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Radian Group, Inc. (NYSE:RDN)

Q2 2014 Earnings Conference Call

August 07, 2014, 10:00 AM ET

Executives

Emily Riley - Senior Vice President, Corporate Communications and Investor Relations

Sanford Ibrahim - Chief Executive Officer

Robert Quint - Executive Vice President and Chief Financial Officer

Teresa Bryce Bazemore - President, Radian Guaranty Inc.

David Beidler - President, Radian Asset Assurance Inc.

Derek Brummer - Executive Vice President and Chief Risk Officer

Analysts

Jack Micenko - SIG

Bose George - KBW

Eric Beardsley - Goldman Sachs

Sean Dargan - Macquarie

Mark DeVries - Barclays

Geoffrey Dunn - Dowling

Douglas Harter - Credit Suisse

Chris Gamaitoni - Autonomous

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Radian's second quarter 2014 earnings call. (Operator Instructions) I'll now turn the conference over to Emily Riley, Senior Vice President, Investor Relations and Corporate Communications. Please go ahead.

Emily Riley

Thank you, and welcome to Radian's second quarter 2014 conference call. Our press release, which contains Radian's financial results for the quarter, was issued earlier today and is posted to the Investors section of our website at www.radian.biz. This press release includes a non-GAAP measure. A complete description of this measure and the reconciliation to GAAP may be found in press release Exhibit E and on the Investors section of our website.

During today's call, you will hear from S.A. Ibrahim, Radian's Chief Executive Officer; and Bob Quint, Chief Financial Officer. Also on hand for the Q&A portion of the call are Teresa Bryce Bazemore, President of Radian Guaranty; David Beidler, President of Radian Asset Assurance; and Derek Brummer, Executive Vice President and Chief Risk Officer of Radian Group.

Before we begin, I would like to remind you that comments made during this call will include forward-looking statements. These statements are based on current expectations, estimates, projections and assumptions that are subject to risks and uncertainties, which may cause actual results to differ materially. For a discussion of these risks, please review the cautionary statements regarding forward-looking statements included in our earnings release and the risk factors included in our 2013 Form 10-K, and subsequent reports filed with the SEC. These are also available on our website.

Now, I would like to turn the call over to S.A.

Sanford Ibrahim

Thank you, Emily. Thank you all for joining us and for your interest in Radian. I am pleased to share with you today the results of our second quarter, which includes solid financial performance and strong credit trends for our mortgage insurance business, as well as the successful closing of our Clayton acquisition.

The primary driver of our profitability is the steadily increasing positive impact of our large and profitable MI book of business, written after 2008, combined with the ongoing improvement in credit performance of our legacy MI book.

Following my comments, Bob will cover the details of our financial position, and then I'll summarize a few key points, before opening the call to your questions.

Radian was profitable on a GAAP and operating basis in the second quarter, with net income of $175 million or $0.78 per diluted share. This compares favorably to a net loss for the second quarter of last year of $33 million or $0.19 per diluted share. Book value per share at June 30, 2014, was $8.29. Adjusted pre-tax operating income was $74 million for the second quarter.

Now, I'd like to review several highlights from the quarter. First, and importantly, we continued to grow and improve our high quality mortgage insurance in force, which is the driver of future earnings. We wrote more than $9 billion of new MI business in the second quarter, an increase of more than a-third from the first quarter of this year. The trend continued in July with NIW of $3.9 billion, representing the fifth consecutive month of new business growth.

This new business growth is representative of the stronger home lending trends seen in the second quarter after hitting a 14 year low in the first quarter of this year. While overall mortgage origination volume is lower today than for the year ago, business has shifted from mainly refinance to purchase. Given that purchase transactions are more likely to use mortgage insurance than refis, this is a positive trend for our business.

At Radian, our sales team continues to succeed in attracting new business, as we signed 59 new customers [Technical Difficulty]. To support this new business growth, we hired four new account managers in 2014, including one dedicated solely to enhancing Radian's commitment to the Hispanic community, which is expected to be one of the fastest growing demographic groups for home ownership in America.

In July, we entered into another exclusive partnership with the National Association of Real Estate Brokers, an organization focused on equal housing opportunities for African-American and other minority groups. The goal is to help the 93-chapter network, better understand the value of private mortgage insurance.

We also continued to pursue cost effective ways to support our small-to-mid size lending partners, including through our enhanced sales team. This team, which assist customers with consultative services by telephone, help bring on nearly half of the new customers Radian signed in 2014.

While market size and new business volume remains top of mind, our ability to grow our mortgage insurance in force is most important. Radian's persistency, which is the amount of business that remains on our books over a 12-month period, reached 83.1% in the second quarter compared to 80.3% in the second quarter of 2013. Our insurance in force grew 9% from the second quarter of last year, and we once again led our industry, as the largest mortgage insurance company with $165 billion of insurance in force.

Second, our continued success in writing new business improves the credit profile of our portfolio. As you can see, on Slide 9, the high-quality books of mortgage insurance business written after 2008, including loans completing a-half refinance represented 76% of our primary mortgage insurance portfolio as of June 30, 2014. This again is one of the key drivers of our future financial results.

And the legacy book continues to shrink with the most problematic 2006 and 2007 books now down to less than 12% of the total portfolio. As our legacy portfolio shrinks and improves, an important indicator of its resiliency is the fact that approximately 70% of our performing loans from 2005 to 2008 have never been delinquent.

Third, Slide 10, shows that for the six months ended June 30, 2014, the earned premiums less incurred losses from our 2009 and later MI vintages were $227 million. This illustrate the steadily increasing positive impact of our business mix, and represents impressive increases from the $148 million for the first six months in 2013 and $96 million for the same period in 2012. It is also noteworthy to mention that the 2008 and prior vintages are now positive by $69 million.

Fourth, our total number of primary delinquent loans dropped by 38% year-over-year, as seen on Slide 21 of our webcast presentation, with the trends continuing in July. Our primary default count decreased to 48,904 loans and our primary default rate, which has been declining steadily since its 2009 peak, fell to 5.8%. This is the lowest rate we've seen since 2007.

In addition, the MI incurred loss ratio was 32% in the quarter, representing another positive trend. This compares to a loss ratio of 69% in the second quarter of 2013.

Fifth, we completed our acquisition of Clayton, a leading provider of outsourced mortgage and real estate solutions in the second quarter. This adds a diversified source of fee-based revenue for Radian, and also broadens our participation in the residential mortgage market value chain with services that complement our MI business.

We plan to leverage the synergies between our two industry-leading businesses, providing a competitive advantage for Radian and another way to differentiate ourselves from our mortgage insurance peers. In the third quarter, results of operations for Clayton will be included in our financial results, and we will further address the company's progress and business strategy.

We are now looking at opportunities that build on the combined capabilities of Radian and Clayton, and in July we invested $20 million to capitalize a newly formed wholly-owned Radian Group insurance subsidiary to offer complementary mortgage insurance-related products to industry participants. These products are in the developmental stage today, but we look forward to providing updates on our progress in the coming quarters.

Sixth, as you know, the FHFA released the draft Private Mortgage Insurer Eligibility Requirements or PMIERs last month for public comment. These PMIERs were developed by Fannie Mae and Freddie Mac and are intended to provide revised requirements for private MI companies to be eligible insurers of loans purchased by Fannie and Freddie.

The public comment period ends on September 8, and we expect to provide meaningful input on the proposed rules. We believe that other private MIs, the state insurance departments, the mortgage and real estate community and various housing and consumer groups will also provide comment on the rules.

Bob will cover this topic in more detail during his remarks. But what is most important to remember is that we and other MI companies have an extended transition period of more than two years to comply with the financial requirements, and we expect to have the ability to fully comply before the transition period ends without a need to raise external capital.

Finally, our success in reducing the exposure in our financial guaranty business continues, with the reduction now at 82% since 2008, including in many of the riskier segments of the portfolio. While there is risk remaining in our financial guaranty book of business, the credit performance has been generally stable and we continue to proactively reduce our total exposure, which decreased to $20 billion in the quarter.

And as we reported last month, after receiving approval from the New York Department of Financial Services, Radian Asset paid an extraordinary dividend to Radian Guarantee of $150 million in July. We expect to request an additional extraordinary dividend next year.

As we discussed in our call last month, we believe the Radian Asset is a solid overcapitalized company with strong economic value. We are actively working to monetize or otherwise utilize Radian Asset in a way that will maximize its value, consistent with PMIERs. Radian maintains strong holding company liquidity of approximately $770 million and Radian Guaranty's risk to capital ratio improved to 18.7:1 at June 30, 2014.

Now, I would like to turn the call over to Bob for details of our financial position.

Robert Quint

Thanks, S.A. I'll be covering our P&L activity and trends for the second quarter of 2014, our capital and liquidity positions as of quarter end, and some updated expectations regarding the balance of 2014.

We introduced non-GAAP measures in the fourth quarter of 2013, to more closely align with the way we evaluate our business performance. And last quarter, we started showing adjusted pre-tax operating income or loss for segment reporting.

Because the Clayton acquisition closed on June 30, only our balance sheet for the second quarter was impacted. Next quarter our P&L will include a third business segment, Mortgage and Real Estate Services, which will contain the results of Clayton.

This quarter we included selected historical Clayton financial results from continuing operations in Exhibit N, which display some important business trends, including strong second quarter 2014 revenues, which we expect to continue at similar levels in the second half of the year.

On our June 30 balance sheet, which is Exhibit C, approximately $295 million of goodwill and other intangible assets represents our Clayton investment. The balance of the $312 million purchase price consist of working capital.

The $295 million is broken up into $192 million of goodwill and $103 million of identified intangibles. Any amortization of these intangibles will be excluded in our adjusted pre-tax operating income metric. Goodwill will be reviewed periodically for impairment, otherwise it will remain as is on the GAAP balance sheet, but is deductible over 15 years for tax purposes.

Our EPS calculation for the second quarter includes both, the dilutive impact of our 2019 convertible debt, which adds 37.7 million shares to our share count and adds back $5.5 million of interest expense to income for EPS calculation purposes; and additional EPS dilution relating to our 2017 convertible debt of approximately 7.6 million shares. A table of our fully diluted share count is presented in Exhibit B.

The MI provision for losses was $64 million this quarter compared to $49 million last quarter and $136 million a year ago. Lower incurred losses continue to reflect improving default trends, as new primary default totals were 22% better than second quarter of last year and cure rates have remained fairly high.

Many other important trends that we follow such as claims submitted, and that you can see on Slide 24, showed improvements during the quarter. Favorable reserve development on the existing default items line, in Slide 14, continues to occur, because paid claims were less than the amounts reserved for such claims, primarily due to curtailments. Similar to last quarter, this favorable movement was only partially offset by default composition changes.

Paid claims for the quarter increased to $240 million, and as we disclosed, would have been approximately $35 million higher had we not entered into the Freddie Mac agreement a year ago. We've nearly completed the process of clearing out the backlog of pending claims, as primary pending claims as of June 30, 2014, were 6,533, down 18% from 7,969 as of March 31. We still expect full year 2014 claims paid to be between $900 million and $1 billion.

Losses in the financial guaranty segment have continued to be modest. In light of the recent developments in Puerto Rico, including the passage of the Debt Enforcement and Recovery Act, which impacts public corporations in the Commonwealth, this quarter we increased our GAAP loss reserves on our Puerto Rico Electric Power Authority or PREPA exposure by $4.6 million to $4.7 million, representing 21% of our $22.3 million of combined direct and assumed exposure.

We also increased our reserves on our $93 million of senior and subordinate transportation bonds of Puerto Rico by $6.5 million to $7.1 million, based on the possibility that the Commonwealth may restructure this debt or use part of the revenue supporting these bonds to further support their GO debt.

Our remaining $331 million of Puerto Rico exposure, for which we have not established a reserve, include $79 million of highway authority bond, which are better secured than the transportation exposure we reserve for and $233 million of GO and appropriation debt.

The additional reserves booked in the financial guaranty segment this quarter was partially offset by favorable reserve development in both public financed and structured finance reinsurance.

Net fair value gains on derivatives for the quarter of $57 million were caused mainly by an improvement in collateral spreads and rating upgrades.

Slide 12 depicts our current balance sheet fair value position along with expected net credit losses or recoveries on fair valued exposures. Based on our projections, we expect to add a $157.8 million or $0.83 per share to pre-tax book value from these positions over time as the exposures mature or are otherwise eliminated. That number is derived by taking the net balance sheet liability of $99.1 million and adding the present value of the expected credit loss recoveries of $58.7 million.

Please note on Slide 12 and Exhibit D, that there is an increase in the present value of net credit losses incurred this quarter of approximately $11 million in the financial guaranty segment. This increase, which does not impact our P&L, only the adjusted pre-tax operating loss is primarily due to a deterioration in our internal view of a $377 million, second-to-pay CLO financial guaranty we have talked about in the past.

We will only be required to pay, if there was a realized loss on the deal and if MBIA Insurance Corp, who is a principal insurer, fails to pay. In order to manage our risk, we purchased a $100 million of default protection on MBIA Insurance Corp, that serves as a meaningful hedge against any potential loss to Radian on the transaction, and which is factored into our probability weighted loss estimated.

During the second quarter, operating expenses were impacted very modestly by long-term incentive compensation expenses. The variability of this expense relating to stock prices performance will be reduced for the next year due to the recent payout of about half of the cash settled award and the variability will be substantially eliminated at this time next year, when most of the remaining awards are settled.

Other operating expenses this quarter also includes $6.7 million of the acquisition expenses relating to the Clayton purchase. We have excluded these acquisition expenses in our measure of adjusted pre-tax operating income.

The valuation allowance against our deferred tax asset was $886 million this quarter or approximately $4.64 per share, reduced from yearend primarily due to our pre-tax income in the first and second quarters. As we make money, we utilize our DTA and reduce the valuation allowance. We still expect to be able to fully recover our valuation allowance by some time in 2015.

While this is also the timeframe to begin admitting the majority of DTA for statutory purposes, keep in mind that admitted DTA is not an available asset under the proposed PMIERs. As we said on our PMIERs investor call we expect to realize much of the DTA over the next two-and-a-half years due to earnings over that time period.

With regard to PMIERs, our first priority is to provide the GSEs and the FHFA with a meaningful set of comments in several areas by September 8.

Two primary examples are the owners' requirements for the 2005 to 2008 vintage loans that have made every payment, since they were originated many years ago including through the downturn. And the exclusion of unearned premium reserves and the available asset calculation, despite the fact, that they are liquid and readily available to pay claims.

Secondly, we are actively evaluating opportunities to transform the economic value of Radian Asset in a manner that is consistent with the PMIERs framework and are also exploring various mortgage insurance, reinsurance possibilities.

Relative returns on our business are clearly lower under the proposed rules, especially for loans with 95 LTVs and higher and FICO scores below 740. However, we believe the current business mix and the current economic environment produces an overall expected unlevered return on our business in the mid-teens as the rules are currently proposed. Absent pricing increases, any meaningful mix shift in our business towards higher LTVs and lower average FICO scores would undoubtedly impact these returns in the future.

Mostly importantly, we remain confident that Radian will meet the financial requirements of the final PMIERs before the two year transition period is over without the need to raise external capital.

I'd now like to turn the call back over to S.A.

Sanford Ibrahim

Thanks Bob. Once again, we are pleased to share with you our solid financial performance in the second quarter and the successful closing of our Clayton acquisition. We believe that there is continued growth and opportunity ahead for us in our mortgage insurance business and we are fully focused on it, while also positioning Radian to leverage our risk management expertise, as well as our new industry-leading mortgage and real estate services for the next phase in the evolution of the U.S. housing finance markets.

It's important to note that as we face the opportunities and challenges that lie ahead, we do so with the benefit of the growing positive impact from our large profitable post-downturn MI book, continued credit improvement in our legacy MI book, a strongly capitalized financial guaranty business and greater strategic opportunities from the Clayton acquisition.

Now operator, we'd like to open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from Jack Micenko with SIG.

Jack Micenko - SIG

Wondering out of the gate, if you could sort of expand on the new insurance subsidiary and strategy a bit more? What kind of related mortgage insurance products are you targeting?

Sanford Ibrahim

Having achieved profitability, having acquired a lot of new customers in our mortgage insurance business and having closed on the Clayton transaction, we believe we are well-positioned now to explore new opportunities within the space we understand, which is in our area of core expertise, which is the mortgage business.

And in that slide, as we look at some of these opportunities, and we believe there are several available to us, we simply capitalize the subsidiary in order to get it licensed. I'd like to differ, talking about any specifics on the products at this stage, because we've got a lot of opportunities available to us, and that is a good thing, and we will give you more details as we continue to make progress.

Jack Micenko - SIG

And then, I guess earlier this week Padilla down in Puerto Rico moved the San Juan subway out of the Highway Transportation Authority, given that it was losing about $50 million a year on that, I think a $350 million debt service. It seems like it's a good news development, given your exposure. I guess if my numbers are right, am I thinking about this the right way. Was this development in your reserve methodology? Just some thoughts around that development?

Derek Brummer

This is Derek. That's factored in. We do view that as a positive development, that being said, and we made a distinction this quarter, as Bob pointed out in terms of our exposure to Highway and Transportation Authority, possibly in the highway bonds and the transportation bonds. The view being that the highway bonds have generally a stronger security structure.

Obviously, getting rid of that negative drag is a positive for all the credits. We still think that overall the Commonwealth has signaled pretty clearly that they're going to protect their own ability to payback their bonds, and potentially at the expense, or at least, from their perspective stop subsidizing the public corporations.

As a result, we think that creates risk for all of our public corporations exposure. That being said, that's certainly a positive development. And then looking at the public corporations, certainly PREPA stands out as the one, the one that's most materially out-risk and we have around $22 million of exposure to that.

Jack Micenko - SIG

And then, just real quick, last question. You really get July results, I guess, the growth in NIW was surprising. It seems maybe like the spring season maybe got pushed out a month or two. Just curious, your observations on the new business volumes side coming in a little bit better than June. And then, obviously, credit trends really get to carry default well above sort of prior July numbers, any specifics there? I know month-to-month numbers can move around a bit on the credit side, but just some thoughts on July?

Derek Brummer

From a credit perspective, it's been a trend we've been seeing in terms of cure rates, so if you look on a year-over-year basis cure rates have been trending up, and so July I think is really just a continuation of that trend that we've been seeing.

Sanford Ibrahim

And Teresa will comment on that.

Teresa Bryce Bazemore

And with respect to NIW, I mean you're right, I mean it was just sort of slower first quarter. And we continue to see as we were sort of in the middle of that quarter, the commits go up and then the NIW in the following months go up. So we've been very pleased with the amount of NIW we would have ride over the quarter and how that's continuing to trend.

Operator

Our next question will come from Bose George with KBW.

Bose George - KBW

Actually, just first a question on the increasing book value. I was just trying to bridge the increase, so I think part was the capital rates, part was earnings. With there some also change in the financial guaranty liability?

Robert Quint

A little bit, Bose, but no, I mean that's reflected in the earnings, so it's going to be the earnings and it's going to be the essentially, the Clayton book value, which we raised capital during the quarter. Some of that was debt, but some was equity, which is going to increase our book value.

Bose George - KBW

And then just switching to the financial guaranty business in Europe plans there. If you're able to get substantial dividends out of that, is that preferable to selling all or part of that business?

Robert Quint

We want to maximize the economic value. So obviously, dividends were great because that brings the liquidity to the MI company, but in terms of the options we have available to us, that's one, and the remaining others, but the object is clear to maximize the value and we think it's there. We think it's a very strong, over capitalized company and we're going to do what we can to maximize value.

Bose George - KBW

And then, actually just one last one on the FHA. They started the HAWK program recently with their offering discounts to borrowers who take counseling. I mean, do you think that all have much traction in terms of loans that could be in the MI market or is it really a different cohort of borrowers?

Teresa Bryce Bazemore

I mean we have taken a look at that, and we don't think that that's going to have much of an impact on the business that we see. If you take a look even at the pricing benefits that those borrowers get, it sort of poses the gap a little bit. But there is still an advantage in terms of getting conventional with private MI. So we just don't think that there is going to be much of an impact there.

Operator

Our next question is from Eric Beardsley with Goldman Sachs.

Eric Beardsley - Goldman Sachs

Just on the actions you might take to mitigate the proposed requirements, would you anticipate doing anything prior to the final rules being issued?

Robert Quint

It's possible, Eric. I mean, I think we want to wait and see what the final rules say. And I think most of our actions will be based on that. But there are certain things that could be done beforehand that would be positive, sort of regardless of the outcome. So I would say, it's possible, although we're certainly going to wait until the final rules are out before we take some of the action.

Eric Beardsley - Goldman Sachs

And then just on, as per financial guaranty, the present value of net credit losses. I guess could you just walk through I guess what the future P&L impact looks like and how that ultimately comes in?

Robert Quint

I mean most of what's sitting there is this recovery that we expect to get down the road. So that's why the number is, it's a present value recovery. There is a little bit of expected losses, which would be cash losses that we expect, and we talked a little bit about the one transaction that was impacted this quarter.

But on a net basis, it's a recovery, so we expect cash to come back over time. Now, this goes through the P&L in the fair value line, so that's why we -- if there is ever a change to that line, that's meaningful in terms of losses or recoveries, we would talk about it, like we did this quarter on the one transaction.

Eric Beardsley - Goldman Sachs

In terms of the one transaction, would you need to set aside provisions for that or you're just going to treat that with the hedges and derivatives?

Robert Quint

I mean it's going to go through the fair value line, any of the P&L. But the hedge we bought was really to mitigate any potential loss. And so we feel like we're well-positioned as a second-to-pay with that hedge in place.

Operator

And next we have Sean Dargan with Macquarie.

Sean Dargan - Macquarie

Looking at the disclosure you provided in Exhibit N around Clayton. So should we assume that second quarter run rate gross profit on services is something that we can kind of pencil in for operating earnings above and beyond what you report in MI and FG?

Robert Quint

I think if you look back, and we gave you several quarters to look at, you can see the gross profit moves within a band. So I think that's fair. Now, I wouldn't look necessarily at one specific quarter, but you have a range of where the gross profit is. And often it's going to be related to the size of the revenues.

Now, what we did say is that Q2 is a strong revenue quarter, and we do expect the rest of the year to be similar to Q2. You can also see that the revenues can jump around, because this business, unlike the MI business, which is based on the in force, this is business based on assignments.

And some times things are going to come in more sporadically in terms of revenue, either a securitization or a contract with a counterparty or a customer. So I think you're going to see some levels of jumping around in terms of the revenues and the gross profit being within this band, but not exactly what it was in second quarter necessarily.

Sean Dargan - Macquarie

And can I just ask about the rationale from excluding amortization of intangibles from operating earnings? I mean in my mind that's something that should be included.

Robert Quint

I mean that's fine. You can evaluate it the way you would like. The rules that we follow are really that we would have a non-GAAP measure, when we, the management, are evaluating the business in certain way, and that's the way we would evaluate the business based on the operating performance. And we view that amortization of intangibles is not something that we're going to evaluate the business based on. Obviously, it's a part of the P&L. And that's I think the way companies like that are typically evaluated, when they standalone.

Sean Dargan - Macquarie

So is this kind of like EBITDA, this gross profit?

Robert Quint

It's akin to that. Obviously, it's not exactly that. But if you think in those terms, that's kind of the way a service kind of company would be evaluated, and it will be the way that management will be evaluating the operating performance of Clayton.

Sean Dargan - Macquarie

And can you disclose maybe the assumed loss severity in PREPA that's baked into your current reserves?

Derek Brummer

In terms of PREPA looking at that we use a probability weighted analysis. Generally, the range we're looking at in terms of losses is between 10% and 35%.

Sean Dargan - Macquarie

Just one last question. Is there any concerted effort between you and your competitors in the U.S. mortgage insurance organization to I guess present the united front during the comment period with PMIERs?

Teresa Bryce Bazemore

Well, I think there is certainly a common view on many of the issues that we'll be commenting on in the PMIERs. And we've also had a number of calls and we will have some additional calls with the GSEs and the FHFA to discuss certain topics that we commonly sort of have concerns with.

Sean Dargan - Macquarie

But do you find yourself in agreement with some of your newer competitors or do you feel that they're working against your interest?

Teresa Bryce Bazemore

I think that we find that some of the newer competitors also are concerned about some of the same issues. But I think certainly those of us who have legacy business, who have a historical view and data around some of these issues I think have a more of a view on what the impact might be going forward. And a lot of what we will be commenting on is related to whether or not the historical data and experience support was presented or proposed in those requirements.

Operator

We now have a question from Mark DeVries with Barclays.

Mark DeVries - Barclays

With your loss ratio already now at more normalized levels and your legacy books still showing credit improvement, where do you think the loss ratio can end up?

Robert Quint

I mean it's conceivable that it comes down from here. Certainly, we're adding really, really, high quality business, and the recently written vintages look like they're going to have a better than expected really superlative loss ratios attached to them. So conceivably the loss ratios can go down into the 20s.

Mark DeVries - Barclays

What's the lowest loss ratio you've had historically?

Robert Quint

Going back, it was probably in the 30s, but it was probably not a book of business that contained high quality that this one does. So it's not really a totally fair comparison. And then of course, the day we stop writing business, you're going to have loss ratios that are very, very low until the loss curve kind of catches up. But on a normalized basis, we had loss ratios in the low 30s, I believe.

Mark DeVries - Barclays

I mean is there any room to bring the expense ratio down here or are you kind of running at normal levels?

Robert Quint

I think we're running at relatively normal levels. We've had a little bit of noise in there due to the variability, which we try to point out every quarter. The growth of the book enhance the growth of the revenue, impacts the expense ratio as well. But we've said, I think that we believe in normalized expense ratios in sort of the 20% to 25% range. And if we grow the book and are successful in growing the book, we can get to the lower end of that.

Mark DeVries - Barclays

Have you commented yet on, if the PMIERs are implemented as proposed and you don't do any additional reinsurance, how much of the value from Radian Asset you would need to extract to meet your required asset test?

Robert Quint

I think we've put the numbers out there, so they are pretty evident in terms of the needs or certainly the range. And I think that, again we believe the financial guaranty value is there, and if we can capture a substantial portion of that, that's our goal. And regardless, I think the ability for us to meet the financial requirements is we're confident in that, because there are other options, reinsurance options and things like that. So we don't need a certain number to get there. But we are obviously trying to maximize value and we believe we can because it's a very strong company.

Mark DeVries - Barclays

Do you have a sense for how much you could get potentially through the issuance of surplus allowance?

Robert Quint

Not specific numbers, but we do have the concept of surplus, which I think we raised on our other call is certainly one that could be pursued and make sense in the context of the PMIERs. But we don't really have numbers out there. Something like that would need the department's approvals and things like that. So that would have to be worked through them.

Mark DeVries - Barclays

And just one last question. Have you commented yet on how much of a buffer over your acquired assets you would want to get to by the end of 2016?

Robert Quint

We really haven't said, obviously that's going to depend on the way the market moves and how we're doing in terms of our results. And so surely you would want some sort of cushion and be able to absorb some growth without having to manage that number so closely. But we haven't really said in terms of a specific amount.

Operator

We'll go next to Geoffrey Dunn with Dowling.

Geoffrey Dunn - Dowling

First Bob, could you comment as to the type of entity that you've invested in, in July. Is it established as a regulated mortgage insurance entity or a different type of structure?

Robert Quint

It's a credit insurer, Jeff. So it can certainly do mortgage insurance-related products, but the specific licensing is a credit insurer.

Geoffrey Dunn - Dowling

And then I couldn't keep up typing, could you just review the details of the FG we're reserving again, the PREPA shift and the transportation shift?

Robert Quint

Well, just the numbers?

Geoffrey Dunn - Dowling

Yes, please.

Derek Brummer

I can give that, Jeff. It's Derek. In terms of the PREPA exposure, we maybe increasing reserves of $6.5 million, so brining that up to $7.1 million -- I'm sorry, PREPA was up right, with $4.6 million to $4.7 million. In terms of the Highway and Transportation Authority, the increase was $6.5 million to $7.1 million.

Geoffrey Dunn - Dowling

And then in terms of the PMIERs, you have a reinsurance recapture option coming up, I believe, December 31, conceivably you may make a decision on that before we get the finalized version. How are you thinking about that opportunity? And then in your previous conference call where you discussed PMIERs, was your commentary assuming your recapture abilities or assuming that that's reinsurance days outstanding?

Robert Quint

We have the option. It's nice to have the options. So we'll make that decision when the time comes. The business is performing really, really well. So it's profitable. So recapture would certainly be from an economic standpoint, would be where we would lean, however in light of PMIERs, recapturing would require us to have more assets. So we'll make that decision, but I think in terms of performance we would lean toward recapturing, and we'll have to see where we stand in terms of required assets versus available assets and make that decision.

Geoffrey Dunn - Dowling

So at this point, it's really comes down to the line of whether or not -- for the '14 recapture, whether or not you have the rules finalized and valuations of cost of capital at that point, et cetera?

Robert Quint

Yes, somewhat, Jeff. But I think there are other ways, conceivably, we could recapture and then do some thing else in terms of reinsurance that's more efficient and less costly that we'd do the same in terms of the impact on required assets. So that could be some thing we do.

Geoffrey Dunn - Dowling

And then last question. In terms of the traditional loss development curves where we see peak incurred [ph] year three, four; paids, four five. Do you think those traditional curves are holding for your '09 in after-books or are those books developing a little bit more slowly? What do you think the experience has been, so we can kind of look at your disclosure and get a feel for what is a seasoned loss ratio versus non --

Derek Brummer

I mean those books are obviously developing slowly, if you look at in terms of where they are from a default and loss rate. They are historically extremely low. So from a development standpoint, we would say they are probably developing a bit slower.

Geoffrey Dunn - Dowling

Any idea to extend? I mean are we looking at peak five, six on incurred versus three, four?

Derek Brummer

I mean I think peak, maybe probably, a year or year-and-a-half out, so forward from what you've traditionally seen. So maybe, you're looking at five-and-a-half, six years.

Operator

Our next question is from Douglas Harter with Credit Suisse.

Douglas Harter - Credit Suisse

When we're thinking about the cash flow generation of Clayton, is that gross profit number a good approximation of the cash flow that could be generated?

Robert Quint

It's not, because there is going to be expenses associated with the company. So I think next quarter you'll get a much better view of what the cash flow will be. I think with this quarter, we really just wanted to show the revenue trends and the gross profit percentage, but of course, there are operating expenses and there will be interest expense associated with the debt that we incurred. So I think you will get a much better view next quarter.

Douglas Harter - Credit Suisse

And then I guess, when we are thinking, should we look back to kind of the net income and the amortization expenses that you gave, I guess last quarter, as in terms of less cash generation?

Robert Quint

We did that for that reason to give you an idea of what they were generating. But again, I think next quarter as we report the results within or consolidated results, you will get a much clearer view of the expected cash flow to group, which we've said and continue to say, we expect to be modest.

Operator

We have a question now from Chris Gamaitoni with Autonomous.

Chris Gamaitoni - Autonomous

Bob, thanks for clarification on the returns in the mid-teens. Just wanted to clarify, is that an unlevered return?

Robert Quint

It is, yes.

Chris Gamaitoni - Autonomous

And I assume that's just on the capital at the mortgage insurance subsidiary?

Robert Quint

Yes. The capital required to be held against the business.

Chris Gamaitoni - Autonomous

Assuming your higher quality business of the current mix, what are kind of the over the run loss ratios implied in that?

Robert Quint

They are going to be pretty low, because in the current environment we're really looking at the more recent books of business. So we're probably looking at the lower 20s or high-teens, lower 20s.

Chris Gamaitoni - Autonomous

And on, just as far as you're provisioning on early stage, I saw the reserve for delinquent went from about 10 point to $1,000 to 9.8 in the quarter, what stage are we at in here, moving back to normal see for what the early stage delinquency reserving was compared to pre-crises levels?

Derek Brummer

I think in terms of development it is drifting back. The thing which you also keep in mind though, in terms of the incremental, the offset are moving into that, that's still predominantly from the legacy books. So I still think about 75% that are moving in are still from the legacy book.

I think you'd move to more normalized level, when you see kind of a transition over time, away from the legacy book. So I think it's just gradually quarter-over-quarter transitioning back. I wouldn't say it's there yet. We continue to watch the developments and we'll make any adjustments that we think are wanted.

Chris Gamaitoni - Autonomous

And could you give us a sense of what this quarter's the expectation of lifetime default was or what you might have seen historically from the new developments?

Derek Brummer

In terms of lifetime defaults, I mean in terms of obviously the new book that you're kind of seeing transition in terms of development over time, as Bob indicated loss ratios on that, we'd see historically at extremely low levels. In terms of what baked-in, in terms of our projections, we're still looking at on a net basis a little over 20%.

Chris Gamaitoni - Autonomous

Did you gave any thoughts or kind of color for the rest of the year for NIW?

Teresa Bryce Bazemore

Yes. I mean we took a look at it, and obviously, the mortgage market as a whole is down a bit from what we thought as we were coming into the year. But given sort of what we've seen over the last few months and where things are trending, we still believe that NIW will be somewhere between 35 and 40.

Operator

And we do have a follow-up from Bose George with KBW.

Bose George - KBW

Just wanted to make sure, wanted to go back to your comment on the returns on new business assuming PMIERs. Did you say that's a mid-teens returned assuming the current book of business under PMIERs?

Robert Quint

The current mix that we're wiring today, which is of really high quality.

Operator

And we have no further questions in queue. So please go ahead with any closing remarks.

Sanford Ibrahim

Well, I'd like to thank you all for participating in our call. And look forward to seeing you again at the next quarter call. Thanks.

Operator

Thank you. Again, ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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