FINAL TRANSCRIPT RDN - Radian Group at Friedman Billings Ramsey Capital Markets Investor Conference Event Date/Time: Dec. 03. 2008 / 10:45AM ET www.streetevents.com Contact Us
CORPORATE PARTICIPANTS Bob Quint Radian Group, Inc. - CFO CONFERENCE CALL PARTICIPANTS Steve Stomac Unidentified Audience Member Unidentified Audience Member Unidentified Audience Member Unidentified Audience Member Unidentified Audience Member Unidentifiedi Audience Member PRESENTATION Steve Stomac - Good morning, thank you for joining us. My name is [Steve Stomac] (inaudible) to FBR. Today we have the pleasure of Bob Quint, the CFO of Radian joining us. And with that, Bob, I'll turn it over to you. Thank you, Steve. Thanks for being here this morning. Radian is always wanting to be out there telling the story in good times and in uncertain times. We are happy to be here. Starting out with just a picture of what the company looks like because it has changed over the past year, I'm going to start with the middle. We still have three reporting segments for reporting purposes, but really the only active segment in the core business is the middle which is the mortgage insurance business, and that we are currently writing substantial amounts of business. I will talk about that regarding profitability, and we believe that business has a very strong future. On the left side is the Financial Guaranty segment. We are not writing new business in the Financial Guaranty segment. Although that segment has a substantial amount of capital and a substantial amount of claims paying resources, we recently dividended the company down underneath the mortgage insurance company, so that company now provides capital support to the mortgage insurance business. That's very important for our ability to continue to write new mortgage insurance, and over time we expect the exposure in the Financial Guaranty business to be managed down and to release cash via dividends to support the MI business. We also have a financial services segment. That essentially now consists of a 29% ownership interest in a consumer asset company called Sherman. Sherman, through the economic turmoil, has performed well, continues to make money, continues to provide us with dividends, and also provides us with a potential capital source via a sale in the future. www.streetevents.com Contact Us 1
Like many companies these days, you really can't just look at the bottom line. You've got to look behind the numbers and really understand what is going on. It is not an uncomplicated accounting situation at Radian. We do have a lot of fair value accounting that is a component of our numbers. So just to go through our third quarter where, from a GAAP net income standpoint, we actually made money in the third quarter. Looking through it, a few highlights. Clearly the mortgage insurance losses continue to be elevated. That's driven by higher delinquencies, higher claims. No surprise there. Some of the third quarter losses were offset by a reduction in a premium deficiency reserve. I will talk about that a little bit later. But the offset to the premium deficiency reserve in the third quarter actually helped the earnings in the third quarter. We did have realized and unrealized losses in our investment portfolio. Generally our investment portfolio is a very high credit quality. Most of the losses were unrealized and ran through the balance sheet, and we consider them temporary. A little bit of the losses went through the P&L and were other than temporary. We've continued to have a fair value impact. A lot of the business in our Financial Guaranty segment is considered derivative, and we have to do fair value accounting on that. Because our credit quality has had concerns, FAS 157 impact to a lot of our marks has been positive for net income, ironically That continued in the third quarter, so that had a positive impact on our net income. And the operating performance in Financial Guaranty and in Sherman continue to be relatively strong and stable. All of that added up to net income. But I think the big story is the elevated MI losses and when will that stabilize. If you look at some of the key balance sheet components and other financial highlights as of September, we still look pretty strong. We are in fairly good shape when it comes to equity, our book value clearly is still solid, our risk to capital, which is a very common measurement of mortgage insurance companies and their ability to write new business is still very very solid. And we have a substantial amount of holding company liquidity, if need be. We don't think we will need that but clearly it's good to have just in case. So we've come through a lot of stress in relatively good shape. And we believe clearly there is more to come but hopefully we will emerge after the cycle turns. If you look at your outstanding risk exposure, I think there is one key take away. Most of your notional exposure is in the Financial Guaranty business in public finance and structured finance, and I will talk more about that. But over time, all we are doing is one thing, we are doing prime MI business. That's all we are doing now. So over time, the prime MI is going to go up and everything else is going to come down, either by natural run off, or by proactive management. We are proactively trying to manage exposure down and we have been relatively successful so far in doing that. We will continue to do that. So the idea is to get all the exposure down, clearly in the Financial Guaranty segment, to free up the capital, make the capital accessible for the MI business. If you think about the mortgage insurance company today, a very very simple strategy. One thing. We are writing prime MI business, and we believe it's profitable, and I will talk more about that, as well. But today we think our business is profitable and primarily has to do with the risk attributes of the business. The business we are writing today is very very high credit quality, it's lower LTV, it's fixed rate loans. It's back to the way the business was many many years ago. And if you pull out that component with the risk attributes of our current business, you see very very strong performance through this credit cycle. So we feel very good about the business we are writing today. In addition, with all the higher delinquencies and claims that are coming in, our loss mitigation efforts are triple what they were. We've multiplied the amount of people, the amount of effort in that area, and I will talk more specifically about that. And then we spend a lot of time with our counterparties. So we've got regulators in the form of rating agencies, the GSEs clearly, which are our chief counterparty at this point. The insurance department. We spend a lot of time with our counterparties helping them understand what's the going on, really on a daily basis with our business. All of it is preparation for being in the market as a strong player when the cycle turns. www.streetevents.com Contact Us 2
If you look at what we are doing today in terms of prime MI -- and that theme will echo -- if you look at the bottom part of the chart, the end of '07, only 70% of our business was prime. We were doing ALTA business. We were doing a minus business. Today, all the way on the right side, 98.4% in the third quarter was prime. That's going up. It's essentially only prime business. The top part of the chart is our risk in force. The needle moves a little more slowly there, in the same direction but more slowly because of the lack of refinance ability in the marketplace. The loans are staying on our books, so the risk in force is moving more slowly, but over time, this portfolio will be become an all prime portfolio. Our loss reserves, and this is a very key part of our story, as well. We have dramatically increased our loss reserves over the past two years to the point where they are very very strong. The loss reserves have gone up to a much much greater degree than the claims have come in. And I will talk more about that. Claims have slowed. There is an effort underway, both from the government and from the servicers, to slow the foreclosure process, eliminate foreclosures via modifications, and that is holding up our claims payments. Our claims payments have been somewhat less than we anticipated; however, we are substantially reserved on all of our delinquent loans. We feel like the balance sheet is strong but given the strength of our loss reserves it's even stronger. One of the measurements, we measure loss reserves as number of different ways, but $2.5 billion in mortgage insurance represents about nine quarters of claim payments in the mortgage insurance. So by any historical measure, that's a very very strong loss reserve position. We did put up a premium deficiency reserve. This is a very unique circumstance for insurance companies. Very few people that have ever been in the insurance industry have ever seen this. However, unfortunately, we did. Premium deficiency is simply when you look forward at your insurance book of business and you determine that future premiums and your existing loss reserves won't be enough to cover future losses, you are required to front load these losses. We did it for our second liens back in '07. And that's all taken care of. We did it for our first liens in the second quarter of this year. What it's supposed to do is essentially front load all of the future impact, our future P&L impact on a MPV basis of your insurance book. If we did this right, it should be book value neutral in the future. That doesn't speak to the timing, but all in in the future it should be book value neutral. The whole thing is based on projections and assumptions and obviously it's all about the actuals coming in like your projections, and we are required and we do update these assumptions every single quarter. We did it in the third quarter, and the future loss projections actually went up a little bit. Clearly we are aware that the news continues to be negative. We have seen the third quarter situation with regard to home price depreciation, unemployment levels. Now people are talking about levels that are higher than they were talking about just a month ago or two months ago. One thing we have done in our 10-Q is we put a sensitivity around these numbers in our 10-Q. So, for instance, we put one that said if unemployment peaks at 10% as opposed to our assumption of 7%, the premium deficiency reserve would result in an incremental $300 million of losses or an incremental addition to the premium deficiency of $300 million. That's the additional gross losses we would suffer, and then reduced by the amount of captive recoveries. The MI industry and Radian has substantial recoveries from insurance that we have entered into with our lenders that's all going to come in over the next few years and is going to provide substantial both GAAP income support and also cash recovery support over the next few years. We will continue to update the premium deficiency analysis in the fourth quarter and beyond. And so far the actual results of the business, even though they have been substantially high losses, they are not inconsistent with the ultimate projections we are putting out there in terms of our premium deficiency loss projections. Loss management is a critical component of our business right now. Our efforts with regard to loss management are very very consistent. They're much aligned with public purpose and public policy. We want to do everything we can to keep borrowers in homes. If the borrower stays in the home, via some sort of help or via modification, we don't pay a claim so we are aligned. All of our efforts are toward that. Internally we done some things. We've put our employees in the servicer shops to help the Radian insured loans either get modified or mitigated in some other way. We also have a claim advance called Fast Advance and that's actually advancing servicers money to try to perform modifications on loans that may have gone to claim but will www.streetevents.com Contact Us 3
now not go to claim and will ultimately save us money. We are also part of the Hope Now initiative and other external means of preventing foreclosures. This is a critical part of what we are doing. Much publicized foreclosure mitigation efforts, both from the government and from industry participants. Critically, none of these initiatives, or the potential benefits of none of those initiatives, are built into either our loss reserves or our loss projections. We understand that this might help us, and hopefully will help us, we have not built it into our projections because we really haven't seen the tangible benefits occur yet. The execution of this stuff takes time. We haven't seen it, although, we mentioned on our third quarter earnings call that we did see a reduction in claims received in October compared to our expectations. Usually claims received is a very predictable number, and we are very good at predicting it. Well, we predicted a number that was much higher than we actually received in October. That is a sign certainly that some foreclosures are being prevented. Now whether that's just a matter of timing and ultimately they will become foreclosures and we'll pay claims, or whether they're actually modifications that will help us really save money in the future, we don't know that. So we haven't built it in. If you just look at the industry participants, be they Countrywide, Citi, JPMorgan, a substantial amount of our delinquent loans are on loans that are serviced by these guys. It's not wrong to think that some portion of our delinquent loans will be affected by these efforts. The other thing about the loss mitigation effort, a huge part of it is trying to keep people in homes. The other part is what we call SIU, or Special Investigation. There is a substantial amount of fraud, misrep, breeches of reps and warranties, and we are not paying a lot of claims today because of that. We have clear legal right to do that, and that's a bigger component of our claim process today. Turning to Financial Guaranty, and I said Financial Guaranty is a means of capital support for the MI business. That's what we are using it for. However there is a major effort to manage that business. It has to do with surveilling the existing exposure and making sure there is no real credit problems in the portfolio, and proactively trying to manage the exposure down. That's what we are doing in Financial Guaranty right now. Luckily for our Financial Guaranty business we don't have a lot of direct mortgage exposure. And I will go through some of the exposure shortly. But the capital in this business, which is over $900 million as of September 30th, claims paying resources are almost $3 billion, as of September 30th. That capital is only as good as its availability after this exposure runs down. If there are substantial losses in these portfolios, that capital is not going to be available. We know that, we understand it. Very importantly, we don't need the liquidity in the MI business. We have plenty of liquidity to pay claims in the MI business. This capital is meant to provide support to write new business, and ultimately, over time, as the exposures run off, provide cash via dividend. The FG business has $111 billion of par outstanding. And I will go into the specifics of it. Almost half of it, or a little less than half of it is reinsurance of the primaries. Most of that is public finance business. We also had a direct public finance business and a direct structured business. Obviously it's our job to make people comfortable with that portfolio and to make sure that we don't have problems lingering in the portfolio that would impact the capital position of the company. $ 111 billion was down from $116 billion as of June 30th, and by year end we expect that that $111 billion will be down towards $100 billion. Probably a little bit more but down towards $100 billion. So managing the exposure down is very important for us. Break it down a bit further. A little bit more than half is public finance, most of that is general obligation. Public finance, not without its individual issues, however, generally has performed very very well in the past, and we are hopeful that it will perform well in the future. That's long dated stuff, that's 20 to 30 years generally before it runs off, unless there is some other way to manage that exposure down. The structured finance portfolio, I mentioned mortgage exposure is very very small. But what jumps out there is obviously the CDO exposure. We've gone through great lengths to provide more disclosure around our CDOs www.streetevents.com Contact Us 4
because it's a substantial amount of our risk. We feel pretty comfortable with it, but we want to make sure that the world does and we've done I think a much better job with our disclosure explaining just what this is. This is a breakdown of the CDO exposure. Clearly what jumps out is the corporate CDOs. Generally speaking, our corporate CDOs are investment grade portfolio, corporate names, and our attachment point is very very high. I'ts well over AAA attachment. In this world that may not mean that much, but we've done a lot of additional disclosure to break it down and explain to you exactly what that really means, and I will do that in a minute. We also have some trust preferred exposure, and that's banks and insurance companies. Again, not without its credit issues, but we attach very very high up in the structures. We don't anticipate credit problems. Our CNBS, again, very very high attachment, don't anticipate problems there. And the other asset classes are relatively small, but in the relatively small realm, that could be a billion dollars or half a billion dollars, so it's not inconsequential from a nominal standpoint. So we've done a lot of disclosure around that to make sure everyone gets comfortable with this. This is a lot shorter portfolio. So a lot of this exposure is going to run off. I think the average life is about five years. A lot of it run offs sooner. I also think there are opportunities to manage this down over time. So as these deals get closer to maturity date, and they look like there is no way to lever attach and become a claim for us, we think we have opportunities to reduce the exposure more quickly than the schedule maturity. Here is the granularity with regard to our corporate CDOs. We've got, by year, scheduled maturities. This schedule is in our 10-Q, it's actually more in the 10-Q. By year of maturity, the number of contracts and net par outstanding, and then literally the average number of sustainable credit events that it would take for us to attach and actually have to pay money on these transactions. If you go just to 2013, because that's the biggest year, there are 36 contracts that expire in 2013. So that's about four to five years from now. Aggregate par exposure is $15.2 billion, so that's about 40% of our total exposure, out of about 100 names in these portfolios, in generally investment grade companies, 32 of them or 31 of them would actually have to default during that time for us to pay claims. Clearly the credit events of the last year have taught us that you can never say never about this, but if you look at this chart and you look at what has to happen in addition to what's already happened in the market, it makes us feel more comfortable. Hopefully it will make you feel more comfortable that we don't have substantial risk in our corporate CDO exposure, which is, by far and away, our biggest risk. So to summarize with take aways, this environment is very uncertain. We have withstood a substantial amount of stress. We think we are in pretty good shape at this point. How much more, when it will stabilize, obviously those are questions that are very very difficult to answer. However, within our businesses, if you look at our businesses, liquidity in the MI business, is fine. We have money to pay our claims, there are no liquidity events in the business that would require us to come up with a substantial amount of cash in the near term. That's the same with our Financial Guaranty business. Our Financial Guaranty business didn't have collateral support agreements or any other substantial drivers of potential liquidity issues within it. And that's really important. We have a big pot of capital, we're paying it out in terms of claims over time, we have substantial loss reserves, and we have capital in reserve just in case, and we are bringing in new premiums on new business that is very substantial. Radian Group has adequate liquidity. We have about $400 million of liquidity at the holding company. We have no principal due on any of our debt until 2011. The needs of the holding company are minimal. They are very very small. We do have financial covenants in our bank credit facility that the outstanding par amount is $150 million. We don't think any of those covenants will be violated imminently, but with fair value accounting you never know, so just in case we have reserves. We have short-term liquidity of $400 million just in case that happens. We are committed to the mortgage insurance business. We think it's a good business fundamentally. We're back to insuring loans that we believe will be profitable. I mentioned before that if you look at the risk attributes of what we are writing today, www.streetevents.com Contact Us 5
we have a lot of confidence in the profitability of the business. Our delinquency rate on our primary loans today, or as of September 30th, was 9.71%. If you reduce that portfolio down to the risk attributes of the business we are writing today, the current delinquency rate is about 3.3%, which is a pretty normal delinquency rate for our business historically. That tells us a lot about the business we are writing today and we feel comfortable. Even with some home price depreciation to come, even with unemployment increases to come, we feel good about the profitability of the business we are writing today. We go through great pains to talk to our regulators, the GSEs, the insurance departments and the rating agencies. That's a big risk. Obviously in this environment, we have to make sure that we don't get surprised by any actions that they take. There is uncertainty on the part of the GSEs. Do we know how they will end up in the future? Obviously not but nothing has changed so far with regard to our relationship, the people we talk to, their monitoring us. And to this date they are comfortable with us and we talk to them all the time. Our loss mitigation activities are paramount. We are clearly putting a lot of effort underway to save money, either via loss mitigation or by denying or rescinding claims that we have the right to do. On the capital preservation side, Financial Guaranty is providing support to the MI business. Over time we will get that money out to the MI business to provide it with support but in the meantime we are prudently managing that business, surveilling it, and will proactively manage the exposure down whenever possible, whenever it makes economic sense to do so, in order to help the MI company continue to write profitable business. So with that, I would be happy to turn it over to questions. QUESTIONS AND ANSWERS (Inaudible question) It's a great question, what is going to happen with the GSEs, where does MI fit? MI is a mandated product within the GSE charters right now. And will that continue? All we can do is monitor the situation. The lobbying efforts are underway in a big way to make sure that the world understands the benefits of mortgage insurance. This is an industry that over the past few years has paid over $15 billion of claims, has capital, has not needed any other support. I think within the context of the mortgage industry, mortgage insurance, it is critical, has demonstrated its value, and speaks for itself. If the entire thing is privatized, then it's a question of providing first loss protection on high LTV loans in an environment where no one wants to take on credit risk. So I think the value of the industry is there. Might the mandate be removed? That's possible. We also have sold insurance to a lot of non GSE mortgages over time, and that's a possibility. But I think in some form it will be there. It's hard to imagine, I can't believe the government would want to take this risk on. They are doing things they have to do. With an industry that is there, and available and willing to take this kind of risk we think it makes sense to have a substantial MI industry, whatever the structure is in the future. www.streetevents.com Contact Us 6
Yes, you know, with regard to FHA, we have always said that FHA play as role because we've changed our underwriting guidelines dramatically, and there is a portion of the mortgage market that FHA serves very well that frankly we don't serve. To co-exist with FHA makes a lot of sense. They have taken a lot of share. Some of the share they taken are loans we would be willing to do and are willing to do. So to coexist with them I think makes a lot of sense. However, to envision them taking the entire portfolio that the MI industry takes, that's pretty hard to imagine. So again I think it makes sense to have them as part of the industry but it also makes sense to have the private side with a big capital base willing to take on a lot of mortgage risk as well. Can you give some color on the reasons why when there are cases where you're denying or challenging claims, or misrepresentation, are things like the stated income, or claims of owner occupancy where they're not primary residences, or any sort of generic type you see more often than not? The latter one is a big one, where a borrower would say it's a primary residence and would have six different loans. They are very, I would say very black and white evidence that there was fraud or misrep. So it's not going to be where the income was stated at $80,000 and they really made $70,000. It's much more dramatic or egregious kinds of situations. What is behind the 46% investment in (inaudible) today, in your org chart at the beginning? We still own 46% of the company; however it's written down to 0, and there is no future liability associated with it. So might there be something when all is said and done? There might be, but I don't think we are counting on it or expecting it. And did Litten transfer over to --? Litten was sold, yes. That was sold. The $400 million, what does that translate into (inaudible)? Our debt service today is about, it's a little under $60 million, it's about $58 million, give or take, a year. Now that debt service is currently covered by expensuring arrangements with our operating subs, so the holding company pays it but then gets reimbursed by the operating subs. However, as we've disclosed, those agreements are potentially subject to insurance company. www.streetevents.com Contact Us 7
They've all been approved and are aware by the insurance departments but in case they're changed in any way, there is substantial coverage there if need be.. No doubt. I would say that most of the situations that we are talking about are on our nonprime business, where the originators either don't exist, or are not current customers. The current customers, if you take a leap and say they are all pretty much prime customers, they have captive, the rates of denial or rescission are much much lower on prime business, and where they exist, it's being accepted because of the amount of work we do before we ever do something like that. We have a lot of captive agreements. It's pretty concentrated. If you think about the biggest lenders in the country, that's where our captive business is concentrated, that's where our risk is concentrated. It's all the guys you would think pretty much. I don't think we are going to expect it and it all has to be sorted out, but honestly I can't give you great wisdom regarding how that will come out. I think it's complicated. What I've also heard is that the legal doc within the securitizations don't provide as much necessarily constraint as was once thought of. To me, if the situation of a modification is done that clearly is better off, whereas there may be some small cost but ultimately the loan is current and the borrower can pay, that's going to benefit everyone. It's hard for me to believe it's not going to benefit one versus the other. But it's a tough one. www.streetevents.com Contact Us 8
I would say generally that's right. However the premium deficiency reserve is a calculation that takes the future into account. What I can't tell you is we will be right about the future. What I can tell you is that we have done our best to project the future. If we are right about the premium deficiency analysis, then we are book value neutral in the future. The risks are clear. The economic uncertainty, a loss is going to be much higher than we are projecting. They very well could be. But we have done our best to project out future losses, and if we have done it right, then ultimately, when all is said and done, the book value impact of that will be neutral. So you're saying historically (inaudible). That's right.. Not changed the methodology but changed the outcome. So in addition to reserving for current delinquencies, you're always supposed to do analysis on your future business. Frankly, up until last year, it was fairly obvious to us that our book of business would bring in more premiums than our existing loss reserves and losses. But now, with all the economic uncertainty, we started doing premium deficiency analysis several quarters ago, which up until second quarter we still thought it would be positive based on changes to our assumptions in the second quarter. We said uh-oh, future losses are going to be higher than our current loss reserves and future premiums, so we front loaded or took that charge in the second quarter. Thanks very much. DISCLAIMER Thomson Financial reserves the right to make changes to documents, content, or other information on this web site without obligation to notify any person of such changes. In the conference calls upon which Event Transcripts are based, companies may make projections or other forward-looking statements regarding a variety of items. Such forward-looking statements are based upon current expectations and involve risks and uncertainties. Actual results may differ materially from those stated in any forward-looking statement based on a number of important factors and risks, which are more specifically identified in the companies' most recent SEC filings. Although the companies may indicate and believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate or incorrect and, therefore, there can be no assurance that the results contemplated in the forward-looking statements will be realized. THE INFORMATION CONTAINED IN EVENT TRANSCRIPTS IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES THOMSON FINANCIAL OR THE APPLICABLE COMPANY ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY EVENT TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. 2008, Thomson Financial. All Rights Reserved. 2040718-2008-12-03T14:24:35.463 www.streetevents.com Contact Us 9