Radian Group Inc (RDN) 2004 Q2 法說會逐字稿

Good morning. My name is Chatina (ph) and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Radian second 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. (OPERATOR INSTRUCTIONS) I would now like to turn the conference over to Mona Zeehandelaar. Please go ahead, ma'am.

Thank you and thank you for joining us today. With me on the call are Frank Filipps, Bob Quint, Roy Kasmar, and Tino Kamarck. Before I turn the call over to Frank, as we do each quarter, let me remind you that today's conference call will contain statements that are forward-looking. As you know, these statements are based on current expectations that are subject to risk and uncertainty. Radian's actual results may differ materially from those expressed or indicated by forward-looking statements.

Factors that can affect Radian's performance are described in our 10-K and in our other filings with the SEC. Let me now turn the call over to Frank Filipps, Chairman and CEO of Radian.

Thank you, Mona. Welcome, everyone. As usual, I will focus my comments today on some highlights and areas of interest, and then we will turn over to Bob for a more complete presentation on the financials, and of course then we will take your questions. For those of you who are logged onto our webcast, the slides that are provided there are provided as background and should be used as supplements and complements to our remarks of today.

Overall, I would characterize the second quarter as a good quarter and an excellent example of how our strategy to diversify our sources of revenue and income around our core competencies continue to produce both earnings and book value growth. Despite the challenges in the Mortgage Insurance and the Financial Guaranty environments, net income grew 8 percent over the quarter to $121 million, and premium written was up strong, 21 percent, over last year to $331 million. Book value was $35.79, up 10 percent over the second quarter of last year, and adjusted book value was $50.54, up 8 percent year-over-year.

As we have said in the past, we believe that adjusted book value is an important measure of the embedded value of the Company and something that you should consider strongly. Although it is not a GAAP measure, it does take our existing book value and our estimations and assumptions about future premiums, losses, and expenses, and give a look at what we believe is the true value of the Company. You should note this does not include any of the embedded value that we believe, and the embedded earnings that we believe, are in Sherman and C-BASS, and we believe that that is another strong component. But since this calculation is done on our insurance businesses, it does not reflect either of those.

I am reminded that I should say that there is a reconciliation of the adjusted book value to GAAP book value posted on our website for those of you who would like to see that in more detail.

As we look at the quarter and our goals, I would remind you that a couple of years ago we showed goals that net income from our non-Mortgage Insurance sources would be about 50 percent. And for the first time, in the second quarter of this year, we achieved that. We achieved that by strong growth contributed from both C-BASS and Sherman, which amounted to 25 percent of our net income. And while some of the income from C-BASS may fluctuate, we do believe that the majority of that is becoming more recurring income. We will give you more details on that.

And we will be giving you more visibility into those two companies in the future. We believe that they are strong components of Radian Group. We believe that they add synergistic opportunities to us. We believe that they are companies that we understand and help direct and manage, and we will give some examples of that as we go forward. So they are strong components of our group. They are strong components of our core competencies, and we value them very highly.

If you look at C-BASS, the percentage of recurring income in the first half of 2004 was about 64 percent. And there again, we think that is a very high-quality income, and that is growing. We look at Sherman, we believe there is great synergies there as well. If you look at both of these companies, we talk about tight spreads in the mortgage insurance business. One of the reasons that C-BASS was able to have such an outstanding quarter was the very tight spreads that existed in the rest of the mortgage business. So we see this as a real complement to our business. It's one that we understand very well and continue to place strong emphasis on growing.

When we look at Sherman, here again, we see great synergies available to us. In fact, in recent months, at Radian in our financial guaranty business, we wrapped two structured deals for Sherman, about $150 million worth of Sherman financial credit card master trust. Here again, when we are seeing very tight conditions in the ABS market, Sherman is able to issue into that market using the very same tight characteristics of that market. We provided the wrap and we believe that is the kind of ability that we have that sets us apart. So when we look at these companies, we see them as a long-term part of Radian Group. We see them as adding value, and we clearly see the synergy that we set out to achieve a couple of years ago.

Other points of note, on June 1 we announced the merger of Radian Reinsurance and Radian Asset Assurance. That combined company now has $1.2 billion in statutory capital, $2.7 billion in claims paying resources, and our insured portfolio is about $65 billion. The risk is more diversified than it had been in either of the individual companies. We now have greater capital, which allows for higher both regulatory and rating agency single-risk exposure limits, and as such, we have completed that. We think that the ability to continue to write business both on the reinsurance and the direct side of the financial guaranty business is very strong, and we believe that we will continue to grow that business in a very, very positive and effective way.

Helping us along that way toward that goal, we received a Aa3 rating from Moody's. That is the first time that Radian Asset Assurance has been rated. The rating for us opens up new sources of fixed income investors, as well as additional counterparties, many of whom, if not all of whom, previously had the requirement of a Moody's rating in order to deal with a financial guaranty company. So we believe that again helps us in opening up this market and driving new opportunities as well. So again, we are comfortable with looking at the financial guaranty business and seeing that as a real growth engine in the future for Radian.

In addition on the rating agency front, in May, S&P affirmed our AA ratings and noted our strong capital resources and the viable niche that the financial guaranty business -- that the Double A financial guaranty business is situated in. I would add that our capital ratios in the financial guaranty world are among the strongest in the industry, and capital adequacy has not been a concern of any of the agencies that we deal with.

Internationally, we are pleased to report that S&P rated Radian Asset Assurance Limited, our UK subsidiary, AA yesterday as well. This will clearly enable that company to grow in that business. The company will grow throughout the EU through the European passport. We expect that we will be active in those markets in the coming quarters.

On the financial side, we completed, as we told you before, a 2.5 million share repurchase program in the first quarter. And in May, our Board of Directors authorized a new $3 million share repurchase program. Under that program to date, we have repurchased 958,000 shares at an average price of $46.81, for a total cost of just under $45 million.

Turning to our businesses, as I said before, the Mortgage Insurance business environment continues to be a challenging one. And you can see the evidence of that in the amount of new insurance that we have written, as well as our insurance in force. Both of those have been sluggish by our standards. But there are positive signs and those positive signs are in the areas of credit and persistency.

In addition, another positive sign to Radian has been in looking at our market share in the mortgage insurance business. We have continued to gain share over the last several quarters. Q1 was about 17.5 percent, and we believe that in Q2 that may be up a bit.

There are some challenges in the industry. First, the biggest challenge probably for that industry is the competitive product known as 80-10-10. It continues to be a key issue for our mortgage insurance business. It is clearly taking away opportunities for mortgage insurance, and we are focusing on internally our options to deal with that in creating new products and creating different alternatives. We think 80-10-10s, the popularity of them, is a reaction to current interest rate environment, the current spread environment, and that can change as both interest rates and spreads change. We believe that with some of the new products that we have in the our R&D lab, that will help with that.

In addition, one of the things that we see as a growth opportunity in the Mortgage Insurance business has been the growth of the subprime market. We believe that market will continue to grow and we plan to play a major role in that market, while carefully managing our portfolio quality and portfolio limits on the nonprime risk business that we put on our books.

In addition, we have been very active and prudent in our subprime market activity and our net interest margin product. To date in that product, we have written about 52 deals, and we have earned over $100 million of premium for wrapping those NIM products, all of which has occurred without a single loss in that product line. So that product line in terms of our development that we are excited about has been very profitable for us. We are continuing to look for new adaptations of that as the market continues to grow and change.

If you continue to look at the mortgage market this year, estimates are coming down as to volume of new originations. We believe the consensus right now is about 2.4 trillion. We are looking at a market of 2.4 at the high end and perhaps a little bit lower than that. Most important is that the purchase money market and housing activity do remain strong across the board, with no signs of weakness and clearly no bubble, no major bubble or market bubble occurring.

Persistency is another factor that has had significant impact in the mortgage insurance business. Our persistency has really bounced around this entire year. We had said last quarter that if interest rates were to stay above 4.5 percent, our persistency would be in the low 60s. However, the 10-year went over 4.5 for a short time, back down to 4.3 currently, just under 4.5, and so our persistency -- the persistency numbers that you have seen has been affected by that. We are still optimistic that persistency will continue to grow a little over the rest of the year, but that is a function of interest rates.

Regarding our credit in our mortgage insurance portfolio, the overall number of defaults were down from year-end, but stable as it relates to the first quarter. We think that is encouraging for the following reason. For the past three years, we have seen a seasonal drop in defaults in Q1, followed by an increase in Q2. That did not happen this year, so we are hoping that is a leading indicator of improving performance in the credit quality of the portfolio to come.

With regard to captives, I think the only thing I can say there is that we have no change to our policy at all. We have said that we will look at captives on an individual basis with each individual customer and determine the profitability of that relationship, and as a result of the profitability, we will determine the level of captive relationship that can be included in that.

If we turn to our financial guaranty business, the second-quarter production was very, very solid, despite a very tight credit environment. We believe we have regained some ground and are continuing to gain ground that we lost earlier in this year as a result of the setbacks that occurred from the Conseco loss and the MBIA clawback. The ratings that we have, the new ratings from Moody's, the stable rating from S&P, will help us a long way toward getting our business back into strong growth as we go forward.

Competitively, we have not seen any changes in our position in the industry. And as I watch our trading spreads in the credit derivatives markets, they are continuing to improve; so again, we are optimistic about that. We are making progress in deploying the capital freed up by the MBIA clawback. Included in the portfolio taken back by MBIA was $2.6 billion in par -- in capacity-constrained names, capacity that we believe we can deploy at higher premium rates in the coming quarters. To date, we have approved requests to take on new exposures to those constrained names in the amount of $762 million. So we think we will have the 2.6 replaced, at this rate, sometime next year.

We are confident about the growth opportunities in the direct business. We had a very strong quarter in our structured financial products markets, where we wrote $35 million of new premium risk. We continue to view the reinsurance business in both financial guaranty worlds and we see those as opportunities to diversify revenue and our portfolio risk. With that, let me turn it over to Bob.

Good morning. As always, I'm going to be providing some details that will help explain some of our key numbers and trends in our second-quarter financial results.

Starting with the MI business, the MI earned premium was down a little bit from the first quarter, and that reflects a decline in the insurance in force, along with a higher percentage of captive reinsurance premiums ceded, and that makes sense in light of our relative reduction in structured transactions over the last several quarters -- structured transactions not being attached to captive, and the rest of the business containing a higher concentration of captive.

We do believe that the increase in persistency and the corresponding decline in new writings for the balance of the year will produce flattish insurance in force. However, we do expect small increases in earned premium over the balance of the year, as pool insurance and other structured products premiums do increase.

You will notice an unusually large increase in MI unearned premiums this quarter. This is a result of a large, structured transaction for one lender that is being paid is an upfront single premium; and therefore, as we book the business, unearned premium reserve will go up. The transaction is being recorded as pool insurance, and is thus not included in our new insurance written or our insurance in force figures. However, the insurance written on this transaction just in the second quarter was in the $3 billion range. We expect to continue to write this business in big chunks for the balance of the year, which will impact both unearned premiums and start to come into premiums earned fairly meaningfully in the 2005/2006 years and beyond.

As we told you last quarter, we have reduced significantly the amount of lower FICO Alt-A business that we have written. This category, consisting of Alt-A loans below 660 FICO, represents a 13.9 percent of the Alt-A new insurance written this quarter, as compared to 19.5 percent in the first quarter and 23.7 percent a year ago. The percentage in force went from 25.7 percent of Alt-A in force at March 31 to 24 percent at June 30, and this is a trend that will definitely continue, hopefully at an even more rapid pace.

The continuation of our positive delinquency trend will likely bode well for 2005 claims. We stand by our 2004 claims paid guidance, which means that claims payable continue to increase for the next two quarters, but then we expect a flattening out of paid claims at fourth-quarter 2004 levels. We are also happy to report that we have reduced our inventory of claims or claims waiting to be paid. That is another positive leading indicator for 2005 claims.

We have remained consistent with our loss provisioning, as witnessed by our continuing to increase our loss reserves this quarter, and we continue to believe that our loss reserves are very strong. We are very proud of our loss mitigation efforts on both first- and second-lien business. We have saved many millions of dollars by paying the full claim and selling properties ourselves, by modifying loans and by collecting from delinquent borrowers who do have the resources to pay. Our loss mitigation efforts have never been more active than we are currently.

Expenses on the MI side will likely continue in this range for the balance of the year. This quarter, contract underwriting costs were up, along with IT expenditures and the amortization of IT projects that have been placed into service this year, as well as increased compliance cost, such as Sarbanes-Oxley compliance. Offsetting these increases this quarter was a big reduction in the contract underwriting remedy reserve charge, which, as you recall, we booked a larger charge in the first quarter.

Turning to financial guaranty, premium results this quarter reflect a normalized quarter with strong new ratings across our different product offerings. One note on structured finance direct is that the quarter did include an inordinate amount of single premium upfront business, which did inflate the written premium line some. Over half of that $35 million in premiums written was upfront premiums. Despite this, and despite a tight spread environment, Radian was still able to book a good amount of high-quality, high-return transactions in the second quarter.

Second quarter was clearly a low point for earned premiums, as negligible refundings, combined with a full-quarter impact of the MBIA clawback, reduced earned premiums. Even though the clawback occurred in the first quarter, we still booked $4.6 million of premiums earned on MBIA business during the first quarter. That number was close to zero in the second quarter.

Growth at a stable pace in earned premiums in the financial guaranty business should resume in the third quarter. Losses incurred this quarter are very normal in the financial guaranty business, but paid claims are not, and that deserves some attention. The $30.8 million of paid claims included $8.6 million of trade credit, 7.7 million from Conseco, $9.2 million from two old public finance transactions that were fully reserved for a long time and happened to be paid this quarter, and $2.9 million for a reinsurance transaction. The third and fourth quarters should be back to normal, with Conseco and trade credit absorbing the bulk of the paids in those periods.

Although our loss reserve declined during the quarter, we feel that the quality of those reserves improved, as much more of the reserve is dedicated to a nonspecific items which support the entire book of business, as opposed to a known specific item. Excluding Conseco, which is fully reserved for, nonspecific reserves as a percentage of the total reserve went from 48 percent of total reserves at June 30, '03 to 66 percent at June 30, '04, and the amount of nonspecific reserves grew during that time from $77 million to over 100. By any comparative measure, our financial guaranty loss reserves are very strong.

The financial guaranty business clearly has several (PH) hundred million dollars of excess capital that we are in the process of deploying, but the tight spread environment means that it will likely take the longer end of our projected range to redeploy this capital. As we have demonstrated during this quarter, we are still very confident that will be able to do this.

As Frank mentioned, the financial services segments was a positive highlight during the quarter. We have begun to provide more specific disclosure regarding C-BASS and Sherman, as they are meaningful to our business and an important component of our diversification strategy. C-BASS had a fantastic quarter, highlighted by several transactions that will not repeat in the second half of the year. Nonetheless, they are transactions that fully reflect what C-BASS sets out to do in their business model. They might not recur every quarter, but that doesn't take away from their quality.

Much of the gain on sale they book represents cash gains as opposed to value in individual securities, and the part that is generated by valuing residuals is done carefully and conservatively, with prepayment and discount rate assumptions that compare very favorably with any published assumptions that we have seen. We do expect that about two-thirds of the calendar year income at C-BASS was (ph) recognized in the first half of the year.

As for Sherman, their extreme success is a result of steady growth in their consumer asset portfolio. Their income is of a very high-quality, not driven by sales or securitizations, but rather by collections of the assets that they own. Although the second half of the year for Sherman is usually seasonally down due to normal collection patterns, their results should remain solid and strong.

Please note that our book value and adjusted book value, which have grown consistently year after year, which is part of our overall strategy -- for the current quarter, this growth was very small, and that was specifically due to a reduction in other comprehensive income, and that was driven by interest rate increases, which reduced the unrealized gains in our fixed-income investment portfolio.

Finally, I would like to address our contingent convertible debt outstanding which is $220 million. There is a possible change in the accounting treatment for this instrument which would potentially reduce diluted earnings per share by between 3 and 4 percent. When we did this financing an early 2002, we viewed it as very low-cost debt, while understanding very well the potential implications of convertibility. Regardless of the accounting, that is what we thought and why we did the transaction. Under the current market conditions, we would expect to exercise our call rights in January, 2005, and most likely refinance into very favorable market. Therefore, any accounting changes, if they do occur, would only impact periods prior to the refinancing and would be a nonevent for earning periods subsequent to the refinancing. We would now like to turn the call over for questions.

Thank you. (OPERATOR INSTRUCTIONS) AJ Grewal of Smith Barney.

Could you -- I know you mentioned that claims paid should rise, but could you give us an idea of the ball park where you expect that, and where do you think reserve building is going to go? Secondly, I was just trying to reconcile your numbers for C-BASS relative to what MGIC (ph) has reported. And they're off slightly, and I'm just trying to understand what the difference is between the two. Thank you.

All we can tell you is that what we book on C-BASS and Sherman is we book our percentage ownership of their earnings; so that is what we book. I can't talk to the differences.

Do you not own the same amount?

No, we own the same amount. Claims paid on the MI side will rise a little bit in the third quarter, a little bit in the fourth quarter. And the total for the year will tie into our previous guidance, which was $100 million more than last year in total.

And our reserve building will be consistent with what we've always done, and it is more related to delinquency trends, and those are dependent on a lot of things, seasoning, the economy, jobs, etc. But if delinquencies rise, our reserve will rise. If delinquencies flatten out, our reserve will probably be in the range that it was in for the first couple quarters.

What is the normal run rate for claims in the financial guaranty business?

If you look at trade credit, that we have spoken about a lot, that behaves more like a P&C business where claims are somewhere in the 60 percent range, and that has been fairly consistent. Conseco, you know, is on a run rate that is consistent. So if you look at those two components, that is going to make up the bulk of claims in the third and fourth quarters. Any claims paid on financial guaranty other than that will be unusual.

This quarter, there happened to be a couple of claims from old deals that were reserved in the case reserve for a long time, but they were finalized and settled this quarter. So the run rate, I think, this quarter is unusual. The run rate is -- if you look at most of the previous quarters, that is going to be our run rate, and it is going to be trade credit and Conseco making up the bulk of the paid.

Thank you.

Paul Miller with FBR.

Thank you very much. Can you just go into a little bit more detail about insurance in force growth? Some of your competitors are out there saying that insurance in force growth could be very weak, even into next year. And they referred to things like penetration rates on the purchase market and the refi market are at all-time lows. I know you talked a little bit about how interest rate volatility this quarter has given a lot of difficulty to (indiscernible) to the future in the second half. But if you could sit there and just talk about your penetration rate and where you do you see insurance in force growing over the next four to six quarters, that would really help.

I think we see some of that growth coming from our structured products. We see it coming from the nonprime business; not necessarily the subprime, but nonprime. We have a number of efforts under development in those product areas. And that is also the fastest-growing market segment in the mortgage market itself. So we see it perhaps a little bit differently.

When you're talking about your nonprime, a lot of people have been talking about -- are you talking about the bulk business or are you talking about other parts of the business outside of the bulk. And is the tightening of the credit spreads, is that hindering your penetration in the nonprime space?

We're looking at nonprime as the A- business and the Alt-A business. Much of that is originated on a flow basis for us. A good portion of it comes from the structured products. And we see that market as still a pretty active market. It is credit-spread and demand driven, but we are still seeing some opportunities. As Bob mentioned, we did do one transaction that was about $3 billion that did not get recorded for because of structural reasons as a structured product, and in fact was recorded as a pool product. But that is the kind of product that we are seeing, and we see them as being out there. So we may have a slightly different view than everyone else.

Thank you very much.

Robert Hottensen with Goldman Sachs.

Two questions, one on the financial guaranty and one on the mortgage insurance. On the financial guaranty, one suggestion is that -- we think of financial guaranty as a low-severity business. And when we get the trade credits in here, it really distorts the numbers. And with the Conseco losses, it is very difficult to tell what the quality of the reserving and the overall portfolio is. You did talk about unallocated reserves and so forth. But you may consider, since it is a P&C type of thing with much higher structural loss rates, it just might be more appropriate to look at the financial guaranty business X the trade credit business.

And I would ask several questions then. The first is that in the trade credits, are you seeing any improvement in margins or industry conditions? I guess AGO has exited that business -- whether there's any structural improvement in that business. So that would be a question there.

And the second is that in the Conseco transaction, are you seeing the actual claims that are being paid above or below the expectations you had when you reserved for the Conseco transaction in the first quarter?

The final question -- and I'll just ask them all now -- on the mortgage insurance area, you expressed the claims activity as unit sizes. There was some issue with some of the business that you were writing, where you had the most severe losses and the highest frequency in loans that had the highest dollar balances, particularly in the Alt-A area. Are you seeing that kind of thing when you talk about the number of claims paid, and is that part of the reason why there is a lag between the improving trends in delinquencies and higher claims paid over the course of the next couple of quarters?

I hope I have all your questions. Let me see (multiple speakers).

It's really only three.

I'll address them. In trade credit, you are right. It is a different business in (ph) the financial guaranty. We approach it right now only on a reinsurance basis. We do describe and break out the claims that are paid in that business, because we do understand that it does give people some concern about whether it's a financial guaranty product or not.

In terms of the business, the margins are okay. It is a profitable line for us. It is generating an acceptable ROE. It is adding shareholder value. But it does, I understand, give some people some question about is it a financial guaranty product, should it be in the financial guaranty line, etc. We are just encumbered by breaking it out. So anyway --

It's very difficult to kind of compare. On one hand, you're articulating a model of reinsurance for the AAA monolines and so forth. And then we've got this thing that just distorts the numbers and there is no way of really isolating how well you're doing in this financial guaranty business.

I got you. I'm with you. We will address it on a go-forward basis. Your point is not a bad point.

On Conseco, our paid claims are somewhat on target. Nothing erratic, nothing unexpected, and so I think that we are okay with that. And the third one --.

The third one was on the severity and size and the number of units that are going to claim in the mortgage insurance business.

We just have -- we are overweight Alt-A. We do have more Alt-A business than the rest of the industry, so that is the explanation for the higher severity on that business. And all of the MI business has a lag between delinquencies and subsequent claims, so that is no different because we have any more Alt-A business.

The question then is as the number of claims flatten out, is there a higher percentage of claims in the Alt-A, so that that would shift the mix of actual paid claims (indiscernible)? In other words, the problem here is that you are mixing up numbers of claims, which is the historic way the MI industry reports, and the actual important information which relates to the dollar balances of actual claims, where the severity and so forth impact the income statement.

When we say that claims payable flatten out, we're talking about the dollars. And that takes into account the mix of the dollar size between an Alt-A claim versus an A claim versus an A- claim. So we are taking that into account. And if you look at the mix of delinquencies between the various pockets (ph), we know that the prime business and the A- business has a similar severity and the Alt-A business has a higher severity. We take that into account when we give claims paid guidance. We're talking about dollars.

Okay.

Geoff Dunn with KBW.

Good morning. I think, Frank, your comment was that you plan to be a major player in the nonprime business. Has that altered your expectations for the mix of your overall prime Alt-A, A-? I think before we have heard 15-15 for those two lower segments. Has that changed at all?

If I characterized ourselves as major in that, I am sorry. I think what I meant to say was that we see that sector of the market as an opportunity for us. And yes, it will probably mean that the percentage of Alt-A business in our portfolio going forward is likely to increase.

As I have mentioned over the past couple of quarters, we have put through a number of pricing increases and a number of credit improvements in that product line. And as such, as we go into the next quarters, we see that product now having profit characteristics that are better than they had been in the last two years. And therefore, it is likely that we will grow that penetration.

It does not mean, though, as Bob was saying, that the losses that are coming out or the claims that are being paid today and in the third quarter and the fourth quarter of this year that will result from the Alt-A business that we put on the books in '02 are going to diminish, so you have to see it as two different things.

Number one, the old book of business that was written in '01 and '02 and early '03 was written at bad rates -- or lower rates than they are today, lower premium rates. And number two, we were looking at different credit characteristics. Both of those elements in the Alt-A business have changed in the last 6, 7, 8 months, and as such, when we look at that business today, we see better profit opportunities. So yes, I guess that was a long-winded answer to your question, but I guess the answer is yes.

On the financial guaranty side, can you give us an idea of the delta on risk-adjusted returns that you're seeing on the redeployment of capital? What kind of returns was it before with the reinsurance and what are you putting that back out at?

I think, especially in some of the capacity constrained names, the capital had been deployed there at probably 8.5 to 10, and it's being redeployed in the 11 to 13.

In terms of specific pricing, I can tell you that we have gotten premium rates that are twice what he had booked in the same names before.

Okay. And just a number question. What was the premium from RIC this quarter?

We will give you that, Geoff.

Geoff, we'll come right back to you. Somebody's looking it up. Let's move on.

Rob Ryan with Merrill Lynch.

Good morning. Just a few numbers. On the new disclosure of the components of the financial guaranty loss reserves, there is the unallocated number. But how much of that relates to trade credit as opposed to bond insurance?

Some of that does, Rob. We've taken yours and Bob's questions and we will break that out. It is not too much of it, but it is some.

Okay. And another numbers question. On the operating expense side, you provided explanations for what I considered to be a somewhat surprisingly high number, although the contract underwriting wasn't all that surprising. But the other explanations, are you saying this is a new run rate X whatever might happen to contract underwriting, or are you saying that there were unusual, non-recurring components to that 36 whatever million dollars, and as a result, it should go down to some lower level in the second half?

This is stuff that is recurring because it is IT-related costs that have been deferred, and when things are put into service, you start amortizing. So that is going to be recurring, certainly. On the compliance stuff, I think there is (technical difficulty).

The conference will resume momentarily. Excuse me, Mr. Kamarck.

Yes?

I am showing that the leader's line has disconnected. Would you like to continue, sir?

Sure.

That question was from Rob Ryan with Merrill Lynch.

Hi, Rob.

Tino, I'll let you off the hook on that one. That's not your area.

That's not my area. I guess we have to wait for -- I don't know what happened in Philadelphia. I'm calling in from New York.

Howard Shapiro with Focus (ph) Asset Management.

Tino, are you the only one on the line?

Evidently.

Okay. Because this is probably more of a question for Frank or Bob. I just wanted to know -- should I wait, or --?

I guess we're waiting for Philadelphia to get hooked back up again, which I assume they are scrambling to do.

Okay, I'm going to wait then, because it was probably more for them. Operator, can you put me back in the queue?

Yes, I will. Adam Weinrich (ph) with Sanford Bernstein.

My question is for Bob as well. Just leave me in the queue.

AJ Grewal with Smith Barney.

I think most of our questions are going to be for Bob and Frank, so you might want to just wait for them to get back on line. Thank you.

Please hold while the conference resumes momentarily. You may resume your conference.

We were in the middle of questions and we got cut off, so why don't we see if there are further questions out there. We apologize, but somehow the lines got crossed in the middle of one of our comments. Don't know exactly where we were, but for those of you who are still on the line, if you will please submit your questions, we can take them on a go-forward basis.

(OPERATOR INSTRUCTIONS) AJ Grewal with Smith Barney.

Could you give us some color on what you expect in the tax rate in the financial guaranty business? It has been quite choppy over the last few quarters. Just trying to get an idea where that's headed.

Yes, obviously the reason that was lower in the first quarter was because investment income was a much bigger component of the total income, and that was a result of the clawback results. And this quarter, it was more back to normal, and over the rest of the year, it will proceed more normally. However, because of the first quarter impact, ultimately for the year the tax rate will still be below what it normally is. Because investment income as a component of the total will be higher and most of our investment income is tax-advantaged.

So I think you'll see the same kind of pattern for the rest of the year, where the tax rate will rise, but not to a level that is more normalized. Next year, if results are more normal, the tax rate will be more consistent with the overall tax rate of the Company, although we do look at investment income as a component of the total and we do allocate taxes equitably across the business lines. And if investment income is a higher component of total income, the tax rate would be lower.

Thank you.

Bruce Harting with Lehman Brothers.

I wanted to -- I felt bad for Tino, so I was going to ask him a question (indiscernible) the queue. But can you talk about credit spreads on that side -- now that we have all of you, we should probably get back to the people in the queue ahead of me who had questions for Bob. But anyway, could you talk about credits spreads and what you're seeing in terms of pricing and just an overall review of your business and the growth outlook? Thanks.

That's for financial guaranty, right?

Yes, please.

With respect to the structured finance business, structured products, spreads continue to bounce around at what you have to call pretty tight levels compared to the preceding two years in particular. It doesn't mean that there isn't business there to be done, and as you can tell from the results, we are doing business. But we're having to be much more picky in terms of not just credit, but also increasingly with respect to decent pricing and getting the hurdle rates that we want to achieve there. So that part of the business is not particularly interest-rate sensitive, of course, because it's either synthetic or floating-rate. But it is credit-spread sensitive in terms of whether or not we can get the pricing that we need.

The good news is, I think, that no one I have seen is predicting even tighter credit quality spreads going forward. If they continue as they have been more or less for the last six months, I expect you will continue to see growth in that line of business, as it has been over the last couple of quarters. But if spreads widen out, there is upside. Obviously I can't quantify it.

On the public finance side of the business, what is really driving things is market volume. While first half this year, volume -- muni issuance was down a little less than 10 percent from last year's pretty amazing year in terms of volume, a lot of that was driven by remaining big issues from California. And the perception in the marketplace now is that the California new issues are slowing down or will be decreasing substantially. And almost all of the other big states, except for Massachusetts and Texas, over the first half of this year actually had declining muni issuance volumes for one reason or another. One macro factor, of course, is that issuers here, like everywhere else, are expecting interest rates to rise over the coming 12 months; and so, unless they have an urgent need to raise money, in which case they may rush to beat the increases, they may be holding back until they see where those come out.

So our muni volume has been, as, again, you will have seen, very solid. But we expect that what you've seen over the last couple of quarters is probably pretty indicative of what will continue to be the case over the remainder of the year, unless we are all surprised and there is a dramatic decrease in muni issuance volume.

And then for both you (ph), on your side of the business as well as Frank, I am kind of at my wits' end on how to convince investors that there is no housing bubble. I know we have had a Fed study -- we've had a couple Fed studies; we had Greenspan the other day talk about the strength of the consumer. You seem like you are just, as we speak, seeing your credit numbers peak out and maybe one quarter away from a decline. We have seen PMI do that and GIC; Fannie Mae with two plus trillion dollars of mortgages outstanding having a whopping 15 million of -- it's just ludicrously strong, almost. And yet there is this constant question on the investors' side, when is the housing bubble going to begin? Can you lend your expertise, from having been through many cycles, on other points we could be making to suggest that deep into your pipeline, you just don't see those problems, number one.

And number two, Fannie Mae yesterday said that private-label issuance has really picked up, and I'm wondering which side of your businesses will that benefit? Is that, Frank, your side -- not to say that the other side is not yours -- but the MI business and the bulk business that will benefit from more private-label? Or is that something on the ABS side, where on the financial guaranty, you should be able to see some more business coming out of private-label issuance?

On the housing bubble comment, I would just make a couple of comments. One, affordability remains pretty strong. I don't think we see excess amounts of inventory in housing in any material way. The way we can tell that is in our loss mitigation efforts, the properties are selling. They tend to sell very quickly and at the prices that we think they're going to sell. So even though house price appreciation may not be as rapid upward, I don't think we see broad reductions in house prices. As it relates to private-label issuance, clearly, if it is on the nonprime side, we will probably see most of that in the form of bulk kinds of transactions.

Bruce, I don't know what we could really add that would give you or investors any more comfort than what Greenspan has said or what people at Fannie have said or what the MBA has said. All of the studies have shown that housing prices have risen slightly ahead of personal income, but not wildly ahead of personal income. And with interest rates at the levels that they are, housing is still very, very affordable. And we are in, I think, an interest rate cycle that is not likely to get us to very much higher, although we all are expecting higher interest rates. But I don't think the cycle is going to change where we're likely anytime soon to see 10 percent mortgages or 9 percent mortgages.

So all of those things combine to lead us to believe that there is not likely to be a housing bubble. There are pockets of weakness very much tied to employment and unemployment and job growth, etc. Some areas of the Midwest are weak, and that does show up in delinquencies and defaults and claims, but it is not leading anyone to believe anywhere in this company or outside that there is a bubble anywhere in the near term. There are no leading indicators that would predict a bubble in the near term. We are as perplexed by the comments as you probably are, but we have not found a good answer that will reduce that tension yet.

Rob Ryan with Merrill Lynch.

This one's for Tino. Where do we stand on the commutation rights that were triggered by what was effectively a downgrade of the old Radian Reinsurance in May by Moody's? Have you renegotiated with the affected customers? Is that in process? Will those rights remain outstanding in the long-term, that kind of thing?

The quick answer is in process. We had conversations at the highest levels and at the staff level with both of those companies, and those conversations continue. There really isn't any news at this point.

Could you remind us of the dollar amount of the par value at risk?

I will look to Bob to have that number.

It's about 18 billion. We have disclosed it previously, and that is from the 2 customers combined.

Very good, thank you.

Rob, we also have an answer for you on your previous question. The non-specific reserves relating to trade credits are just under $16 million.

Makiko Kokli with Endeavor Capital.

0Thank you. Frank, you mentioned 80/10/10 and its relationship to lower interest rate environment. Could you give us any idea as to amount of MI volumes that are stolen away by 80/10/10 now that are just a more normal rate environment?

The estimate we have is that somewhere between one-third, around one-third of the market may be higher than that of the MI eligible market, is currently using an 80/10/10 form of product.

And they should be more like a quarter in normal years?

No, the product has been out in the marketplace for quite a long time. It has gained acceptance and penetration probably at an increasing rate over the last 5 years, and where it had been a very small percentage of the market, it is now what we consider to be a very large percentage of the market. And so I think that is the issue.

Does its continue to grow from here as a percentage? We don't see it growing much more from here, but right now it is that high percentage. And as I said before, we are working on products that will hopefully compete with that. Another issue that would change the competitive landscape is if the MI deductibility passes in Congress and that makes mortgage insurance premiums deductible along with mortgage interest, that would certainly make the mortgage insurance product more competitive as well. So all of those things are in the works. Where would it get back to? Very hard to say at this point, but if that penetration level was cut in half, that would be a huge success for us.

Okay, and did you say that you expect continued improvement in number of loans in default?

No, we did not say regarding number of loans in default. We said it would be dependent on macroeconomic factors and the book seasoning.

Okay, thank you.

Howard Shapiro with Focus Asset Management.

I just wanted to ask you a question that one of your -- kind of a follow up that one of your competitors brought up. They said that they are being negatively selected in the flow business in terms of the higher FICO score business, which is going to alternative structures. I don't know if this is the right way to look at it, but when I look at one of your supplemental disclosures, I see that the percentage of your risk in force going to high FICO scores either year-over-year from the beginning of the year seems to be the same percentage or slightly higher. Can you comment if you are seeing the same negative selection or not?

I think the numbers you just stated are pretty clear. The percentage over the last two years, anyway, of FICO distribution appears to be relatively static -- up or down a couple percent, but -- in fact, it's gone both down and back up. So I think that is what we are seeing. Clearly, what we are seeing, though, is in terms of opportunity, the opportunities are in the alternative products, and that is where we are focusing a lot of our energy. So as I said previously, it is likely that some of those products will have higher sub limits within our total portfolio on a going-forward basis.

We are also working on a number of ideas to limit the exposure in those products, to limit the volatility around the results of those products, to reinsure any catastrophic risk. And so while we are looking to increase the penetration, we are also looking to limit the volatility and cap risk exposure. And as those products are available, we will give you more information about them. Right now, we believe that they are generally proprietary.

Okay. And also, can you just tell us what percentage of the earnings that are coming from Sherman would you characterize as reoccurring at this point?

All of them.

All of them. Okay, thanks.

Robert Hottensen with Goldman Sachs.

Very, very quick follow-up, I think to Rob Ryan's question. What you have had, Tino, is that you have had -- MBIA, obviously, clawed you back. Ambac clawed back two international reinsurance companies. More and more capacity coming into the AAA monoline sector. And the real question is what really is stopping other competitors, kind of given rising capital, fewer and fewer loan demand and so forth for business? In other words, why does the reinsurance business even exist on a longer-term basis? And I think the final point here is that you see other companies forming third-party relationships to capture the reinsurance business.

The second part of the question is that if you think of the other big AA monoline, AGO, their strategy and basically is to become AAA. And their idea is that the returns and the markets are much larger in the AAA business, that as a smaller company, they can grow in that marketplace where there is more longer-term opportunities. How do you look at the difference between the opportunities on a longer-term basis in the AA versus the AAA business?

Once again, that's two questions. The future of reinsurance and then the prospects of strategically looking at a AAA execution at some point in time.

The glib answer to the first question is you never know what the future holds, but actually, the real substance in there is that is exactly why we proceeded -- a very important reason why we proceeded to merge Radian Re into Radian Asset, so that reinsurance for us is one of several product lines, so that we are not putting too many eggs in that one basket, because we don't know what the future holds.

Having gotten that out of the way and looking perhaps more near-term, reinsurance is a hedging strategy, and there are a variety of hedging strategies and hedging counterparties out there. Prudent portfolio risk management always dictates that you try and diversify your sources and your counterparty risk in those kinds of circumstances. So reinsurance should never be thought of properly as a market share kind of business model.

We expect -- we have always had competition in one form or another, and all of the different forms of competition have both positives and negatives to them. And the result of that is that through one cycle or another, one form of competition or another, reinsurance has been a consistent and steady earner for us, as well as providing substantial benefits, as Frank mentioned, in terms of diversifying our risk and giving us a broader window on our markets. We don't see that fundamental dynamic changing over time.

It has not been true for quite a while that reinsurance for financial guaranty was mostly about banking capacity and conserving capital. There has been for quite some time both abundant capital and abundant capability to grow capital in the industry. It has really been much more about portfolio risk shaping. That is the motivation, the primary motivation, on the part of any, I think these days, primary financial guarantor in looking at reinsurance or other portfolio risk hedging strategies.

That is why it's very important for us to be able to manage those relationships, because if the primary goal is one form of risk transfer or another, we want to make sure that it works for both of us, both parties to the transaction; it isn't simply serving the one party and a zero sum gain, where what's good for the ceding company is bad for the reinsurer. So once again, it makes sense for us to be able to have more diversified sources of revenue and think about our financial guaranty business that way, so that we have the discipline to be able to negotiate on an equal and arms' length basis to manage that business, which, as we have been talking about for quite some time, we have been actively doing for a couple of years.

I now forget, Bob, your second question. Remind me.

It was, you are really saying that AA is -- that your prospects are better for longer-term returns staying AA than trying to be AAA and address a larger market?

That is our analysis. To put it in the simplest possible terms, to be number 8 in a market and to be fighting to establish trading value, particularly at this point in the market cycles, with the strong likelihood that the core municipal issuance volume will be down from its recent peaks, just really doesn't make any sense to us.

There is another factor to this to take into account, which is that optionality is worth quite a bit, flexibility in business planning. And if we are AA, it is always possible for us to move to AAA. If you are AAA, it is -- I won't say impossible, but much more difficult to change your course and move into the Double A space.

That's in fact what happened to you. You were AAA and you were moved into AA.

In the reinsurance business, but not in the direct business. Direct business has always been AA.

I understand. Okay, thanks.

At this time, there are further questions. Will there be any closing remarks?

Thank you all. Sorry for the interruption there. We apologize for the technical difficulties. We hope next quarter we will have no technical difficulties and even a more positive and optimistic report for you. Thanks.

Thank you. This now concludes today's Radian second-quarter conference call. You may now disconnect.