Credit Opinion: Radian Guaranty Inc.

Transcription

1 Credit Opinion: Radian Guaranty Inc. Global Credit Research - 22 Oct 2013 Philadelphia, Pennsylvania, United States Ratings Category Rating Outlook Insurance Financial Strength Radian Group Inc. Rating Outlook Senior Unsecured Moody's Rating POS Ba3 POS Caa1 Contacts Analyst Phone Brandan Holmes/New York City Yulia Davletova/New York City Stanislas Rouyer/New York City Key Indicators Radian Guaranty Inc. New Insurance Written ,061 15,510 11,558 16,969 32,513 Risk in Force 34,372 30,692 31,461 33,765 34,951 Insurance in Force 140, , , , ,239 Market Position Avg. NIW as a % of Total Industry NIW 7.7% 4.3% 3.4% 5.5% 10.2% Prime loans % RIF 88.3% 84.7% 82.6% 80.2% 77.8% Client Concentration 27.0% 32.2% 35.4% 34.3% 28.8% Geographic Concentration 26.3% 25.7% 26.5% 28.3% 27.9% Capital Adequacy Adjusted Risk to Capital Profitability Return on Capital -30.0% 15.8% -79.8% -5.3% -12.5% Combined Ratio (SAP) 154.3% 217.2% 232.3% 186.1% 268.0% Financial Flexibility Earnings Coverage -4.8x -5.2x -23.4x -6.4x -24.9x Cash Flow Coverage.x.x.x.x.x Financial Leverage 48.6% 41.8% 53.6% 26.6% 30.4% Total Leverage 52.3% 47.7% 63.8% 33.8% 34.0% Opinion SUMMARY RATING RATIONALE The Ba3 IFS ratings of Radian Guaranty Inc. (Radian Guaranty) and its wholly owned subsidiary, Radian Mortgage Assurance Inc. (RMA) reflects: 1) their consolidated financial resources, including expected dividends from Radian Asset Assurance Inc. (Radian Asset), in excess of our base case losses, and 2) their ability to write new business given current counterparty forbearance and the firm's success, thus far, in maintaining a capital profile below the minimum regulatory risk-to-capital threshold of 25 to 1. Fannie Mae and Freddie Mac (the GSEs) are, however, expected to finalize new eligibility criteria over the next few months and Radian will likely need to

2 take substantial steps to achieve compliance prior to the effective date of the new criteria. As June 30, 2013, Radian Guaranty's risk-in-force to capital ratio was 19.7 to 1. New, higher quality business production has partially mitigated legacy losses, which have decreased since the prior year, and helps progress Radian's turnaround. Radian Group's Caa1 senior debt rating reflects the holding company's substantial debt burden, despite its improved liquidity position and demonstrated ability to access capital markets, following its capital raise, as well as the continued weakness at its main operating subsidiaries. Dividends from Radian Guaranty are unlikely for the foreseeable future given its weak regulatory capital position and substantial but declining legacy losses. We believe that, despite the significant addition to liquidity from its capital raise, the holding company may not be able to meet all of its senior debt obligations without further improvement in the performance of its subsidiaries, or the infusion of additional capital. Credit Strengths Credit strengths of the company include: - Higher quality new business and improved production volume - Access to Radian Asset's capital resources - Increased holding company liquidity enables a greater degree of capital support of main insurance subsidiaries, if necessary Credit Challenges Credit challenges for the company include: - Prolonged operating losses pressure capital and liquidity position - Uncertainty about Radian's ability to become compliant with new GSE eligibility criteria - Uncertainty about the role of mortgage insurers in the future mortgage finance market Rating Outlook The positive rating outlooks reflects improving visibility about mortgage insurance losses, the firm's high quality new business production, and the additional capital and liquidity resources available to the group as a result of the recent issue of common stock and convertible debt. What Could Change the Rating - Up The following factors could result in an upgrade: - Improving housing market outlook and unemployment levels, resulting in substantially lower downside risk for insured mortgage losses - Injection of additional capital that meaningfully improves the firm's capital adequacy - Better than expected loss developments in its financial guaranty or mortgage insurance portfolios - Ability to comply with revised GSE eligibility criteria when they are finalized What Could Change the Rating - Down The following factors could result in a downgrade: - Regulatory actions preventing Radian Guaranty from writing new business or loss of eligibility status with the GSEs - Substantial adverse loss developments in the financial guaranty and/or mortgage insurance portfolios - Capital deficiency relative to its Ba rating threshold that remains uncorrected Recent Developments

3 Radian's mortgage insurance operations reported a pre-tax loss of $84 million for the six months ended June 30, 2013, compared to a pre-tax loss of $90 million for the same period in However, on an operating basis, excluding realized and unrealized investment gains and losses, the mortgage operations reported a pre-tax income of approximately $5 million for the six months ended June 30, 2013 versus a pre-tax loss of approximately $148 million for the same period in Radian's new insurance written (NIW) increased to $24 billion for the six months ended June 30, 2013 over $15 billion for the same period in Significantly, as of Q2 2013, profitable new business written after 2008 represented 53% of primary risk in force, outweighing the legacy mortgage insurance book. In the absence of unexpected adverse macroeconomic developments, we expect Radian's financial results to continue improving as it continues to write profitable new business, and losses on the legacy book decrease due to burnout of the book, and a steady decline in new delinquencies. In August, 2013, Radian Guaranty entered into an agreement with Freddie Mac to settle claim payments on all primary first-lien mortgage insurance policies to which Freddie Mac is the counterparty, and which were delinquent as of 31 December The settlement, which was in line with the company's current reserves on the affected delinquent exposures, included a $205 million collateralized account set aside to cover the cost of reinstatement of rescissions, denials and curtailments that may occur on that book of business. In April, 2013, Radian amended the terms of a quota share reinsurance agreement with a third-party reinsurer to reduce the amount all premiums and losses incurred on new business that will be ceded to the reinsurer under this reinsurance agreement, on a prospective basis from 20% to 5% with respect to NIW on conventional GSE loans. As of June 30, 2013, Radian had ceded approximately $2.5 billion of Risk-in-Force to the above mentioned reinsurer. Radian has the option to recapture amounts ceded under the first and second quota share agreements at the end of 2014 and 2015, respectively. DETAILED RATING CONSIDERATIONS Moody's currently rates Radian Ba3 for insurance financial strength, which is based on an analysis of the key rating factors described below: MARKET POSITION: Baa - STRONG GROWTH OF PROFITABLE NEW INSURANCE ALIEVIATES LOSSES IN THE LEGACY BOOK Since the financial crisis, private mortgage insurance production volume has fallen significantly as the credit profiles of the mortgage insurers weakened. The Federal Housing Administration (FHA), a government mortgage insurer, became the lead provider of mortgage insurance in the U.S. Although, more recently, private mortgage insurers regained some ground after the FHA repeatedly increased pricing and tightened up terms and conditions. Private mortgage insurers' market share totaled about 35% of the overall insured market at December 31, 2012, compared to around 65% during early 2000 and 80% in Radian, like its peers, has not yet returned to precrisis levels of market penetration, although it has increased its issuance of new business significantly since the post-financial crisis low. The Baa score reflects Radian's strengthening market presence, its well-diversified insured book and healthy exposure to higher quality loans. As of year-end 2012, Radian's insured book was comprised of about 88% in prime loans, which tend to exhibit lower delinquency rates than non-prime mortgage loans. Due to Radian's solid growth in NIW, the proportion of post-2008 book of business now exceeds the legacy business, going a long way to help reduce the effect of legacy losses. HOUSING MARKET ATTRIBUTES: Baa - INCREASING DEMAND FOR PRIVATE MORTGAGE INSURANCE AMID AN IMPROVING HOUSING ENVIRONMENT I. Demand for Mortgage Insurance: Ba The mortgage insurance industry is well established in the U.S. with mortgage insurers benefiting from the GSEs' requirement, under their federal charter, to use credit enhancement on mortgages with loan-to-value (LTV) in excess of 80%. Private mortgage insurers currently face strong competition from the FHA, which stepped in to provide mortgage insurance as a result of the weakened financial condition of private mortgage insurers. However, with the slow but steady improvement in the financial condition of the private MIs, the FHA has started to pull back. Private MIs' franchise may come under pressure as a result of housing market reform. A contemplated narrower role for, or termination of, the GSEs would reduce or eliminate the MIs' core franchise, forcing them to compete against other sources of mortgage credit enhancement. The timing and extent of housing finance reform could also

4 affect demand for mortgage insurance. For example, it is unclear whether the final Qualified Residential Mortgage (QRM) rule will expressively include mortgage insurance in determining which loans are eligible for exemption from the risk retention rules for securitization. MIs currently benefit from the slow pace of GSE reform, that maintains the current status-quo, and are positioning themselves to remain relevant in the future mortgage finance market. The recognition of private MI in the recently finalized Basel III rules for US banks and the explicit inclusion of private MI in the Corker-Warner bill on housing reform have been positive developments for the industry. II. Generic Loan Attributes: A The score reflects the continued tight mortgage underwriting standards, the partial recourse nature of mortgage lending and improving servicing practices in the U.S. Since the financial crisis, U.S. mortgage insurers have been writing business almost exclusively in the prime, first-lien segment of the mortgage market. We expect underwriting standards to remain fairly conservative despite some anticipated loosening as the industry recaptures market share from the FHA. Insured mortgage loans in the U.S. are typically long-term, fixed-rate products with partial recourse to the borrower. While residential mortgage loans in the U.S. are secured by the underlying property, lenders generally have no recourse beyond the property itself. The mortgage insurers also insure a material amount of high LTV loans, though their LTV>95% new production has greatly declined since Historically, exposure to high LTV loans has made mortgage insurers particularly vulnerable to housing downturns. While lengthy property disposition timelines will likely persist in the U.S. for some time, a rise in short sales may help shorten the timelines and lower loss severities. In addition, as property prices increase, borrowers' equity positions will improve, potentially reducing default rate and loss severities. During the housing crisis, the U.S. mortgage servicing industry experienced problems with delays in collections, loan modifications and foreclosures, and bad practices such as shoddy recordkeeping. Lender practices have improved, driven in part by greater regulatory oversight, including by the Consumer Financial Protection Bureau (CFPB). III. Housing Market Conditions: A The score reflects our view that the US economic recovery is gaining traction, though it still faces the challenges of a large foreclosure pipeline and uncertain impact of the global economy. After the unprecedented downturn in recent years in the U.S., house prices are steadily improving, in part aided by limited available existing home inventory and relatively low new construction levels. Housing affordability, while still good by historical standards, is moderating because of housing price appreciation and rising interest rates. CAPITAL ADEQUACY: Ba - CAPITAL LEVELS STEADY BUT RISK IN THE UNCERTAINTY ABOUT REVISED GSE CAPITAL REQUIREMENTS In addition to using the adjusted risk-to-capital scorecard metric, Moody's estimates Radian's future losses using a loss curve approach derived from the mortgage insurance industry's experience in prior severe regional stresses and adjusted for current experience. We believe that Radian's claims paying resources (including dividend support from Radian Asset) are in excess of base case claims at a level consistent with a Ba rating. New high quality business production has partially mitigated losses incurred on business written prior to Furthermore, to alleviate some near-term regulatory capital pressures Radian has used reinsurance, restructurings and commutations to manage its capital. The recently completed commutation with FGIC, reduces Radian Asset's exposure to toxic credits such as Jefferson County. That is credit positive for Radian Asset, and, in turn benefits its owner, Radian Guaranty, because the commutation removes the uncertainty of losses attributable to these credits. In addition, as a result of liquidity provided by the recent capital raise, the holding company is in a better position to provide capital support to Radian, and, as of June 30, 2013, had made a capital contribution of $115 million to Radian Guaranty. Due to these actions, Radian's capital ratio is likely to remain steady, even at elevated levels of new insurance written, unless losses are meaningfully higher than expected. While we expect Radian Guaranty to be able to maintain risk-to-capital levels at or below 20 to 1, there is meaningful uncertainty about where revised GSE capital levels will be set. Should revised capital levels be materially higher than 20 to 1, Radian Guaranty would need additional capital resources in order to retain its eligibility status with the GSE's. Moody's notes that RMA and Radian Guaranty, although separate legal entities are evaluated jointly for capital

5 adequacy. RMA and Radian Guaranty entered into a cross guaranty agreement in 1999 that remains in place. Under the agreement, if RMA fails to make payment to policyholders, Radian Guaranty will make the payment, and vice versa. The obligations of both parties are unconditional and irrevocable, though any payments are subject to regulatory approval. PROFITABILITY: B - PROFITABILTY FROM NEW PRODUCTION OVERTAKE LEGACY LOSSES Radian's profitability metrics remain depressed due to slowly declining, elevated losses in the legacy portfolio. However, burnout of the legacy book, the steady decline in new delinquencies and the increasing levels of new, profitable business being written are contributing to Radian's return to profitability. During both Q1 and Q2 of 2013, Radian's reported earnings, adjusted for unusual items, were positive on an operating basis. Should current new business and loss trends hold, we expect the improvement in profitability to continue. FINANCIAL FLEXIBILITY: Ba - HIGH DEBT BURDEN, BUT DEMONSTRATED ACCESS TO CAPITAL MARKETS Moody's scores Radian Ba for financial flexibility to reflect the holding company's improved liquidity position and demonstrated ability to access capital markets, following its capital raise, somewhat offset by ongoing stress at the mortgage insurance subsidiaries and meaningful debt burden relative to holding company liquidity. The quotashare reinsurance agreement helps to alleviate some near-term regulatory capital pressure, and the debt exchange offer pushes maturity back to 2017 on a significant amount of debt; both these measures, however, come at a cost to earnings. Dividends from Radian Guaranty are unlikely for the foreseeable future given its weak regulatory capital position and we believe that, despite the significant addition to liquidity from the recent capital raise, the holding company may not be able to meet all of its senior debt obligations without further improvement in the performance of its subsidiaries. As of June 30, 2013, Radian had unrestricted cash and liquid investments of approximately $919 million before taking into consideration any further capital contributions to Radian Guaranty. Radian stated that it expects to maintain a risk-in-force to capital ratio at or below 20 to 1 at Radian Guaranty and may have, as a result, to make additional capital contributions to its subsidiary over the next few years, decreasing the amount of liquidity retained at the holding company. Moody's also notes that Radian Group has expense-sharing agreements in place with its principal operating subsidiaries that require that these subsidiaries pay their share of holding company expenses, including interest expense on debt. However, these arrangements could be terminated at the discretion of the insurance regulator, and such termination would increase expenses for the holding company. Rating Factors Radian Guaranty Inc. Financial Strength Rating Scorecard [1] Aa A Baa Ba Score [2]Adjusted Score Factor 1: Market Position (20%) Baa Baa Avg. NIW as a % of Total Industry NIW 7.7% Prime Loans (% of RIF) 88.3% Client Concentration 27.0% Geographical Concentration 26.3% Factor 2: Housing Market Attributes (25%) Baa Baa Demand for Mortgage Insurance x Generic Loan Attributes x Housing Conditions x Factor 3: Capital Adequacy (30%) B Ba Adjusted Risk-to-Capital Ratio 37.70x Factor 4: Profitability (15%) Caa B Return on Capital (after-tax) -22.0% Combined Ratio 212.0%

6 Factor 5: Financial Flexibility (10%) B Ba Cash Flow Coverage 0.0x Adjusted Financial Leverage 49.0% Total Leverage 52.0% Aggregate profile B Ba3 [1] Information based on statutory and GAAP financial statements as of 12/31/2012, unless noted [2] The Scorecard rating is an important component of the company's published rating, reflecting the stand-alone financial strength before other considerations are incorporated into the analysis 2013 Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. ("MIS") AND ITS AFFILIATES ARE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY'S ("MOODY'S PUBLICATIONS") MAY INCLUDE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY'S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY'S OPINIONS INCLUDED IN MOODY'S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. CREDIT RATINGS AND MOODY'S PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODY'S PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODY'S PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY'S ISSUES ITS CREDIT RATINGS AND PUBLISHES MOODY'S PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY'S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY'S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided "AS IS" without warranty of any kind. MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable, including, when appropriate, independent third-party sources. However, MOODY'S is not an auditor and cannot in every instance independently verify or validate information received in the rating process. Under no circumstances shall MOODY'S have any liability to any

7 person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY'S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY'S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The ratings, financial reporting analysis, projections, and other observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. Each user of the information contained herein must make its own study and evaluation of each security it may consider purchasing, holding or selling. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY'S IN ANY FORM OR MANNER WHATSOEVER. MIS, a wholly-owned credit rating agency subsidiary of Moody's Corporation ("MCO"), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MIS have, prior to assignment of any rating, agreed to pay to MIS for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,500,000. MCO and MIS also maintain policies and procedures to address the independence of MIS's ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at under the heading "Shareholder Relations Corporate Governance Director and Shareholder Affiliation Policy." For Australia only: Any publication into Australia of this document is pursuant to the Australian Financial Services License of MOODY'S affiliate, Moody's Investors Service Pty Limited ABN AFSL and/or Moody's Analytics Australia Pty Ltd ABN AFSL (as applicable). This document is intended to be provided only to "wholesale clients" within the meaning of section 761G of the Corporations Act By continuing to access this document from within Australia, you represent to MOODY'S that you are, or are accessing the document as a representative of, a "wholesale client" and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to "retail clients" within the meaning of section 761G of the Corporations Act MOODY'S credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail clients. It would be dangerous for retail clients to make any investment decision based on MOODY'S credit rating. If in doubt you should contact your financial or other professional adviser.