a successor to BofA Home Loan Servicing f/k/a Countrywide Home Loans Servicing LP
IRS
Internal Revenue Service
JPMorgan
JPMorgan Chase Bank, N.A. and its affiliates
LAE
Loss adjustment expenses, which include the cost of investigating and adjusting losses
Legacy Loans
With respect to the BofA Settlement Agreement, loans that were originated or acquired by an Insured and were insured by Radian Guaranty prior to January 1, 2009, excluding such loans that were refinanced under HARP 2

Legacy Portfolio
Mortgage insurance written during the poor underwriting years of 2005 through 2008, together with business written prior to 2005
Loss Mitigation Activity/Activities
Activities such as rescissions, denials, claim curtailments and cancellations
LPV
A limited purpose vehicle created in connection with the termination of six TruPs transactions in 2012
LTV
Loan-to-value which is calculated as the percentage of the original loan amount to the original value of the property


4



Term
Definition
MD&A
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Minimum Required Assets
A risk-based minimum required asset amount as defined in the proposed PMIERs
Monthly Premium
Premiums on mortgage insurance products paid on a monthly installment basis
Moody’s
Moody’s Investor Service
MPP Requirement
Certain states’ statutory or regulatory risk-based capital requirement that the mortgage insurer must maintain a minimum policyholder position, which is calculated based on both risk and surplus levels
NAIC
National Association of Insurance Commissioners
NIMS
Net interest margin securities
NIW
New insurance written
NOL
Net operating loss
NYSDFS
New York State Department of Financial Services
OCI
Other comprehensive income (loss)
PDR
Premium deficiency reserve
PMIERs
Private Mortgage Insurer Eligibility Requirements issued by the FHFA for public comment on July 10, 2014
PMIERs Financial Requirements
Financial requirements of the PMIERs
PML
Probable maximum loss, representing the anticipated value of the largest potential loss affecting the insured exposure under a highly stressed scenario
PREPA
Puerto Rico Electric Power Authority
PRHTA
Puerto Rico Highway & Transportation Authority
Primaries
Counterparties to certain reinsurance transactions, which are the primary insurers of the underlying credits
Puerto Rico
The Commonwealth of Puerto Rico
Puerto Rico Exposure
Indebtedness issued by Puerto Rico and certain of its agencies and instrumentalities and insured by Radian Asset Assurance
QSR
Quota share reinsurance
QSR Reinsurance Transactions
The Initial QSR Transaction and Second QSR Transaction, collectively
Quicken
Quicken Loans Inc.
Radian
Radian Group Inc. together with its consolidated subsidiaries
Radian Asset Assurance
Radian Asset Assurance Inc., a New York domiciled insurance subsidiary of Radian Guaranty
Radian Group
Radian Group Inc., the registrant
Radian Guaranty
Radian Guaranty Inc., a Pennsylvania domiciled insurance subsidiary of Radian Group
Radian Insurance
Radian Insurance Inc., a Pennsylvania domiciled insurance subsidiary of Radian Guaranty
RBC States
Risk-based capital states, which are those states that currently impose a statutory or regulatory risk-based capital requirement
Recovery Act
The Puerto Rico Public Corporations Debt Enforcement and Recovery Act
Refunding
Recognition of remaining unearned premium that is earned upon redemption or other retirement (including defeasance) of a security that our financial guaranty segment insures
REMIC
Real Estate Mortgage Investment Conduit
REO
Real Estate Owned
RESPA
Real Estate Settlement Procedures Act of 1974


5



Term
Definition
RGRI
Radian Guaranty Reinsurance Inc., a Pennsylvania domiciled insurance subsidiary of EFSG
RIF
Risk in force
Risk-to-capital
Under certain state regulations, a minimum ratio of statutory capital calculated relative to the level of net risk in force
RMAI
Radian Mortgage Assurance Inc., a Pennsylvania domiciled insurance subsidiary of Radian Guaranty
RMBS
Residential mortgage-backed securities
S&P
Standard & Poor’s Financial Services LLC
SAP
Statutory accounting practices include those required or permitted, if applicable, by the insurance departments of the respective states of domicile of our insurance subsidiaries
SEC
United States Securities and Exchange Commission
Second QSR Transaction
Second quota share reinsurance transaction entered into with a third-party reinsurance provider in the fourth quarter of 2012
Second-liens
Second-lien mortgage loans
Senior Notes due 2015
Our 5.375% unsecured senior notes due June 2015 ($250 million principal amount)
Senior Notes due 2017
Our 9.000% unsecured senior notes due June 2017 ($195.5 million principal amount)
Senior Notes due 2019
Our 5.500% unsecured senior notes due June 2019 ($300 million principal amount)
Servicing Only Loans
With respect to the BofA Settlement Agreement, loans other than Legacy Loans that were or are serviced by the Insureds and were 90 days or more past due as of July 31, 2014, or if servicing has been transferred to a servicer other than the Insureds, 90 days or more past due as of the transfer date

Settlement Agreement
An agreement between Quicken Loans Inc. and Radian Guaranty, effective August 15, 2014, to settle and fully resolve certain litigation
Single Premium
Premiums on mortgage insurance products paid in a single payment at origination
Sovereign
Sovereign and sub-Sovereign, collectively
Stage of Default
The stage a loan is in relative to the foreclosure process, based on whether or not a foreclosure sale has been scheduled or held (i.e., Early Stage Defaults and Foreclosure Stage Defaults)
Statutory RBC Requirement
Risk-based capital requirement imposed by the RBC States, requiring a minimum surplus level and, in certain states, a minimum ratio of statutory capital relative to the level of Risk-to-capital
Stressed European Countries
Greece, Spain, Italy, Hungary, Portugal and Ireland, collectively
Structured Transactions
With respect to mortgage insurance, transactions in which mortgage insurance is provided on a group of mortgages after they have been originated. Structured Transactions contrast with Flow business, in which mortgage insurance is provided on mortgages on an individual loan basis as they are originated
Subject Loans
Loans covered under the BofA Settlement Agreement, comprising Legacy Loans and Servicing Only Loans

Terminated TruPs Bonds
TruPs bonds underlying certain TruPs collateralized debt obligations that were terminated in a commutation transaction in 2012
Time in Default
The time period from the point a loan reaches default status (based on the month the default occurred) to the current reporting date
TruPs
Trust preferred securities
TruPs Liquidity Claim
An obligation of Radian Asset Assurance to pay its CDS counterparty the outstanding par amount with respect to four insured TruPs bonds, which may arise if an event of default under any of these TruPs bonds (e.g. failure to pay interest or a breach of a covenant requiring the maintenance of a certain level of performing collateral) exists as of the termination date of the relevant TruPs CDS contract
U.S.
The United States of America


6



Term
Definition
U.S. Treasury
United States Department of the Treasury
Unearned Premium Reserves
Premiums received but not yet earned
VIE
Variable interest entity is a legal entity subject to the variable interest entity subsections of the accounting standard regarding consolidation, and generally includes a corporation, trust or partnership in which, by design, equity investors do not have a controlling financial interest or do not have sufficient equity at risk to finance activities without additional subordinated financial support
Walkaway
Termination of a transaction at the option of the counterparty to certain of our CDS transactions in which such counterparty is not obligated to pay any unaccrued premium or other amount to terminate the transaction




7




Cautionary Note Regarding 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 Exchange Act 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,” “will,” “could,” “should,” “would,” “expect,” “intend,” “plan,” “goal,” “contemplate,” “believe,” “estimate,” “predict,” “project,” “potential,” “continue,” “seek,” “strategy,” “future,” “likely” or the negative or other variations on these words and other similar expressions. These statements, which may 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 statement. These statements speak only as of the date they were made, and we undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. We operate in a changing environment. New risks emerge from time to time and it is not possible for us to predict all risks that may affect us. The forward-looking statements, as well as our prospects as a whole, are subject to risks and uncertainties that could cause actual results to differ materially from those set forth in the forward-looking statements including:
changes in general economic and political conditions, including unemployment rates, changes in the U.S. housing and mortgage credit markets (including declines in home prices and property values), the performance of the U.S. or global economies, the amount of liquidity in the capital or credit markets, changes or volatility in interest rates or consumer confidence and changes in credit spreads, all of which may be impacted by, among other things, legislative activity or inactivity (including legislative changes impacting the obligations of the public or sovereign entities that our financial guaranty business insures), actual or threatened downgrades of U.S. government credit ratings, or actual or threatened defaults on U.S. government obligations;
changes in the way customers, investors, regulators or legislators perceive the strength of private mortgage insurers or financial guaranty providers, in particular in light of the fact that certain of our former competitors have ceased writing new insurance business and have been placed under supervision or receivership by insurance regulators;
catastrophic events, municipal and sovereign or sub-sovereign bankruptcy filings or other economic changes in geographic regions where our mortgage insurance exposure is more concentrated or where we have financial guaranty exposure;
our ability to maintain sufficient holding company liquidity to meet our short- and long-term liquidity needs;
a reduction in, or prolonged period of depressed levels of, home mortgage originations due to reduced liquidity in the lending market, tighter underwriting standards, or general reduced housing demand in the U.S., which may be exacerbated by regulations impacting home mortgage originations, including requirements established under the Dodd-Frank Act;
our ability to maintain an adequate Risk-to-capital position, minimum policyholder position and other surplus requirements for Radian Guaranty, our principal mortgage insurance subsidiary, and an adequate minimum policyholder position and surplus for our insurance subsidiaries that provide reinsurance or capital support to Radian Guaranty;


8




Radian Guaranty’s ability to comply with the financial requirements of the PMIERs (once adopted) within the applicable transition period which, based on the proposed PMIERs, may require us to contribute a substantial portion of our holding company cash and investments to Radian Guaranty, and could depend on our ability to, among other things: (1) successfully monetize Radian Asset Assurance, a direct subsidiary of Radian Guaranty, or otherwise utilize the capital at Radian Asset Assurance in a manner that provides credit for Radian Asset Assurance under the PMIERs; and (2) obtain reinsurance for a portion of our mortgage insurance RIF in a manner that provides capital relief compliant with the PMIERs. The amount of credit or capital relief that may be required to comply with the PMIERs also may be impacted by terms on which we are able to monetize Radian Asset Assurance or utilize the capital in Radian Asset Assurance in a manner that provides credit under the PMIERs, if at all, as well as the performance of our mortgage insurance business, including our level of defaults, the losses we incur on new and existing defaults and the amount and credit characteristics of new business we write, among other factors. Contributing a substantial portion of our holding company cash and investments to Radian Guaranty would leave Radian Group with less liquidity to satisfy its obligations, and we may not be successful in monetizing or otherwise utilizing the capital of Radian Asset Assurance or in obtaining qualifying reinsurance for our mortgage insurance RIF on terms that are acceptable to us, if at all. In the event we are unable to successfully execute these or similar transactions or strategies, or such transactions are not available on terms that are acceptable to us, we may be required or we may decide to seek additional capital by incurring additional debt, by issuing additional equity, or by selling assets, which we may not be able to do on favorable terms, if at all. The ultimate form of the PMIERs and the timeframe for their implementation remain uncertain;
changes in the charters or business practices of, or rules or regulations applicable to the GSEs, including the adoption of the PMIERs, which in their current proposed form: (1) would require Radian Guaranty to hold significantly more capital than is currently required and could negatively impact our returns on equity; (2) could limit the type of business that Radian Guaranty and other private mortgage insurers are willing to write, which could reduce our NIW; (3) could increase the cost of private mortgage insurance, including as compared to the FHA pricing, or result in the emergence of other forms of credit enhancement; and (4) could require changes to our business practices that may result in substantial additional costs in order to achieve and maintain compliance with the PMIERs;
our ability to continue to effectively mitigate our mortgage insurance and financial guaranty losses;
a more rapid than expected decrease in the levels of mortgage insurance rescissions and claim denials, which have reduced our paid losses and resulted in a significant reduction in our loss reserves, including a decrease in net rescissions or denials resulting from an increase in the number of successful challenges to previously rescinded policies or claim denials (including as part of one or more settlements of disputed rescissions or denials), or by the GSEs intervening in or otherwise limiting our loss mitigation practices, including settlements of disputes regarding loss mitigation activities;
the negative impact that our loss mitigation activities may have on our relationships with our customers and potential customers, including the potential loss of current or future business and the heightened risk of disputes and litigation;
the need, in the event the BofA Settlement Agreement is not implemented or we are unsuccessful in defending our loss mitigation activities, to increase our loss reserves for, and reassume risk on, rescinded or cancelled loans or denied claims, and to pay additional claims, including amounts previously curtailed;
any disruption in the servicing of mortgages covered by our insurance policies, as well as poor servicer performance;
adverse changes in the severity or frequency of losses associated with certain products that we formerly offered (and which remain a small part of our insured portfolio) that are riskier than traditional mortgage insurance or financial guaranty insurance policies;
a substantial decrease in the persistency rates of our mortgage insurance policies, which has the effect of reducing our premium income on our Monthly Premium policies and could decrease the profitability of our mortgage insurance business;
heightened competition for our mortgage insurance business from others such as the FHA, the U.S. Department of Veterans Affairs and other private mortgage insurers, including with respect to other private mortgage insurers, those that have been assigned higher ratings than we have, that may be perceived as having a greater ability to comply with the PMIERs, that may have access to greater amounts of capital than we do, that are less dependent on capital support from their subsidiaries than we are or that are new entrants to the industry, and therefore, are not burdened by legacy obligations;


9




changes to the current system of housing finance, including the possibility of a new system in which private mortgage insurers are not required or their products are significantly limited in effect or scope;
the effect of the Dodd-Frank Act on the financial services industry in general, and on our businesses in particular, including whether and to what extent loans with private mortgage insurance may be considered “qualified residential mortgages” for purposes of the Dodd-Frank Act securitization provisions;
the adoption of new or application of existing federal or state laws and regulations, or changes in these laws and regulations or the way they are interpreted, including, without limitation: (i) the resolution of existing, or the possibility of additional, lawsuits or investigations (including in particular investigations and litigation relating to arrangements under RESPA); (ii) changes to the Mortgage Guaranty Insurers Model Act being considered by the NAIC that could include more stringent capital and other requirements for Radian Guaranty in states that adopt the new Mortgage Guaranty Insurers Model Act in the future; and (iii) legislative and regulatory changes (a) impacting the demand for our products, (b) limiting or restricting the products we may offer or increasing the amount of capital we are required to hold, (c) affecting the form in which we execute credit protection, or (d) otherwise impacting our existing businesses or future prospects;
the amount and timing of potential payments or adjustments associated with federal or other tax examinations, including deficiencies assessed by the IRS resulting from the examination of our 2000 through 2007 tax years, which we are currently contesting;
the possibility that we may fail to estimate accurately the likelihood, magnitude and timing of losses in connection with establishing loss reserves for our mortgage insurance or financial guaranty businesses, or to estimate accurately the fair value amounts of derivative instruments in determining gains and losses on these instruments;
volatility in our earnings caused by changes in the fair value of our assets and liabilities carried at fair value, including our derivative instruments, a significant portion of our investment portfolio and certain of our long-term incentive compensation awards;
our ability to realize some or all of the tax benefits associated with our gross DTAs, which will depend, in part, on our ability to generate sufficient sustainable taxable income in future periods;
changes in GAAP or SAP, rules and guidance, or their interpretation;
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;
our ability to fully realize the benefits anticipated from our recent acquisition of Clayton, which may be impeded by, among other things, a loss of customers and/or employees; the potential inability to successfully incorporate Clayton’s business into Radian Group; and the potential distraction of management time and attention in connection with the post-acquisition process; and
the possibility that we may need to impair the estimated fair value of goodwill established in connection with our acquisition of Clayton, the valuation of which requires the use of significant estimates and assumptions with respect to the estimated future economic benefits arising from certain assets acquired in the transaction such as the value of expected future cash flows of Clayton, Clayton’s workforce, expected synergies with our other affiliates and other unidentifiable intangible assets.
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 our 2013 Form 10-K and in our subsequent quarterly and other reports, including Item 1A of Part II of this Quarterly Report on Form 10-Q, filed from time to time with the SEC. We caution you not to place undue reliance on these forward-looking statements, which are current only as of the date on which we issued this report. We do not intend to, and we disclaim any duty or obligation to, update or revise any forward-looking statements to reflect new information or future events or for any other reason.



10




PART I

Radian Group Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 
September 30,
2014
 
December 31,
2013
($ in thousands, except share and per share amounts)
 
 
 
ASSETS
 
 
 
Investments
 
 
 
Fixed-maturities held to maturity—at amortized cost (fair value $50 and $351)
$
50

 
$
358

Fixed-maturities available for sale—at fair value (amortized cost $448,155 and $120,385)
450,670

 
120,553

Equity securities available for sale—at fair value (cost $78,106 and $78,106)
144,593

 
135,168

Trading securities—at fair value
2,479,496

 
3,117,429

Short-term investments—at fair value
1,778,433

 
1,429,228

Other invested assets—(including variable interest entity (“VIE”) assets at fair value of $82,502 and $81,000)
122,159

 
128,421

Total investments
4,975,401

 
4,931,157

Cash
31,908

 
23,858

Restricted cash
16,509

 
22,527

Deferred policy acquisition costs
60,140

 
66,926

Accrued investment income
26,043

 
30,264

Accounts and notes receivable
93,644

 
75,106

Property and equipment, at cost (less accumulated depreciation of $104,503 and $101,625)
22,077

 
10,516

Derivative assets
24,213

 
16,642

Deferred income taxes, net

 
17,902

Reinsurance recoverables
23,335

 
46,846

Goodwill and other intangible assets, net
293,632

 
2,300

Other assets (including VIE other assets of $88,219 and $92,023)
392,789

 
377,647

Total assets
$
5,959,691

 
$
5,621,691

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Unearned premiums
$
796,742

 
$
768,871

Reserve for losses and loss adjustment expense (“LAE”)
1,620,351

 
2,185,421

Long-term debt
1,201,069

 
930,072

VIE debt—at fair value
91,232

 
94,645

Derivative liabilities (including VIE derivative liabilities of $46,653 and $68,457)
185,258

 
307,185

Other liabilities (including VIE accounts payable of $221 and $254)
330,638

 
395,852

Total liabilities
4,225,290

 
4,682,046

Commitments and Contingencies (Note 16)

 

Stockholders’ equity
 
 
 
Common stock: par value $.001 per share; 485,000,000 shares authorized at September 30, 2014 and December 31, 2013, respectively; 208,597,427 and 190,636,972 shares issued at September 30, 2014 and December 31, 2013, respectively; 191,049,937 and 173,099,515 shares outstanding at September 30, 2014 and December 31, 2013, respectively
209

 
191

Treasury stock, at cost: 17,547,490 and 17,537,457 shares at September 30, 2014 and December 31, 2013, respectively
(892,961
)
 
(892,807
)
Additional paid-in capital
2,599,183

 
2,347,104

Retained deficit
(21,044
)
 
(552,226
)
Accumulated other comprehensive income (“AOCI”)
49,014

 
37,383

Total stockholders’ equity
1,734,401

 
939,645

Total liabilities and stockholders’ equity
$
5,959,691

 
$
5,621,691


See Notes to Unaudited Condensed Consolidated Financial Statements.


11



Radian Group Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
($ in thousands, except per share amounts)
2014
 
2013
 
2014
 
2013
Revenues:
 
 
 
 
 
 
 
Net premiums earned—insurance
$
227,156

 
$
211,984

 
$
646,935

 
$
617,696

Services revenue
42,243




42,243



Net investment income
26,178

 
26,732

 
76,144

 
81,220

Net (losses) gains on investments
(7,839
)
 
(7,132
)
 
103,831

 
(142,891
)
Change in fair value of derivative instruments
19,360

 
10,778

 
126,923

 
(70,357
)
Net gains (losses) on other financial instruments
982

 
902

 
(229
)
 
(3,585
)
Other income
1,171

 
1,314

 
4,115

 
5,319

Total revenues
309,251

 
244,578

 
999,962

 
487,402

Expenses:
 
 
 
 
 
 
 
Provision for losses
42,526

 
154,849

 
167,527

 
427,821

Policy acquisition costs
6,034

 
7,958

 
23,069

 
35,159

Direct cost of services
23,896

 

 
23,896

 

Other operating expenses
56,262

 
70,974

 
181,722

 
212,055

Interest expense
23,989


19,570


66,264

 
54,871

Amortization of intangible assets
3,294




3,294



Total expenses
156,001

 
253,351

 
465,772

 
729,906

Equity in net (loss) income of affiliates




(13
)
 
1

Pretax income (loss)
153,250

 
(8,773
)
 
534,177

 
(242,503
)
Income tax (benefit) provision
(340
)

3,909


2,995

 
(9,149
)
Net income (loss)
$
153,590

 
$
(12,682
)
 
$
531,182

 
$
(233,354
)
Basic net income (loss) per share
$
0.80

 
$
(0.07
)
 
$
2.91

 
$
(1.43
)
Diluted net income (loss) per share
$
0.67

 
$
(0.07
)
 
$
2.37

 
$
(1.43
)
Weighted-average number of common shares outstanding—basic
191,050

 
171,830

 
182,357

 
162,828

Weighted-average number of common and common equivalent shares outstanding—diluted
238,067

 
171,830

 
230,662

 
162,828

Dividends per share
$
0.0025

 
$
0.0025

 
$
0.0075

 
$
0.0075














See Notes to Unaudited Condensed Consolidated Financial Statements.


12



Radian Group Inc.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands)
2014
 
2013
 
2014
 
2013
Net income (loss)
$
153,590

 
$
(12,682
)
 
$
531,182

 
$
(233,354
)
Other comprehensive (loss) income, net of tax (see Note 12):
 
 
 
 
 
 
 
Foreign currency translation adjustments:
 
 
 
 
 
 
 
Unrealized foreign currency translation adjustment
(186
)
 

 
(186
)
 

Less: Reclassification adjustment for net gains (losses) included in net income (loss)

 

 

 

Net foreign currency translation adjustments
(186
)
 

 
(186
)
 

Unrealized (losses) gains on investments:
 
 
 
 
 
 
 
Unrealized holding (losses) gains arising during the period
(2,236
)
 
4,978

 
11,530

 
13,924

Less: Reclassification adjustment for net (losses) gains included in net income (loss)
(419
)
 
304

 
(287
)
 
879

Net unrealized (losses) gains on investments
(1,817
)
 
4,674

 
11,817

 
13,045

Other comprehensive (loss) income, net of tax
(2,003
)
 
4,674

 
11,631

 
13,045

Comprehensive income (loss)
$
151,587

 
$
(8,008
)
 
$
542,813

 
$
(220,309
)




























See Notes to Unaudited Condensed Consolidated Financial Statements.



13



Radian Group Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN COMMON STOCKHOLDERS’ EQUITY (UNAUDITED)

(In thousands)
Common
Stock

Treasury
Stock

Additional Paid-in Capital
Retained
Deficit
AOCI
Total
BALANCE, JANUARY 1, 2013
$
151

$
(892,094
)
$
1,967,414

$
(355,241
)
$
16,095

$
736,325

Net loss



(233,354
)

(233,354
)
Net unrealized gain on investments, net of tax




13,045

13,045

Repurchases of common stock under incentive plans

(713
)



(713
)
Issuance of common stock - stock offering
39


299,371



299,410

Issuance of common stock under benefit plans


643



643

Issuance of common stock under incentive plans
1


62



63

Amortization of restricted stock


3,883



3,883

Issuance of convertible debt


77,026



77,026

Stock-based compensation expense, net


(608
)


(608
)
Dividends declared


(1,200
)


(1,200
)
BALANCE, SEPTEMBER 30, 2013
$
191

$
(892,807
)
$
2,346,591

$
(588,595
)
$
29,140

$
894,520

 
 
 
 
 
 
 
BALANCE, JANUARY 1, 2014
$
191

$
(892,807
)
$
2,347,104

$
(552,226
)
$
37,383

$
939,645

Net income



531,182


531,182

Net foreign currency translation adjustment, net of tax




(186
)
(186
)
Net unrealized gain on investments, net of tax




11,817

11,817

Repurchases of common stock under incentive plans

(154
)



(154
)
Issuance of common stock - stock offering
18


247,170



247,188

Issuance of common stock under benefit plans


922



922

Issuance of common stock under incentive plans


175



175

Amortization of restricted stock


6,283



6,283

Stock-based compensation expense, net


(1,083
)


(1,083
)
Dividends declared


(1,388
)


(1,388
)
BALANCE, SEPTEMBER 30, 2014
$
209

$
(892,961
)
$
2,599,183

$
(21,044
)
$
49,014

$
1,734,401


























See Notes to Unaudited Condensed Consolidated Financial Statements.


14




Radian Group Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
 
 
 
(In thousands)
Nine Months Ended September 30,
2014
 
2013
Cash flows used in operating activities
$
(223,270
)
 
$
(567,642
)
Cash flows from investing activities:
 
 
 
Proceeds from sales of fixed-maturity investments available for sale
54,030

 
19,124

Proceeds from sales of trading securities
721,531

 
1,155,310

Proceeds from redemptions of fixed-maturity investments available for sale
8,056

 
7,721

Proceeds from redemptions of fixed-maturity investments held to maturity
300

 
255

Proceeds from redemptions of equity securities available for sale

 
10,503

Purchases of fixed-maturity investments available for sale
(386,593
)
 
(80,758
)
Purchases of trading securities

 
(507,034
)
Purchases of short-term investments, net
(349,313
)
 
(646,098
)
Sales of other assets, net
7,765

 
15,311

Purchases of property and equipment, net
(12,030
)
 
(3,677
)
Acquisitions, net of cash acquired
(294,869
)
 

Net cash used in investing activities
(251,123
)
 
(29,343
)
Cash flows from financing activities:
 
 
 
Dividends paid
(1,388
)
 
(1,200
)
Proceeds/payments related to issuance or exchange of debt, net
293,809

 
381,165

Redemption of long-term debt
(57,223
)
 
(79,372
)
Issuance of common stock
247,188

 
299,410

Excess tax benefits from stock-based awards
106

 
752

Net cash provided by financing activities
482,492

 
600,755

Effect of exchange rate changes on cash
(49
)
 

Increase in cash
8,050

 
3,770

Cash, beginning of period
23,858

 
31,555

Cash, end of period
$
31,908

 
$
35,325

 
 
 
 
Supplemental disclosures of cash flow information:
 
 
 
Income taxes paid
$
8,496

 
$
2,414

Interest paid
$
26,058

 
$
18,172









See Notes to Unaudited Condensed Consolidated Financial Statements.


15



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements



1. Condensed Consolidated Financial Statements—Basis of Presentation and Business Overview
Our condensed consolidated financial statements include the accounts of Radian Group Inc. and its subsidiaries. We refer to Radian Group Inc. together with its consolidated subsidiaries as “Radian,” the “Company,” “we,” “us” or “our,” unless the context requires otherwise. We generally refer to Radian Group Inc. alone, without its consolidated subsidiaries, as “Radian Group.” Unless otherwise defined in this report, certain terms and acronyms used throughout this report are defined in the Glossary of Abbreviations and Acronyms included as part of this report.
Our condensed consolidated financial statements are prepared in accordance with GAAP and include the accounts of all wholly-owned subsidiaries. Companies in which we, or one of our subsidiaries, exercise significant influence (generally ownership interests ranging from 20% to 50%), are accounted for in accordance with the equity method of accounting. VIEs for which we are the primary beneficiary are consolidated, as described in Note 5. All intercompany accounts and transactions, and intercompany profits and losses, have been eliminated. We have condensed or omitted certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with GAAP pursuant to the instructions set forth in Article 10 of Regulation S-X of the SEC.
The financial information presented for interim periods is unaudited; however, such information reflects all adjustments that are, in the opinion of management, necessary for the fair statement of the financial position, results of operations, comprehensive income and cash flows for the interim periods presented. Such adjustments are of a normal recurring nature. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. These interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in our 2013 Form 10-K. The results of operations for interim periods are not necessarily indicative of results to be expected for the full year or for any other period. Certain prior period amounts have been reclassified to conform to current period presentation.
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. While the amounts included in our condensed consolidated financial statements include our best estimates and assumptions, actual results may vary materially.
In July 2013, the FASB issued an update to the accounting standard regarding income taxes. This update provides guidance concerning the balance sheet presentation of an unrecognized tax benefit when a Carryforward is available. We adopted this update in the first quarter of 2014. See Note 13 for additional information.
In April 2014, the FASB issued an update regarding reporting discontinued operations and disclosures of disposals of components of an entity. This update changes the requirements for reporting discontinued operations. A disposal of a component of an entity or a group of components of an entity is required to be reported in discontinued operations if the disposal represents (or would represent) a strategic shift that has (or will have) a major effect on an entity’s operations and financial results when any of the following occurs: (i) the component of an entity or group of components of an entity meets the criteria to be classified as held for sale; (ii) the component of an entity or group of components of an entity is disposed of by sale; or (iii) the component of an entity or group of components of an entity is disposed of other than by sale (for example, by abandonment or in a distribution to owners in a spin-off). The amendments in this update require expanded disclosures about discontinued operations. The provisions of this update are effective for all disposals (or classifications as held for sale) of components of an entity that occur within annual periods beginning on or after December 15, 2014, and interim periods within those years. Early adoption is permitted, but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issuance. We are currently evaluating the impact of this update, if any.
In May 2014, the FASB issued an update to the accounting standard regarding revenue recognition. This update is intended to provide a consistent approach in recognizing revenue. In accordance with the new standard, recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, the new standard requires that reporting companies disclose the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. While this update does not change revenue recognition principles related to our insurance and derivative products, this update may be applicable to revenues from our new mortgage and real estate services segment, which has been included in our condensed consolidated statements of operations beginning with the third quarter of 2014. The provisions of this update are effective for interim and annual periods beginning after December 15, 2016. We are currently evaluating the impact of this update, if any.


16



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

In August 2014, the FASB issued an update regarding measuring the financial assets and the financial liabilities of a consolidated collateralized financing entity. A reporting entity that consolidates a collateralized financing entity may elect to measure the financial assets and the financial liabilities of that collateralized financing entity using either the measurement alternative included in this update or the accounting standard regarding fair value measurement. When a reporting entity elects the measurement alternative included in this update, consolidated net income (loss) should reflect the reporting entity’s own economic interests in the collateralized financing entity, including (i) changes in the fair value of the beneficial interests retained by the reporting entity and (ii) beneficial interests that represent compensation for services. This update also clarifies that, when using the accounting standard regarding fair value measurement, (a) the fair value of the financial assets and liabilities of the consolidated entity should be measured using the accounting standard regarding fair value measurement and (b) any differences in the fair value of the financial assets and liabilities of that consolidated entity should be reflected in earnings. This update is effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. A reporting entity may apply the amendments in this update using a modified retrospective approach by recording a cumulative-effect adjustment to equity as of the beginning of the annual period of adoption. We are currently evaluating the impact of this update, if any.
Business Overview
We are a credit enhancement company with a primary strategic focus on domestic, residential mortgage insurance on First-lien mortgage loans. We currently have three operating business segments—mortgage insurance, financial guaranty and mortgage and real estate services.
Mortgage Insurance
Our mortgage insurance segment provides credit-related insurance coverage, principally through private mortgage insurance, to mortgage lending institutions. We provide our mortgage insurance products and services mainly through our wholly-owned subsidiary, Radian Guaranty. Private mortgage insurance protects mortgage lenders from all or a portion of default-related losses on residential mortgage loans made to home buyers who generally 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 the GSEs.
Our mortgage insurance segment offers primary mortgage insurance coverage on residential First-liens. At September 30, 2014, primary insurance on First-liens comprised approximately 96.5% of our $44.0 billion total direct RIF. In the past, we also wrote pool insurance, which at September 30, 2014, comprised approximately 3.3% of our total direct RIF. Additionally, we offered other forms of credit enhancement on residential mortgage assets. These products included mortgage insurance on Second-liens, credit enhancement on NIMS, and primary mortgage insurance on international mortgages (collectively, we refer to the risk associated with these transactions as “non-traditional”). Our non-traditional RIF was $79.9 million as of September 30, 2014, representing less than 1% of our total direct RIF.
Financial Guaranty
Our financial guaranty segment has provided direct insurance and reinsurance on credit-based risks through Radian Asset Assurance, our principal financial guaranty subsidiary. Radian Asset Assurance is a wholly-owned subsidiary of Radian Guaranty, which has allowed our financial guaranty business to serve as an important source of capital for Radian Guaranty and our mortgage insurance business. We have provided financial guaranty credit protection in several forms, including through the issuance of financial guaranty policies, by insuring the obligations under one or more CDS and through the reinsurance of both types of obligations. While we discontinued writing new financial guaranty business in 2008, we continue to provide financial guaranty insurance on our existing portfolio, which primarily consists of public finance and structured finance insured transactions. We have continued to reduce our financial guaranty exposures in order to mitigate uncertainty, maximize the ultimate capital and liquidity available for our mortgage insurance business and accelerate access to that capital and liquidity through transactions such as risk commutations, ceded reinsurance, discounted insured bond purchases and transaction settlements and terminations. In light of the proposed PMIERs, which do not provide Radian Guaranty with any credit for its investment in Radian Asset Assurance, we are actively pursuing alternatives to monetize Radian Asset Assurance, including a potential sale of the business, and we are exploring other alternatives to utilize the capital at Radian Asset Assurance in a manner that provides credit for Radian Asset Assurance under the PMIERs. Due to the dynamic nature of these pursuits, the range of factors that could impact negotiations regarding a potential sale or other transaction and the inherent uncertainty of the outcome of such matters, it is possible that any price we are able to realize with respect to the business could differ materially from the current carrying value of the related assets and liabilities reflected in our condensed consolidated financial statements as of September 30, 2014.


17



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

Mortgage and Real Estate Services
Our mortgage and real estate services segment provides services and solutions to the mortgage and real estate industries, primarily through Clayton, as further described below.
Recent Developments
Acquisition of Clayton
On June 30, 2014, we acquired all of the outstanding equity interests of Clayton for a cash purchase price, including working capital adjustments, of approximately $312 million. The acquisition is consistent with Radian’s growth and diversification strategy to pursue opportunities to provide additional mortgage- and real estate-related products and services to the mortgage finance market and complements Radian’s existing mortgage-related products and services.
Clayton is a leading provider of services and solutions to the mortgage and real estate industries, providing outsourced services, information-based analytics and specialty consulting for buyers and sellers of, and investors in, mortgage- and real estate-related loans and securities and other debt instruments. Clayton’s primary services include:
Loan Review/Due Diligence—Loan-level due diligence for the mortgage and RMBS markets utilizing skilled professionals and proprietary technology, with offerings focused on credit underwriting, regulatory compliance and collateral valuation;
Surveillance—Third-party performance oversight, risk management and consulting services, with offerings focused on RMBS surveillance, loan servicer oversight, loan-level servicing compliance reviews and operational reviews of mortgage servicers and originators;
Component Services—Outsourced solutions focused on the single family rental market, including valuations, property inspections, title reviews, lease reviews and due diligence reviews for single family rental securitizations;
REO Management—REO asset management, which includes management of the entire REO disposition process for our clients; and
EuroRisk—Outsourced mortgage services in the United Kingdom and Europe, with offerings that include due diligence services, quality control reviews, valuation reviews and consulting services.
The acquisition of Clayton was treated as a purchase for accounting purposes. Therefore, the assets and liabilities were recorded based on their fair values as of June 30, 2014, the date of acquisition. At acquisition, the fair value of assets acquired was $152.4 million and the fair value of liabilities assumed was $31.8 million. The excess of the acquisition price over the estimated fair value of the net assets acquired resulted in goodwill of $191.9 million. The goodwill represents the estimated future economic benefits arising from the assets acquired that did not qualify to be identified and recognized individually, and includes the value of discounted expected future cash flows of Clayton, Clayton’s workforce, expected synergies with our other affiliates and other unidentifiable intangible assets. Goodwill is deemed to have an indefinite useful life and is subject to review for impairment annually, or more frequently, whenever circumstances indicate potential impairment. Currently, we believe approximately $189.0 million of the goodwill related to this transaction will be deductible for tax purposes over a period of 15 years. See Note 7 for additional information regarding goodwill and other intangible assets.


18



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

The allocation of the purchase price, based on the fair values of assets and liabilities as of the acquisition date, was as follows:
(in thousands)
June 30,
2014
Cash
$
16,521

Restricted cash
1,591

Accounts receivable, net
11,236

Property and equipment, net
2,419

Goodwill
191,932

Other intangible assets, net
102,750

Other assets
17,852

Less:
 
Other liabilities
31,803

Total purchase price
$
312,498

The results of Clayton’s operations have been included in our financial statements from the date of acquisition, and are reflected in our mortgage and real estate services segment. Historical results for Clayton for the periods prior to our acquisition were not material to our consolidated financial results for those periods.
We used proceeds from our May 2014 issuance of debt and equity to fund this acquisition. See Notes 7, 11 and 18 for additional information related to the goodwill and other intangible assets resulting from this acquisition and the issuance of debt and equity, respectively. Acquisition-related costs, which include costs such as advisory, legal, accounting, valuation and other professional or consulting fees, have been expensed as incurred and classified as other operating expenses. During the third quarter of 2014, previously estimated acquisition-related costs were adjusted to reflect actual amounts, resulting in a $0.4 million reduction in other operating expenses. During the nine-month period ended September 30, 2014, total acquisition-related costs of $6.3 million have been recognized as other operating expenses.
BofA Settlement Agreement
As previously disclosed, we have been in settlement discussions with one servicer regarding a large population of disputed rescissions, denials, curtailments, and potential insurance cancellations. On September 16, 2014, Radian Guaranty entered into the BofA Settlement Agreement with this servicer in order to resolve various actual and potential claims or disputes related to the mortgage insurance coverage on these loans. Implementation of the BofA Settlement Agreement remains subject to the consent of the GSEs. In addition, loans subject to the BofA Settlement Agreement that were either not held in portfolio by the Insureds or were purchased by non-GSE investors, require the consent of certain other investors for these loans to be included in the BofA Settlement Agreement other than with respect to certain limited rights of cancellation which will apply to such loans as of the Implementation Date. The consent of these other investors, who hold approximately 12% of the number of Subject Loans, is not a condition precedent to the implementation of the BofA Settlement Agreement. The BofA Settlement Agreement provides that either party may terminate the BofA Settlement Agreement if consent of the GSEs is not received by November 15, 2014, except that the parties can agree to an extension and neither party can refuse an extension while any party is actively seeking consent from the GSEs. The parties are currently in the process of seeking consent from the GSEs. See Note 9 for additional information about the BofA Settlement Agreement.


19



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

Business Conditions
As a seller of credit protection, our results are subject to macroeconomic conditions and specific events that impact the mortgage origination environment and the credit performance of our underlying insured assets. The financial crisis and the downturn in the housing and related credit markets that began in 2007 has had a significant negative impact on the operating environment and results of operations for our mortgage insurance and financial guaranty business segments. This was characterized by a decrease in mortgage originations, a broad decline in home prices, mortgage servicing and foreclosure delays, and ongoing deterioration in the credit performance of mortgage and other assets originated prior to 2009, together with macroeconomic factors such as high unemployment, limited employment growth, limited economic growth and a lack of meaningful liquidity in many sectors of the capital markets. More recently, we are experiencing a period of economic recovery and the operating environment for our mortgage insurance and financial guaranty businesses has improved. Our results of operations have continued to improve as the negative impact from losses in our Legacy Portfolio has been reduced and we continue to write insurance on higher credit quality loans. As of September 30, 2014, our Legacy Portfolio had been reduced to approximately 33% of our total primary RIF, while insurance on loans written after 2008 constituted approximately 67% of our total primary RIF.
Although the U.S. economy and certain housing markets remain weak compared to historical standards, home prices have been appreciating on a broad basis throughout the U.S., foreclosure activity has declined and the credit quality of recent mortgage market originations continues to be significantly better than the credit quality of our Legacy Portfolio. In addition, there are positive indications of a broader recovery in the U.S. economy, including importantly, a reduction in unemployment rates. As a consequence of these and other factors, in the first nine months of 2014 we have experienced improvement in our results of operations, driven primarily by a significant reduction in our incurred losses as a result of a 20% decline in new primary mortgage insurance defaults compared to the first nine months of 2013 and by other positive default and claim developments.
Currently, our business strategy is primarily focused on: (1) growing our mortgage insurance business by writing insurance on high-quality mortgages in the U.S.; (2) pursuing other potential opportunities for providing credit-related services to the mortgage finance market, such as expanding our presence in the mortgage finance market through Clayton; (3) continuing to manage losses in our legacy mortgage insurance and financial guaranty portfolios; (4) continuing to reduce our legacy mortgage insurance and financial guaranty exposures; and (5) continuing to effectively manage our capital and liquidity positions, including efforts to ensure compliance with the PMIERs Financial Requirements.
Our businesses also are significantly impacted by, and our future success may be dependent upon, legislative and regulatory developments impacting the housing finance industry. The FHA remains our primary competitor outside of the private mortgage insurance industry. The current federal charters of the GSEs 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 mortgage 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 the GSEs generally are insured with private mortgage insurance. Changes in the charters or business practices of the GSEs, including the introduction of alternatives to private mortgage insurance as a condition to purchasing high LTV loans, could reduce the number of mortgages they purchase that are insured by us and consequently diminish our franchise value.
The GSEs are in the process of revising their eligibility requirements for private mortgage insurers. As part of this process, the FHFA released proposed PMIERs for public comment on July 10, 2014. The PMIERs, when finalized and adopted, will establish the revised requirements that the GSEs will impose on private mortgage insurers, including Radian Guaranty, to remain eligible insurers of mortgage loans purchased by the GSEs. The proposed PMIERs include the PMIERs Financial Requirements, which are expected to replace the capital adequacy standards under the current GSE eligibility requirements. The proposed PMIERs Financial Requirements require a mortgage insurer’s Available Assets to meet or exceed Minimum Required Assets that are calculated based on RIF and a variety of measures designed to evaluate credit quality. Among other things, the proposed PMIERs exclude from Available Assets: (i) Unearned Premium Reserves; and (ii) certain subsidiary capital, including Radian Guaranty’s capital that is attributable to its ownership of Radian Asset Assurance.


20



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

The public comment period for the proposed PMIERs ended on September 8, 2014. The FHFA is currently reviewing and considering input before adopting the final PMIERs. All aspects of the final PMIERs are expected to become effective 180 days after their final publication. Approved insurers who fail to meet the PMIERs Financial Requirements when they become effective 180 days after their publication may operate under a transition plan during an extended transition period of up to two years from the final publication date and would continue to be eligible insurers during that period. Based on an estimated final publication date of the end of 2014, we expect Radian Guaranty to have a transition period through January 1, 2017 to comply with the PMIERs Financial Requirements.
Under state insurance regulations, Radian Guaranty is required to maintain minimum surplus levels and, in certain states, a minimum ratio of statutory capital relative to the level of net RIF, or “Risk-to-capital.” The sixteen RBC States currently impose a Statutory RBC Requirement. The most common Statutory RBC Requirement is that a mortgage insurer’s Risk-to-capital may not exceed 25 to 1. In certain of the RBC States there is a Statutory RBC Requirement that a mortgage insurer satisfy an MPP Requirement. The statutory capital requirements for the non-RBC States are de minimis (ranging from $1 million to $5 million); however, the insurance laws of these states generally grant broad supervisory powers to state agencies or officials to 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. Unless an RBC State grants a waiver or other form of relief, if a mortgage insurer is not in compliance with the Statutory RBC Requirement of such state, that mortgage insurer may be prohibited from writing new mortgage insurance business in that state. Radian Guaranty’s domiciliary state, Pennsylvania, is not one of the RBC States. As of September 30, 2014, Radian Guaranty was in compliance with all applicable Statutory RBC Requirements.
Capital and Liquidity
Since the financial crisis that began in 2007, we have engaged in a number of strategic actions and initiatives to respond to the negative economic and market conditions that impacted our businesses as well as to changes in the regulatory environment. These actions, many of which are ongoing, include the following:
We significantly tightened our mortgage insurance underwriting standards to focus primarily on insuring high credit quality First-liens originated in the U.S., and we ceased writing mortgage insurance on non-traditional and other inherently riskier products.
We expanded our claims management and loss mitigation efforts to better manage losses in the weak housing market and high default and claim environment.
We discontinued writing new financial guaranty business and Radian Group contributed its ownership interest in Radian Asset Assurance to Radian Guaranty. This structure makes the capital adequacy of our mortgage insurance business dependent, to a significant degree, on the successful run-off of our financial guaranty business. This provides Radian Guaranty with substantial statutory capital and, through dividends from Radian Asset Assurance, has increased liquidity at Radian Guaranty. If the proposed PMIERs become effective in their current form, however, Radian Guaranty’s ownership of Radian Asset Assurance would not be included in Radian Guaranty’s Available Assets. Under current SAP, Radian Guaranty would continue to treat its investment in Radian Asset Assurance as an admitted asset regardless of the form of the PMIERs.
We reduced our legacy mortgage insurance portfolio, non-traditional mortgage insurance RIF and our financial guaranty portfolio through risk commutations, discounted security purchases, ceded reinsurance, discounted insured bond purchases and transaction settlements and terminations.
Additionally, consistent with our strategy, we are pursuing the following initiatives:
Since Radian Asset Assurance ceased writing new business in June 2008, Radian Asset Assurance has reduced its aggregate net par exposure by approximately 83% to $19.4 billion as of September 30, 2014. This reduction included large declines in many of the riskier segments of Radian Asset Assurance’s insured portfolio. In light of this risk reduction and the significant level of capital held by Radian Asset Assurance, Radian Asset Assurance declared and paid an Extraordinary Dividend of $150 million to Radian Guaranty in July 2014. Given the significant level of capital still remaining at Radian Asset Assurance, we currently expect to request approval from the NYSDFS for an additional Extraordinary Dividend in 2015. As of September 30, 2014, Radian Asset Assurance had $1.0 billion of statutory policyholders’ surplus.


21



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

In light of the proposed PMIERs, which do not provide Radian Guaranty with any credit for its investment in Radian Asset Assurance, we are actively pursuing alternatives to monetize Radian Asset Assurance, including a potential sale of the business, and are exploring other alternatives to utilize the capital at Radian Asset Assurance in a manner that provides credit for Radian Asset Assurance under the PMIERs.
We are also exploring alternatives that do not involve Radian Asset Assurance, including external reinsurance, in order to comply with the final form of the PMIERs Financial Requirements within the applicable transition period.
In May 2014, Radian Group issued the Senior Notes due 2019 and received aggregate net proceeds of approximately $293.8 million after deducting underwriting discounts and commissions and offering expenses. See Note 11 for further information. Also in May 2014, we issued 17.825 million shares of our common stock at a public offering price of $14.50 per share, and we received aggregate net proceeds of approximately $247.2 million after deducting underwriting discounts and commissions and offering expenses. As discussed above, a portion of the proceeds from these offerings was used to fund the acquisition of Clayton.
In addition, on June 16, 2014, in accordance with their optional redemption provisions, we used a portion of the proceeds to redeem all of the remaining outstanding principal amount of the Senior Notes due 2015 at a price established in accordance with the governing indenture. We paid $57.2 million to holders of the notes at redemption and recorded a loss of $2.8 million.
As of September 30, 2014, Radian Group currently has available, either directly or through an unregulated subsidiary, unrestricted cash and liquid investments of approximately $762 million. This amount excludes certain additional cash and liquid investments that have been advanced from our subsidiaries for corporate expenses and interest payments. Substantially all of Radian Group’s obligations to pay corporate expenses and a significant portion of interest payments on outstanding debt are reimbursed to Radian Group through the expense-sharing arrangements currently in place with its subsidiaries.

2. Segment Reporting
Our mortgage insurance, financial guaranty and, effective with the June 30, 2014 acquisition of Clayton, mortgage and real estate services segments, are strategic business units that we manage separately. We allocate corporate income and expenses to our mortgage insurance and financial guaranty segments based on either an allocated percentage of time spent on each segment or internally allocated capital, which is based on the relative GAAP equity of each segment. We allocate corporate cash and investments to our mortgage insurance and financial guaranty segments based on internally allocated capital.
Because the Clayton acquisition occurred on June 30, 2014, we have included its results of operations from the date of acquisition. We allocate to our mortgage and real estate services segment: (i) corporate expenses based on an allocated percentage of time spent on the mortgage and real estate services segment; and (ii) all interest expense related to the Senior Notes due 2019. No corporate cash or investments are allocated to the mortgage and real estate services segment.
The results of operations for each segment for each reporting period can cause significant volatility in internally allocated capital based on relative GAAP equity, which can impact the allocations of income and expenses to our mortgage insurance and financial guaranty segments.
Adjusted Pretax Operating Income (Loss)
Our senior management, including our Chief Executive Officer (our chief operating decision maker), uses adjusted pretax operating income (loss) as our primary measure to evaluate the fundamental financial performance of the Company’s business segments and to allocate resources to the segments. Adjusted pretax operating income (loss) is defined as pretax income (loss) excluding the effects of net gains (losses) on investments and other financial instruments, acquisition-related expenses, amortization of intangible assets and net impairment losses recognized in earnings. It also excludes gains and losses related to changes in fair value estimates on insured credit derivatives and instead includes the impact of changes in the present value of expected insurance claims and recoveries on insured credit derivatives, based on our ongoing insurance loss monitoring, as well as premiums earned on insured credit derivatives. Management’s use of this measure as its primary measure to evaluate segment performance began with the quarter ended March 31, 2014. Accordingly, for comparison purposes, we also present the applicable measures from the corresponding periods of 2013 on a basis consistent with the current year presentation.


22



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

Although adjusted pretax operating income (loss) excludes certain items that have occurred in the past and are expected to occur in the future, the excluded items represent those that are: (1) not viewed as part of the operating performance of our primary activities; or (2) not expected to result in an economic impact equal to the amount reflected in pretax income (loss). These adjustments, along with the reasons for their treatment, are described below.
(1)
Change in fair value of derivative instruments. Gains and losses related to changes in the fair value of insured credit derivatives are subject to significant fluctuation based on changes in interest rates, credit spreads (of both the underlying collateral as well as our credit spread), credit ratings and other market, asset-class and transaction-specific conditions and factors that may be unrelated or only indirectly related to our obligation to pay future claims. With the exception of the estimated present value of net credit (losses) recoveries incurred and net premiums earned on derivatives, discussed in items 2 and 3 below, we believe these gains and losses will reverse over time and consequently these changes are not expected to result in economic gains or losses. Therefore, these gains and losses are excluded from our calculation of adjusted pretax operating income (loss).
(2)
Estimated present value of net credit (losses) recoveries incurred. The change in present value of insurance claims we expect to pay or recover on insured credit derivatives represents the amount of the change in credit derivatives from item 1 above, that we expect to result in an economic loss or recovery based on our ongoing loss monitoring analytics. Therefore, this item is expected to have an economic impact and is included in our calculation of adjusted pretax operating income (loss). Also included in this item is the expected recovery of miscellaneous operating expenses associated with our consolidated VIEs.
(3)
Net premiums earned on derivatives. The net premiums earned on insured credit derivatives are classified as part of the change in fair value of derivative instruments discussed in item 1 above. However, since net premiums earned on derivatives are considered part of our fundamental operating activities, these premiums are included in our calculation of adjusted pretax operating income (loss).
(4)
Net gains (losses) on investments and other financial instruments. The recognition of realized investment gains or losses can vary significantly across periods as the activity is highly discretionary based on the timing of individual securities sales due to such factors as market opportunities, our tax and capital profile and overall market cycles. Unrealized investment gains and losses arise primarily from changes in the market value of our investments that are classified as trading. These valuation adjustments may not necessarily result in economic gains or losses. We do not view them to be indicative of our fundamental operating activities. Trends in the profitability of our fundamental operating activities can be more clearly identified without the fluctuations of these realized and unrealized gains or losses. Therefore, these items are excluded from our calculation of adjusted pretax operating income (loss).
(5)
Acquisition-related expenses. Acquisition-related expenses represent the costs incurred to effect an acquisition of a business (i.e., a business combination). Because we pursue acquisitions on a limited and selective basis and not in the ordinary course of our business, we do not view acquisition-related expenses as a consequence of a primary business activity. Therefore, we do not consider these expenses to be part of our operating performance and they are excluded from our calculation of adjusted pretax operating income (loss).
(6)
Amortization of intangible assets. Amortization of intangible assets represents the periodic expense required to amortize the cost of intangible assets over their estimated useful lives. These charges are not viewed as part of the operating performance of our primary activities and therefore are excluded from our calculation of adjusted pretax operating income (loss).
(7)
Net impairment losses recognized in earnings. The recognition of net impairment losses on investments can vary significantly in both size and timing, depending on market credit cycles. Intangible assets with an indefinite useful life are also periodically reviewed for potential impairment and impairment adjustments are made whenever appropriate. We do not view impairment losses on investments or intangibles to be indicative of our fundamental operating activities. Therefore, these losses are excluded from our calculation of adjusted pretax operating income (loss).


23



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

Summarized financial information concerning our operating segments as of and for the periods indicated, is as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands)
2014
 
2013
 
2014
 
2013
Mortgage Insurance
 
 
 
 
 
 
 
Net premiums written—insurance
$
245,775

 
$
250,799

 
$
680,675

 
$
719,244

Increase in unearned premiums
(27,948
)
 
(50,679
)
 
(60,440
)
 
(138,180
)
Net premiums earned—insurance
217,827

 
200,120

 
620,235

 
581,064

Net premiums earned on derivatives

 

 

 

Net investment income
15,904

 
14,868

 
45,196

 
45,236

Other income
1,130

 
1,250

 
3,813

 
5,121

Total revenues
234,861

 
216,238

 
669,244

 
631,421

 
 
 
 
 
 
 
 
Provision for losses
48,942

 
149,687

 
163,216

 
418,675

Estimated present value of net credit (recoveries) losses incurred
(190
)
 
(74
)
 
129

 
(50
)
Policy acquisition costs
4,240

 
5,839

 
18,003

 
24,072

Other operating expenses
41,368

 
59,590

 
141,333

 
176,665

Interest expense
7,936

 
4,447

 
19,713

 
10,820

Total expenses
102,296

 
219,489

 
342,394

 
630,182

 
 
 
 
 
 
 
 
Adjusted pretax operating income (loss)
$
132,565

 
$
(3,251
)
 
$
326,850

 
$
1,239

 
 
 
 
 
 
 
 
NIW (in millions)
$
11,210

 
$
13,720

 
$
27,340

 
$
38,003



24



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

 
Three Months Ended September 30,

Nine Months Ended September 30,
(In thousands)
2014
 
2013
 
2014

2013
Financial Guaranty
 
 
 
 
 
 
 
Net premiums written—insurance
$
(1,523
)
 
$
43

 
$
(350
)
 
$
(9,988
)
Decrease in unearned premiums
10,852

 
11,821

 
27,050

 
46,620

Net premiums earned—insurance
9,329

 
11,864

 
26,700

 
36,632

Net premiums earned on derivatives
2,882

 
4,170

 
9,673

 
14,019

Net investment income
10,274

 
11,864

 
30,948

 
35,984

Other income
41

 
64

 
302

 
198

Total revenues
22,526

 
27,962

 
67,623

 
86,833

 
 
 
 
 
 
 
 
Provision for losses
(6,416
)
 
5,162

 
4,311

 
9,146

Estimated present value of net credit (recoveries) losses incurred
(475
)
 
3,347

 
10,303

 
(116
)
Policy acquisition costs
1,794

 
2,119

 
5,066

 
11,087

Other operating expenses
6,663

 
11,384

 
25,426

 
35,390

Interest expense
11,629

 
15,123

 
42,127

 
44,051

Total expenses
13,195

 
37,135

 
87,233

 
99,558

 
 
 
 
 
 
 
 
Equity in net (loss) income of affiliates

 

 
(13
)
 
1

 
 
 
 
 
 
 
 
Adjusted pretax operating income (loss)
$
9,331

 
$
(9,173
)
 
$
(19,623
)
 
$
(12,724
)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands)
2014
 
2014
Mortgage and Real Estate Services
 
 
 
Services revenue
$
42,243

 
$
42,243

Direct cost of services
23,896

 
23,896

Gross profit on services
18,347

 
18,347

 
 
 
 
Operating expenses
8,663

 
8,663

Interest expense
4,424

 
4,424

Total expenses
13,087


13,087

 
 
 
 
Adjusted pretax operating income
$
5,260

 
$
5,260



25



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

 
At September 30, 2014
(In thousands)
Mortgage Insurance
 
Financial Guaranty
 
Mortgage and Real Estate Services
 
Total
Cash and investments
$
3,017,737

 
$
1,978,972

 
$
10,600

 
$
5,007,309

Restricted cash
11,574

 
73

 
4,862

 
16,509

Deferred policy acquisition costs
27,595

 
32,545

 

 
60,140

Goodwill
2,095

 

 
191,931

 
194,026

Other intangible assets, net
154

 

 
99,452

 
99,606

Total assets
3,447,406

 
2,175,773

 
336,512

 
5,959,691

Unearned premiums
625,269

 
171,473

 

 
796,742

Reserve for losses and LAE
1,588,131

 
32,220

 

 
1,620,351

VIE debt
3,196

 
88,036

 

 
91,232

Derivative liabilities

 
185,258

 

 
185,258

 
At September 30, 2013
(In thousands)
Mortgage Insurance
 
Financial Guaranty
 
Total
Cash and investments
$
2,767,160

 
$
2,293,485

 
$
5,060,645

Restricted cash
22,890

 
101

 
22,991

Deferred policy acquisition costs
29,158

 
39,303

 
68,461

Total assets
3,238,224

 
2,520,349

 
5,758,573

Unearned premiums
535,420

 
216,167

 
751,587

Reserve for losses and LAE
2,314,785

 
32,094

 
2,346,879

VIE debt
11,109

 
93,109

 
104,218

Derivative liabilities

 
344,870

 
344,870




26



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

The reconciliation of adjusted pretax operating income (loss) to consolidated pretax income (loss) and consolidated net income (loss) is as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands)
2014
 
2013
 
2014
 
2013
Adjusted pretax operating income (loss):
 
 
 
 
 
 
 
Mortgage insurance
$
132,565

 
$
(3,251
)
 
$
326,850

 
$
1,239

Financial guaranty
9,331

 
(9,173
)
 
(19,623
)
 
(12,724
)
Mortgage and real estate services
5,260

 

 
5,260

 

Total adjusted pretax operating income (loss)
$
147,156


$
(12,424
)

$
312,487

 
$
(11,485
)
 
 
 
 
 
 
 
 
Change in fair value of derivative instruments
19,360

 
10,778

 
126,923

 
(70,357
)
Less: Estimated present value of net credit recoveries (losses) incurred
665

 
(3,273
)
 
(10,432
)
 
166

Less: Net premiums earned on derivatives
2,882

 
4,170

 
9,673

 
14,019

Change in fair value of derivative instruments expected to reverse over time
15,813


9,881


127,682

 
(84,542
)
 
 
 
 
 
 
 
 
Net (losses) gains on investments
(7,839
)
 
(7,132
)
 
103,831

 
(142,891
)
Net gains (losses) on other financial instruments
982

 
902

 
(229
)
 
(3,585
)
Acquisition-related expenses
432

 

 
(6,300
)
 

Amortization of intangible assets
(3,294
)
 

 
(3,294
)
 

Consolidated pretax income (loss)
153,250


(8,773
)

534,177

 
(242,503
)
Income tax (benefit) provision
(340
)
 
3,909

 
2,995

 
(9,149
)
Consolidated net income (loss)
$
153,590


$
(12,682
)

$
531,182

 
$
(233,354
)
On a consolidated basis, “adjusted pretax operating income (loss)” is a measure not determined in accordance with GAAP. Total adjusted pretax operating income (loss) is not a measure of total profitability, and therefore should not be viewed as a substitute for GAAP pretax income (loss). Our definition of adjusted pretax operating income (loss) may not be comparable to similarly-named measures reported by other companies.

3. Derivative Instruments
We provide a significant portion of our credit protection within our financial guaranty segment in the form of CDS, which are accounted for as derivatives. Derivative instruments are recorded at fair value and changes in fair value are recorded as such in the condensed consolidated statement of operations. All of our derivative instruments are recognized in our condensed consolidated balance sheets as either derivative assets or derivative liabilities. In many of our CDS transactions, primarily our corporate CDOs, we are required to make payments to our counterparty above a specified level of subordination, upon the occurrence of credit events related to the borrowings or bankruptcy of obligors contained within pools of corporate obligations or, in the case of pools of mortgage or other asset-backed obligations, upon the occurrence of credit events related to the specific obligations in the pool. When we provide a CDS as credit protection on a specific obligation, we generally guarantee the full and timely payment of principal and interest when due on such obligation. These derivatives have various maturity dates, but the majority of the net par outstanding of our remaining insured CDS transactions, including all of our corporate CDOs, mature within four years.
We record premiums and origination costs related to our CDS and certain other derivative contracts in change in fair value of derivative instruments and policy acquisition costs, respectively, on our condensed consolidated statements of operations. Our classification of these contracts is the same whether we are a direct insurer or we reinsure these contracts.


27



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

The following table sets forth our derivative assets and liabilities as of the dates indicated. Certain contracts are in an asset position because the net present value of the contractual premium we receive exceeds the net present value of our estimate of the expected future premiums that a financial guarantor of similar credit quality to us would charge to provide the same credit protection, assuming a transfer of our obligation to such financial guarantor as of the measurement date.
(In thousands)
September 30,
2014
 
December 31,
2013
Balance Sheets
 
 
 
Derivative assets:
 
 
 
Financial Guaranty credit derivative assets
$
6,102

 
$
6,323

Other derivative assets
18,111

 
10,319

Total derivative assets
24,213

 
16,642

Derivative liabilities:
 
 
 
Financial Guaranty credit derivative liabilities
138,605

 
238,728

Financial Guaranty VIE derivative liabilities
46,653

 
68,457

Total derivative liabilities
185,258

 
307,185

Total derivative liabilities, net
$
161,045

 
$
290,543

The notional value of our derivative contracts at September 30, 2014 and December 31, 2013 was $9.1 billion and $12.3 billion, respectively.
The components of the gains (losses) included in change in fair value of derivative instruments are as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands)
2014
 
2013
 
2014
 
2013
Statements of Operations
 
 
 
 
 
 
 
Net premiums earned—derivatives
$
2,882

 
$
4,170

 
$
9,673

 
$
14,019

Financial Guaranty credit derivatives
8,979

 
9,198

 
97,521

 
(86,233
)
Financial Guaranty VIE derivatives
4,982

 
(4,026
)
 
20,123

 
513

Other derivatives
2,517

 
1,436

 
(394
)
 
1,344

Change in fair value of derivative instruments
$
19,360

 
$
10,778

 
$
126,923

 
$
(70,357
)
The valuation of derivative instruments may result in significant volatility from period to period in gains and losses as reported on our condensed consolidated statements of operations. Generally, these gains and losses result, in part, from changes in corporate credit or asset-backed spreads and changes in the market’s perception of the creditworthiness of any: (i) underlying corporate entities; (ii) assets underlying ABS; or (iii) primary obligors of obligations for which we provide second-to-pay credit protection. Additionally, when determining the fair value of our liabilities, we are required to incorporate into the fair value of those liabilities an adjustment that reflects our own non-performance risk, and consequently, changes in the market’s perception of our non-performance risk can also result in gains and losses on our derivative instruments. Any realized losses resulting from claim payments on our financial guaranty contracts that are accounted for as derivatives are recognized as a change in fair value of derivative instruments. Because our fair value determinations for derivative and other financial instruments are based on assumptions and estimates that are inherently subject to risk and uncertainty, the fair value amounts could vary significantly from period to period. See Note 4 for information on the fair value of our financial instruments.


28



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

The following table shows selected information about our derivative contracts:
($ in thousands)
September 30, 2014
Number of
Contracts
 
Par/
Notional
Exposure
 
Total Net Asset
(Liability)
Product
 
 
 
 
 
Corporate CDOs
14

 
$
6,060,500

 
$
(423
)
Non-Corporate CDOs and other derivative transactions:
 
 
 
 
 
TruPs
9

 
816,257

 
(18,378
)
CDO of CMBS
1

 
430,000

 
(39,341
)
Other:
 
 
 
 
 
Structured finance
3

 
436,865

 
(39,728
)
Public finance
19

 
1,071,409

 
(25,144
)
Total Non-Corporate CDOs and other derivative transactions
32

 
2,754,531

 
(122,591
)
Assumed financial guaranty credit derivatives:
 
 
 
 
 
Structured finance
21

 
128,112

 
(9,185
)
Public finance
4

 
95,015

 
(304
)
Total Assumed
25

 
223,127

 
(9,489
)
Financial Guaranty VIE derivative liabilities (1)
1

 
79,473

 
(46,653
)
Other (2)
3

 

 
18,111

Grand Total
75

 
$
9,117,631

 
$
(161,045
)
________________
(1)
Represents the fair value of a CDS included in a VIE that we have consolidated.
(2)
Represents derivative assets related to other purchased derivatives for which we do not have loss exposure that exceeds our net asset amount.

4. Fair Value of Financial Instruments
Certain assets and liabilities are recorded at fair value. These include: available for sale securities, trading securities, VIE debt, derivative instruments, and certain other assets. All derivative instruments are recognized in our condensed consolidated balance sheets as either derivative assets or derivative liabilities. All changes in fair value of trading securities, VIE debt, derivative instruments, and certain other assets are included in our condensed consolidated statements of operations. All changes in the fair value of available for sale securities are recorded in AOCI.
Our estimated fair value measurements are intended to reflect the assumptions market participants would use in pricing an asset or liability based on the best information available. Assumptions include the risks inherent in a particular valuation technique (such as a pricing model) and the risks inherent in the inputs to the model. Changes in economic conditions and capital market conditions, including but not limited to, credit spread changes, benchmark interest rate changes, market volatility and changes in the value of underlying collateral or of any third-party guaranty or insurance, could cause actual results to differ materially from our estimated fair value measurements. We define fair value as the current amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In the event that our investments or derivative contracts were sold, commuted, terminated or settled with a counterparty or transferred in a forced liquidation, the amounts received or paid may be materially different from those determined in accordance with the accounting standard regarding fair value measurements. Differences may also arise between our recorded fair value and the settlement or termination value with a counterparty based upon consideration of information that may not be available to another market participant. Those differences, which may be material, are recorded as realized gains (losses) in our condensed consolidated statements of operations in the period in which the transaction occurs. There were no significant changes to our fair value methodologies during the nine months ended September 30, 2014.


29



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

When determining the fair value of our liabilities, we are required to incorporate into the fair value of those liabilities an adjustment that reflects our own non-performance risk. Our five-year CDS spread is an observable quantitative measure of our non-performance risk and is used by typical market participants to determine the likelihood of our default; the CDS spread actually used in the valuation of specific fair value liabilities is typically based on the remaining term of the insured obligation. Assuming all other factors are held constant, as our CDS spread tightens or widens, it has the effect of increasing or decreasing, respectively, the fair value of our liabilities with a corresponding impact on our results of operations.
In accordance with GAAP, we established a three-level valuation hierarchy for disclosure of fair value measurements based on the transparency of inputs to the valuation of an asset or liability as of the measurement date. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level I measurements) and the lowest priority to unobservable inputs (Level III measurements). The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is significant to the measurement in its entirety. The three levels of the fair value hierarchy are described below:
Level I
—    Unadjusted quoted prices for identical assets or liabilities in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level II
—    Prices or valuations based on observable inputs other than quoted prices in active markets for identical assets and liabilities; and
Level III
—    Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable. Level III inputs are used to measure fair value only to the extent that observable inputs are not available.
The level of market activity used to determine the fair value hierarchy is based on the availability of observable inputs market participants would use to price an asset or a liability, including market value price observations. We provide a qualitative description of the valuation techniques and inputs used for Level II recurring and non-recurring fair value measurements in our audited annual financial statements as of December 31, 2013. For a complete understanding of those valuation techniques and inputs used as of September 30, 2014, these unaudited condensed consolidated financial statements should be read in conjunction with the audited annual financial statements and notes thereto included in our 2013 Form 10-K.


30



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

The following is a list of those assets and liabilities that are measured at fair value by hierarchy level as of September 30, 2014:
(In millions)
Level I
 
Level II
 
Level III
 
Total
Assets and Liabilities at Fair Value
 
 
 
 
 
 
 
Investment Portfolio:
 
 
 
 
 
 
 
U.S. government and agency securities
$
1,009.0

 
$
320.2

 
$

 
$
1,329.2

State and municipal obligations

 
614.3

 
18.8

 
633.1

Money market instruments
740.1

 

 

 
740.1

Corporate bonds and notes

 
1,007.3

 

 
1,007.3

RMBS

 
299.3

 

 
299.3

CMBS

 
303.8

 

 
303.8

Other ABS

 
261.5

 

 
261.5

Foreign government and agency securities

 
43.4

 

 
43.4

Equity securities (1)
137.0

 
96.0

 

 
233.0

Other investments (2)

 
2.1

 
82.9

 
85.0

Total Investments at Fair Value (3)
1,886.1

 
2,947.9

 
101.7

 
4,935.7

Derivative assets

 
18.1

 
6.1

 
24.2

Other assets (4)

 

 
88.1

 
88.1

Total Assets at Fair Value
$
1,886.1

 
$
2,966.0

 
$
195.9

 
$
5,048.0

 
 
 
 
 
 
 
 
Derivative liabilities
$

 
$

 
$
185.3

 
$
185.3

VIE debt (5)

 

 
91.2

 
91.2

Total Liabilities at Fair Value
$

 
$

 
$
276.5

 
$
276.5

______________________
(1)
Comprising broadly diversified domestic equity mutual funds included within Level I and various preferred and common stocks invested across numerous companies and industries included within Level II.
(2)
Comprising TruPs ($0.5 million) and short-term certificates of deposit ($1.6 million) included within Level II and lottery annuities ($0.2 million), TruPs ($0.2 million), and a guaranteed investment contract held by a consolidated VIE ($82.5 million) within Level III.
(3)
Does not include fixed-maturities held to maturity ($0.1 million) and certain other invested assets ($39.6 million), primarily invested in limited partnerships, accounted for as cost-method investments and not measured at fair value.
(4)
Primarily comprising manufactured housing loan collateral related to two consolidated financial guaranty VIEs.
(5)
Comprising consolidated debt related to NIMS VIEs ($3.2 million) and financial guaranty VIEs ($88.0 million).
At September 30, 2014, our total Level III assets were approximately 3.9% of total assets measured at fair value and total Level III liabilities accounted for 100% of total liabilities measured at fair value. Realized and unrealized gains and losses on Level III assets and liabilities in the rollforward represent gains and losses for the periods in which they were classified as Level III.


31



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

The following is a list of those assets and liabilities that are measured at fair value by hierarchy level as of December 31, 2013:
(In millions)
Level I
 
Level II
 
Level III
 
Total
Assets and Liabilities at Fair Value
 
 
 
 
 
 
 
Investment Portfolio:
 
 
 
 
 
 
 
U.S. government and agency securities
$
755.0

 
$
402.9

 
$

 
$
1,157.9

State and municipal obligations

 
602.3

 
18.7

 
621.0

Money market instruments
672.6

 

 

 
672.6

Corporate bonds and notes

 
1,036.6

 

 
1,036.6

RMBS

 
560.4

 

 
560.4

CMBS

 
288.9

 

 
288.9

Other ABS

 
194.9

 
0.9

 
195.8

Foreign government and agency securities

 
40.7

 

 
40.7

Equity securities (1)
128.3

 
97.1

 
0.4

 
225.8

Other investments (2)

 
2.2

 
81.5

 
83.7

Total Investments at Fair Value (3)
1,555.9

 
3,226.0

 
101.5

 
4,883.4

Derivative assets

 
10.3

 
6.3

 
16.6

Other assets (4)

 

 
91.9

 
91.9

Total Assets at Fair Value
$
1,555.9

 
$
3,236.3

 
$
199.7

 
$
4,991.9

 
 
 
 
 
 
 
 
Derivative liabilities
$

 
$

 
$
307.2

 
$
307.2

VIE debt (5)

 

 
94.6

 
94.6

Total Liabilities at Fair Value
$

 
$

 
$
401.8

 
$
401.8

______________________
(1)
Comprising broadly diversified domestic equity mutual funds included within Level I and various preferred and common stocks invested across numerous companies and industries included within Levels II and III.
(2)
Comprising TruPs ($0.6 million) and short-term certificates of deposit ($1.6 million) included within Level II and lottery annuities ($0.3 million), TruPs ($0.2 million), and a guaranteed investment contract held by a consolidated VIE ($81.0 million) within Level III.
(3)
Does not include fixed-maturities held to maturity ($0.4 million) and certain other invested assets ($47.4 million), primarily invested in limited partnerships, accounted for as cost-method investments and not measured at fair value.
(4)
Primarily comprising manufactured housing loan collateral related to two consolidated financial guaranty VIEs.
(5)
Comprising consolidated debt related to NIMS VIEs ($2.8 million) and financial guaranty VIEs ($91.8 million).
At December 31, 2013, our total Level III assets approximated 4.0% of total assets measured at fair value and our total Level III liabilities accounted for 100% of total liabilities measured at fair value. Realized and unrealized gains and losses on Level III assets and liabilities in the rollforward represent gains and losses for the periods in which they were classified as Level III.


32



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

The following tables quantify the estimated impact of our non-performance risk on our derivative assets, derivative liabilities and net VIE liabilities (in aggregate by type) presented in our condensed consolidated balance sheets as of the dates indicated:
(In basis points)
September 30,
2014
 
December 31,
2013
 
September 30,
2013
 
December 31,
2012
Radian Group’s five-year CDS spread
317

 
323

 
419

 
913

(In millions)
Fair Value Liability
before Consideration
of Radian Group’s
Non-Performance Risk
September 30, 2014
 
Impact of Radian Group’s
Non-Performance Risk September 30, 2014
 
Fair Value Liability
Recorded
September 30, 2014
Product
 
 
 
 
 
Corporate CDOs
$
16.0

 
$
15.6

 
$
0.4

Non-Corporate CDO-related (1)
276.9

 
144.8

 
132.1

NIMS-related (2)
5.6

 
2.4

 
3.2

Total
$
298.5

 
$
162.8

 
$
135.7

(In millions)
Fair Value Liability
before Consideration
of Radian Group’s
Non-Performance Risk
December 31, 2013
 
Impact of Radian Group’s
Non-Performance Risk
December 31, 2013
 
Fair Value Liability
Recorded
December 31, 2013
Product
 
 
 
 
 
Corporate CDOs
$
30.4

 
$
29.0

 
$
1.4

Non-Corporate CDO-related (1)
409.7

 
178.7

 
231.0

NIMS-related (2)
5.0

 
2.2

 
2.8

Total
$
445.1

 
$
209.9

 
$
235.2

________________
(1)
Includes the net fair value liability recorded within derivative assets and derivative liabilities and the net fair value liabilities included in our consolidated VIEs.
(2)
Includes NIMS VIE debt.
Non-performance risk is commonly measured by default probability, with a credit spread tightening indicating a lesser probability of default. Radian Group’s five-year CDS spread at September 30, 2014 implies a market view that there is a 22.6% probability that Radian Group will default in the next five years as compared to a 22.9% implied probability of default at December 31, 2013. The cumulative impact on our derivative assets, derivative liabilities and VIE liabilities attributable to the market’s perception of our non-performance risk decreased by $47.1 million during the first nine months of 2014, as presented in the tables above. This decrease was primarily due to the decrease in net derivative liabilities outstanding.


33



Radian Group Inc.
Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

The following is a rollforward of Level III assets and liabilities measured at fair value for the three months ended September 30, 2014: