The Company provides credit insurance and financial services to mortgage lenders and other global financial institutions. As a holder of credit risk, the Company’s results are subject to macroeconomic conditions and specific events that impact the credit performance of the underlying insured assets. The Company generally experienced favorable results for 2004, although the operating environment for mortgage insurance and financial guaranty insurance continued to present difficulties. The results of the Company’s mortgage insurance business trended positively, even with the continuation of the unprecedented refinance wave that has caused continued high cancellation rates and has negatively impacted insurance in force. Claims appear to have leveled off and, over the course of 2004, there was a reduction in delinquencies, which is a leading indicator of future claims. The mortgage insurance mix of business has continued to include lower credit profile business such as Alternative A (“Alt-A”) and A minus mortgages and new products such as interest-only loans. This is considered the growth area of the market as some of the prime mortgage market continues to be absorbed by “80-10-10” and other hybrid products that do not typically include mortgage insurance. The Company expects to continue to increase its insurance of new and emerging products that the Company has less experience with, which adds to the uncertainty of future credit performance. The financial guaranty business continued to slowly recover from setbacks caused by a large loss on a manufactured housing transaction, the “clawback” of significant reinsurance business by one of its customers in the first quarter of 2004 and the impending clawback of a smaller piece of business by another customer in the first quarter of 2005. The year 2004 showed another period of unprecedented earnings strength and growth and return on investment for the financial services segment, some of which was a result of the low interest rate environment and a favorable environment for the issuers of asset-backed securities.
Net income for 2004 was $518.7 million or $5.33 per share compared to $385.9 million or $3.95 per share for 2003. Net income per share for both periods reflects the inclusion of 3.8 million shares underlying the Company’s contingently convertible debt, as required by newly issued accounting rules. The impact of including these shares in the calculation was a reduction of $0.18 per share for 2004 and $0.13 per share for 2003. The results for 2004 reflect an immediate reduction in net income of $10.3 million or $0.11 per share in the first quarter of 2004 related to the recapture of business previously ceded to the Company by one of the primary insurer customers of the financial guaranty segment. This recapture of previously ceded business also resulted in the loss of premiums that would have been earned over the balance of 2004 and the avoidance of losses that would have been incurred on the recaptured business, and that would have resulted in an estimated additional $0.15 per share of net income over that period. Net income for 2004 includes an increase of $76.4 million compared to 2003 due to the inclusion of $50.8 million in gains on sales of investments and $47.1 million for the change in fair value of derivative instruments compared to $17.4 million and $4.1 million, respectively, for 2003. Net income for 2004 also includes an increase of $19.3 million resulting from a reduction in the provision for losses in 2004 compared to 2003 primarily from the inclusion of a $96.0 million charge in the fourth quarter of 2003 for an insurance policy related to manufactured housing loans originated by Conseco Finance Corp. Also included in 2003 was a $13.0 million charge to other operating expenses in the fourth quarter of 2003 for the cessation of operations at RadianExpress.com Inc. (“RadianExpress”), which was primarily responsible for the $12.1 million reduction in other operating expenses in 2004 as compared to 2003. Insurance in force for the mortgage insurance business segment, which includes the activities of Radian Guaranty Inc. (“Radian Guaranty”), Amerin Guaranty Corporation (“Amerin Guaranty”) and Radian Insurance Inc. (“Radian Insurance”) (together referred to as “Mortgage Insurance”), decreased from $119.9 billion at December 31, 2003 to $115.3 billion at December 31, 2004.
In the third quarter of 2004, the Company developed an innovative way to reinsure its unexpected losses and to manage its internal credit limits through unaffiliated reinsurance companies funded by the issuance of credit-linked notes in the capital markets. On August 3, 2004, the Company entered into a reinsurance agreement under which it ceded a significant portion of the risk associated with an $882 million portfolio of first-lien, non-prime residential mortgage loans insured by the Company. The Company’s counterparty under the reinsurance agreement is SMART HOME Reinsurance 2004-1 Limited (“Smart Home”), a Bermuda reinsurance company that is not affiliated with the Company, which was formed solely to enter into the reinsurance arrangement. Smart Home was funded in the capital markets by its issuance of credit-linked notes rated between AA and BB by S&P, and between Aa2 and Ba1 by Moody’s, that were issued in separate classes related to loss coverage levels on the reinsured portfolio. The Company anticipates retaining the risk associated with the first loss coverage levels, and may retain or sell, in a separate risk transfer agreement, the risk associated with the AAA-rated coverage level.
business increased 105 basis points to 9.0% at December 31, 2004 from 8.0% at December 31, 2003 as a result of that business seasoning, with the default rate on the prime business down 28 basis points from December 31, 2003. A strong economy generally results in better default rates and a decrease in the overall level of losses. A weakening of the economy could negatively impact the Company’s overall default rates, which would result in an increase in the provision for losses.
Also in connection with the recapture in the first quarter of 2004, Financial Guaranty was reimbursed for policy acquisition costs of approximately $31.0 million for which the carrying value under GAAP was $21.3 million. In addition, the recapture included approximately $11.5 million that had been recorded as case reserves under GAAP. Finally, Financial Guaranty took a charge of $0.8 million for mark-to-market adjustments
The following table shows the breakdown of the reserve for losses and loss adjustment expenses for the financial guaranty segment at the end of each period indicated:
The provision for losses was $55.9 million for 2004 compared to $166.8 million for 2003. The provision for losses represented 26.0% of net premiums earned (including the impact of the recapture of business previously ceded to the Company by one primary insurer customer in the first quarter of 2004) for 2004, compared to 67.1% for 2003. The provision for losses was 23.3% of net premiums earned for 2004, excluding the impact of the recapture. The provision for losses in 2003 includes $111.0 million related to Conseco Finance Corp. The
In January 2002, the Company issued $220 million of senior convertible debentures due 2022. Approximately $125 million of the proceeds from the offering were used to increase capital at Radian Asset Assurance. The remaining proceeds were used to redeem the Company’s preferred stock in August 2002, to buy back the Company’s common stock, and for other general corporate purposes. The debentures bear interest at the
Company’s exercise of its call right; (4) following the issuance of securities by the Company at a rating below a specified level; (5) following a downgrade of the debentures below a specified level; or (6) following certain major corporate events, such as a change of control. The Company may redeem some or all of the debentures at any time after providing the requisite notice to holders. On January 3, 2005, $663,000 in principal amount of the debentures was redeemed by holders, leaving $219.3 million in principal amount outstanding. The remaining debenture holders may not require the Company to repurchase the debentures until January 1, 2007, and may do so thereafter only on January 1, 2009, 2012 and 2017.
Under Illinois insurance regulations, Amerin Guaranty is required to maintain statutory-basis capital and surplus of $1.5 million. The statutory policyholders’ surplus at December 31, 2004 and 2003 was $189.7 million and $305.4 million, respectively. Amerin Guaranty’s statutory net income for 2004, 2003 and 2002 was $8.4 million, $14.4 million and $4.9 million, respectively.