Effective June 9, 1999, Radian Group Inc. was formed by the merger of CMAC Investment Corporation and Amerin Corporation pursuant to an Agreement and Plan of Merger dated November 22, 1998. The transaction was accounted for on a pooling of interests basis and, therefore, all financial statements presented reflect the combined entity. On February 28, 2001, the Company acquired Enhance Financial Services Group Inc. The results for 2001 include the results of operations for Enhance Financial Services Group Inc. from the date of acquisition. See Note 1 of Notes to Consolidated Financial Statements.
Calculated on a GAAP basis using provision for losses to calculate the loss ratio and policy acquisition costs and other operating expenses to calculate the expense ratio as a percentage of net premiums earned.
Expense ratio in 1999 calculated net of merger expenses of $21.8 million recognized by statutory companies.
See Notes to Consolidated Financial Statements included in Item 8 of this report.
Radian provides credit insurance and financial services to the 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 performance of the underlying insured assets. 2003 was a challenging year. Mortgage insurance results continued to be solid despite an unprecedented refinance wave that caused very high cancellation rates, and a trend of increasing delinquencies and claims. The mortgage insurance mix of business has continued to shift toward a lower credit profile business such as Alternative A (“Alt-A”) and A minus, changing the profile of the mortgage insurance exposure. The financial guaranty business continued to grow successfully and expand its product offerings, but was set back by a large loss on a manufactured housing transaction and by the “clawback” of a substantial book of reinsurance by one of its financial guaranty customers that both occurred early in 2004. The financial services segment had another strong year of earnings growth, return on investment and balance sheet discipline.
Net income for 2003 was $385.9 million or $4.08 per share compared to $427.2 million or $4.41 per share for 2002. Although the Company achieved growth in business volumes and revenues, the overall 9.7% decline in net income was principally a result of a higher provision for losses. The higher provision in the fourth quarter of 2003 was a result of a $96 million charge for an insurance policy related to manufactured housing loans originated by Conseco Finance Corp. In addition, the Company’s increased revenue was offset by increases in policy acquisition costs, other operating expenses and interest expense to support the higher business volumes. 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”), increased from $110.3 billion at December 31, 2002 to $119.9 billion at December 31, 2003. Total net debt service outstanding (par plus interest) on transactions insured by the financial guaranty business segment increased from $104.8 billion at December 31, 2002 to $117.9 billion at December 31, 2003. The financial guaranty business segment (“Financial Guaranty”) is conducted primarily through two insurance subsidiaries, Radian Asset Assurance Inc. (“Radian Asset Assurance,” formerly Asset Guaranty Insurance Company) and Radian Reinsurance Inc. (“Radian Reinsurance,” formerly Enhance Reinsurance Company). These increases in business volumes produced increases in written and earned premiums, investment income and other income. In addition, equity in net income of affiliates increased by $23.8 million in 2003 to $105.5 million from the $81.7 million recorded in 2002 primarily due to strong results at Credit-Based Asset Servicing and Securitization LLC (“C-BASS”) and Sherman Financial Services Group LLC (“Sherman”). Equity in net income of affiliates for 2003 also includes $9.1 million (pre-tax) related to the Company’s investment in Primus Guaranty, Ltd., a Bermuda holding company and parent to Primus Financial Products, LLC. (“Primus”), a company rated “Aaa” by Moody’s Investor Services Inc. (“Moody’s”) and “AAA” by Standard & Poor’s Insurance Rating Service, a division of McGraw-Hill Companies, Inc. (“S&P”) that provides credit risk protection to derivatives dealers and credit portfolio managers on individual investment-grade entities. The results of Primus for 2002 were immaterial to the Company’s Consolidated Financial Statements.
The provision for losses was $476.1 million for 2003, an increase of $232.8 million or 95.7% from $243.3 million in 2002. Approximately $114.8 million of this increase was related to Mortgage Insurance to support an increase in claims payments and delinquency rates, and $118.0 million was related to Financial Guaranty, of which $96 million was added during the fourth quarter of 2003 in anticipation of approximately $111 million in claims from a single manufactured housing transaction originated and serviced by Conseco Finance Corp. The remainder was due to reserve additions at Financial Guaranty to support business growth and an increase in trade credit reinsurance claims. Policy acquisition costs for 2003 were $128.5 million, up $27.7 million or 27.5% from $100.8 million in 2002. Other operating expenses of $211.1 million for 2003 increased $35.8 million or 20.4% from $175.3 million in 2002. Included in operating expenses in 2003 is a $13.0 million charge for the cessation of operations of RadianExpress.com Inc. (“RadianExpress”), which was announced in the fourth quarter of 2003 and is expected to occur during the first quarter of 2004. The charge includes the write-off of the carrying cost of the investment of $7.2 million and provisions for severance, leasehold commitments and other charges of $5.8 million. The remaining increase in operating expenses was primarily due to increases in salaries and benefits related to an increase in headcount to support higher volumes, increased rent expense as the Company took over more space to support the increased growth, and increased depreciation and software costs due to increased capital expenditures in late 2001 through 2003 offset by reductions in professional fees and fees for outside services. The Company recorded a pension gain in 2002 related to the curtailment of Financial Guaranty’s pension plan. Interest expense of $37.5 million for 2003 increased from $28.8 million in 2002 as a result of the issuance of $250 million of long-term debt in February 2003. The Company’s consolidated effective tax rate was 27.4% for 2003 compared to 29.0% for 2002. The decline in the effective tax rate in 2003 is a result of a higher proportion of tax exempt securities to taxable income.
Net income for 2002 was $427.2 million or $4.41 per share compared to $360.4 million or $3.88 per share for 2001. The 18.5% increase in net income was primarily due to an increase in the Company’s business volumes and the inclusion of the results from the financial guaranty business segment and the equity in net income of affiliates component of the financial services segment for all of 2002, compared to 10 months in 2001, as a result of the acquisition of Enhance Financial Services Group Inc. (“EFSG”) on February 28, 2001. Direct primary insurance in force for the mortgage insurance business increased from $107.9 billion at December 31, 2001 to $110.3 billion at December 31, 2002. Total net debt service outstanding on transactions insured by Financial Guaranty increased from $97.9 billion at December 31, 2001 to $104.8 billion at December 31, 2002. These increases in business volumes produced increases in written and earned premiums and investment income. In addition, equity in net income of affiliates increased by $40.4 million or almost 98% in 2002 to $81.7 million from $41.3 million in 2001, primarily due to strong results at C-BASS and Sherman. Partially offsetting these increases were increases in the provision for losses, policy acquisition costs, other operating expenses and interest expense to support the business growth.
Mortgage Insurance is dependent on a small number of lenders for providing a substantial portion of its business. Mortgage Insurance’s top 10 lenders were responsible for 42.5% of the direct primary risk in force at December 31, 2003. The top 10 lenders were also responsible for 53.3% of primary new insurance written in 2003. The highest state concentration of risk is California at 14.7%. At December 31, 2003, California also accounted for 14.8% of Mortgage Insurance’s total direct primary insurance in force and 15.2% of Mortgage Insurance direct primary new insurance written for 2003. The largest single customer of Mortgage Insurance (including branches and affiliates of such customer), measured by new insurance written, accounted for 10.4% of new insurance written during 2003, compared to 8.1% in 2002.
The concentration of business with lenders may increase or decrease as a result of many factors. These lenders may reduce the amount of business currently given to Mortgage Insurance or cease doing business with it altogether. Mortgage Insurance’s master policies and related lender agreements do not, and by law cannot, require its lenders to do business with it. The loss of business from a major lender could materially adversely affect Mortgage Insurance’s and the Company’s business and financial results. The Company expects customer concentration to be a continuous trend as a result of the ongoing consolidation in the financial services industry in general and the mortgage industry in particular.
Mortgage Insurance’s volume in 2003 continued to be impacted by low interest rates that affected the entire mortgage industry. The continued low interest rate environment caused refinancing activity to remain high throughout 2003, and contributed to the industry’s significant volume of new insurance volume in 2003. Mortgage Insurance’s refinancing activity as a percentage of primary new insurance written was 49.8% for 2003
The Company insures non-traditional loans, specifically Alt-A and A minus loans (collectively, referred to as “non-prime” business). Alt-A borrowers have a similar credit profile to the Company’s prime borrowers, but these loans are underwritten with reduced documentation and verification of information. The Company typically charges a higher premium rate for this business due to the reduced documentation, but the Company does not consider this business to be significantly more risky than its prime business, as long as the loans contain credit scores similar to the prime business. The A minus loan programs typically have non-traditional credit standards that are less stringent than standard credit guidelines. To compensate for this additional risk, the Company receives a higher premium for insuring this product that the Company believes is commensurate with the additional default risk. During 2003, non-prime business accounted for $27.4 billion or 40.1% of Mortgage Insurance’s new primary insurance written compared to $16.2 billion or 33.1% for the same period in 2002. At December 31, 2003, non-prime insurance in force was $37.8 billion or 31.5% of total primary insurance in force as compared to $25.6 billion or 23.2% of primary insurance in force a year ago. Of the $27.4 billion of non-prime business in 2003, $20.0 billion or 73.0% was Alt-A. The Company anticipates that the trend of a higher mix of non-traditional insured loans will continue as a result of alternative competitive products in the prime loan area, such as second mortgages.
at that time. In 2002, most of the credit insurance on mortgage and mortgage-related assets was written in Radian Asset Assurance. Some of this business was reinsured by Radian Insurance. During 2003, this business was written in both Radian Asset Assurance and Radian Insurance. Risk in force in Radian Insurance and Amerin was $1.1 billion at December 31, 2003 compared to $.5 billion at December 31, 2002. The Company expects that future business will be written by both Radian Insurance and Radian Asset Assurance, but that the risk will remain on the Company that originated the business.
The provision for losses was $309.3 million for 2003, an increase of $114.8 million or 59.0% from $194.5 million in 2002 primarily as a result of a higher mix of non-traditional insured loans. This resulted primarily from an increase in claims coupled with higher delinquency (or default) rates. Claim activity is not spread evenly throughout the coverage period of a book of business. Relatively few claims on prime business are received during the first two years following issuance of a policy and on non-prime business during the first year. Historically, claim activity on prime loans has reached its highest level in the third through fifth years after the year of policy origination and on non-prime loans, this level is expected to be reached in the second through fourth years. Approximately 82.9% of the primary risk in force and approximately 40.7% of the pool risk in force at December 31, 2003 had not yet reached its highest claim frequency years. The combined default rate for both primary and pool insurance, excluding second lien insurance coverage, was 3.2% at December 31, 2003, compared to 2.8% at December 31, 2002, while the default rate on the primary business was 4.7% at December 31, 2003 compared to 4.1% at December 31, 2002. The change in the default rate on the primary business was caused by a 15-basis-point increase in the delinquency rate on the non-prime business as a result of that business seasoning, with the delinquency rate on the prime business up 39 basis points year over year as described in the following tables. A strong economy generally results in better loss experience and a decrease in the overall level of losses. A continued weakening of the economy could negatively impact the Company’s overall default rates, which would result in an increase in the provision for losses.
level of mortgage delinquencies. The lower reserve per default is a result of a higher percentage of newer business which has not reached peak delinquency. The loss reserve as a percentage of risk in force was 1.6% at December 31, 2003, compared to 1.7% at December 31, 2002. The non-prime mortgage insurance business has experienced a consistent increase in the number of defaults. Although the default rate on this business is higher than on the prime book of business, the higher premium rates charged for the non-prime business are expected to compensate for the increased level of expected losses associated with this business. The number of non-prime loans in default at December 31, 2003 was 19,840, which represented 47% of the total primary loans in default, compared to 14,305 non-prime loans in default at December 31, 2002, which represented 40% of the total primary loans in default. The default rate on the Alt-A business was 5.3% at December 31, 2003 compared to 5.2% at December 31, 2002. The default rate on the A minus and below loans was 11.4% at December 31, 2003 compared to 11.3% at December 31, 2002. It is too early to determine whether ultimate losses on the non-prime business will reflect the assumptions made when the business was originated. The default rate on the prime business was 3.5% at December 31, 2003 and 3.1% at December 31, 2002.
Direct claims paid for 2003 were $271.2 million compared to $165.0 million for 2002. The severity of loss payments has increased over the past few years due primarily to deeper coverage amounts and larger loan balances. In addition, claims paid in 2003 have been impacted by the rise in delinquencies in 2001 and 2002 that have proceeded to foreclosure. A disproportionately higher incidence of claims in Georgia and Utah is directly related to questionable property value estimates in those states. The Company’s Risk Management department identified these issues several years ago and has put into place several property valuation checks and balances to mitigate the risk of these issues from recurring. Further, these same techniques are being applied to all mortgage insurance transactions. The Company expects this higher incidence of claims in Georgia and Utah to continue until loans originated in Georgia and Utah prior to the implementation of these preventive measures become sufficiently seasoned. The higher level of claim incidence in Texas partly resulted from unemployment levels which were higher than the national average and lower home price appreciation. The Company believes that claims in the Midwest and Southeast have been rising and will continue to rise due to the weakening of the industrial sector of the economy. The Company anticipates that overall claim payments will continue to increase in 2004.
Mortgage Insurance’s volume in 2002 continued to be impacted by low interest rates that affected the entire mortgage industry. The continued low-interest-rate environment caused refinancing activity to remain high
Net premiums earned in 2002 were $660.5 million, a $51.1 million or 8.4% increase from $609.4 million for 2001. This increase included a slightly higher percentage of non-prime business, which has higher premium rates, commensurate with the increased level of risk associated with such insurance. The insurance in force growth resulting from strong new insurance volume in 2002 was offset by a decrease in persistency levels. Direct primary insurance in force increased to $110.3 billion at December 31, 2002 from $107.9 billion at December 31, 2001. Total pool risk in force was $1.7 billion at December 31, 2002 compared to $1.6 billion at December 31, 2001.
For 2002, premiums ceded under captive reinsurance arrangements were $57.1 million, or 8.3% of total premiums earned during 2002, as compared to $52.8 million, or 8.4% of total premiums earned for the same period of 2001. New primary insurance written under captive reinsurance arrangements was $17.0 billion, or 34.8% of total primary new insurance written in 2002 as compared to $14.7 billion, or 32.9% of total primary new insurance written in 2001.
Net investment income for 2002 was $107.1 million, a $10.0 million or 10.3% increase compared to $97.1 million in 2001. This increase was a result of continued growth in invested assets, primarily due to positive operating cash flows during 2002 and the allocation of interest income from net financing activities. This was offset by declining investment yields that were experienced throughout the year.
Interest expense for 2003 was $21.5 million compared to $17.2 million for 2002. This represented the allocation of interest on the long-term debt issued during 2001, 2002 and 2003. The Company issued an additional $250 million of debt in February 2003. Net gains on dispositions of investments and changes in the fair value of derivative instruments were $11.4 million for 2003 compared to gains of $5.1 million in 2002. This related to the change in the fair value of derivative instruments, primarily embedded derivatives in convertible debt securities as well as an increase in gains on sales of investments.
Underwriting and other operating expenses were $175.9 million in 2002, an increase of $21.5 million or 13.9% compared to $154.4 million for 2001. Policy acquisition costs were $66.8 million in 2002, an increase of $4.4 million or 7.0% from $62.4 million in 2001. Much of the amortization in 2002 represents costs that were expended in 2001. Other operating expenses were $109.0 million for 2002, an increase of $17.0 million or 18.5% from $92.0 million for 2001. This reflects an increase in expenses associated with the Company’s technological, administrative and support functions to support increased business volumes. Contract underwriting expenses for 2002, included in other operating expenses, were $46.2 million as compared to $44.6 million in 2001, an increase of $1.6 million or 3.6%. Other income, which primarily includes income related to contract underwriting services, was $20.4 million for 2002 and 2001. During 2002, loans underwritten via contract underwriting accounted for 30.4% of applications, 28.7% of commitments, and 23.0% of certificates issued by Mortgage Insurance as compared to 34.5%, 32.0% and 25.8%, respectively, in 2001.
The financial guaranty insurance segment operations are conducted through insurance subsidiaries of EFSG and primarily involve the direct insurance and reinsurance of public finance bonds and asset-backed securities, and other structured financial obligations, including credit default swaps and certain other financial guaranty contracts. Financial guaranty and trade credit reinsurance (which protects sellers of goods under certain circumstances against non-payment of the receivables they hold from buyers of their goods) is assumed primarily from a limited number of direct insurers. Approximately 30.9% of total gross written premiums for Financial Guaranty were derived from four insurers in 2003. A substantial reduction in the amount of insurance assumed from one or more of these principal clients could have a material adverse effect on Financial Guaranty’s gross written premiums and, potentially, its results of operations. Effective July 1, 2003, Radian Reinsurance and one of its primary customers terminated their ongoing treaty relationship. As discussed below, effective January 31, 2004, this customer exercised its right to recapture financial guaranty business previously ceded to Radian Reinsurance, representing 8.7% of gross written premiums for Financial Guaranty in 2003. In addition, five trade credit insurers were responsible for 10.5% of premiums written in 2003. The Company’s trade credit reinsurance may cover receivables as to which the buyer and seller are in the same country, as well as cross-border receivables. In such cross-border transactions, the Company sometimes provides coverage that extends to certain political risks, such as foreign currency controls and expropriation, which could interfere with the payment by the buyer of the goods that are the subject of the transaction being reinsured by the Company.
As a result of the downgrade by S&P, one of the primary insurers exercised its right to recapture the financial guaranty reinsurance ceded to Radian Reinsurance. Radian Reinsurance has reached agreement with the remaining primary insurers without additional cost to Radian Reinsurance whereby such primary insurers have agreed not to exercise their rights with respect to the downgrade of Radian Reinsurance by S&P. None of the primary insurers has a similar right with respect to the downgrade by Fitch.
value under accounting principles generally accepted in the United States of America (“GAAP”) was approximately $71.5 million. In addition, Radian Reinsurance was reimbursed for policy acquisition costs of approximately $31.0 million for which the carrying value under GAAP was $21.3 million. Radian Reinsurance also reimbursed the primary insurer for case reserves recorded under GAAP for approximately $11.5 million. Finally, Radian Reinsurance took a charge of $0.8 million for mark-to-market adjustments related to certain insurance policies associated with the recapture. The sum of the above adjustments related to this recapture resulted in an estimated initial reduction of pre-tax income of $15.9 million and is summarized as follows:
There have been internal discussions regarding, and management has taken steps toward, the merger of the financial guaranty reinsurance business of Radian Reinsurance into Radian Asset Assurance (the “Potential Merger”). If the Potential Merger were to occur, the financial guaranty reinsurance business currently conducted by Radian Reinsurance and the direct financial guaranty business conducted by Radian Asset Assurance would be conducted by Radian Asset Assurance as part of one company, and Radian Asset Assurance would have greater assets, liabilities and shareholder’s equity than it currently has on a stand-alone basis. However, the Potential Merger has not been fully approved by either Radian Asset Assurance’s or Radian Reinsurance’s respective boards of directors and shareholder. In addition, if such a merger were to occur, the transaction and its potential effects on Radian Asset Assurance and Radian Reinsurance would have to be approved by applicable regulatory bodies, including the New York Insurance Department and relevant rating agencies. Financial Guaranty has received preliminary regulatory approval from the New York and California Insurance Departments to the Potential Merger, subject to the satisfaction of certain conditions. However, there can be no assurance that the Potential Merger will occur.
If the Potential Merger were to occur, the STAT capital available to Radian Asset Assurance to write direct insurance would increase in an amount equal to the STAT capital of Radian Reinsurance. Consequently, Radian Asset Assurance’s regulatory and rating agency single risk exposure limits would increase to permit Radian Asset Assurance to insure and retain net exposure to larger risks than Radian Asset Assurance would be able to without the Potential Merger, without the need to find ample reinsurance capacity, whether from Radian Reinsurance or an unaffiliated third party. Similarly, the combined entity with larger regulatory and rating agency single risk exposure limits would be able to reinsure and retain net exposure to larger risks than Radian Reinsurance would be able to write without the Potential Merger, without the need to retrocede its risk to Radian Asset Assurance or an unaffiliated third party. Radian Asset Assurance also anticipates that its internally established criteria for single risk exposure should also permit it to retain exposure to larger risks. There can be no assurance, however, that Radian Asset Assurance would be able to insure or reinsure larger risks on terms and conditions acceptable to Radian Asset Assurance.
The Company believes that the Potential Merger could have the effect of making the rating of the larger combined Financial Guaranty company from the major rating agencies more stable, and could decrease the risk of a downgrade of Radian Asset Assurance by such agencies. However, the rating agencies are reviewing the Potential Merger and its potential effects on Financial Guaranty, and such review could result in a change in the rating (either positive or negative) of a combined Financial Guaranty company. Any determination by any of the rating agencies to lower any of its ratings for the combined Financial Guaranty company from those currently in effect for either Radian Asset Assurance or Radian Reinsurance could affect a decision whether or not to proceed with the Potential Merger, and if the Potential Merger were consummated notwithstanding a lowering of the combined Financial Guaranty company rating, it could have a materially adverse effect on Financial Guaranty’s business and would permit its largest financial guaranty primary insurance customers to terminate their current reinsurance relationships with Radian Reinsurance and recapture the reinsurance business ceded to Radian Reinsurance. See “Ratings” in this Item 1 for a description of the rights of certain of Radian Reinsurance’s customers upon a downgrade of the rating of Radian Reinsurance.
company could have a material adverse effect on Financial Guaranty’s business. Since Radian Reinsurance has a relatively small number of customers, primarily consisting of most of the largest financial guaranty primary insurers, if any of these customers were to reduce or eliminate the reinsurance ceded to Financial Guaranty, or to require the return of unearned premium, it could have a material adverse effect on Financial Guaranty.
If the Potential Merger were to occur, the reinsurance, public finance and structured finance business would be written by Radian Asset Assurance, which would have greater assets, liabilities and shareholder’s equity than either Radian Asset Assurance or Radian Reinsurance would have in the absence of the Potential Merger.
The results of operations for the financial guaranty segment for the year-to-date period of 2001 include the results of EFSG from the date of its acquisition, February 28, 2001. Since the acquisition, business volumes in the financial guaranty segment have increased significantly, leading to large increases in premiums written, and more gradual increases in premiums earned as premiums are often earned over many years.
Net income for 2002 was $93.1 million, a $37.0 million or 66.0% increase from $56.1 million for 2001. Net premiums written and earned for 2002 were $286.3 million and $186.6 million, respectively, compared to $143.2 million and $106.5 million for 2001. Included in net premiums written and earned for 2002 were $40.4 million and $19.8 million, respectively, of credit enhancement fees on derivative financial guaranty contracts, compared to $5.3 million for both net premiums written and earned in 2001. In 2001, Financial Guaranty originated $5.4 billion in par in the public finance area, including $2.1 billion in general obligations, $1.1 billion in the healthcare sector, $0.8 in the utilities sector and $0.7 billion in the transportation sector. Financial Guaranty also originated $5.8 billion of par in the structured finance area in 2001, primarily in the form of guarantees on collateralized debt obligations and asset-backed securities.
The gross par originated for 2003, 2002 and 2001 is as follows:
In August 2003, the Financial Services Authority of the United Kingdom granted permission under Part IV of the Financial Services & Markets Act 2000 for Radian Asset Assurance Limited (“RAAL”), a subsidiary of Radian Asset Assurance, to conduct an insurance business in the United Kingdom. As a result of this additional authority, through RAAL, the Company will have additional opportunities to write financial guaranty insurance in the United Kingdom and, subject to compliance with the European passport rules, throughout the European Union, which could increase Radian Asset Assurance’s net premiums written (on a consolidated basis) in the future, and subsequently increase its net premiums earned (on a consolidated basis), as such premium written becomes earned over the life of the obligations insured.
The following table shows the breakdown of premiums written and earned for each period:
Included in net premiums earned for 2003, 2002 and 2001 were refundings of $7.9 million, $7.8 million and $6.7 million, respectively.
Net investment income was $78.4 million for 2003 compared to $71.5 million for 2002. Equity in net income of affiliates for 2003 was $10.0 million and primarily includes the results related to the Company’s investment in Primus. The results for Primus in 2002 were immaterial to the Company’s Consolidated Financial Statements. The Company accounts for the Primus investment under the equity method of accounting. The Company cannot predict whether the results for Primus will be as favorable in the future as they were for 2003, as much of Primus’ income was related to mark-to-market gains due to corporate credit spreads tightening. The provision for losses was $166.8 million for 2003 compared to $48.8 million for 2002. The provision for losses represented 67.1% of net premiums earned for 2003 compared to 26.2% for 2002. The provision in 2003 includes $111 million related to a manufactured housing transaction originated and serviced by Conseco Finance Corp. The remaining increase in 2003 was due to reserve additions at Financial Guaranty to support business growth and an increase in trade credit reinsurance claims. Policy acquisition and other operating expenses were $96.4 million for 2003 compared to $61.6 million in 2002. This increase resulted from an increase in expenses to support the growth in business volumes. The operating expense ratio of 38.8% for 2003 was up from 33.0% in 2002, due to higher commissions associated with higher business volumes. In 2002, the Company recorded a $6.0 million gain on the curtailment of Financial Guaranty’s employee benefit plans. Included in other operating expenses for 2003 and 2002 were $6.6 million and $4.3 million, respectively, of origination costs related to derivative financial guaranty contracts. Interest expense was $12.9 million for 2003 compared to $9.6 million for 2002. This represented interest on the $75.0 million of short-term debt which matured in March 2003, as well as interest allocated on the Company’s debt financing. Net gains (losses) on sales of investments and changes in the fair value of derivative instruments was a net gain of $12.3 million for 2003 compared to an $11.1 million loss in 2002. The fair value of derivative instruments, primarily convertible debt securities and financial guaranty contracts that are considered to be derivative instruments, was a gain of $0.8 million in 2003 compared to a loss of $13.5 million in 2002. During 2003, Financial Guaranty received $11.5 million as settlement proceeds and paid out $14.0 million related to the settlement of derivative financial guaranty contracts that are considered to be credit derivatives. There were no such settlements in 2002. Gains on sales of investments were $11.5 million for 2003 compared to $2.4 million in 2002.
Net investment income was $71.5 million for 2002 compared to $50.3 million for 2001. The provision for losses was $48.8 million for 2002 compared to $29.0 million for 2001. The provision for losses represented 26.2% of net premiums earned for 2002 compared to 27.2% for 2001. Financial Guaranty paid one large claim totaling $9.0 million in 2002. The remaining claims of $25.1 million for 2002 relate primarily to trade credit reinsurance. Policy acquisition and other operating expenses were $61.6 million for 2002 compared to $43.4 million in 2001. This increase resulted from an increase in expenses to support the growth in business volumes. The operating expense ratio of 33.0% for 2002 was down from 40.8% in 2001, due to efficiencies from higher business volumes and a higher mix of direct written business. Included in other operating expenses for 2002 were $4.3 million of origination costs related to derivative financial guaranty contracts and gains of $6.0 million from the curtailment of employee benefit plans. Interest expense was $9.6 million for 2002 compared to $6.0 million for 2001. This represented interest on the $75.0 million of short-term debt, as well as interest allocated on the Company’s debt financing. Net losses on sales of investments and changes in the fair value of derivative instruments of $11.1 million for 2002 increased from $2.4 million in 2001. This related primarily to the change in the fair value of derivative instruments, primarily convertible debt securities and financial guaranty contracts that are considered to be derivative instruments.
The effective tax rate was 17.2% for 2003 compared to 27.6% for 2002 and 27.7% for 2001. The effective tax rate reflects the significant investment in tax-advantaged securities. In 2003, the proportion of tax exempt income to total income was significantly higher than in 2002 and 2001 as a result of the overall decline in 2003 earnings.
RadianExpress recorded $19.8 million of revenues and $38.7 million of operating expenses for 2003 compared to $17.4 million and $23.2 million, respectively, in 2002. Included in operating expenses for 2003 is the $13.0 million described above, as well as a provision for uncollectible accounts of $2.3 million. RadianExpress processed approximately 271,000 applications during 2003 compared to 341,000 during 2002. In June 2002, the Company received a cease and desist order from the State of California in connection with the offering of its Radian Lien Protection product, which it appealed. On January 6, 2003, the Company received a decision from an administrative law judge in California sustaining the cease and desist order, which was subject to the approval of the California Commissioner of Insurance. In July 2003, after initially rejecting the proposed opinion of the administrative law judge and reopening the matter, the California Commissioner of Insurance affirmed the cease and desist order. In January 2004, the California Superior Court issued an order denying the Company’s appeal from the California Commissioner of Insurance’s decision. That denial is currently on appeal. The decision significantly reduced the potential for increased revenues at RadianExpress, the Radian entity through which Radian Lien Protection sales would be processed. The Company had contained operating expenses in RadianExpress as a result of the effect on business caused by the cease and desist order, and after reviewing alternative business propositions and strategies for RadianExpress, decided to cease doing business at RadianExpress. In December 2003, the Company announced that it would cease operations of RadianExpress. The phased shutdown is expected to be completed on or about March 31, 2004. The cessation of operations resulted in a pre-tax charge of approximately $13.0 million, which includes the write-off of the investment and provisions for severance, leasehold commitments and other charges. Any income or expense from operations during the phased shutdown is expected to be immaterial.
Net income for 2002 was $40.3 million, up from $24.3 million in 2001. Equity in net income of affiliates was $81.9 million for 2002, up $39.4 million or 92.7% from the $42.5 million in 2001. C-BASS accounted for $63.5 million (pre-tax) of the total income from affiliates in 2002 compared to $38.1 million (pre-tax) in 2001.
Another insurance subsidiary, Van-American Insurance Company, Inc., is engaged on a run-off basis in reclamation bonds for the coal mining industry and surety bonds covering closure and post-closure obligations of landfill operations. Such business is not material to the financial results of the Company.
The Company has various contractual obligations which are recorded as liabilities in its Consolidated Financial Statements. Other items, including payments under operating lease agreements, are not recorded on the balance sheet as liabilities but represent a contractual commitment to pay.
The following table summarizes the Company’s significant contractual obligations and commitments as of December 31, 2003 and the future periods in which such obligations are expected to be settled in cash. The table reflects the timing of principal payments on outstanding debt. Additional details regarding these obligations are provided in the Notes to the Consolidated Financial Statements as referenced in the table:
The Company also has some case reserves that are subject to discounting. These reserves are not included here, as the Company believes the amounts are not material.
Stockholders’ equity increased to $3.2 billion at December 31, 2003 compared to $2.8 billion at December 31, 2002. This increase in stockholders’ equity resulted from net income of $385.9 million, proceeds from the issuance of common stock of $23.2 million and an increase in the market value of securities available for sale of $76.8 million, net of tax, offset by dividends of $7.5 million, and the purchase of 0.5 million shares of the Company’s common stock, net of reissues, for approximately $8.6 million pursuant to the Company’s repurchase plan described below.
On September 24, 2002, the Company announced that its board of directors had authorized the repurchase of up to 2.5 million shares of its common stock on the open market. Shares will be purchased from time to time, depending on the market conditions, share price and other factors. These purchases will be funded from available working capital. At December 31, 2003, approximately 1.9 million shares had been repurchased under this program, at a cost of approximately $61.2 million. The remaining shares under this program were purchased in 2004.
On October 4, 2002, S&P lowered the Insurer Financial Strength rating of Radian Reinsurance to “AA” from “AAA,” and on April 8, 2003, Fitch lowered the Insurer Financial Strength rating of Radian Reinsurance to “AA” as further described above, under “Financial Guaranty-Results of Operations.”
The Company owns a 46% interest in C-BASS. The Company has not made any capital contributions to C-BASS since the Company acquired its interest in C-BASS in connection with the acquisition of EFSG in February 2001. C-BASS paid $15.0 million of dividends to the Company during 2003 and paid $20.1 million during 2002. In February 2004, the Company received a $5.0 million dividend from C-BASS.
The Company owns a 41.5% interest in Sherman. In January 2003, Sherman’s management exercised its right to acquire additional ownership of Sherman, reducing the Company’s ownership interest in Sherman from 45.5% to 41.5%. The Company received $3.4 million in cash for the 4% interest, recording a $1.3 million loss on the transaction. The Company did not make any capital contributions to Sherman in 2003 or 2002. In December 2002, the Company guaranteed payment of up to $25.0 million of a revolving credit facility issued to Sherman that expires in December 2004. Sherman paid $12.5 million of dividends to the Company during 2003. Sherman did not pay any dividends during 2002. In January 2004, Sherman paid a dividend of $29.0 million to the Company.
In January 2002, the Company issued $220 million of senior convertible debentures. Approximately $125 million of the proceeds from the offering was used to increase capital at Radian Asset Assurance. The remaining proceeds were used to redeem the preferred stock in August 2002, to buy back the Company’s common stock, as described above, and for other general corporate purposes. The debentures bear interest at the rate of 2.25% per year and interest is payable semi-annually on January 1 and July 1, beginning July 1, 2002. The Company will also pay contingent interest on specified semi-annual periods, if the sale price of its common stock for the specified period of time is less than 60% of the conversion price. The debentures are convertible, at the purchaser’s option, into shares of common stock at prices and on dates specified in the offering memorandum. At that time, the shares become common shares for the purposes of calculating earnings per share. The Company may redeem all or some of the debentures on or after January 1, 2005.
In February 2003, the Company issued $250 million of unsecured senior notes in a private placement. These notes bear interest at the rate of 5.625% per year, payable semi-annually on February 15 and August 15, beginning August 15, 2003. These notes mature in February 2013. The Company has the option to redeem some or all of the notes at any time with not less than 30 days’ notice. The Company used a portion of the proceeds from the private placement to repay the $75.0 million in principal on the 6.75% debentures due March 1, 2003 that EFSG had issued. The remainder will be used for general corporate purposes. In late July 2003, the Company offered to exchange all of the notes for new notes with terms substantially identical to the terms of the old notes, except that the new notes are registered and have no transfer restrictions, rights to additional interest or registration rights, except in limited circumstances.
Critical accounting policies comprise those policies that require the Company’s most difficult, subjective and complex judgments. These policies require estimates of matters that are inherently uncertain. The accounting policies that the Company believes meet the criteria of critical accounting policies are described below.
As described in Notes 2 and 6 to Consolidated Financial Statements, the Company establishes reserves to provide for the estimated costs of settling claims in both the mortgage insurance and financial guaranty business. Setting loss reserves in both businesses involves the significant use of estimates with regard to the likelihood, magnitude and timing of a loss.
In 2003, the Company provided approximately $111 million of reserves on a manufactured housing transaction with Conseco Finance Corp. which represents the total par exposure on this transaction. Losses are expected to be paid out over the next several years. No claims have been paid as of December 31, 2003. This transaction had been performing within expectations. The bankruptcy of Conseco led to a deterioration in the transaction’s performance. When the Company performed its year-end review, which incorporated financial projections of the transaction’s performance over its remaining life, it decided it was necessary to establish reserves for the entire exposure.
Reserve for losses and LAE for Financial Guaranty’s other lines of business, primarily trade credit reinsurance, are based on reports and individual loss estimates received from ceding companies, net of anticipated estimate recoveries under salvage and subrogation rights. In addition, a reserve is included for losses and LAE incurred, but not reported on trade credit insurance.
In January 2003, the FASB issued FASB Interpretation (“FIN”) No. 46, “Consolidation of Variable Interest Entities.” The Interpretation clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. In December 2003, FIN 46 was revised in FIN 46R. FIN 46R scopes out many but not all businesses, as business is defined in FIN 46. The FASB partially delayed FIN 46’s implementation until no later than the end of the first reporting period after March 15, 2004. Currently, the Company is not the primary beneficiary of a variable interest entity. However, the Company has been a transferor of financial assets (as discussed above in “Assignment Operations”) considered to be a qualifying special-purpose entity (“QSPE”) described in SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” These QSPEs are not within the scope of the Interpretation. In management’s opinion, this Interpretation will not have a material effect on the Company’s financial statements.
In December 2003, the FASB revised SFAS No. 132 “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” This revision is intended to improve financial statement disclosures for defined benefit plans. The standard requires that companies give more details about their plan assets, benefits obligations, cash flows, benefit costs and other relevant information. The standard also requires expanded disclosures in interim financials. This standard is effective for fiscal years ending on or after December 15, 2003. The required disclosure has been included in the Company’s financial statements.
Private mortgage insurance and risk management services are provided to mortgage lending institutions located throughout the United States through the Company’s wholly owned principal mortgage guaranty subsidiaries, Radian Guaranty Inc. (“Radian Guaranty”), Amerin Guaranty Corporation (“Amerin Guaranty”) and Radian Insurance Inc. (“Radian Insurance”) (together referred to as “Mortgage Insurance”). Private mortgage insurance generally protects lenders from default-related losses on residential first mortgage loans made to home buyers who make down payments of less than 20% of the purchase price and facilitates the sale of these mortgages in the secondary market. Mortgage Insurance currently offers two principal types of private mortgage insurance coverage, primary and pool. At December 31, 2003, primary insurance comprised 88.7% of Mortgage Insurance’s risk in force and pool insurance comprised 7.9% of Mortgage Insurance’s risk in force. During the third quarter of 2000, the Company commenced operations in Radian Insurance, a subsidiary that writes credit insurance on non-traditional mortgage-related assets such as second mortgages and manufactured housing, and provides credit enhancement to mortgage-related capital market transactions. Other risk in force, primarily in Radian Insurance, was $1.1 billion at December 31, 2003, which represented 3.4% of the mortgage insurance risk in force.
On February 28, 2001, the Company acquired the financial guaranty and other businesses of Enhance Financial Services Group Inc. (“Financial Guaranty”), a New York-based insurance holding company that primarily insures and reinsures credit-based risks, at a purchase price of approximately $581.5 million. The financial guaranty insurance business is conducted primarily through two insurance subsidiaries, Radian Asset Assurance Inc. (“Radian Asset Assurance,” formerly Asset Guaranty Insurance Company) and Radian Reinsurance Inc. (“Radian Reinsurance,” formerly Enhance Reinsurance Company). In addition, as part of the acquisition, Radian has an interest in two active credit-based asset businesses (see Note 4). Several smaller businesses are either in run-off or have been terminated. The purchase price represented the value of the Company’s common stock and stock options issued in connection with the acquisition and other consideration in accordance with an Agreement and Plan of Merger, dated November 13, 2000, by and among the Company, a wholly owned subsidiary of the Company and Financial Guaranty. The acquisition, which was structured as a merger of a wholly owned subsidiary of the Company with and into Financial Guaranty, entitled Financial Guaranty stockholders to receive 0.22 shares of the Company’s common stock in a tax-free exchange for each share of Financial Guaranty’s common stock that they owned at the time of the merger. The acquisition was treated as a purchase for accounting purposes, and accordingly, the assets and liabilities were recorded based on their fair values at the date of acquisition. The fair value of assets acquired was $1,357.9 million. The liabilities assumed were $833.1 million. The excess of purchase price over fair value of net assets acquired of $56.7 million represents the future value of insurance profits, which is being amortized over a period that approximates the future life of the insurance book of business. During 2003 and 2002, the Company amortized $3.7 million and $4.5 million, respectively, related to this transaction. The results of Financial Guaranty’s operations for 2001 have been included in the Company’s financial statements for the period from the date of the acquisition through December 31, 2001.
The purchase price of Financial Guaranty reflects the issuance of 8,462,861 shares (pre-stock split) of the Company’s common stock at $65.813 per share (pre-stock split) which represented the average closing price of the Company’s common stock for the three days preceding and following the announcement of the acquisition, and the issuance of 1,320,079 options (pre-stock split) to purchase shares of the Company’s common stock to holders of options to purchase shares of Financial Guaranty’s common stock. The value of the option grant was based on a Black-Scholes valuation model assuming an average life of 2.8 years, a risk-free interest rate of 4.75%, volatility of 43.4% and a dividend yield of 0.22%.
On December 30, 2003, the Company announced that it would cease operations of RadianExpress in a phased shutdown that is expected to be completed on or about March 31, 2004. The Company’s decision followed its receipt of an order from the California Superior Court denying the Company’s appeal from a decision by the California Commissioner of Insurance sustaining a California cease-and-desist order applicable to the Company’s offering of its Radian Lien Protection product. The California Superior Court’s denial is on appeal, but the decision significantly reduced the potential for increased revenues at RadianExpress, which was the Radian entity through which Radian Lien Protection sales would have been processed. The cessation of operations resulted in a pre-tax charge of $13.0 million in the fourth quarter of 2003, which includes the write-down of the remaining goodwill of $7.2 million and provisions for severance, leasehold commitments, and other charges of approximately $5.8 million. These amounts are included in operating expenses in the Consolidated Statements of Income. This resulted in an after-tax impact of $8.4 million or $.09 per share in 2003. Any income or expense from RadianExpress operations during 2004 will be recorded during 2004, but is expected to be immaterial.
In August 2003, the Financial Services Authority of the United Kingdom granted permission under Part IV of the Financial Services & Markets Act 2000 for Radian Asset Assurance Limited (“RAAL”), a subsidiary of Radian Asset Assurance, to conduct an insurance business in the United Kingdom. As a result of this additional authority, through RAAL, the Company will have additional opportunities to write financial guaranty insurance in the United Kingdom and, subject to compliance with the European passport rules, throughout the European Union.
SFAS No. 60, “Accounting and Reporting by Insurance Enterprises,” specifically excludes mortgage guaranty insurance from its guidance relating to the earning of insurance premiums. Consistent with GAAP and industry accounting practices, mortgage insurance premiums written on an annual and multiyear basis are initially deferred as unearned premiums and earned over the policy term, and premiums written on a monthly basis are earned over the period coverage is provided. Annual premiums are amortized on a monthly, straight-line basis. Multiyear premiums are amortized over the terms of the contracts in accordance with the anticipated claim payment pattern based on historical industry experience. Ceded premiums written are initially set up as prepaid reinsurance and are amortized in accordance with direct premiums earned.
The mortgage insurance reserve for losses and LAE consists of the estimated cost of settling claims on defaults (or delinquencies) reported and defaults that have occurred but have not been reported. SFAS No. 60 specifically excludes mortgage guaranty insurance from its guidance relating to the reserve for losses. Consistent with GAAP and industry accounting practices, the Company does not establish loss reserves for future claims on insured loans that are not currently in default. In determining the liability for unpaid losses related to reported outstanding defaults, the Company establishes loss reserves on a case-by-case basis. The amount reserved for any particular loan is dependent upon the characteristics of the loan, the status of the loan as reported by the servicer of the insured loan as well as the economic conditions and estimated foreclosure period in the area in which the default exists. As the default progresses closer to foreclosure, the amount of loss reserve for that particular loan is increased, in stages, to approximately 100% of the Company’s exposure and that adjustment is included in current operations. With respect to delinquent loans that are in the early stage of delinquency, considerable judgment is exercised as to the adequacy of reserve levels. The Company relies on its historical models and makes adjustments to its estimates based on current economic conditions and recent trend information. These adjustments in estimates for delinquent loans in the early stage of delinquency are more judgmental in nature than for loans that are in the later stage of delinquency. If the default cures, the reserve for that loan is removed from the reserve for losses and LAE. The curing process causes an appearance of a reduction in reserves from prior years. The Company also reserves for defaults that have occurred but have not been reported using
historical information on defaults not reported on a timely basis by lending institutions. The estimates are continually reviewed and, as adjustments to these liabilities become necessary, such adjustments are reflected in current operations.
Reserves for losses and LAE in the financial guaranty business are established based on the Company’s estimate of specific and non-specific losses, including expenses associated with settlement of such losses on its insured and reinsured obligations. The Company’s estimation of total reserves considers known defaults, reports and individual loss estimates reported by ceding companies and annual increases in the total net par amount outstanding of the Company’s insured obligations. The Company records a specific provision for losses and related LAE when reported by primary insurers or when, in the Company’s opinion, an insured risk is in default or default is probable and the amount of the loss is reasonably estimable. In the case of obligations with fixed periodic payments, the provision for losses and LAE represents the present value of the Company’s ultimate expected losses, adjusted for estimated recoveries under salvage or subrogation rights. The non-specific reserves represent the Company’s estimate of total reserves, less provisions for specific reserves. Generally, when a case-basis reserve is established or adjusted, an offsetting adjustment is made to the non-specific reserve. The Company discounts certain financial guaranty liabilities arising from defaults over the life of the claim payment at annual rates, which correspond to the financial guaranty insurance subsidiaries’ investment yields ranging from 4.05% to 4.75% in 2003 and 4.10% to 5.25% in 2002. Discounted liabilities at December 31, 2003 were $17.5 million, net of discounts of $3.2 million compared to discounted liabilities of $18.5 million at December 31, 2002, net of discounts of $7.3 million.
Reserves for losses and LAE for Financial Guaranty’s other lines of business, primarily trade credit reinsurance, are based on reports and individual loss estimates received from ceding companies, net of anticipated estimated recoveries under salvage and subrogation rights. In addition, a reserve is included for losses and LAE incurred but not reported on trade credit reinsurance.
If the Company’s estimates are inadequate, it may be forced by insurance and other regulators or rating agencies to increase its reserves. Unanticipated increases to its reserves could lead to a reduction in the Company’s and its subsidiaries’ ratings. Such a reduction could have a significant negative impact on the Company’s ability to attract and retain business.
Costs associated with the acquisition of mortgage insurance business, consisting of compensation and other policy issuance and underwriting expenses, are initially deferred. Because SFAS No. 60 specifically excludes mortgage guaranty insurance from its guidance relating to the amortization of deferred policy acquisition costs, amortization of these costs for each underwriting year book of business are charged against revenue in proportion to estimated gross profits over the life of the policies using the guidance provided by SFAS No. 97, “Accounting and Reporting by Insurance Enterprises For Certain Long Duration Contracts and for Realized Gains and Losses From the Sale of Investments.” This includes accruing interest on the unamortized balance of capitalized acquisition costs. The estimate for each underwriting year is updated annually to reflect actual experience and any changes to key assumptions such as persistency or loss development.
Deferred policy acquisition costs in the financial guaranty business comprise those expenses that vary with, and are primarily related to, the production of insurance premiums, including: commissions paid on reinsurance assumed, salaries and related costs of underwriting and marketing personnel, rating agency fees, premium taxes and certain other underwriting expenses, offset by commission income on premiums ceded to reinsurers. Acquisition costs are deferred and amortized over the period in which the related premiums are earned. Deferred policy acquisition costs are reviewed periodically to determine that they do not exceed or are less than recoverable amounts, after considering investment income.
Deferred income taxes are provided for the temporary difference between the financial reporting basis and the tax basis of the Company’s assets and liabilities using enacted tax rates applicable to future years.
The Company is required to group assets in its investment portfolio into one of three categories: held to maturity, available for sale and trading securities. Fixed-maturity securities for which the Company has the positive intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost. Fixed-maturity and equity securities purchased and held principally for the purpose of selling them in the near term are classified as trading securities and are reported at fair value, with unrealized gains and losses included in earnings. All other investments are classified as available for sale and are reported at fair value, with unrealized
The Company accounts for derivatives under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended and interpreted. Transactions that the Company has entered into that are accounted for under SFAS No. 133, as amended, include investments in convertible debt securities and selling credit protection in the form of credit default swaps and certain financial guaranty contracts that are considered credit default swaps. Credit default swaps and certain financial guaranty contracts that are accounted for under SFAS No. 133 are part of the Company’s overall business strategy of offering financial guaranty protection to its customers. Currently, none of the derivatives qualifies as a hedge under SFAS No. 133. Therefore, changes in fair value are included in the periods presented in current earnings in the Consolidated Statements of Income. Net unrealized losses on credit default swaps and certain other financial guaranty contracts are included in accounts payable and accrued expenses on the Consolidated Balance sheets. Settlements under derivative financial guaranty contracts are charged to accounts payable and accrued expenses. During 2003, the Company received $11.5 million as settlement proceeds on derivative financial guaranty contracts and paid $14.0 million as settlement on derivative financial guaranty contracts. There were no such settlements in 2002.
The following table presents information related to net unrealized losses on derivative financial guaranty contracts (included in accounts payable and accrued expenses on the Consolidated Balance Sheets).
The application of SFAS No. 133, as amended, could result in volatility from period to period in gains and losses as reported on the Company’s Consolidated Statements of Income. These gains and losses result primarily from changes in corporate credit spreads, changes in the creditworthiness of underlying corporate entities and the equity performance of the entities underlying the Company’s convertible securities. The Company is unable to predict the effect this volatility may have on its financial position or results of operations.
prospectively except for the provisions of this Statement that relate to SFAS No. 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003. These provisions are to be applied in accordance with their respective effective dates. The implementation of this Statement did not have a material impact on the Company’s financial statements.
The Company accounts for stock-based compensation in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123 requires expanded disclosures of stock-based compensation arrangements with employees and encourages, but does not require, the recognition of compensation expense for the fair value of stock options and other equity instruments granted as compensation to employees and directors. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”), and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company’s stock at the date of the grant over the amount an employee must pay to acquire the stock. To date, there have been no options issued at a price that was less than the market price at the date of issuance.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123.” SFAS No. 148 amended SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value-based method of accounting for stock-based employee compensation. In addition, this Statement amended the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. This statement is effective for financial statements for fiscal years ending after December 15, 2002.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation (in thousands, except per-share amounts).
In accordance with the adoption of SFAS No. 123, the pro forma effect on net income for 2003, 2002 and 2001 is not representative of the pro forma effect on net income in future years because it does not take into consideration pro forma compensation expense related to grants made prior to 1995.
At December 31, 2003, 2002 and 2001, there were 297,600 options, 770,000 options and 789,000 options, respectively, excluded from the net income per-share calculation because the options were anti-dilutive.
The Company is required to present, as a component of comprehensive income, the amounts from transactions and other events that are currently excluded from the Consolidated Statements of Income and are recorded directly to stockholders’ equity.
The Company has three reportable segments: mortgage insurance, financial guaranty and financial services. The mortgage insurance segment provides private mortgage insurance and risk management services to mortgage lending institutions located throughout the United States and globally. Private mortgage insurance primarily protects lenders from default-related losses on residential first mortgage loans made to homebuyers who make down payments of less than 20% of the purchase price and facilitates the sale of these mortgages in the secondary market. The financial guaranty segment provides credit-related insurance coverage, credit default swaps and certain other financial guaranty contracts to meet the needs of customers in a wide variety of domestic and international markets. The Company’s insurance businesses within the financial guaranty segment include the assumption of reinsurance from monoline financial guaranty insurers for both public finance bonds and structured finance obligations. The Company also provides direct financial guaranty insurance for public finance bonds and structured transactions, and trade credit reinsurance, which may or may not include political risk cover. The financial services segment deals primarily with credit-based servicing and securitization of assets in underserved markets, in particular, the purchase and servicing of and securitization of special assets, including sub-performing/non-performing mortgages, seller-financed residential mortgages and delinquent consumer assets. In addition, financial services include the results of RadianExpress, an Internet-based settlement company that provides real estate information and closing products and services to the first and second lien mortgage industry. On December 30, 2003, the Company announced that it would cease operations of RadianExpress in a phased shutdown by March 2004. The Company’s reportable segments are strategic business units, which are managed separately, as each business requires different marketing and sales expertise. Certain corporate income and expenses have been allocated to the segments. For the years ended December 31, 2003 and 2002, the Company’s revenue attributable to foreign countries was approximately 6%; the amount in 2001 was approximately 3%. In addition, long-lived assets located in foreign countries were immaterial for the periods presented.
In the mortgage insurance segment, the highest state concentration of risk is California at 14.7%. At December 31, 2003, California also accounted for 14.8% of Mortgage Insurance’s total direct primary insurance in force and 18.5% of Mortgage Insurance’s total direct pool risk in force. California accounted for 15.2% of Mortgage Insurance’s direct primary new insurance written in 2003. The largest single customer of Mortgage Insurance (including branches and affiliates of such customer) measured by new insurance written, accounted for 10.4% of new insurance written during 2003 compared to 8.1% in 2002 and 12.6% in 2001. The amount originated in 2003 includes a large structured transaction for one customer composed of prime mortgage loans originated through the United States.
The Company evaluates performance based on a number of financial measures including net income and return on equity. Summarized financial information concerning the Company’s operating segments as of and for the year-to-date periods indicated is presented in the following tables:
In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities.” The Interpretation clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. In December 2003, FIN 46 was revised in FIN 46R. FIN 46R scopes out many but not all businesses, as business is defined in FIN 46. The FASB partially delayed FIN 46’s implementation until no later than the end of the first reporting period after March 15, 2004. Currently, the Company is not the primary beneficiary of a variable interest entity. However, the Company has been a transferor of financial assets (as discussed above in “Assignment Operations”) considered to be a qualifying special-purpose entity (“QSPE”) described in SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” These QSPEs are not within the scope of the Interpretation. In management’s opinion, this Interpretation will not have a material effect on the Company’s financial statements.
In November 2003, the Emerging Issues Task Force (“EITF”) reached a consensus on certain disclosures required for securities accounted for under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” EITF issue 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” requires additional disclosure of quantitative and qualitative information for investments with unrealized losses at the balance sheet date that have not been recognized as other-than-temporary impairments. The Company has included the required disclosures in the Notes to Financial Statements and in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 6.
For the years ended December 31, 2003, 2002 and 2001, the Company did not sell any fixed-maturity investments held to maturity.
Includes mark-to-market adjustments for derivatives of affiliates not included in the Company’s Consolidated Balance Sheets.
At December 31, 2003, fixed-maturity investments available for sale had gross unrealized losses of $10.8 million. At December 31, 2003, equity securities available for sale had gross unrealized losses of $6.5 million. For these securities in an unrealized loss position at December 31, 2003, the length of time such securities have been in an unrealized loss position, as measured by their month-end fair values is as follows:
Securities on deposit with various state insurance commissioners amounted to $18.5 million at December 31, 2003 and $14.1 million at December 31, 2002. The Company also had $58.6 million on deposit at December 31, 2003 and $60.9 million at December 31, 2002 for the benefit of reinsurers.
As a result of the acquisition of Financial Guaranty, the Company owns a 46.0% interest in C-BASS and a 41.5% interest in Sherman. Effective January 1, 2003, Sherman’s management exercised its right to acquire additional ownership of Sherman, reducing the Company’s ownership interest from 45.5% to 41.5%. The Company recorded a $1.3 million loss on the transaction. C-BASS is engaged in the purchasing, servicing and/or securitization of special assets, including sub-performing/non-performing and seller-financed residential mortgages, real estate and subordinated residential mortgage-based securities. Sherman conducts a business that focuses on purchasing and servicing delinquent, primarily unsecured consumer assets. At December 31, 2003 and 2002, C-BASS had total assets of $3.2 billion and $1.8 billion, respectively, and total liabilities of $2.7 billion and $1.4 billion, respectively. C-BASS had net income for 2003, 2002, and 2001 of $143.9 million, $138.3 million and $86.5 million, respectively. At December 31, 2003 and 2002, Sherman had total assets of $505.0 million and $385.9 million, respectively, and total liabilities of $345.1 million and $269.4 million, respectively. Sherman had net income for 2003, 2002 and 2001 of $70.9 million, $40.3 million and $10.6 million, respectively.
The Company accounts for its investment in these affiliates in accordance with the equity method of accounting, as the control of these affiliates does not rest with the Company and since the other shareholders have substantial participating rights.
The Company utilizes reinsurance as a risk management tool, to reduce net risk in force to meet regulatory risk-to-capital requirements and, with respect to mortgage insurance, to comply with the regulatory maximum per loan coverage percentage limitation of 25%. Although the use of reinsurance does not discharge an insurer from its primary liability to the insured, the reinsuring company assumes the related liability. Included in other assets are unearned premiums (prepaid reinsurance) of $6.8 million and $8.6 million at December 31, 2003 and 2002, respectively.
The 2003, 2002 and 2001 amounts in the preceding table included ($1,327,000), ($15,000) and $4,062,000, respectively, for premiums written and $1,181,000, $173,000 and $4,299,000, respectively, for premiums earned, for reinsurance ceded under variable quota-share treaties entered into in 1997, 1996, 1995 and 1994 covering the books of business originated by Radian Guaranty in those years. Commissions under these treaties were $1,251,000, $3,840,000 and $2,216,000 for the years ended December 31, 2003, 2002 and 2001, respectively. The Company recovered variable quota-share losses under these treaties of $528,000, $1,809,000 and $611,000 in 2003, 2002 and 2001, respectively.
Premiums are payable to the reinsurer on a quarterly basis net of commissions due and any losses calculated under the variable quota-share coverage. At the end of the fourth, seventh and tenth years of each treaty, depending on the extent of losses recovered to date under the variable quota-share provisions of the treaty, Radian Guaranty may recover amounts due under the underwriting-year excess coverage provisions of the treaty.
The Company accounts for this reinsurance coverage under guidance provided in EITF 93-6, “Accounting for Multiple-Year Retrospectively Rated Contracts by Ceding and Assuming Enterprises.” Under EITF 93-6, the Company recognizes an asset for amounts due from the reinsurer based on experience to date under the contract.
The default and claim cycle on mortgage loans that the Company covers begins with the receipt from the lender of notification of a default on an insured loan. The master policy with each lender requires the lender to inform the Company of an uncured default on a mortgage loan within 75 days of the default. The incidence of default is influenced by a number of factors, including change in borrower income, unemployment, divorce and illness, the level of interest rates, and general borrower creditworthiness. Defaults that are not cured result in claims to the Company. Borrowers may cure defaults by making all delinquent loan payments or by selling the property and satisfying all amounts due under the mortgage.
When a specific loan initially defaults, it is uncertain the default will result in a claim. It is the Company’s experience that a significant percentage of mortgage loans in default are cured. The reserve is increased in stages, as the foreclosure progresses, to approximate the estimated total loss for that particular claim. At any time during the foreclosure process, until the lender takes title to the property, the borrower may cure the default, at which time the reserve for that loan is removed. Therefore, it is appropriate to increase the reserve stages as new insight and information is obtained. At the time of title transfer, the Company has approximately 100% of the estimated total loss reserved.
In the financial guaranty business, policies are monitored by the Company or the primary insurers over the life of the policy. When the policy’s performance deteriorates below underwriting expectations, or if the circumstances dictate, the related transaction is more actively monitored, which may include communication with the borrower, site inspection or the engagement of a third-party consultant. If the transaction continues to deteriorate to a point where a default is reasonably probable, based on all the facts and circumstances then known and estimable, the Company will establish specific loss reserve that represents the present value of the amount of the claim Financial Guaranty expects that it will ultimately have to pay. Financial Guaranty has a regular
surveillance committee meeting where experts in the risk management and surveillance area provide input before any case reserves are determined, and the surveillance team actively monitors any problem deals and notifies the committee if a change in the loss reserve is necessary. Financial Guaranty establishes a reserve based on the present value of the estimated loss, including expenses associated with the settlement of the loss that Financial Guaranty expects that it will ultimately have to pay.
As a result of changes in estimates of insured events in prior years, the provision for losses and loss adjustment expenses in the mortgage insurance business decreased by $19.7 million, $125.7 million, and $141.0 million in 2003, 2002 and 2001, respectively, due primarily to lower than anticipated claim payments as compared to the amounts previously reserved.
In February 2003, the Company issued, in a private placement, $250 million of unsecured Senior Notes. These notes bear interest at the rate of 5.625% per annum, payable semi-annually on February 15 and August 15. These notes mature in February 2013. The Company has the option to redeem some or all of the notes at any time with not less than 30 days notice. The Company used a portion of the proceeds from the private placement to repay the $75.0 million in principal outstanding of the 6.75% debentures due March 1, 2003 issued by Enhance Financial Services Group Inc. (“EFSG”). The remainder was used for general corporate purposes. In late July 2003, the Company offered to exchange all of the notes for new notes with terms substantially identical to the terms of the old notes, except that the new notes are registered and have no transfer restrictions, rights to additional interest or registration rights, except in limited circumstances.
On August 15, 2002, the Company redeemed its $4.125 Preferred Stock, par value $.001 per share. Pursuant to the Company’s sinking fund redemption obligation, 72,000 shares were redeemed at $50.00 per share, and the remaining 728,000 shares were redeemed at $54.125 per share. Accrued and unpaid dividends on the shares to the date of redemption were also paid as part of the redemption price. The excess of the amount paid over the carrying value of the preferred stock of $3.0 million was accounted for as a charge to equity and resulted in an approximate $.03 reduction in earnings per share for the year-to-date period of 2002.
In September 2003, Radian Asset Assurance closed on $150 million of money market committed preferred custodial trust securities, pursuant to which it entered into a series of three perpetual put options on its own preferred stock to Radian Asset Securities Inc. (“Radian Asset Securities”), a newly formed affiliate and wholly owned subsidiary of the Company. Radian Asset Securities in turn entered into a series of three perpetual put options on its owned preferred stock (on substantially identical terms to the Radian Asset Assurance preferred stock). The counterparty to the Radian Asset Securities put options are three trusts established by two major investment banks (“The Broker-Dealers”). The trusts were created as a vehicle for providing capital support to Radian Asset Assurance by allowing Radian Asset Assurance to obtain immediate access to additional capital at its sole discretion at any time through the exercise of one or more of the put options and the corresponding exercise of one or more of the corresponding Radian Asset Securities put options. If the Radian Asset Assurance put options were exercised, Radian Asset Securities, through the Radian Asset Assurance preferred stock thereby acquired by Radian Asset Securities and investors, through their equity investment in the Radian Asset Securities preferred stock, would give Radian Asset Securities and the investors rights to the assets of Radian Asset Assurance of an equity investor in Radian Asset Assurance. Such rights would be subordinate to policyholders’ claims, as well as to claims of general unsecured creditors of Radian Asset Assurance, but ahead of those of the Company, through EFSG, as the owner of the common stock of Radian Asset Assurance. If all the Radian Asset Assurance put options were exercised, Radian Asset Assurance would receive up to $150 million in return for the issuance of its own perpetual preferred stock, the proceeds of which may be used for any purpose including payment of claims. Dividend payments on the preferred stock will be cumulative only if Radian Asset Assurance pays dividends on its common stock. Each trust will be restricted to holding high-quality, short-term commercial paper investments to ensure that it can meet its obligations under the put option. To fund these investments, each trust will issue its own auction market perpetual preferred stock. Each trust is rated “A” by each of S&P and Fitch. The initial costs to issue this facility are recorded as a reduction to additional paid-in capital. Ongoing costs of the put premium are charged to other operating expenses.
The ability of Amerin Guaranty to pay dividends on its common stock is restricted by certain provisions of the insurance laws of the State of Illinois, its state of domicile. The insurance laws of Illinois establish a test limiting the maximum amount of dividends that may be paid from positive unassigned surplus by an insurer without prior approval by the Illinois Insurance Commissioner. Under such test, Amerin Guaranty may pay dividends during any 12-month period in an amount equal to the greater of (i) 10% of the preceding year-end statutory policyholders’ surplus or (ii) the preceding year’s statutory net income. In accordance with such restrictions, $30.4 million is available for dividends in 2004 without prior regulatory approval.
Radian Guaranty’s current excess of loss reinsurance arrangement prohibits the payment of any dividend that would have the effect of reducing the total of its statutory policyholders’ surplus plus its contingency reserve below $85 million. As of December 31, 2003, Radian Guaranty had statutory policyholders’ surplus of $255.6 million and a contingency reserve of $1.9 billion, for a total of $2.1 billion. As of December 31, 2002, Radian Guaranty had statutory policyholders’ surplus of $163.5 million, and a contingency reserve of $1.7 billion, for a total of $1.8 billion. During 2001, Radian Guaranty and Amerin Guaranty entered into an assumption agreement whereby Radian Guaranty assumed 100% of the rights, duties and obligations related to first lien mortgage guaranty insurance written by Amerin Guaranty. Amerin Guaranty’s contingency reserve of $310.9 million was transferred to Radian Guaranty in accordance with the terms of the assumption agreement.
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, 2003 and 2002 was $304.0 million and $296.4 million, respectively. Amerin Guaranty’s statutory net income for 2003, 2002 and 2001 was $14.4 million, $21.1 million and $53.2 million, respectively.
New York insurance law requires financial guaranty insurers to maintain minimum policyholders’ surplus of $65 million. When added to the minimum policyholders’ surplus of $3.4 million separately required for the other lines of insurance that it is licensed to write, each of the insurance subsidiaries is required to have an aggregate minimum policyholders’ surplus of $68.4 million. Radian Reinsurance had statutory policyholders’ surplus of $370.1 million and $272.1 million at December 31, 2003 and 2002, respectively, a contingency reserve of $261.8 million and $280.4 million at December 31, 2003 and 2002, respectively, and statutory net income for 2003, 2002 and 2001 of $79.0 million, $78.4 million and $40.0 million, respectively. Radian Asset Assurance had statutory policyholders’ surplus of $453.0 million and $309.5 million at December 31, 2003 and 2002, respectively, a contingency reserve of $59.5 million and $39.3 million at December 31, 2003 and 2002, respectively, and statutory net income of $60.4 million for 2003, $33.4 million for 2002 and $10.6 million for 2001. Under Statutory Accounting (“STAT”) the $111 million provision for the manufactured housing transaction with Conseco Finance Corp. is recorded in 2004.
(a) Under STAT, mortgage guaranty insurance companies are required to establish each year a contingency reserve equal to 50% of premiums earned in such year. Such amount must be maintained in the contingency reserve for 10 years after which time it is released to unassigned surplus. Prior to 10 years, the contingency reserve may be reduced with regulatory approval to the extent that losses in any calendar year exceed 35% of earned premiums for such year.
(b) In accordance with New York insurance law, financial guaranty insurance companies are required to establish a contingency reserve in the amount prescribed by legislation. Such legislation requires that for financial guaranty policies written after June 30, 1989, each primary insurer must establish a contingency reserve equal to the greater of 50% of premiums written or a stated percentage of the principal guaranteed, ratably over 15-20 years dependent upon the category of obligation insured. Reinsurers are required to establish a contingency reserve equal to their proportionate share of the reserve established by the primary insurer. Also under New York insurance law (STAT), case reserves are required to be established in the accident year in which the default occurred. Under GAAP, non-specific reserves are established when a claim is probable and estimable.
The following table summarizes information concerning currently outstanding and exercisable options at December 31, 2003:
The Company currently maintains a noncontributory defined benefit pension plan (the “Pension Plan”) covering substantially all full-time employees of Radian Group, Radian Guaranty, RadianExpress and Financial Guaranty. Until its termination on October 31, 2002, EFSG maintained a defined benefit pension plan (“EFSG Pension Plan”) for the benefit of all eligible employees. The Company recorded a gain of $3.0 million related to the termination of this plan in 2002. Employers’ contributions were based upon a fixed percentage of employee salaries at the discretion of Financial Guaranty. Financial Guaranty became a participating employer under the Pension Plan effective November 1, 2002. The Company granted past service credit for eligibility and vesting purposes under the Pension Plan for all such service credited under the EFSG Pension Plan on behalf of the eligible employees of Radian Reinsurance who were active participants in the EFSG Pension Plan prior to its termination and who became participants in the Pension Plan effective November 1, 2002. Retirement benefits are a function of the years of service and the level of compensation. Assets of the plan are allocated in a balanced fashion with approximately 40% in fixed-income securities and 60% in equity securities. As a result of the termination of the EFSG Pension Plan, those assets are invested in short-term securities, awaiting distribution in the near future.
EFSG also maintained a non-qualified restoration plan (the “Restoration Plan”) for eligible employees, which was frozen effective October 31, 2002. The Company recorded a gain of $2.3 million in 2002 related to the curtailment of this plan. Participants in the Restoration Plan began participating in the Company’s SERP effective November 1, 2002.
In addition to providing pension benefits, the Company provides certain healthcare and life insurance benefits to retired employees of Radian Group, Radian Guaranty and Financial Guaranty who were hired before January 1, 1990 under a postretirement welfare plan (the “Postretirement Welfare Plan”). Until its curtailment on August 31, 2002, EFSG had a plan which provided certain healthcare benefits for retired employees (the
“Enhance Postretirement Medical Plan”). The plan was frozen effective August 31, 2002 so that only Financial Guaranty employees hired before February 2, 1990 are eligible for the retirement benefits available under this plan, and the Company recorded a gain of approximately $0.7 million in 2002 from the curtailment of this plan. The postretirement benefit cost for 2003 and 2002 was a credit of $82 thousand and $0.3 million respectively, due to the curtailment of the Enhance Postretirement Medical Plan, while the expense for 2001 was $0.3 million. The Company accrues the estimated cost of retiree medical and life benefits over the period during which employees render the service that qualifies them for benefits. All of the Company’s plans together are referred to in the tables below as the “Radian Plans.”
The accumulated benefit obligation at December 31, 2003 and 2002 for the Radian Pension Plan/SERP was $16.5 million and $8.7 million, respectively. The accumulated benefit obligation for the EFSF Pension Plan/Restoration Plan at December 31, 2003 and 2002 was $7.3 million and $6.7 million, respectively.
The selected long-term rate on assets (8.5%) was primarily based on the allocation of the Pension Plan’s assets (approximately 60% equities and 40% fixed-income investments) coupled with the actual expected returns provided by the Company’s investment advisor by asset type. This assumption is a long-term assumption that has been in place for more than seven years. The Company has periodically reviewed its assumptions against various capital market simulations to assure that its assumptions remain reasonable. The Company believes that an 8.5% long-term return assumption remains reasonable in calculating pension expense.
On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act (“the Act”) of 2003 was signed into law. In accordance with FASB Staff Position No. 106-1 “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003,” issued in December 2003, management has elected to defer any financial impact resulting from the Act pending the availability of more information. As such, measure of the accumulated projected benefit obligation or net periodic postretirement benefit cost in the financial statements or accompanying notes do not reflect the effects of the Act on the plan. Furthermore, specific authoritative guidance on the accounting for the federal subsidy is pending and that guidance, when issued, could require changes to previously reported information.
In addition to the Pension Plan, the SERP and the Postretirement Welfare Plan, the Company also maintains a Savings Incentive Plan, which covers substantially all full-time and all part-time employees of Radian Group, Radian Guaranty, RadianExpress and, effective January 1, 2003, Financial Guaranty, employed for a minimum of 90 consecutive days. Participants can contribute up to 25% of their base earnings as pretax contributions. The Company will match at least 25% of the first 6% of base earnings contributed in any given year. These matching funds are subject to certain vesting requirements. The expense to the Company for matching funds for the years ended December 31, 2003, 2002 and 2001 was $2.7 million, $1.4 million and $1.5 million, respectively.
Until its termination on December 31, 2002, Financial Guaranty had a savings incentive plan. Under this plan, employees of Financial Guaranty could contribute up to 15% of their base earnings as pretax contributions. Financial Guaranty would match 50% of the first 6% of base salary made to the plan by eligible employees. The expense to Financial Guaranty in 2002 and 2001, since acquisition, was $176,000 and $219,000, respectively. Effective January 1, 2003, Financial Guaranty’s savings incentive plan participants became part of the Company’s Savings Incentive Plan.
In December 2000, a complaint seeking class action status on behalf of a nationwide class of home mortgage borrowers was filed against Radian Group Inc. (and certain of its mortgage insurance subsidiaries) in the United States District Court for the Middle District of North Carolina (Greensboro Division). In February 2001, a complaint seeking class action status on behalf of similar plaintiffs represented by Texas counsel was filed against Radian Group Inc. (and certain of its mortgage insurance subsidiaries) in the United States District Court for the Eastern District of Texas. This latter action was dismissed, and on June 2, 2003, the United States Court of Appeals for the Fifth Circuit affirmed such dismissal.
The Radian defendant entities in the North Carolina case are collectively referred to here as “Radian”. The complaint alleges that Radian violated Section 8 of RESPA, which generally prohibits the giving of any fee, kickback or thing of value pursuant to any agreement or understanding that real estate settlement services will be referred. The complaint asserts that the pricing of pool insurance, captive reinsurance, contract underwriting, performance notes and other, unidentified “structured transactions” should be interpreted as imputed kickbacks made in exchange for the referral of primary mortgage insurance business, which, according to the complaint, is a settlement service under RESPA. The complaint seeks injunctive relief and damages of three times the amount of any mortgage insurance premiums paid by persons who were referred to Radian pursuant to the alleged agreement or understanding.
The plaintiffs in the North Carolina lawsuit are represented by the same group of plaintiffs’ lawyers who filed six similar lawsuits in federal court in Georgia against other providers of primary mortgage insurance. Four of the Georgia lawsuits were settled; two are currently in discovery. In November 2002, the Georgia court ruled against one of the defendants on certain preliminary motions substantially similar to those on which Radian had prevailed in the Texas lawsuit. However, in February 2003, the Georgia court refused to certify a class in both of the lawsuits before it. Radian’s North Carolina case is in the motions and early discovery phase, and Radian has filed a motion to dismiss. Because this case is still developing, it is not possible to evaluate the outcome, to determine the effect, if any, that the Texas or Georgia court rulings could have on this case, or to estimate the amount or range of potential loss.
Mortgage Insurance utilizes its underwriting skills to provide an outsourced underwriting service to its customers. Mortgage Insurance often gives recourse to its customers on loans it underwrites for compliance. If the loan does not meet agreed-upon guidelines and is not salable in the secondary market for that reason, Mortgage Insurance agrees to remedy the situation either by placing mortgage insurance coverage on the loan, by purchasing the loan, or indemnifying the loan against future loss. Purchasing the loan would subject the Company to credit risk and interest rate risk. During 2003, less than 1% of all loans were subject to these remedies and the costs associated with these remedies were immaterial.
The Company is a party to reinsurance agreements with the four largest primary financial guaranty insurance companies. The Company’s facultative and treaty agreements are generally subject to termination (i)
The commitment for non-cancelable operating leases in future years has not been reduced by future minimum sublease rental payments aggregating approximately $35,890,000. A portion of these payments relates to subleases to affiliates of the Company. The Company also has the option to lease an additional 5,000 square feet of space in its Philadelphia headquarters in 2004.
Net income per share is computed independently for each period presented. Consequently, the sum of the quarters may not equal the total net income per share for the year.
Fixed-Maturity and Equity Securities-The fair values of fixed-maturity securities and equity securities are based on quoted market prices or dealer quotes. For investments that are not publicly traded, management has made estimates of fair value that consider that issuers’ financial results, conditions and prospects, and the values of comparable public companies.
Trading Securities-The fair values of trading securities are based on quoted market prices, dealer quotes or estimates using quoted market prices for similar securities.
Unearned Premiums-In the mortgage insurance business, as the majority of the premiums received are cash-basis, the fair value is assumed to equal the book value. The fair value of unearned premiums in the financial guaranty insurance business, net of prepaid reinsurance premiums, is based on the estimated cost of entering into a cession of the entire portfolio with third-party reinsurers under current market conditions, adjusted for commissions based on current market rates.
Long-Term Debt-The fair value is estimated based on the quoted market prices for the same or similar issue or on the current rates offered to the Company for debt of the same remaining maturities.
Reinsurance also reimbursed the primary insurer for case reserves recorded under GAAP for approximately $11.5 million. Finally, Radian Reinsurance took a charge of $0.8 million for mark-to-market adjustments related to certain insurance policies associated with the recapture. The sum of the above adjustments related to this recapture resulted in an estimated initial reduction of pre-tax income of $15.9 million and is summarized as follows:
Management is responsible for the preparation, integrity and objectivity of the consolidated financial statements and other financial information presented in this annual report. The accompanying consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America, applying certain estimations and judgments as required.
The Company’s internal control over financial reporting is designed to provide reasonable assurance as to the integrity and reliability of the financial statements and to adequately safeguard, verify and maintain accountability of assets. Such controls are primarily based on established written policies and procedures and are implemented by trained, skilled personnel with an appropriate segregation of duties. These policies and procedures prescribe that the Company and all its employees are to maintain the highest ethical standards and that its business practices are to be conducted in a manner that is above reproach.
Deloitte & Touche LLP, independent auditor, is retained to audit the Company’s financial statements. Its accompanying report is based on audits conducted in accordance with auditing standards generally accepted in the United States of America, which include the consideration of the Company’s internal control over financial reporting to establish a basis for reliance thereon in determining the nature, timing and extent of audit tests to be applied.
The board of directors exercises its responsibility for these financial statements through its Audit and Risk Management Committee, which consists entirely of independent non-management board members. The Audit and Risk Management Committee meets periodically with the independent auditor, both privately and with management present, to review accounting, auditing, internal control and financial reporting matters.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Radian Group Inc. and subsidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.