Radian Group Inc (RDN) 2002 Q2 法說會逐字稿

Good morning. I will be your conference facilitator today. At this time I would like to welcome everyone to the Radian Group third quarter conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer period. If you would like to ask a question during this time, press star and number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key.

Thank you. Mr. Filipps, you may begin your conference.

Good morning and thank you, everyone. Welcome to our third quarter call. With me this morning, Bob Quint, Tino Kamarck (ph), Roy Kasmar, Howard Yaruss, and assorted supporting staff.

We will go through our normal presentation. I'm going to give some highlights, some observations, some of our strategic objectives, and Bob will give some detailed review, and then we'll have some questions.

I'd like to open by saying I think we had a very very fine quarter this year this 3rd quarter. I'd like to make a couple of points around which we'll base the rest of the presentation.

We have continued to diversify our and income streams in accordance with our plan. We've told you that for the last 2 years and we are well on track to do that. We increased our net income 3rd quarter over 3rd quarter substantially in light of a very difficult market, and we are extraordinarily proud and pleased with that accomplishment.

We have continued to build the strength of our balance sheet. We've continued to add lost (ph) reserves and, again, we are proud of that accomplishment. We paid down our preferred stock, our preferred stock that was very expensive, and was a vestige of our IPO which was 10 years ago this month.

We saw an opportunity to execute a very wise, timely financial transaction, and in so doing, we also repurchased 1.4 million of our common shares outstanding. While we had a very good quarter in MI (ph), we had a drop-dead great quarter in our guarantee business, and we will continue to do that, and that will continue to drive earnings as we go forward. Again, a testament to our diversification plans, which we set out to accomplish over 2 years ago.

We have continued to focus on expenses and will continue to do so. You can see that in our expense ratios. Our financial guarantee ratio is continuing to come down as we continue to write more direct business. And our mortgage insurance expense ratio is at a very attractive 21.3%.

Of course, we have maintained our discipline and our focus, and you can see that in our participation in what we call the structured mortgage insurance business. In the 3rd quarter of this year, we found that business to be relatively unattractive in terms of the returns on our equity that we could employ, and therefore we employed our equity in other areas - as I've just said, repurchase of our shares, repurchase of the preferred, and the dedication of our equity to the structured products in the financial guarantee marketplace.

Now, that being said, I can also say two very positive things -- number 1, I think we have had a very strong and very successful start to the fourth quarter in the structured mortgage business and we have written substantial in the month of October. While we wrote $400 million in the entire quarter of this 3rd quarter of this year, we have written substantially more than that already in the 1st month of the 4th quarter. So we would expect that the 4th quarter will produce significantly greater success in the structured mortgage insurance business.

For those of you who don't know what the structured mortgage insurance business is, other people refer to that as bulk. We think that's a lousy way to describe it, and so we're talking about structured mortgage insurance business. And as you see the way we're going to be moving and directing our organizational efforts in the near term, I think that will become clearer to you.

Another very successful thing I will talk about is the most recent MBA, which we have just come back from. Those of you who know the industry, that is a time when everyone gets together and really positions relationships for next year. And over the last couple of weeks and culminated in the last couple of days, we have been highly successful, and I think that I can say that we have established relationships with 2 very major national lenders, and that should lead to substantial increase in market share, probably starting in the 1st quarter of next year in the traditional flow mortgage insurance business.

As we move on to the slides, for those of you are on our Webcast, you can see slide number 1, which shows our net income mix for the quarter. And in that slide, you will see that, of our net income, 68% of that was originated through our mortgage insurance operation, 26% of that through our financial guarantee business, and 6% of that has come from our mortgage and financial services business. Again, a very clear testament to our diversification strategy and through the benefits of our focus on the financial guarantee side of our business.

For those of you who recall, last quarter financial guarantee was about 19 percent of our net income, and with the outstanding results that they have continued to contribute, that is now up to 26 percent. We believe that that is going to continue.

In the mortgage services, that's off a little from last quarter, when it was about 12 or 13 percent, but please recall that we have told you and will continue to remind you, that is a rather lumpy business. So we think that that's the business that really must be measured on a year over year basis, and year over year the results are continuing to be outstanding.

As we look to slide number 2, you can see our business mix in terms of premium, premium written. Here again, the most important note that I would tell you is that net premium written is up 28 percent to $235 million, with 31 percent of that coming from our financial guarantee . And that's double the 2001 in the quarter, where we produced $72 million of net premium written -- that's double the same quarter in 2001. So, there again, a strong testimonial to our strategic plan and to the execution of that plan and program.

And it is coming from all the right areas. Very high-quality muni business. We continue to see our insured or wrapped (ph) products in that sector realizing a better and better spread compression. We think that, as our name and as our - the value of our product is recognized, that that spread compression will continue, and that validates our assumption that, as a AA participant in this market, there is a lively, growing, and valid market that we can participate in. That will continue to take a very high level of internal focus and attention.

And also, from our structured financial products group, where our focus has been on credit quality and, as you will see later, the credit quality in that group continues to be very very high in terms of new products that were underwritten this quarter.

In term of net income for quarter, net income was $106.6 million, up 16 percent compared to the $91.5 million in 3rd quarter last year, and for the first 9 months, earnings were 319.4 compared to 264.4 million for the 9 months of last year, and that's up an astounding 21 percent. I don't think that should be minimized in any way. I think everyone here is extremely excited and proud of the achievement of that was level of record earnings and growth.

And you can see in slide number 3, our net income continues to grow at very, very strong rates, and has over the last 6, 7 years.

The other thing that I'm very proud of is our operating cash flow, which for 9 months was $421 million. That's up 30 percent from $323 million in the 9 months of last year. That's going -- that operating cash flow, the strength of that, will continue to lead to net investment income growth and will give quality and sustainability to our income over the next years. So we are continuing to build our balance sheet, continuing to build reserves, and continuing to build a base to go forward with.

If you look at the next slide, where we show our net income per share, net income for the quarter was reported at $1.07; however, if you exclude the 3 cents that was used to redeem the preferred stock, our net income per share would have been reported at $1.10, and that would have been up 15% year over year 3rd quarter to 3rd quarter. Again, a pretty outstanding result.

Premium earned in the quarter 210 million, an increase of 16% compared to the 181 million in the 3rd quarter of 2001, and for the first nine months, premium earned grew 22 percent to $630 million as shown in slide number 5.

Slide number 6, you can see that our paid claims to incurred claims continues to be properly balanced for the quarter. Our net paid claims were about 47 million compared to 27 million a year ago, up substantially. As everyone knows and has everyone has heard, the paid claims in the mortgage insurance business have risen substantially over the last year, and as we look forward, they are likely to remain at this level and probably increase slightly over the next couple of quarters. So we have that well in our forecast. You should have that well imbedded into your forecast.

Nonetheless, our goal is to continue to build the reserves and continue to add to the strength of our balance sheet.

As can you see on the next slide, our total loss reserves have continued to build. At September 30 of this year, they were at $612 million. About 133 of that is in our financial guarantee business, and the rest was obviously in our mortgage and insurance business.

If you go to the next 2 slides, those are areas that are probably 2 of my favorites because I think what they do show is the strength, again, of our diversification plan, the fact that our business continues to build on multiple legs, and you can see that in our risk in force; at the end of September we had over $93 billion of risk in force (ph). Of that, 28 billion or 30 percent was in our mortgage insurance portfolio, and 65 billion or almost 70% was in our financial guarantee portfolio.

And importantly, of the 70 percent that is in the financial guarantee, 50 percent of that was attributable to the very, very high quality municipal business. Again, building a quality - a quality portfolio, a quality balance sheet.

And the last slide I'm going to talk about is the one that shows our mortgage insurance in force by asset quality. You can see there that the asset quality, I think, is very high. We have about 2.5 of that in the B&C product. That comes to us not because we want it, because honestly, I hate it. I don't think we should have any of our business in that category, but it does slip in . It comes to us indirectly through our lender partners. It comes to us sometimes in some of the structure products that we underwrite, and it's there.

We will not be increasing that substantially. In fact, I hope we don't increase it at all. We're at the level we should be at. We do have about 9 percent of our business in the all-day product. For those of you who were at or listened to or participated in our investor conference, you saw that we believe that that is a high quality and high ROE business. We're pleased with the 9 percent we have in that category and we'll be holding or add to that.

A couple last points I would make -- we want to talk about where we are with our lean protection products. That is still being held up in the California courts. We believe we made a very strong case. We are very optimistic about the outcome of that. We are continuing to hold capacity at Radian Express to provide for that product, and as a result, in this quarter, that actually had a slight depressing effect on our net income. Having that capacity idle in that subsidiary is a high cost of doing business without having the product flow-through that we had expected, but we are very confident that we will be delivering that product to the marketplace and so we have made the decision to hold that capacity in place.

If that were to change, we would change some of that outlook and some of that decision, but I can also tell you again that, having come back from the MBA, the demand for that product is just as strong as ever -- in fact, probably stronger. If anything, the notoriety around this case has brought to lenders that we didn't talk to about this product the awareness that this product is out there, the validity of the product, and the demand on the lenders' part is increasing.

So, as soon as we get over this court (ph) hurdle, we will be writing this product. We will be writing it as aggressively and ambitiously as possible, and we would use that as a base to add to the operating profits in our mortgage services business.

So, for those of you in the (inaudible) world who are listening, I can tell you that we aren't marketing this product, but the demand was very high. So you guys ought to get out there and do something and get it validated instead of fighting it in court, because the market will always win.

With that I'll turn it over to Bob and he'll give you more details.

Thank you, and good morning. Following the Webcast slides that Frank spoke about, there are a number of other slides that we have presented this quarter with a lot of results and statistics about the quarter. Many of them are updates of slides that you've seen on our investor day. We're not going to speak specifically about them, but they are there for your information, and we are -- will be glad to answer any questions about them.

The financial results this quarter really, to repeat what Frank said, highlighted by phenomenal financial guarantee segment performance. We grow overall top line very very well despite the challenges in the mortgage insurance in-force (ph). We had very very strong operating cash flow. That is consistent and a theme for our company. We had a decrease in operating expenses this quarter, and we also had a meaningful increase in the book value of our investment portfolio.

Revenue growth for the third quarter was 15 percent from the 3rd quarter of '01, including almost 7 percent in the mortgage insurance segment. We saw a sequential decline in premiums earned in the mortgage insurance segment. Three real reasons for that --, one which is obviously because of persistency staying low; two, because of our lack of participation in the structured MI market -- that was clearly our choice and was return-related; and also third, which isn't as apparent to see is the continued run-off of the rating insurance book, which is mostly 2nd mortgages and other structured mortgage products.

Premiums earned rating insurance (ph) were 7.2 million for the third quarter. That compares with 14 million in the 3rd quarter of 2001.

In addition to the great news that Frank spoke about relating to new large national accounts that we're going to do a lot of business with and the improving trends we're seeing in the structured MI market, we are also expecting to write some structured business in Radian Insurance in the fourth quarter, and that's going to help offset what will most definitely be another low persistency quarter, and we should be able to keep our insurance in force at least flat for the quarter, and also premiums earned at least flat for the quarter until persistency picks up. And right now we're not (ph) looking at at least the 2nd quarter of '03 for persistency to pick up.

Financial guarantee premiums obviously grew meaningfully. They're up 67 percent premiums earned from September '01 and 10 percent sequentially from the 2nd quarter. As importantly as that, we've been following the future lock-in premium value, and it's really astounding. If you look at numbers, we grew unearned premiums by 24 million in the quarter - that makes $74 million year to date, and we've grown the future value of installments $25 million in the quarter and $153 million year to date. That's $227 million of future financial guaranteed earned premium that we have produced just in the three quarters of this year's new business. That's a 31 percent increase over what it was, and that compares only to a 5 percent increase in the risk or the exposure that we have grown. So we're obviously writing very high quality profitable business. Between half and two-thirds of this premium will be booked over 5 years or less.

In addition, earned premiums coming from refundings were low this quarter. That was somewhat unexpected for us, but it further highlights the strong growth inherent in the financial guarantee earned premium.

Investment income continues to grow very well, as it has been our pattern of strong cash flow being the main reason for that. And one of the natural offsets to the persistency issues on the MI book has been a meaningful increase in our portfolio value. We've also been able to realize $5.7 million of real cash gains on sales of investments this quarter.

Equity in affiliates had another strong quarter. We know it's going to be lumpy, and certainly this quarter is an example of that, but another strong quarter, and we do expect the fourth quarter to be at least as good as the 3rd. We are very, very pleased with Seabass (ph) and Sherman, and they're running these businesses with discipline, the same kind of return on equity focus that we consider so important to our core business.

Other income declined a lot (ph) this quarter, primarily due to issues around Radian Link Protection (ph). And that in turn caused a pretax loss in Radian Express of $3.1 million for the quarter. We did a very successful job reducing expenses in Radian Express throughout the quarter, and we've done enough to expect a fourth quarter loss in Radian Express of something around half of what it was in the 3rd quarter. And obviously we have a great infrastructure ready to support Radian Link Protection (ph) when that product begins to be written again.

Losses continue to perform very well, as expected, both on the delinquency side and the paid loss side. Our increase in the number of delinquencies from year end total is only 1,400, and that's made up of an increase of 2,700 on the primary side and a reduction of 1,300 on the pool side. We've added $14 million to reserves on the MI side to support these delinquencies. That's consistent with the reserve practices we've always followed, which are very conservative.

The delinquency are very much in line by product, and importantly, the delinquency rate increase from year-end and from June is very much a function of the denominator going down as much as it is the numerator going up. So if you look at the number of delinquencies that have increased, it's very low; our denominator has not grown as much, and the delinquency rates have gone up.

Very important, loss reserves for dollar of risk enforce (ph) at September 30 were up to 172 basis point, the highest they've ever been. That compares to 167 basis points in June, so it's up 5 basis points, and that's by far the highest in the industry.

Claims paid, again, very much as expected. Second (ph) did tick back up a little bit, but no concerns there. We expect it will go back down next quarter, but you should expect to see generally a claims pace increase over the next several quarters at similar levels to what you've seen over the past year or so.

Financial guarantee losses were as expected. All of claims paid pertained to trade credit, and we have continued to build nonspecific reserves supporting the additional business we have written.

On the expense side, we have had a reduction - a couple of things there. One, Radian Express -- the expense reductions at Radian Express were pretty meaningful. They didn't offset all the loss of income, but they were meaningful. We also, because we wrote less MI business, there were lower expenses. In addition, we have some stock-based compensation awards that require variable accounting, and therefore there were some reduced expenses this quarter that are related to stock price decline.

One very positive trend that is noteworthy and really jumps out is the expense ratio and financial guarantee . It was down 30 percent this quarter. If you look at that last quarter it was over 40 percent. 2 reasons - one is the growth in the book of business. Generally we're spreading expenses over a bigger section of premiums. And also the mix shift to more direct business where we have more control over the expenses, and therefore the expense ratio in the direct business is much lower. That's a very positive trend.

We did have a $5 million mark to market loss on our FAS 133 derivatives booked during the quarter, resulting from continuing widening spread and also from our value loss in equity components of our convert. Unlike realized gains, this is not a cash flow item.

We have zero loss reserves on our direct CDO business, and we only have a very small loss reserve on our reinsurance book of CDOs.

Finally, I just want to talk a little bit about capital. You've heard from us consistently how important capital allocation is, and our discipline this quarter with regard to capital allocation did have some short-term impact on the MI top line. We're going to continue to run the business this way. We feel it's the right way for long-term return maximization. One of the results of this quarter is an even better, stronger capitalized MI company. Our ERISA capital ratio down to 11.9 to one. The financial guarantee business will need additional capital to support 3 to 5 year business plan. Some of this capital could be redeployed from the MI segment on a gradual efficient baize. Other capital could be redeployed from the financial guarantee reinsurance business, depending on how attractive that business is to us and what the marketplace demand regarding that product.

We demonstrated our willingness to buy back stock if we see the opportunity in the marketplace, and we really just want to emphasize that we are not only in the credit enhancement business, but we're in the capital allocation business, and we think that our ability to allocate our capital efficiently is a real positive for the company.

We'd now look to turn the conference over to questions.

At this time, I would like to remind everyone, in order to ask a question, please press star 1 on your telephone keypad.

We will pause for a moment to compile the roster.

Your first question comes from Rob Bryan (ph).

Rob Bryan (ph): Good morning. Could you give the year to date breakdown of the profits generated within financial guarantee from the reinsurance versus the direct business? Obviously the growth is towards the direct business, but where does it stand year to date? And then provide some detail on when you typically negotiate your bond insurance treaties. And what information might be missing at this point to allow those typical year-end negotiations to occur?

Well, I'll address the earnings, and then Tino (ph) can talk about the reinsurance.

You're right - the direct business is growing a lot faster and premiums written on the direct side are much higher now. But from a net income standpoint, the direct side is probably a little bit higher, but not much. It was sort of 50/50 at the beginning of the year, and that's skewed even more toward the direct. But there's still a good deal of imbedded premiums earned from the (inaudible).

Tino Kamarck (ph): And Rob, in terms of the - as you know, our treaty business is annual renewal, and the renewals for our 4 material treaty relationships are somewhat staggered over the year. If I'm remembering correctly, we have two that are calendar year, a third that is first quarter, and the fourth is as of end of second quarter.

So we kind of approach those different times in the year. Obviously these are close working partnership relationships that require us to be in close consultation with our clients throughout the year, as we are now.

With respect to your question about information that may be needed to - on either side for fully informed discussions about the upcoming renewals, that's complicated. It changes every year as the relative efficiency vis-a-vis alternatives in the marketplace of mono-line (ph) reinsurance might (ph) vary, our alternative uses of - (inaudible) uses of the capital might vary year to year.

I think what you're looking for there is that there's been some suggestion publicly that S&T (ph) might be reconsidering the methodology they use to compute the capital release credit for reinsurance at different ratings levels. And to the extent that that is true and that does change, that obviously will be an important moving part that will change the picture for the upcoming renewals.

Rob Bryan (ph): Thank you.

Next question comes from Jeffrey Dunn (ph).

Jeffrey Dunn (ph): Good morning guys. Two questions. First, on the new insurance written on the flow business, that's dropped off this year somewhat. Is that due to credit competition or you being more conservative in the business you're going after? Two, can you give us some color on what type of business you're writing in the direct municipal line?

Relative to the MI business, I'd say we are continuing our disciplined approach around what we're willing to do as it relates to return on equity and the risks that we're willing to take. So I think that's a continuation of that strategy. And where we're able to opportunistically take advantage of the market, we do that, but still relying on our expectations of ROE and risk.

Jeffrey Dunn (ph): Looking at just sort of the trends of originations, it doesn't seem like your shares track that. Are competitors being more aggressive in the high volume period?

I don't see competition changing dramatically, but I would also remind you, as Frank mentioned earlier in the call, that we have two major accounts at the national account level, so that's going to have a meaningful impact in the business going forward into 2003.

I think Bob and Frank both mentioned, on the bulk side, we are well ahead of certainly the 3rd quarter's volume, and we are opportunistically, again assessing that market. When the ROEs and risk are acceptable to us, we're taking advantage of it. So I think -- we're picking our spots where it makes sense, and we can be successful when we like the ROE and when we like the risk that is available to us.

Your next question comes from Howard Shapiro (ph).

If you could hold on, we have a second half of that question.

What specifically are you interested in with respect to the muni direct business?

In terms of the product types there, as you know, our consistent strategy has been to find and pursue the niches in the muni bond insurance market that are -- have been underserved by the AAA direct writers of municipal bond insurance.

And in general, those can be categorized as the smaller deals, the more complicated deals, and the classes of business that for one reason or another have been out of favor where we have been able to find that there are underwriting criteria and structuring standards that allow us to do sound business.

Okay, we can take the next question now.

Your next question comes from Howard Shapiro (ph).

Howard Shapiro (ph): Good morning. Two questions. Yesterday, Magic (ph) announced that they are no longer going to enter into captive reinsurance arrangements that require them to see (ph) more than 25 percent of the premium. Just wondering if you guys have formulated a response yet, if you would go along with that kind of a position.

And along those lines, what percentage of your new insurance written right now is subject to arrangements above 25 percent? And Bob, a numbers question -- if you want to follow-up offline that's fine -- in the financial guarantee business, the par (ph) written in the quarter.

We have also heard the rumor that MEIC (ph) has ...

Howard Shapiro (ph): It's not a rumor -- it's a filing. It was an 8-K last night.

Okay. Then we have also heard this information, and we want to see how it plays out in the marketplace. I'm not sure it's totally clear how they're going to implement that, so I think we'll wait and see a little bit as to how that plays out and then how we would respond to that.

Secondly, as it relates to the amount of business above 25 percent - I don't have the exact number in front of me, but it is relatively small. We have only a handful of customers that we have done this with. So it's not as meaningful to us as it is to some other players.

Howard, the amount of business we did in captive was one-third exactly. And the amount of premiums we seeded in captives is 8 percent. So if you do that math, it's almost 25 percent right on the nose. So we do have just a very small amount above 25, but you can see the average is 25, so it's not much at all.

Can we follow-up with you on the par?

Howard Shapiro (ph): Absolutely.

Howard (ph), I would ask, if they filed an 8-K stating that they weren't going to do anything over 25, do they have to file an 8-K if they ever do anything over 25 again?

Howard Shapiro (ph): I'm not a lawyer. Good question.

We'll keep our ears open. If we hear anything, we'll let you know. You can send it to your legal department.

Next question comes Mitch Press (ph).

Makiko Coakley (ph): Hi -- Makiko Coakley (ph), Unterberg Capital (ph).

The expense reduction this quarter was really impressive, and I was wondering if you could actually give us the number of expense reductions at Radian Express and also the stock compensation-related expense savings in dollar amounts?

Yeah. The expense reductions in ratings were a couple million -- probably a little less than $2 million. Obviously, the other income reductions were more than that. So, net it was negative. And the other number had an impact of about 1.5 million on expense.

Makiko Coakley (ph): And the Radian (inaudible) expenses will continue to go down, or you are at the minimum level right now?

We're at the level, but it took the whole quarter to reduce. The run rate is less than the rate it was for the quarter because we really ramped down during the quarter.

Makiko Coakley (ph): So run rate is low.

Yes. Basically what we're saying is that, because the (inaudible) protection issue is still out there, we don't expect income to go up meaningfully in the fourth quarter, but we're saying the net loss will be half of what it was. So it was 3.1, it's going to be 1.5 million.

Makiko Coakley (ph): And the tax rate this quarter was lower by about one cent?

I'm sorry?

Makiko Coakley (ph): The tax rate?

For the quarter -- yeah, the - you really have to look at the tax rate on a year to date basis. We're consistently updating the year to date numbers. So sometimes from - in an individual quarter it might be a little higher or a little lower based on different mix of tax-advantaged income et cetera. So, if you look at year to date number, it's pretty much consistent with where it's been and really right on. That's not a trend that you will see continuously.

Makiko Coakley (ph): Okay, thank you.

Next question comes from Tom Benbarser (ph).

Tom Benbarser (ph): In term of your plans to gradually sort of redeploy capital in financial guarantee away from the muni reinsurance business into other parts of the business, what kind of pace do you think that will go on? And how does that change -- how quickly could you do that in the event that the rating downgrade in reinsurance might have some impact on your ability to continue to reinsure business with the AAAs.

I think we are actively looking at how to restack our capital right now. I would tell you, based on everything we have reviewed and investigated, what we're unlikely to be doing would be any massive reallocation of capital amongst the subsidiary companies from Radian Re (ph) to Radian Asset (ph). There may be some of that, but in all likelihood, we will figure out ways in which to just make that capital more available across our product lines on a consolidated basis.

So, while we had $600 million plus in our reinsurance company and $300 million plus in our direct writing company, the way we're looking at it internally now is that we have $1 billion available for reinsurance or direct business, and we're going to use that, and we have been using it effectively since we made that announcement 2 weeks ago. That is our business plan. So we now look at it as being a billion-dollar financial guarantee reinsurance and direct writing organization.

So in essence, the capital has already been fully deployed.

Tom Benbarser (ph): Thanks.

If you would like to ask a question, please press star 1 on your telephone key pad.

At this time there are no further questions.

Well, if there are no further questions, we thank you, and we will talk to you again in a couple of months.

That concludes today's conference. You may now disconnect.