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Radian Group Inc. (NYSE:RDN)

Q3 2008 Earnings Call Transcript

November 5, 2008, 10:00 am ET

Executives

Terri Williams-Perry – IR

S.A. Ibrahim – CEO

Bob Quint – EVP and CFO

Teresa Bryce – President of Radian Guaranty

Scott Theobald – SVP and Chief Risk Officer, Radian Guaranty Inc.

Analysts

Howard Shapiro - Fox-Pitt

Steve Stelmach - FBR Capital Markets

Donna Halverstadt - Goldman Sachs

David Cast [ph] - J.P. Morgan

Matt Ottis [ph] - KBW

Mark Debrey [ph] - Barclays Capital

Mike Grandall – Key Colony

John Giordano – Credit Suisse

Maria Panganiban – New York Life

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Radian’s third quarter 2008 earnings call. At this time, all lines are in a listen-only mode. Later, there’ll be an opportunity for questions, and instructions will be given at that time. (Operator instructions) And as a reminder, this conference is being recorded. I’ll now turn the conference over to Terri Williams-Perry. Please go ahead, ma’am.

Terri Williams-Perry

Good morning, and welcome to Radian’s third quarter 2008 conference call. By now, you should have all received our press release, which contains the financial results for the quarter. If you have not yet received this, you may obtain it from our Investor Relations Web site at www.radian.biz.

During this morning’s call, you will receive prepared remarks from S.A. Ibrahim, Radian’s Chief Executive Officer; Bob Quint, Chief Financial Officer; and, Teresa Bryce, President of Radian Guaranty. Also on hand for the Q&A portion of the call are Steve Cooke, President of Radian Asset Assurance; Scott Theobald, Senior Vice President of Risk Management; and, Paul Fischer, Executive Vice President of Laws Mitigation.

Before we begin with our prepared remarks, I would like to remind you that any forward-looking statements that we make this morning should be considered in conjunction with the cautionary statement set forth in the Safe Harbor statement included with our webcast slides and the statements contained in our SEC filings. These are available on our Investor Relations Web site.

I would now turn the call over to S.A.

S.A. Ibrahim

Thank you, Terri. Good morning, and thank you all for joining us to review Radian’s third quarter results.

This morning, I would begin by reviewing the quarter’s financial highlights, followed by comments on Radian’s capital and businesses, and conclude with an overview of general industry clients. As always, Bob Quint will follow with financial details. We also have Teresa Bryce joining us this morning. Teresa will provide an update on our mortgage insurance business and the implications of recent government and legislative actions. We will then open the call to take your questions.

Beginning with our earnings, earlier today, we reported net income of $36.7 million for the third quarter, resulting in earnings per share of $0.46. As of September 30, our book value per share was $28.90. Our results were significantly impacted by the reduction of approximately $272 million of the first lean premium deficiency reserve established last quarter, which offsets a significant amount of our mortgage insurance losses booked during the quarter.

In addition, our results reflected profitable financial guaranty business, the positive impact from our ownership interest in Sherman, some realized losses in our investment portfolio, and the ongoing impact of mark-to-market valuations for our (inaudible). Bob will provide credit detail on these results in a few moments.

Importantly, in the third quarter, in spite of a loss on our investment portfolio, it remained strong. And the market insurance claims paid for the quarter were at the lower end of our forecasted range.

The financial industry environment continues to be characterized by change and uncertainty. Moreover, while there are (inaudible) by the financial relief efforts currently underway, and in particular, the renewed focus in solving the current housing crisis, we still remain cautious about the near term. We at Radian continue to take many actions to deal with this challenging environment. And I would like to highlight some of these actions for you now.

During the third quarter, we executed upon our capital plan by contributing our financial guaranty business to our mortgage insurance business. This non-dilutive action adds statutory capital to our mortgage insurance business, and is expected to provide this business with GAAP infusions over time.

In addition, while we believe that our capital is adequate to meet our current needs, we recognize that additional capital could be necessary if the housing downturn continues longer than projected. As a result, we continue to view our interest in Sherman as a resource of additional capital to future dividends or a potential sale. And this remains open to opportunistically exploring other alternatives for raising capital.

Radian has adequate plain staying resources in both our mortgage insurance and our financial guaranty businesses. We have loan loss reserves of $2.7 billion. Our $6.3 billion investment portfolio remains strong despite a challenging investment environment.

Current market conditions require flexibility. And we have changed the priorities for our three business segments over the last year. First, with respect to financial guaranty, market conditions have severely restrained the prospects for this business. And as a result, we have written very little business this year and have seized writing new business for the foreseeable future. Financial guaranty now serves as an important source of non-dilutive capital for our mortgage insurance business. And we have re-oriented our financial guaranty operations commensurate with this new purpose. Importantly, this business continues to have a strong capital position, and has benefited from low exposure to market risks compared to its peers. We are also actively exploring alternatives toward using our existing risks in order to free up capital for our mortgage insurance business.

With respect to financial services, our ownership interest in Sherman has increased and currently stands at 29%. We’ve received $16 million in dividends from Sherman in the third quarter of 2008. We remain strongly committed to our core mortgage insurance business. While Teresa is going to discuss some of the developments in this business, let me highlight a couple.

In the last year, we successfully shifted our business to focus on prime loans while maintaining a strong market position. We have invested and continued to invest in this business by expanding our sales and operations capability and improving our technology. The priorities of this business are to work with our service partners in mitigating lawsuits, originate high quality new business, and to invest and position ourselves to benefit from future opportunities.

We believe the recent changes with respect to the GFTs will allow them to continue to provide liquidity to the housing market and to contribute in moving this market towards recovery. Most critical for us, the GFT charter remains unchanged. Fannie Mae and Freddie Mac are required to obtain credit enhancement from loans with the loan-to-value ratio of greater than 80%. Fannie Mae and Freddie Mac have historically relied heavily on mortgage insurance for this purpose, and we expect to continue to insure loans sold to them. We remain a top tier provider to the GFTs. And we’ll continue to work closely with both organizations through this difficult environment.

We are encouraged by the recent focus, including legislative efforts on mitigating the current housing crisis. For example, as part of the Housing and Economic Recovery Act, which preceded the recent $700 billion relief package, the Treasury is authorized to use loan guarantees and credit enhancements to facilitate loan modification to prevent avoidable foreclosures. The government has also provided $280 million for foreclosure mitigation counseling.

Other players have also begun the process of modifying troubled residential loans. Bank of America has recently entered into a settlement with various states, attorney generals, by pledging $8.4 billion for interest rate and principal reductions that will systematically modify loans for nearly 400,000 country wide customers. JPMorgan Chase has also announced plans to modify terms of $70 billion in mortgages for borrowers who are behind on their payments. This move will again assist as many as 400,000 borrowers. The FDIC, in its role as the conservator for IndyMac, has also proposed broad modification procedures.

Radian is monitoring and engaged in these developments to determine the impact these changes will have on our mortgage insurance coverage and losses. However, we believe that any reasonably crafted effort to keep borrowers in their homes and out of foreclosure will ultimately benefit Radian and the economy as a whole. Clearly, these measures are of significant interest to Radian. And we have been very proactive and remaining close to these events unfolding in Washington.

Now, I will turn the call over to Bob.

Bob Quint

Thank you, S.A. I will be updating you on the P&L activity and trends for the third quarter of 2008 and our financial position as of September 30th, 2008.

As you know in the second quarter, we booked a GAAP premium deficiency reserve of $422 million on our entire domestic first-lien mortgage insurance book. We have updated several items in our third quarter analysis, including an adjustment to our unemployment assumptions to reflect our current expectations of the 7% peak compared to a 6.2% peak last quarter. There is no positive impact from any government or service or action considered in our projection.

Our updated first-lien premium deficiency reserve as of September 30th is $150 million. Therefore, the P&L for the quarter contains a net reduction of $272 million. This means that as of September 30th, the present value of our projected aggregate future losses and expenses on the first-lien domestic business on our books at June 30th, 2008 exceed future premiums, and our current losses are – by $150 million. Because we projected a profit on the new business written during the third quarter, this business does not impact the premium deficiency and will be accounted for normally.

If updated projected losses on the June 30th book don’t materially worsen in the fourth quarter, we would expect the balance of the premium deficiency to be reduced to zero. If that is the case, the fourth quarter results will contain our normal loss revision based on delinquencies and claims offset by $150 million elimination of the premium deficiency balance.

Please remember that our projections over the remaining life of the book that existed at June 30th, which represent several years. The timing of this will likely be volatile as we expect the next several quarters to contain net losses, followed by net income, and longer term future quarters. For example, using hypothetical numbers, there could be a $10 net loss in 2009, followed by a total of $10 net income in future years. And our analysis would show breakeven and no need for a premium deficiency liability. We have updated the components of our premium deficiency analysis in our webcast live.

Expenses for the quarter included some unusual non-repetitive items, including an $11 million charge for financial guarantied severance and $10 million of expenses related to the termination of our pension plan and other compensation items. Because the mortgage insurance business written in the third quarter is not included in the premium deficiency reserve, related acquisition costs were deferred in accordance with normal practice.

Our mortgage insurance loss provision of $519 million this quarter reflects the higher delinquencies and claims that occurred offset by recoverables of $134 million from the Captives and Smart Home. Our paid claims worth $277 million, consisting of $232 million of first-lien and $45 million of second-lien.

Looking forward into the balance of 2008, we expect the claims paid in the fourth quarter will be similar to the third quarter number, which would bring us to the $950 million range for the year, 5% lower than our previous expectation. We expect that claims paid will be significantly higher in 2009, although the potential impact of the government and service or actions makes the number very difficult to project at this time. We are just beginning to see a slowdown in claims received, which maybe a result of these actions aimed at reducing foreclosures. We expect the number of delinquencies to continue to increase in the fourth quarter due to the ongoing deterioration in the housing and credit market as well as from traditional seasonal factors.

We have added disclosure in our press release regarding our modified pool risk, which we include within our primary risk in force. The total modified pool risk as of September 30th is $854 million. And in our premium deficiency projections, we have included $620 million of projected losses or 73% of this risk.

With regard to pool insurance, of the almost $3 billion of risk in force, we have included over $600 million or 21% of this risk in our projection. A substantial portion of our pool risk is from 2004 and prior. And the performance of that business has been very good. Both pool and modified pool business have significant deductibles and stock loss components that impact the loss projections materially.

With regard to NIM, our current risk in force is $456 million, compared $712 million a year ago, and $485 million as of June 30th. The updated total balance sheet liability on NIM is $248 million. We expect future principal credit losses on NIM will be approximately $440 million, with claim payments expected to begin in 2010, and to occur mostly in 2011 and 2012. Because these future expected losses are greater than our current liability due to the FAS 157 impact, which takes into account the market perception of our non-performance risks, the balance of this expense is expected to be booked in future quarters.

Premium deficiency on second-lien, which was initially booked in the third quarter of 2007, was on the balance sheet at June 30th of $162 million. Updated projections on losses, premiums, and reductions toward discount rates resulted in increase to the premium deficiency in the third quarter to its current balance of $181 million. The risk in force on second-lien is $696 million as of September 30th. So between our loss reserve of $154 million and a premium deficiency of $181 million, this exposure is 48% reserved.

The domestic mortgage insurance CDS business had a positive fair value adjustment this quarter related primarily to FAS 157 non-performance risk, which results in a current fair value liability at quarter-end of $89 million, compared to our expected credit losses of $128 million. Like on our NIMs, this differential between the current fair value and the expected credit losses is expected to be booked over time. The international CDS has a negative markup of $6 million as of September 30th, 2008. We still see no reasonable scenario, in which we would incur any credit losses in such exposure.

Financial guaranty has much lower premiums written this quarter due to our decision to seize writing new business in light of current market conditions. Premiums earned were very strong reflecting heavy refunding. And we continue to see relatively stable credit performance. We are watching the Jefferson County, Alabama situation closely. We currently have $284 of exposure, all via reinsurance.

We have booked a case reserve this quarter of $12.6 million, which will cover the next few quarters of our share of expected principal and interest payments as a solution to the situation we’ve worked on.

Financial guaranty paid $107 ordinary dividend in July, and $100 million of this was subsequently contributed to the MI business rating guarantee. The next ordinary dividend of approximately $100 million is expected to be paid in mid 2009, and would go directly to a parent company rating guaranty.

Significantly, our net par outstanding financial guaranty was reduced this quarter to $111 billion, from $116 billion at June 30th.

The change in fair value line was significantly impacted by the adoption of FAS 157 in the first quarter of 2008, and less so in the second and third quarters, although we did have some credit quality addresses this quarter that had a positive impact on fair value. There is one large positive fair value adjustment based on Radian’s credit quality on a CDO of ABS transactions that according to our updated assumptions, we expect to take credit losses earned, but not until around 2024. We have no other CDOs, for which we currently to pay any material credit losses, and have done extensive work on our corporate CDOs and trust-preferred CDOs in light of recent corporate credit events to confirm that. We have also expanded our disclosures significantly in this area, and included that disclosure in our webcast play.

Our investment portfolio continues to hold up in the stressed environment. Its safe credit profile, diversity among holdings, and our policy of generally not investing in residential mortgages have proven sound. We have booked losses through the P&L in the third quarter via other a loss on sale or on other than temporary impairment on $17 million related to Fannie Mae and Freddie Mac, and $21 million related to Lehman. The majority of the rest of the losses in our investment portfolio had an either run through the P&L or run through the balance sheet this quarter are not credit related, and therefore, we believe they are temporary. We also believe our portfolio is positioned as well as possible in this environment.

We currently have approximately $360 million of cash available to Radian Group, with a very minimal near term expected need for cash up the holding company. The primary financial covenant in our bank facility for the maintenance of at least $1.7 billion in GAAP equity, and that compares to $2.3 billion that we have as of September 30th, had a 35% debt to capital valuation ratio, which compares to 28% as of September 30th.

In addition to just under $1 billion of statutory surplus as of 9/30/08, the financial guaranty company has another $1.9 billion in claims paying resources, including (inaudible) premium reserve, future value of installment premiums, and contingency reserves, for a total of approximately $2.9 billion in claims paying resources. We believe that these resources will help allow us to continue to write profitable new MI business.

We expect to continue to continue to pursue ways to reduce the risk at Radian Asset Insurance in an economically advantageous way, potentially making the existing capital more freely accessible.

In addition, although our financial guaranty counterparties have the right to either claw back or walk away from our exposures, they’re in no collateral support or any other agreement that could significantly impact the liquidity of this business.

At quarter end, the total statutory surplus, including contingency reserves in our mortgage insurance business is $2.2 billion. And we have another $2.9 billion in loss and premium deficiency reserve. We believe the liquidity in the mortgage insurance business is more than adequate to meet all these obligations for the foreseeable future.

Now, I would like to turn the call over to Teresa Bryce.

Teresa Bryce

Thank you, Bob. As S.A. mentioned earlier, we remain 100% committed to our mortgage insurance business. While we can do little to change the current market conditions, we have been working hard to build a mortgage insurance franchise that will be successful in the long term.

While we are managing risks and costs aggressively, we are also making improvements to our operations to streamline process leads and improve service levels. We continue to maintain our strong market position in 2008 despite a significant decrease in mortgage origination volume across the industry. During the third quarter of 2008, Radian’s mix of new MI business was over 98% prime. This represents the dramatic shift during the past year, and is a trend we expect to continue into 2009.

We realized that our ability to maintain a strong market position and add new quality business is dependent on an experienced and stable workforce, which includes field sales representatives. During 2008, we have increased our sales force significantly to assure that we are building long term relationships, adding new relationships with high quality lenders, and assisting our clients with the many issues facing our industry. There is no question that this is one of the most challenging times for our economy and our housing industry.

Radian remains committed to maintaining its current five days product mix, and ensuring appropriate risk reductive returns by making necessary guideline changes and pricing increases, which are expected to improve the profitability of new business.

On a risk adjusted basis, we believe the pricing changes that we have made will result in enhanced profitability. We constantly monitor the marketplace, review loan and lender performance, adjust our models in real time, and make the appropriate changes in our guideline and pricing formulas.

While the rapidly rising default rate for subprime and (inaudible) should be no surprise to anyone, most disconcerting is the rise in the prime default rate. This is now approximately 5.7% during the third quarter of 2008. And it is our expectation that the default rate will continue to rise in the short term, although we are seeing positive trends in certain institutes. We continue to monitor and track these default rate trends as well as trends for early payment default.

During the third quarter, we have seen a turnaround in the performance of our 2008 book. Considering the guideline and pricing changes we have been made, we expect the 2008 book to be profitable. Radian continually monitors loan and lender performance trends, and adjust underwriting standards as warranted. Recently announced changes include lowering the maximum loan-to-value ratio in stable markets to 95% and in declining markets to 90%, increasing the minimum credit score, and reducing risk layering with regard to occupancy and property types. We will continue to monitor the market. And we’ll take further actions as they are needed.

Our process for evaluating risk is driven by the latest loan performance data, and in particular, early payment default trends. The multiple guideline changes we made during the third quarter reflect loan characteristics and performance data well beyond basic credit scores and loan-to-value.

Radian is also looking carefully at lender performance. We are working closely with our lender partners to improve underwriting, and to ultimately reduce the rate of default to levels that would drive greater profitability. As you are aware, a number of our peers have made decisions during the quarter regarding their Captive structures. Specifically, some have announced that they will no longer see new business under excess of loss reinsurance plan with lender Captive Insurance Company. We have no present plans to exit this market. However, we are currently evaluating the terms of all of our reinsurance programs. Once we have completed this analysis, we will communicate our plans by this area of our business.

As you would expect, our efforts in loss mitigation has been a priority and a key part of our capital preservation strategy. Just as we are making tough decisions regarding our guidelines and programs, Radian is aggressively managing loss strategy to preserve capital.

A major component of our loss mitigation approach is devaluating every opportunity to keep people in their homes. We have placed staff on site with major mortgage servicers to identify and expedite solutions. We continue to promote the use of our Fast Advance Program that advances up to 15% of a potential claim to our servicers. In turn, they can use the funds to provide solutions directly to the homeowner, such as low modifications and buy-downs.

We are also an active participant in the Hope Now initiative. These initiatives represent the variety of solutions that are available to our mortgage servicing partners. Radian has also launched outreach programs that go directly to customers. Our borrower Web site educates homeowners on a variety of solutions available to them. And to date, we have tracked over 5,000 visits to the site. Radian has set over 30,000 mailers to borrowers inviting them to visit our Web site for more information.

Radian has also continued its partnership with the consumer credit counseling service of Delaware Valley to contact borrowers on a national basis to offer free credit counseling services. The result of this outreach program has been a contract – contact rate of 27%, with over 400 counseling sessions conducted.

As S.A. mentioned earlier, I will now provide you an update of our September meetings on capital build. We believe it is important for our legislators, our regulators, and the public to recognize the important role of the MI industry and Radian during this downturn.

First, although the industry has experienced losses and downgrades, the MI industry has set exactly what it was supposed to do during this time. Claims paid by the industry have exceeded $15 billion over the past two years. At the same time, we are working in partnership with servicers to help borrowers stay in their homes, if at all possible. This clearly demonstrates the value of MI to the GSEs, taxpayers, and the overall stability of the housing market.

Also, we have not only been closely monitoring the developments in Washington, but we have participated in meetings and discussions with legislators. Their reactions were receptive and favorable. We and others within the MI industry have provided our input on the industry’s role moving forward. Based on our meetings, we believe that legislators recognize the benefit of private mortgage insurance and the need to preserve it, and whatever financial reform legislation Congress undertakes next year. We will continue to meet with legislators and regulators as appropriate.

I would like to close by reiterating our commitment to our MI business. We remain focused on efficiently managing our operations, and preserving capital to ensure that Radian is best prepared to emerge from the current challenges positioned as a long term value player. This has meant taking measures, such as making pricing and guideline changes and adjusting our business mix, in addition to ensuring cost control.

I would now turn the call back to S.A.

S.A. Ibrahim

Thank you, Teresa. Before we open the call for questions, I would like to reiterate four key points.

First, we contributed our financial guaranty business for our mortgage insurance business in the third quarter. We still view our interest in Sherman as a source of additional capital for future dividends or potential sale, while remaining opportunistically open for other alternatives for raising capital. Second, we believe we have adequate claims paying resources in both the mortgage insurance and financial guaranty businesses. Third, going forward, we are strongly committed to our mortgage insurance business, and our franchise remains resilient. And fourth, our investment portfolio is strong, and we believe we have adequate liquidity to meet near term anticipated needs.

We remain focused on insuring Radian is best positioned to weather the current economic climate and to take advantage of future opportunities.

Now, we will open the call to your questions. Operator.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And our first question comes from Howard Shapiro with Fox-Pitt. Please go ahead.

Howard Shapiro – Fox-Pitt

Hi. Thank you very much. Just a couple of questions, you published, I think, three risks to capital ratios. I’m just wondering which one we should consider the operative one as far as the regulators, the rating agencies, and the GSEs are concerned. And just tell us what your capital is relative to that. And if it’s the 19 and changed to one, what would that mean in terms of your need to raise capital, how soon you would have to do it?

Bob Quint

Well, Howard, the only risk to capital ratio that is really relevant for the purposes that you’re talking about is the rating guarantee. That’s the primary writer of business. And that’s the 50 state-licensed company that is regulated by the State Insurance Department to the 25:1. So it’s the 14.5:1. The other numbers are really much less relevant because they include credit insurers or insurers that are not still regulated.

Howard Shapiro – Fox-Pitt

Okay. And then, just some questions, I guess, on credit and claims. Your average claim rate continues to go up. You guys, I think S.A. said earlier in the call, you’re just beginning to see maybe a decline in new claims. Can you kind of tell us where we are in the process, where you would expect – when you would expect severity to max out? And where would you say we are in terms of the maximum delinquency rates and frequency?

Bob Quint

Howard, you’re referring to the claim size as severity. Is that what you’re referring to? It sounds like you were.

Howard Shapiro – Fox-Pitt

Yes, I am. I’m sorry. Yes.

Bob Quint

We do expect the average claim now will continue to rise. And in terms of delinquencies, we did say that we expect delinquencies to increase in the fourth quarter due to the continuation of the market and due to seasonality, which typically occurs in the fourth quarter.

Unidentified Company Speaker

Howard, though, one of the points that – I might ask Scott to comment on this. Some of our vintages actually seeing delinquencies level off. Scott, I turn then to you.

Scott Theobald

That’s true. What we’re saying is that’s a question everybody knows, places like California, Arizona, and continue to have delinquency issues. Prices in states where there are also a lot (inaudible) products like all day and subprime. However, overall, we’re seeing some nice leveling off in 2005. But 2007 has actually performed recently so far.

Howard Shapiro – Fox-Pitt

Perfect. Thank you very much.

Operator

Thank you. We’ll go next to Steve Stelmach with FBR Capital Markets. Please go ahead.

Steve Stelmach – FBR Capital Markets

Hi. Good morning. Teresa, you mentioned some positive comments from Capital Hill, or at least a relatively receptive legislator – legislative discussions. Could you discuss what the nature is of those discussions? Is it to keep the GSE structure and the MI structure intact after the GSEs are removed from the serviceship [ph]? Or is it discussion in terms of what the business is going to look like? And after the conservatorship issue, what the MI role is going to be under a potentially new structure? What’s the flavor of discussions?

Teresa Bryce

Yes. Thanks for this question. And the major focus really of those discussions was on making sure that those on the Hill were really focused on how important MI has been over the course of this downturn, and how it should really be preserved in any legislation going forward. So in fact, when we were there, it was just about 10 days after the conservatorship was announced. And so, we didn’t really focus on what that would be going forward as much as just trying to make sure that people have on their radar screens as they’re moving forward what a critical role MI has had and how it should be preserved.

Steve Stelmach – FBR Capital Markets

Yes, yes. I don’t think there’s much (inaudible) you got preserved a lot of capital for the GSEs. But on a prospective basis, are you guys contemplating it – any potential change of business models for the industry? Or are you – is the going assumption that – what the status quo business models you’ll see in the next few years?

S.A. Ibrahim

Steve, this is S.A. As you are probably aware, that the number of different groups and industry stakeholders were going to weigh in as future administrative and legislative efforts shape the role of the GSEs and the financial policy going forward. Among the players that are going to participate in that are the mortgage insurance industry as a whole because this is something that affects the whole industry as well as on a larger basis, the mortgage banking industry.

And as such, the Mortgage Bankers Association have setup a taskforce, which is going to focus on liquidity and GSE issues. And very importantly, they have invited the mortgage – a couple of mortgage insurance players, including myself, to be part of that taskforce that is going to look at different alternatives for the GSEs. And you heard, there have been (inaudible) views, the other views that come into play, and will have an opportunity to have a say in whatever got shaped in Washington.

Steve Stelmach – FBR Capital Markets

Okay. Great. Thank you very much. And Bob, just a quick follow up. You mentioned the dividend from the bond source industry, a business up to the MI business. What was that number? I’m sorry, I missed it.

Bob Quint

$107 million, and we paid at the very beginning of July.

Steve Stelmach – FBR Capital Markets

Great. Thank you very much.

Bob Quint

Sure.

Operator

Thank you. Next, we have Amanda Lynam with Goldman Sachs. Please go ahead.

Donna Halverstadt – Goldman Sachs

Hi, it’s Donna Halverstadt. I have a question on liquidity. You had mentioned that resources available to Radian Group, I think, are $360 million. And last quarter, we talked about, I think, pro forma for the pay down on the facility, about $50 million being at the wholesale. So with respect to the $360 million, can you tell us how much of that is actually at the holding company? How much is that a in an intermediate holding company? And why is that an intermediate holding co.? And under what circumstances can you access it? And if that doesn’t get us up to $360 million, what other buckets are there to get you up to that $360 million? Thank you.

Unidentified Company Speaker

That is the amount – we view either being at the hold co. or at a non-insurance affiliate of the hold co. as being pretty much tangible. So we don’t do that as being any different. We view the $360 million in total as the amount that Radian Group has available. And right now, there is a – there is some money at another intermediary holding company. But that’s not really very relevant.

Donna Halverstadt – Goldman Sachs

Okay. Just one follow up then, if – were there some change in your thinking that led you to now talk about $360 million as opposed to the amounts that used to be literally at the hold co.? I mean, should we thinking about anything different here?

Unidentified Company Speaker

No. Nothing in our – we’ve been consistent in describing the amount. And there are also a lot of disclosure in our 10-Q regarding these amounts as well.

Donna Halverstadt – Goldman Sachs

All right. Thank you.

Operator

Thank you. (Operator instructions) And we’ll go next to David Cast [ph] with J.P. Morgan. Please go ahead.

David Cast – J.P. Morgan

Hi. You talked a little bit about your expectations of possible legislation, and your attempt to influence the legislators’ view on the value of mortgage insurance. At the same time, FHA has been gaining market share. I was hoping that you could comment on that, and how you expect that to shape out over the next couple of quarters and possibly next few years?

Teresa Bryce

Well, you’re certainly right that FHA has been gaining a market share given all the changes that have been going on from a guideline and pricing perspective. And we anticipate, particularly with some of the programs that were put in place, like Hope for Homeowners, that we’ll see a continued increase with FHA. At the same time, I think it’s difficult for us to say exactly what we think that will do in terms of the mortgage market overall. It may reduce slightly the amount that is private MI covered over the next couple of quarters. But I think that’s something that we’re really monitoring. And our focus really is on making sure that we are taking the right approach in terms of underwriting and pricing to make sure we’re putting profitable new business on our book.

David Cast – J.P. Morgan

Does that mean that the market share that we’ve seen last quarter is what you see as the more stabilized number going forward for the next couple of quarters? Or do you think that the private MI number could shrink even further?

Teresa Bryce

I think that’s really hard to say at this point in terms of the – how lenders are separately looking at where they’re going to put their share of business. And I think that as we talk to lenders, they seem to be continuing to expect to put a significant amount of (inaudible) with the more private mortgage insurers. At the same time, especially with trying to refinance out some of the borrowers who have had credit issues, FHA has been gaining some share there.

David Cast – J.P. Morgan

Okay. And then you’re – so that you have no – I believe the phrase you used was no present plans to access data in Captive reinsurance. Isn’t it?

Teresa Bryce

That’s correct.

David Cast – J.P. Morgan

But you said that you were investigating it. What would cause you to change and to follow the tactics that some of your competitors have used?

Teresa Bryce

Well I think what we’re saying is that, at this point, we’re looking at really what the right terms should be in terms of moving forward with that business. And so, our expectation at the moment is that we will be able to come up with terms that we feel comfortable with going forward. And then we would communicate that, and see what customers might be interested in continuing on those terms.

David Cast – J.P. Morgan

And so in other words, perhaps the business – the present arrangement goes on, but at terms that are more favorable to Radian.

Teresa Bryce

That’s correct.

David Cast – J.P. Morgan

Okay. And then, finally, you talked about the trends in claims and delinquencies. I was hoping that you could go over the trends that you’re seeing in frequency and severity, and how that has affected your loss and reserve assumptions.

Bob Quint

Well, the severity in terms of average loan size and average claim payment has continued to go up. And all of that is reflected within our current reserves, so. If there’s a delinquent loan and it’s a larger loan, it’s going to have a higher reserve. So our reserve reflects the path that we expect the average claim size to keep going up as well as the delinquency rolls into foreclosure, what we call rotate. Those have been going up as well. And those are also taking into account our reserve calculations and a lot of the increases. And our rates are incorporated within our reserve expectations. So that’s why we believe our reserves are strong. They have always been consistently strong in light of the rising delinquency levels.

David Cast – J.P. Morgan

Okay. Thank you very much.

Operator

We have a question from Matt Ottis [ph] with KBW. Please go ahead.

Matt Ottis – KBW

Yes. Good morning. Just a quick follow up on that first-lien premium deficiency, just that maybe you can provide a little bit more color on – how with assumptions maybe done and appointment assumption getting worse to 7% from 6.2%. And you guys just put the premium – first-lien premium deficiency on how we kind of get to the point that it’s being reduced so much this quarter and will go away within a couple of quarters have actually being put on. Could you just give a little color? I’d appreciate it.

Bob Quint

Yes. I’ll try. And hopefully this will be helpful. What the premium deficiency does, it really front loads the – all of our projected results on the business. So as the actual results unfold, you’re really – you’re booking those actual results. But that’s really all been pre-booked, essentially, via the premium deficiencies. So as time goes on, the premium deficiency will be released with our premium deficiency that we booked in the second quarter, and then the way losses and premiums develop in the third quarter, and our review of all assumptions regarding the future performance. We believe the premium deficiency needs to be $150 million.

So that’s sort of the mechanics of it. And then, judging from our expectation about fourth quarter, again, if we don’t change those ultimate projections materially, we would expect that $150 million to be reduced to zero in the fourth quarter.

Matt Ottis – KBW

So it sounds like it was really how they developed in the third quarter, less of maybe that change and assumption going forward. On employment, it was really how they developed in the third quarter is how you ultimately are looking at it now for the fourth quarter.

Bob Quint

Wait, more of the P&L impact in the third quarter was based on the – just the business unfolding as compared to changes in future projection. There were changes in future projections that also were incorporated within that.

Matt Ottis – KBW

Okay. That’s helpful. Thank you.

Operator

Next question comes from Mark Debrey [ph] with Barclays Capital. Go ahead please.

Mark Debrey – Barclays Capital

Thanks. I know it’s still early in the life of the homeowners plan, but have you been active at all at this point working with lenders and services loan mortgage and insurance on it that are interested in refinancing those loans into the program?

Teresa Bryce

Well, as a general proposition, we have been very active from a loss litigation perspective as a whole that’s an area that we started ramping up significantly over a year ago. And so we’ve been actively working with servicers to try to look for opportunities to stem foreclosures and achieve borrowers in their homes. And so that is an area that we continue to focus on. We continue to work with the various trade groups with the Hope Now initiative and others to look for opportunities to further that aim. But that’s certainly something that we’ve been quite focused on. We’ve seen an increase in loan modifications, a significant increase in loan modifications. And so those are activities that we will continue.

Mark Debrey – Barclays Capital

So are you more focused at this point on more minor modifications than considering principal reduction at this point?

Teresa Bryce

No. I wouldn’t say that. I mean, I think we’re looking at all opportunities with respect to individual loans. For instance, I talked about our Fast Advance Program. And the Fast Advance Program is when there is a delinquent loan, and we essentially offer 15% of the prospective claim amount to servicers. And they can use that to reduce the principal amount. They can also use it to reduce the interest rate on the loan. So we’re really – I mean, each one of these situations is different. We’re really working actively with the servicer in order to find what the right solution is for each borrower.

Mark Debrey – Barclays Capital

Okay. Do you have any data yet on how effective some of the loan modification efforts have been? How many of those loans are remaining current?

Teresa Bryce

Our data now says it’s about 50%.

Mark Debrey – Barclays Capital

Okay. Thank you.

Operator

So our next question is from Mike Grandall with Key Colony. Go ahead, please.

Mike Grandall – Key Colony

Yes. Thanks, guys. Just two questions, one, on your premium deficiency reserve. Can you just handicap your initial assumptions that you used? Were you satisfied with how aggressive or the level that you came up with? Or just kind of give us some highlights there. And then secondly, have you begun discussions with Bank of America or J.P. Morgan about the loans you have that they may provide some assistance with and any potential look at ranges of benefits or loans that could be identified?

Teresa Bryce

I’ll take the second part of your question first, and then turn it over to Bob. We actually have been working with those servicers with respect to the settlement that we mentioned earlier in the call. We’ve taken a look at that. And based on the parameters of the settlement that Bank of America entered into, it affects about 8% of the default that we currently have. So it’s a material amount of default.

With respect to the Chase announcement, we’re still trying to – that was more recent. And we’re still trying to ascertain what that impact maybe on the default. From what we know at this point, it focuses more on the payment option arm. So we expect it to have a positive impact. But I can’t give you a percentage of default at this point that we think that could affect.

Bob Quint

Mike, on a lot of projections, we’re required to put out the best estimate that we can possibly come up with regarding future losses. We’ve done that. And we’re confident in the number, although there is – obviously, there are assumptions and uncertainties involved. But I think importantly, nothing we’re seeing in the actual results through the third quarter and into fourth quarter are leading us to believe that these projections are not accurate.

Mike Grandall – Key Colony

Right. And then last question, can you talk a little bit about your – maybe the change in the volume of what you’re able to resend due to fraud this quarter versus the year ago quarter?

Teresa Bryce

Well, we have seen an increase and our rescissions and denials over the last year. And a significant amount of that is due to fraud. So I would say that we continue to see that as a trend. And we are – we’ve always, at Radian, had a special investigative unit. And that unit has been focused on looking at claims for fraud. That’s a unit that we’ve expanded. We’re seeing, based on our risk filters, more of loans going through that unit at this point. And so, we would expect that we would see an even higher number of loans going through that unit as a result of the fraud that we’re seeing.

Operator

Thank you. And next, we’ll go to Howard Shapiro with Fox-Pitt. Please, go ahead.

Howard Shapiro – Fox Pitt

Yes. Hi. Just a follow-up to Mike’s question and, Bob, it’s more of an accounting question. I just want to make sure that I understand. Until that you actually begin to see the positive effects of these modification programs in run rates or roll rates, there’s no way you can change your, I guess, assumptions in terms of reserving, is that correct?

Bob Quint

Yes. We wouldn’t do that because we really don’t – we can’t quantify them, but to the extent that the impact roll rates go forward. So if less delinquencies go to claim as a result of these, then the roll rates are going to be impacted over time, and that will get into the reserves that way. But we’re not going to anticipate some sort of change in roll rates because that’s – it’s really impossible to do.

S.A. Ibrahim

Howard, if you look at out history, we’ve been fairly consistent in basing our reserves on the statistics – portfolio statistics and our experience. So while there is a view that some of the government and private actions that we just talked about may have a positive impact, at some point in the future, on our defaults, until we see that actually come through in our default and our severity and our roll rate experience, we would be very reluctant to modify our reserve or change the way we reserve.

Howard Shapiro – Fox Pitt

Okay. Thank you.

Operator

Thank you. Next, we have John Giordano with Credit Suisse. Please, go ahead.

John Giordano – Credit Suisse

Hi, good morning. Just a couple of questions, one thing I wanted to ask was, I know the FDIC has been sort of gathering some steam and a plan to possibly guarantee mortgages. And I’m curious, given your comments on the importance of private MI, that you were sort of making in Capitol Hill, how would that change the view of the need for private mortgage insurance going forward if they were able to put something together?

Teresa Bryce

Well, I think our focus with respect to what the FDIC has been proposing is a plan that would essentially look at modifying borrowers on the basis of the existence of MI, and in part, in looking at the net present value of the loan. And one of the concerns that we have with that plan is we think that the focus really should be from a policy perspective on keeping borrowers in their home and stemming foreclosures because we also believe that that is the way to help stabilize the housing market overall.

And so, as a result, our concern is that looking at whether to work with the borrower to try to stem a foreclosure in terms of whether MI is on their loan or not doesn’t really meet up with that policy objective. We’re also concerned about the fact that it may have a larger impact on people who (inaudible) affordable housing, borrowers as well as single borrowers, and minority borrowers just because those are the people who tend to have less than 20% to put down and would be participating in private mortgage insurance.

John Giordano – Credit Suisse

Okay. Great. And then I guess, you had mentioned the possibility – earlier in the call, the possibility of needing additional capital. And I guess, your comment around the fact that prime defaults are probably going to go up. If you did need capital and you needed it in the short term, what are the sources?

Unidentified Company Speaker

You think that you could type quickly?

S.A. Ibrahim

Again, in terms of capital, we’ve been pretty consistent in what we’ve said. We’ve said that we believe we have adequate capital to meet the projected needs. But at the same time, we recognize that there is a lot of uncertainty and stress in the environment. And if this uncertainty and stress continues, we have to remain open to the possibility of accepting capital.

We also have the benefit of having the flexibility that comes from our Chairman’s investment, which stands at 29%. And beyond that investment, we would be open to evaluating all the alternatives that are possible. But that is a – in this environment, we can’t say anything, other than the fact that as long as the environment continues to have stress, we have to be – we have to be to open, opportunistically speaking, capital that doesn’t mean that our needs are imminent. It just means that we have to take into consideration all of these factors and balance.

John Giordano – Credit Suisse

Okay. Great. Now, I’ll just ask one last question. And there are a couple of questions around the whole cold liquidity and the $360 million that you had referenced. I’m curious – maybe I’ll just ask you differently. Is any of that money at a regulated entity?

Bob Quint

It’s not. And there’s no near term expectation that that will be paid down.

John Giordano – Credit Suisse

Okay. Great. That’s all my questions. Thank you.

Operator

Thank you. Our final question will come from Maria Panganiban with New York Life. Please, go ahead.

Maria Panganiban – New York Life

Yes. Just questions on two topics. Just to follow up on that liquidity question, what is that non-insurance entity that you’re talking about that has some of that liquidity? And how does that break out in terms of hold co. resistant entity for the $360 million?

Bob Quint

The non-insurance is called Enhanced Financial Services. And the break out is something like $300 million there and $60 million at the hold co. But again, we don’t view that as being any different. There is no significance in where this is necessarily.

Maria Panganiban – New York Life

And then my second question is on the financial guaranty CDO portfolio. You gave some disclosure with regards to average attachment points, but you didn’t actually say what that number is. You referenced SMP CDO evaluator. But what exactly would be 2.2 times AAA level?

Unidentified Company Speaker

I mean, typically, within the industry, if you’re looking at one other attachment point is and where our CDO falls relative to that. The industry standard is to refer to a CDO evaluated. It is used by SMP to determine what is the AAA attachment point in the given transaction. That is your base. Also, when we use that number and say that the average attachment point is 2.2 times that level, that’s what we’re referencing with respect to that.

Maria Panganiban – New York Life

But can you just quantify what exactly that would be? What’s a AAA level? Is that 10%, 5%?

Unidentified Company Speaker

It would depend on the particular type of transaction. It would depend on whether it’s a corporate CDO transaction. It would depend on whether it’s a CMBS CDO. There will be different attachment points defined by the rating agencies according to the type of transaction. So what we’re doing is using whatever the appropriate or applicable attachment point is for that shared type of transaction. And the number that you’re seeing in our disclosure is a multiple of that particular number.

Maria Panganiban – New York Life

Just to press you a little bit again on that, is it possible to give us some generic numbers? Just because of–?

Unidentified Company Speaker

Let’s say for example on a corporate CDO, let’s say that you’re the CD of the AAA attachment point with a 6% level. We’re saying that for our deals that our attachment points are based on the 15 range with respect to that. So the other deals with that AAA attachment point will be lower than the 6%, might be 3%. And again, that’s based on the agency’s assessment of the performance of the underlying assets in that transaction, also combined with the structure of a particular deal.

Maria Panganiban – New York Life

So would you say that the average for that corporate CDO bucket, which is 80 something percent of that portfolio would be kind of 6%. And it would be the AAA attachment point, on average?

Unidentified Company Speaker

It’s a little hard to say. I mean I’d rather get back to being in terms of the specifics with respect to the entire of our corporate CDO portfolio. The one thing that I will say to you from a perspective of comfort in that sense is that that CDO evaluator number is not something that we derived. That’s something that’s specified by the rating agencies across all CDOs. Our deals were structured sort of looking at that and then saying, “At what point in the credit spectrum do we wish to attach?” Because the conscious decision was made when we did these deals because remember a lot these deals were done in a much tighter spread environment. That we were comfortable in doing these deals only if we weren’t attached higher up in the credit spectrum, which is why we placed a premium on having higher attachment points.

Bob Quint

The other thing you could do is you can look at our webcast file on credit exposures to direct corporate CDOs. We played out the amount of sustainable credit events and the amount of current remaining names. So you can compute the percentages that would be necessary to go through our subordination.

Maria Panganiban – New York Life

Now what would be a better way to look at it because I’m looking at page 20? So that would then be the best way to figure out for instance–?

Bob Quint

That is a way, yes.

Maria Panganiban – New York Life

Now, when you say credit event, is that the same as saying a default?

S.A. Ibrahim

Right. That’s same as default. That’s right.

Maria Panganiban – New York Life

Okay. All right. Thank you very much.

Operator

Thank you. We have no further questions. I’ll turn the call back to S.A. Ibrahim for closing remarks.

S.A. Ibrahim

Thank you, operator. And I’d like to thank all of you for participating in the call and for the questions you asked. And thank you again.

Operator

Thank you, and ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference.

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Source: Radian Group Inc. Q3 2008 Earnings Call Transcript
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