Radian Group 10-K 2011
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended December 31, 2010
For the transition period from to
Commission file number 1-11356
RADIAN GROUP INC.
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES x NO ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ¨ NO x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES ¨ NO ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check One):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of June 30, 2010, the aggregate market value of the registrants common stock held by non-affiliates of the registrant was $961,538,094 based on the closing sale price as reported on the New York Stock Exchange. Excluded from this amount is the value of all shares beneficially owned by executive officers and directors of the registrant. These exclusions should not be deemed to constitute a representation or acknowledgement that any such individual is, in fact, an affiliate of the registrant or that there are not other persons or entities who may be deemed to be affiliates of the registrant.
The number of shares of common stock, $.001 par value per share, of the registrant outstanding on February 25, 2011 was 133,105,845 shares.
DOCUMENTS INCORPORATED BY REFERENCE
TABLE OF CONTENTS
Forward Looking StatementsSafe Harbor Provisions
All statements in this report that address events, developments or results that we expect or anticipate may occur in the future are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934 and the United States (U.S.) Private Securities Litigation Reform Act of 1995. In most cases, forward-looking statements may be identified by words such as anticipate, may, will, could, should, would, expect, intend, plan, goal, contemplate, believe, estimate, predict, project, potential, continue, or the negative or other variations on these words and other similar expressions. These statements, which may include, without limitation, projections regarding our future performance and financial condition, are made on the basis of managements current views and assumptions with respect to future events. Any forward-looking statement is not a guarantee of future performance and actual results could differ materially from those contained in the forward-looking statement. The forward-looking statements, as well as our prospects as a whole, are subject to risks and uncertainties, including the following:
For more information regarding these risks and uncertainties as well as certain additional risks that we face, you should refer to the Risk Factors detailed in Item 1A of Part I of this Annual Report on Form 10-K. We caution you not to place undue reliance on these forward-looking statements, which are current only as of the date on which we filed this report. We do not intend to, and we disclaim any duty or obligation to, update or revise any forward-looking statements made in this report to reflect new information or future events or for any other reason.
We are a credit enhancement company with a primary operating focus on providing first-lien, residential mortgage insurance in the United States (U.S.). In addition, we also maintain a significant financial guaranty insurance portfolio, consisting of public finance and structured finance risks.
In recent years, our business has undergone significant changes due to the macroeconomic conditions and other specific events that affected the production environment and credit performance of our underlying insured assets. The downturn in the housing and related credit markets, characterized by a broad decline in home prices, deteriorating credit performance of mortgage and other assets and reduced liquidity for many participants in the mortgage and financial services markets, has had, and continues to have, a significant negative impact on the operating environment and results of operations for each of our business segments. Beginning in 2008, in response to these market conditions, we took a number of strategic actions, including the following:
In 2010, our primary business focus was to continue to write high-quality new mortgage insurance in the U.S., while also effectively managing losses in our legacy mortgage insurance and financial guaranty portfolios.
Our businesses have been significantly impacted by, and our future success may depend upon, legislative and regulatory developments impacting the housing finance industry. Freddie Mac and Federal National Mortgage Association (Fannie Mae) are the primary beneficiaries of the majority of our mortgage insurance policies (see RegulationFederal RegulationFreddie Mac and Fannie Mae), and the Federal Housing Authority (FHA)
remains our primary competitor outside of the private mortgage insurance industry. Federal and state efforts to support homeowners and the housing market, including through the U.S. Department of Treasurys Homeowner Affordability and Stability Plan (HASP), have had a positive impact on our business (see RegulationFederal RegulationHomeowner Assistance Programs). Various regulatory agencies are now in the process of developing new rules under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) that are expected to have a significant impact on the housing finance industry, and the U.S. Congress is in the early stages of planning for the reform of the housing finance market, including the future roles of the Government Sponsored Enterprises (GSEs) (see RegulationFederal RegulationFreddie Mac and Fannie Mae).
Business Segments. We have three business segments, two of whichmortgage insurance and financial guarantyrepresent our primary operating businesses.
A summary of financial information for each of our business segments for each of the last three fiscal years is included in Segment Reporting in Note 3 of Notes to Consolidated Financial Statements. Radian Group Inc. (Radian Group) acts principally as a holding company for our insurance subsidiaries and does not have any significant operations of its own.
Background. Radian Group incorporated as a business corporation under the laws of the State of Delaware in 1991. Our principal executive offices are located at 1601 Market Street, Philadelphia, Pennsylvania 19103, and our telephone number is (215) 231-1000.
Additional Information. Our website address is www.radian.biz. Copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, as well as any amendments to those reports, are available free of charge through our website as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission (the SEC). In addition, copies of our guidelines of corporate governance, code of business conduct and ethics (which includes the code of ethics applicable to our chief executive officer, principal financial officer and principal accounting officer) and the governing charters for each committee of our board of directors are available free of charge on our website, as well as in print to any stockholder upon request. Information contained or referenced on our website is not incorporated by reference into and does not form a part of this report.
Our mortgage insurance segment provides credit-related insurance coverage, principally through private mortgage insurance and risk management services to mortgage lending institutions. Private mortgage insurance protects mortgage lenders from all or a portion of default-related losses on residential mortgage loans made
mostly to home buyers who make down payments of less than 20% of the homes purchase price. Private mortgage insurance also facilitates the sale of these mortgage loans in the secondary mortgage market, most of which are sold to Freddie Mac and Fannie Mae.
1. Traditional Types of Coverage and Forms of Transactions
In 2010, we wrote $11.6 billion of primary mortgage insurance (discussed below), compared to $17.0 billion of primary mortgage insurance written in 2009. These levels of new business are significantly lower than historic levels due primarily to a decrease in overall mortgage originations and a reduction in the market share of private mortgage insurers since the economic downturn beginning in 2007. All of our primary mortgage insurance written during 2010 was written on a flow (which is loan-by-loan) basis. Primary insurance on first-lien mortgages made up $31.5 billion or 92.8% of our total first-lien mortgage insurance risk in force at December 31, 2010, as compared to $33.8 billion or 92.6% at December 31, 2009.
We did not write any pool insurance (discussed below) in 2010 or 2009. Pool insurance made up approximately $2.5 billion or 7.2% of our total first-lien mortgage insurance risk in force at December 31, 2010, as compared to 7.4% at December 31, 2009.
Primary Mortgage Insurance. Primary mortgage insurance provides protection against mortgage defaults on prime and non-prime mortgages (non-prime mortgages include Alternative-A (Alt-A), A minus and B/C mortgages, each of which are discussed below under Mortgage InsuranceDirect Risk in Force/Insurance in ForceLender and Mortgage Characteristics) at a specified coverage percentage. When there is a claim under primary mortgage insurance, the coverage percentage is applied to the claim amount, which consists of the unpaid loan principal, plus past due interest (which is capped at a maximum of two years) and certain expenses associated with the default, to determine our maximum liability.
We provide primary mortgage insurance on a flow basis and we have also provided primary mortgage insurance on a structured basis (in which we insure a group of individual loans). In flow transactions, mortgages typically are insured as they are originated (or shortly after), while in structured transactions, we typically provide insurance on a group of mortgages after they have been originated. A portion of our structured business has been written in a second loss position, meaning that we are not required to make a payment until a certain aggregate amount of losses have already been recognized. Most of our structured mortgage insurance transactions in the past have involved non-prime mortgages and mortgages with higher than average loan balances. A single structured mortgage insurance transaction may be provided on a primary or pool basis, and some structured transactions have both primary and pool insured mortgages. Included in our primary mortgage insurance in force and risk in force is modified pool insurance, which differs from standard pool insurance in that it includes an exposure limit on each individual loan as well as an aggregate limit of loss for the entire pool of loans.
Pool Insurance. We offer pool insurance on a limited basis. Pool insurance differs from primary insurance in that our maximum liability is not limited to a specific coverage percentage on each individual mortgage. Instead, an aggregate exposure limit, or stop loss, generally between 1% and 10%, is applied to the initial aggregate loan balance on a group or pool of mortgages. In addition to a stop loss, many of our pool policies were written in a second loss position. We believe the stop loss and second loss features have been important in limiting our ultimate liability on individual transactions.
We wrote much of our pool insurance in the form of structured transactions, whole loan sales and credit enhancement on residential mortgage loans included in residential mortgage-backed securities (RMBS). An insured pool of mortgages may contain mortgages that are already covered by primary mortgage insurance. In these transactions, pool insurance is secondary to any primary mortgage insurance that exists on mortgages within the pool. Generally, the mortgages we insure with pool insurance have similar characteristics to mortgages insured on a primary basis.
2. Non-Traditional Forms of Credit Enhancement
In addition to traditional mortgage insurance, in the past we have provided non-traditional mortgage insurance.
As discussed below in Reduction of Traditional Legacy Risk and Non-Traditional Risk, beginning in 2007, we began pursuing opportunities to reduce our legacy, non-traditional mortgage insurance risk in force. As of December 31, 2010:
Second-Liens. Previously, we have provided insurance on second mortgages (second-liens). We have not written any new second-lien business since 2007. This type of insurance is considered more risky than first-lien business as these loans are subordinate to first-lien mortgages, and therefore, the ability to repay on these loans depends on the ability to satisfy the first-lien mortgage. This second-lien business was largely susceptible to the disruption in the housing market and the subprime mortgage market that began during 2007.
Credit Enhancement on NIMS. Previously, we have provided credit enhancement on NIMS bonds. We stopped writing insurance on NIMS bonds in 2007. A NIMS bond represents the securitization of a portion of the excess cash flow and prepayment penalties from a mortgage-backed security (MBS) comprised mostly of subprime mortgages. The majority of this excess cash flow consists of the spread between the interest rate on the MBS and the interest generated from the underlying mortgage collateral. Historically, issuers of MBS would have earned this excess interest over time as the collateral aged, but market efficiencies enabled these issuers to sell a portion of their residual interests to investors in the form of NIMS bonds.
Our credit protection on insured NIMS bonds covers any principal and interest shortfalls on the insured bonds. For certain transactions, we only insured a portion of the NIMS bond that was issued. Like second-liens, NIMS bonds have largely been susceptible to the disruption in the housing market and the subprime mortgage market that began in 2007.
Domestic CDS Transactions. In the past, we wrote insurance on mortgage-related assets, such as RMBS, in structured CDS transactions. In these transactions, similar to our financial guaranty insurance business, we insured the timely payment of principal and interest to the holders of debt securities, the payment of which was backed by a pool of residential mortgages. Our last remaining domestic mortgage insurance CDS transaction was terminated in May 2009.
International Mortgage Insurance Operations. In the past, Radian Insurance Inc. (Radian Insurance) had written credit protection in the form of CDS on international mortgage collateral, traditional mortgage insurance in Hong Kong and several mortgage reinsurance transactions in Australia. During the fourth quarter of 2010, we terminated our last remaining international CDS transaction written in our mortgage insurance segment. Consistent with our strategic focus on writing domestic mortgage insurance business, and as a result of ratings downgrades of Radian Insurance, we ceased writing new international business and have terminated most of our international mortgage insurance risk, with the exception of our insured portfolio in Hong Kong. While we are no longer writing new business in Hong Kong, we continue to service the existing book of business.
3. Reduction of Traditional Legacy Risk and Non-Traditional Risk
In 2009, we began pursuing opportunities to reduce our legacy mortgage insurance portfolio (primarily the poorly underwritten vintages of 2005 through 2008) and non-traditional mortgage insurance risk in force. We executed upon this strategy through a series of commutations, transaction settlements and terminations, including the following during 2010:
4. Premium Rates
We cannot change our premium rates after we issue coverage. Accordingly, we determine premium rates in our mortgage insurance business on a risk-adjusted basis that includes borrower, loan and property characteristics. We use proprietary default and prepayment models to project the premiums we should charge, the losses and expenses we expect to incur and the capital we need to hold in support of our risk. We establish pricing in an amount that we expect will allow us to achieve a reasonable return on allocated capital.
Premiums for our mortgage insurance may be paid by the lender, who in turn typically charges a higher interest rate to the borrower, or directly by the borrower. We price our borrower-paid flow business based on rates that we have filed with the various state insurance departments. We generally price our structured business and some lender-paid business based on the specific characteristics of the insured portfolio, which can vary significantly from portfolio to portfolio depending on a variety of factors, including the quality of the underlying loans, the credit history of the borrowers, the amount of coverage required and the amount, if any, of credit protection or subordination in front of our risk exposure.
Premium rates for our pool insurance business have been generally lower than primary mortgage insurance rates due to the aggregate stop loss included in this form of insurance.
Our underwriting activities are transacted through delegated underwriting, non-delegated underwriting and contract underwriting.
Delegated Underwriting. Loans are underwritten to determine whether they are eligible for our mortgage insurance. We perform this function or, alternatively, we delegate to our customers the ability to underwrite the loans based on agreed-upon underwriting guidelines. This delegated underwriting program enables us to meet
lenders demands for immediate insurance coverage. With delegated underwriting, because the underwriting is being performed by third parties, we have additional rights to rescind coverage as a result of an insureds breach of representations and warranties pertaining to the insured loans having been written in accordance with the agreed upon underwriting guidelines and in the absence of any fraud or misrepresentation. We recently have introduced a limited rescission waiver program for our delegated underwriting customers, in which we agree not to rescind or deny coverage due to non-compliance with our agreed upon underwriting guidelines so long as the borrower makes 24 consecutive payments (commencing with the initial required payment) from his or her own funds. As part of this program, which remains subject to final approval by the GSEs and certain state insurance departments, we may require that some or all of the loans underwritten through the program be run through an approved fraud model as part of the origination process. This program does not impact (i.e., we continue to retain) our rights to rescind coverage in the event of fraud or misrepresentation in the origination of the loans we insure.
Our delegated underwriting program currently involves only lenders that are approved by our risk management group. Once we accept a lender into our delegated underwriting program, however, we generally insure all loans submitted to us by that lender even if the lender has, without our knowledge, not followed our specified underwriting guidelines. As a result, a lender could commit us to insure a number of loans with unacceptable risk profiles before we discover the problem and terminate that lenders delegated underwriting authority as well as pursue other rights, such as our rights to rescind coverage or deny claims. We mitigate this risk by regularly evaluating compliance with our underwriting guidelines and through periodic audits and on-site reviews of selected lenders. As of December 31, 2010, approximately 59% of our total first-lien mortgage insurance in force had been originated on a delegated basis, compared to 55% as of December 31, 2009.
Non-Delegated Underwriting. Lenders that either do not qualify or choose not to participate in our delegated underwriting program can submit loan files to our Field Service Center for underwriting. In addition, lenders participating in our delegated underwriting program may choose not to use their delegated authority and to submit loans directly to our Field Service Center. For those loans underwritten by us, we generally do not have the remedies for breach of representations or warranties that we do with respect to delegated underwriting. We mitigate the risk of employee underwriting error through quality control sampling and performance monitoring. As of December 31, 2010, approximately 41% of our total first-lien mortgage insurance in force had been originated on a non-delegated basis, compared to 45% as of December 31, 2009.
Contract Underwriting. In our mortgage insurance business, we also utilize our underwriting skills to provide an outsourced underwriting service to our customers known as contract underwriting. For a fee, we underwrite our customers loan files for secondary market compliance (i.e., for sale to the GSEs), and may concurrently assess the file for mortgage insurance. During 2010, loans underwritten through contract underwriting accounted for 17.9% of applications for insurance, 16.5% of commitments for insurance and 13.7% of insurance certificates issued for our flow business. Such loans are included within the non-delegated underwriting percentages above.
Typically, we agree that if we make a material error in underwriting a loan, we will provide a remedy to the customer by purchasing the loan or placing additional mortgage insurance on the loan, or by indemnifying the customer against loss up to a maximum specified amount. During 2010, we paid losses related to these remedies of approximately $3.5 million. By providing these remedies, we assume some credit risk and interest-rate risk if an error is found during the limited remedy period in the agreements governing our provision of contract underwriting services. Recently, we limited the recourse available to our contract underwriting customers to apply only to those loans that we are simultaneously underwriting for compliance with secondary market compliance and for potential mortgage insurance. We monitor this risk and negotiate our underwriting fee structure and recourse agreements on a client-by-client basis. We also routinely audit the performance of our contract underwriters.
B. Direct Risk in Force/Insurance in Force
Our business has traditionally involved taking credit risk in various forms across various asset classes, products and geographies. Credit risk is measured in our mortgage insurance business as risk in force, which approximates the maximum loss exposure that we have at any point in time.
The following table shows the direct risk in force associated with our mortgage insurance segment as of December 31, 2010 and 2009:
Risk in force for modified pool loans, which we include in primary insurance risk in force as discussed above, was $289 million and $583 million as of December 31, 2010 and 2009, respectively.
The following discussion mainly focuses on our primary risk in force, which represents approximately 92% of our total mortgage insurance risk in force at December 31, 2010. For additional information regarding our pool and non-traditional mortgage insurance risk in force, see Mortgage InsuranceBusiness above.
We analyze our portfolio in a number of ways to identify any concentrations or imbalances in risk dispersion. We believe the performance of our mortgage insurance portfolio is affected significantly by:
A significant portion of our total mortgage insurance in force (and consequently our premiums earned) are derived from policies written in prior years. Therefore, the amount of policy cancellations and the period of time that our policies remain in force, can have a significant impact on our revenues and our results of operations. One measure for assessing the impact of policy cancellations on insurance in force is our persistency rate, defined as the percentage of insurance in force that remains on our books after any 12-month period. Because most of our insurance premiums are earned over time, higher persistency rates enable us to recover more of our policy acquisition costs and generally result in increased profitability. At December 31, 2010, the persistency rate of our primary mortgage insurance was 81.8%, compared to 82.0% at December 31, 2009. The persistency rate for 2009 and 2010 was impacted by the termination of certain mortgage insurance transactions, which had the effect of reducing the overall rate. Historically, there was a close correlation between low or declining interest rate environments and lower persistency rates, primarily as a result of increased refinance activity during this time. However, in recent years, despite historically low interest rates, our persistency rate has remained high as many borrowers have been unable to refinance due to home price depreciation, the weak housing market and limited access to mortgage credit. As a result, we expect that persistency rates will continue to remain at elevated levels as long as the current disruption in the housing and mortgage credit markets continues.
1. Direct Primary Risk in Force by Year of Policy Origination
The following table shows the percentage of our direct primary mortgage insurance risk in force and the associated percentage of reserve for losses by policy origination year as of December 31, 2010 and 2009:
2. Geographic Dispersion
The following tables show the percentage of our direct primary mortgage insurance risk in force and the associated percentage of reserve for losses by location of property for the top 10 states and top 15 metropolitan statistical areas (MSAs) in the U.S. (measured by primary mortgage insurance risk in force as of December 31, 2010) as of December 31, 2010 and 2009:
3. Lender and Mortgage Characteristics
Although geographic dispersion is an important component of our overall risk diversification, we believe that other factors also contribute significantly to the quality of the risk in force, including product distribution and our risk management and underwriting practices.
LTV. An important indicator of claim incidence in our mortgage insurance business is the relative amount of a borrowers equity that exists in a home. Generally, absent other mitigating factors such as high Fair Isaac and Company (FICO) scores, loans with higher LTVs at inception (i.e., smaller down payments) are more likely to result in a claim than lower LTV loans. For example, claim incidence on mortgages with LTVs between 90.01% and 95% is significantly higher than the claim incidence on mortgages with LTVs between 85.01% and 90%. In the past, we insured a significant number of loans with LTVs between 95.01% and 100%. These loans are expected to have a higher claim incidence than mortgages with LTVs of 95% or less. We also insured a small number of loans having an LTV over 100%. We are no longer insuring these types of loans. In 2010, we resumed writing business on loans with LTV ratios between 95.01% and 97% on a highly selective basis. The average LTV of our primary new insurance written in 2010 was 89.83% (which we expect will increase as we write more higher-LTV business), compared to 89.63% and 91.44% in 2009 and 2008, respectively.
Loan Grade. The risk of claim on non-prime loans is significantly higher than that on prime loans. We generally define prime loans as loans where the borrowers FICO score is 620 or higher and the loan file meets fully documented standards of our credit guidelines and/or the GSEs guidelines for fully documented loans. Prime loans made up substantially all of our primary new insurance written in 2010 and 2009. Prime loans comprised 82.6% of our primary risk in force at December 31, 2010, compared to 80.2% at December 31, 2009. We expect that prime loans will continue to constitute substantially all of our primary new insurance written for the foreseeable future.
We generally define Alt-A loans as loans where the borrowers FICO score is 620 or higher and where the loan documentation has been reduced or eliminated. Because of the reduced documentation, we consider Alt-A loans to be more risky than prime loans, particularly Alt-A loans to borrowers with FICO scores below 660. We have insured Alt-A loans with FICO scores ranging from 620 to 660. Alt-A loans tend to have higher loan balances than other loans that we insure because they are often more heavily concentrated in higher-cost areas.
We generally define A minus loans as loans where the borrowers FICO score ranges from 575 to 619. We also classify loans with certain characteristics originated within the GSEs automated underwriting system as A minus loans, regardless of the FICO score.
We generally define B/C loans as loans where the borrowers FICO score is below 575. In the past, certain structured transactions that we have insured contained a small percentage of B/C loans.
Adjustable Rate Mortgages (ARMs); Interest-Only Mortgages. We consider loans to be ARMs if the interest rate for those loans will reset at any point during the life of such loans. Our claim frequency on insured ARMs has been higher than on fixed-rate loans due to monthly payment increases that occur when interest rates rise. It has been our experience that loans subject to reset five years or later from origination perform more like fixed-rate loans and are therefore less likely to result in a claim than shorter term ARMs.
We also have insured ARMs that provide the borrower with a number of different payment options (Option ARMs). One of these options is a minimum payment that is below the full amortizing payment, which results in interest being capitalized and added to the loan balance so that the loan balance continually increases. This process is referred to as negative amortization. As of December 31, 2010, Option ARMs represented approximately 2.9% of our primary mortgage insurance risk in force compared to 3.9% at December 31, 2009. We have not written any Option ARMs since 2007.
We also have insured interest-only mortgages, where the borrower pays only the interest charge on a mortgage for a specified period of time, usually five to ten years, after which the loan payment increases to include principal payments. Interest rates on interest-only mortgages may reset, in which case we would consider this to be an ARM, or may be fixed. These loans may have a heightened propensity to default because of possible payment shocks after the initial low-payment period expires and because the borrower does not automatically build equity in the underlying property as payments are made. At December 31, 2010, interest-only mortgages represented approximately 7.3% of our primary mortgage insurance risk in force compared to 8.4% at December 31, 2009. Interest-only mortgages currently represent only a small portion of our new insurance written.
As of December 31, 2010, our exposure to ARMs represented approximately $4.2 billion or 13.2% of our primary risk in force. Approximately 55.7% of the ARMs we insure, including Option ARMs and interest-only ARMs, have already had initial interest rate resets. An additional 6.0%, 14.4% and 9.5% are scheduled to have initial interest rate resets during 2011, 2012 and 2013, respectively.
Loan Size. The average loan size of our primary mortgage insurance in force (by product) as of December 31, 2010 and 2009 was as follows (in thousands):
The five states (or districts) with the highest average loan size (measured by primary mortgage insurance in force as of December 31, 2010) and the corresponding average loan size as of the dates indicated were as follows (in thousands):
The average size of the loans included in our primary mortgage insurance portfolio remained relatively flat in 2010 compared to 2009. Prior to 2010, we had experienced a general decrease in average loan size as a result of our decision to cease insuring non-prime loans, in particular Alt-A loans, which tended to have larger loan balances relative to our other loans.
Property Type. Our risk of loss also is affected by the type of property securing our insured loans, and we have adjusted our underwriting guidelines to limit our exposure to certain property types. For example, we are no longer insuring properties with multiple units.
We believe loans on single-family detached housing are less likely to result in a claim than loans on other types of properties. Conversely, we generally consider loans on attached housing types, particularly condominiums and cooperatives, to be more volatile due to the higher density (and greater supply in some markets) of these properties.
We believe that loans on non-owner-occupied homes purchased for investment purposes are more likely to result in a claim and are subject to greater potential declines in value than loans on either primary or second homes and borrowers are more likely to neglect maintenance and repairs on these homes.
It has been our experience that higher-priced properties experience wider fluctuations in value than moderately priced residences and that the incomes of many people who buy higher-priced homes are less stable than those of people with moderate incomes. Therefore, such higher priced properties are more likely to result in a claim.
The following table shows the percentage of our direct primary mortgage insurance risk in force (as determined on the basis of information available as of the date of mortgage origination) by the categories and dates indicated:
C. Defaults and Claims
Defaults. The default and claim cycle in our mortgage insurance business begins with our receipt of a default notice from the servicer. For financial statement reporting and internal tracking purposes, we do not consider a loan to be in default until the borrower has missed two monthly payments.
Defaults, whether voluntary or involuntary, can occur due to a variety of factors, including death or illness, divorce or other family problems, unemployment, overall changes in economic conditions, housing value changes that cause the outstanding mortgage amount to exceed the value of a home, or other events. Depending on the type of loan, default rates may be affected by rising interest rates or an accumulation of negative amortization. Involuntary defaults are those that occur due to factors generally outside the control of the borrower (e.g., job loss, unexpected interest rate changes or death). Voluntary defaults are those where the borrower willingly walks away from his or her mortgage obligation despite the ability to continue to pay. These types of defaults often are caused by significant declines in property values where the borrower makes a decision not to continue to support a mortgage balance that exceeds the value of the home. Voluntary defaults may be exacerbated by the fact that many borrowers in the recent past were not required to pay closing costs or make a significant, if any, down payment on their homes, leaving these borrowers with little incentive to remain in their homes when values have depreciated. In addition, we believe that some borrowers may voluntarily default on their mortgages to take advantage of many of the loan modification programs that have been announced or implemented.
We establish reserves to provide for losses and the estimated costs of settling expected claims on our defaulted loans in our mortgage insurance business. Setting loss reserves involves significant use of estimates with regard to the likelihood, magnitude and timing of a loss. We do not establish reserves for loans that are in
default if we believe we will not be liable for the payment of a claim with respect to that default. For example, for those defaults in which we are in a second loss position, we initially calculate the reserve as if there were no deductible. If the existing deductible for a given structured transaction is greater than the reserve amount for the defaults contained within the transaction, we do not record a reserve for the defaults, or if appropriate, we record a partial reserve. We have determined that the setting of loss reserves in our businesses constitutes a critical accounting policy. Accordingly, a detailed description of our policy is contained in Managements Discussion and Analysis of Financial Condition and Results of OperationsCritical Accounting PoliciesReserve for Losses included in Item 7 below and in Notes 2 and 10 of Notes to Consolidated Financial Statements.
The following table shows the number of primary and pool loans that we have insured, the number of loans in default and the percentage of loans in default as of the dates indicated:
The following table shows the number of modified pool loans that we have insured (included within primary insurance), the number of loans in default and the percentage of loans in default as of the dates indicated:
The default rate in our mortgage insurance business is subject to seasonality. Historically, our mortgage insurance business experiences a fourth quarter seasonal increase in defaults and a first quarter seasonal decline in defaults. While this historically has been the case, macroeconomic factors in any given period may influence the default rate in our mortgage insurance business more than seasonality.
The following table shows the number and percentage of primary mortgage insurance defaults by policy origination year as of the dates indicated:
The following table shows the trend in our default rates on our primary insured book of business at the end of each quarter following the year of original policy issuance, referred to as a year of origination.
Business written in 2005 through 2008 contained a significant number of poorly underwritten and higher risk loans. As a result of this and the economic downturn which began in 2007, we expect substantially higher ultimate loss ratios for these loans than in previous policy years. In 2008, as a result of the significant downturn in the housing market, we implemented a number of changes to our underwriting guidelines aimed at significantly improving the risk characteristics of the loans we were insuring. As a result of these more restrictive underwriting guidelines, the default rates for vintages beginning in the second half of 2008 have significantly improved, in particular when compared to the 2005 through the first half of 2008 books of business. Our 2010 and 2009 policy years consist of loans with significantly improved risk characteristics, including predominantly prime credit quality, with FICO scores of 740 or above and LTV ratios lower than any of our previous policy years.
The following table shows the states with the highest number of primary mortgage insurance defaults (measured as of December 31, 2010) and the corresponding percentage of total defaults as of the dates indicated:
The states of California, Illinois, Georgia and Ohio account for a large portion of our total defaults, but their share of total defaults is generally proportional to the size of their insured portfolios. In the state of Florida, the number of defaults is disproportionately larger relative to the size of the insured population. In general, the states that represent a disproportionate share of total defaults have experienced the largest declines in home prices, high levels of unemployment, and in some cases contain higher levels of exposure to risky products. Given our exposure to these markets, our loss experience has been significantly affected and will continue to be negatively affected if in those states the pace of improvement fails to accelerate or conditions there should begin to deteriorate again.
Claims. Mortgage insurance claim volume is influenced by the circumstances surrounding the default. The rate at which defaults cure, and therefore do not go to claim, depends in large part on a borrowers financial resources and circumstances, local housing prices and housing supply (i.e., whether borrowers may cure defaults by selling the property in full satisfaction of all amounts due under the mortgage), interest rates and regional economic conditions. In our first-lien mortgage insurance business, the insured lender is required to complete foreclosure proceedings and obtain title to the property before submitting a claim. It can take anywhere from three months to five years for a lender to acquire title to a property through foreclosure, depending on the state. On average, we do not receive a request for claim payment until approximately 18 months following a default on a first-lien mortgage. This time lag has increased recently, as we have observed a slowdown in foreclosures (and consequently, a slowdown in claims submitted to us) largely due to foreclosure moratoriums imposed by various government entities and lenders and increased scrutiny in the general foreclosure process. In our second-lien mortgage insurance business, we typically are required to pay a claim much earlier, within approximately 150 days of a borrowers missed payment.
Claim activity is not spread evenly throughout the coverage period of a book of business. Historically, relatively few claims on prime business are received during the first two years following issuance of a policy and on non-prime business during the first year. Claim activity on prime loans has historically reached its highest level in the third through fifth years after the year of policy origination, and on non-prime loans this level is expected to be reached in the second through fourth years. Based on these trends, approximately 35.6% of our primary risk in force, and approximately 1.9% of our pool risk in force at December 31, 2010 had not yet reached its highest claim frequency years. At December 31, 2009, the comparable percentages were 50.6% and 27.2%, respectively. Notwithstanding historical trends, the insurance we wrote from 2005 through 2008 has experienced default and claim activity sooner than has been the case for our historical books of business.
In the following tables, direct claims refers to claims paid before reinsurance recoveries from captives and Smart Home, while net claims refers to claims paid after reinsurance recoveries from captives and Smart Home.
The following table shows cumulative direct claims paid by us on our primary insured book of business at the end of each successive year after origination, expressed as a percentage of the cumulative premiums written by us in each year of origination:
Direct Claims Paid vs. Premiums WrittenPrimary Insurance
The following table shows net claims paid information for primary mortgage insurance for the periods indicated:
The following tables show direct claims paid by policy origination year and the states with the highest direct claims paid (measured as of December 31, 2010) as of the periods indicated:
Claims paid in California, Florida and Arizona continue to account for a disproportionate share of total claims paid reflecting the significant home price depreciation in those states and the higher percentage of Alt-A loans, which have had a higher claim frequency, as well as the relatively high proportion of risk in force in those states. A much higher level of claims also exists in Michigan, as problems with the domestic auto industry and related industries have depressed economic growth, employment and housing prices in that state. In addition, claim payments in California, Florida, Arizona and Michigan increased as a result of the termination of certain first-lien transactions during 2010 (these termination payments are included in claims paid) compared to prior years.
Severity. In addition to claim volume, another significant factor affecting losses is claim severity. The severity of a claim is determined by dividing the claim paid by the original loan amount. The main determinants of the severity of a claim are the size of the loan, the amount of mortgage insurance coverage placed on the loan and the impact of our loss management activities with respect to the loan. Pre-foreclosure sales, acquisitions and other early workout efforts help to reduce overall claim severity. The average claim severity for loans covered by our primary insurance was 27.4% for 2010, compared to 26.6% in 2009 and 27.6% in 2008. The average claim severity for loans covered by our pool insurance was 48.1% for 2010, compared to 33.4% in 2009 and 38.5% in 2008.
D. Loss Management
In the past few years, we have added significant resources to our mortgage insurance loss management department in order to better manage losses in the weak housing market and high default and claim environment. Our loss management function consists of approximately 189 full-time employees at December 31, 2010 dedicated to mitigating claim losses, including facilitating modifications or other means of keeping borrowers in their homes and ensuring proper claim payments. This represented a 23.5% increase in the number of full-time loss management employees from December 31, 2009.
Beginning in 2008, we began placing experienced loss mitigation personnel on-site with our key servicing partners to improve communication and workflow, allowing us to act more quickly to reduce loss exposure. We also created a Default Servicing Strategy Group which includes field-based representatives of loss management
who make regular visits to our servicing partners to improve communication and better implement our programs that could mitigate losses. In 2009, we implemented a Servicing Review Program, pursuant to which we audit our servicers performance with respect to default management (with a focus on collections and loss mitigation) and their compliance with our established underwriting guidelines. In instances where issues are identified, we work with our servicers to affect appropriate and acceptable remediation to address those deficiencies.
Loss management pursues opportunities to mitigate losses both before and after claims are received. For pre-claim default situations, our loss management specialists focus on the following activities to reduce losses:
We have also implemented a number of borrower help initiatives, such as:
We continue to participate in the large scale modification programs being led by the U.S. Treasury Department and the Federal Housing Finance Agency (FHFA), several top 10 mortgage servicers and numerous borrower outreach campaigns being conducted by HOPE NOW, of which we are a member. See RegulationFederal RegulationFreddie Mac and Fannie Mae below for information regarding recent modification programs.
In our traditional mortgage insurance business, upon receipt of a valid claim, we generally have the following three settlement options:
In general, we base our selection of a settlement option on the value of the property. In 2010, we settled 85.3% of claims by paying the maximum liability (compared to 89.5% of claims in 2009), 14.5% by paying the deficiency amount following an approved sale (compared to 10.4% of claims in 2009) and less than 1% by paying the full claim amount and acquiring title to the property (also less than 1% in 2009). Declining property values in many regions of the U.S. since 2007 have made our loss management efforts more challenging.
After a claim is received and/or paid, our loss management specialists focus on:
When a claim is submitted for payment, we investigate (i) whether the loan qualified for insurance at the time the certificate of coverage was issued and (ii) whether the claimant has satisfied its obligation in meeting all conditions precedent to claim payment. We may deny a claim if the servicer does not produce documents necessary to perfect a claim, including evidence that the insured has acquired title to the property, within the time period specified in the master insurance policy with our lending customers (the Master Policy). Most often, a claim denial is the result of the servicers inability to provide the loan origination file or other servicing documents for review. If, after requests by us, the loan origination file or other servicing documents are not provided to us, we deny the claim. Under the terms of our Master Policy, our insureds must provide to us the necessary documents to perfect a claim within one year after foreclosure.
We have the legal right, under certain conditions, to unilaterally rescind coverage on our mortgage insurance policies. Under the terms of our Master Policy, we have 60 days to pay the claim, subject to various conditions, such as the insured providing additional items necessary for us to complete a review of the claim. If we determine that a loan did not qualify for insurance, as part of our internal procedures, we issue an intent to rescind letter that explains the basis of our decision and provides the insured with a period of up to 90 days from the date of the letter to challenge or rebut our decision. We are not contractually obligated under the terms of our Master Policy to provide the insured with this opportunity to rebut our decision to rescind coverage.
Typical events that may give rise to our right to rescind include the following: (i) a certificate of insurance issued under the Master Policy in reliance upon an application for insurance contains any material misstatement, misrepresentation or omission, whether intentional or otherwise, or was issued as a result of any act of fraud, subject to certain exceptions, or (ii) negligence in the origination of a loan. We also have rights of rescission arising from a breach of the insureds representations and warranties contained in the delegated underwriting endorsement to our Master Policy, and we may in certain circumstances seek rescission in certain structured transactions for breach of representations and warranties pertaining to the insured loans having been underwritten in accordance with the agreed underwriting guidelines, and in the absence of any fraud or misrepresentation.
If a rebuttal is received and the insured provides additional information supporting the continuation (i.e., non-rescission) of coverage, the claim is re-examined internally by a new group of individuals. If the additional information supports the continuation of coverage, the claim is paid. After completion of this process, if we
determine that the loan did not qualify for coverage, the insurance certificate is rescinded (and the premium refunded), and we consider the rescission to be final and resolved. Although we may make a final determination with respect to a rescission, it is possible that a challenge to our decision to rescind coverage may be made for a period of time after we have rescinded coverage. Under our Master Policy, any suit or action arising from any right of the insured under the policy must be commenced within two years after such right first arose and within three years for certain other policies, including certain pool insurance policies.
In addition, we have the right under our Master Policy to adjust claims for servicer negligence to the extent that such negligence increases the loss to the insured and can be reasonably quantified. Examples of servicer negligence may include, without limitation, a failure to report information to us on a timely basis as required under our Master Policy, a failure to pursue loss mitigation opportunities presented by borrowers, realtors, and/or any other interested parties, a failure to pursue loan modifications and/or refinancings through programs available to borrowers or an undue delay in presenting claims to us (including as a result of improper handling of foreclosure proceedings), which increases the interest (up to a maximum of two years) or other components of a claim we are required to pay. In certain circumstances, servicer negligence could result in our denying the claim in its entirety.
Although we could seek post-claim recoveries from the beneficiaries of our policies if we later determine that a claim was not valid, because our loss mitigation process is designed to ensure compliance with our policies prior to payment of claim, we have not sought, nor do we currently expect to seek, recoveries from the beneficiaries of our mortgage insurance policies once a claim payment has been made.
E. Risk Management
Our mortgage insurance business has a comprehensive risk management function, which is responsible for overall credit policy creation, compliance monitoring, portfolio management, limit setting and communication of credit related issues to management and our board of directors. The risk management function includes a Risk Origination group and Portfolio Management, Credit Analytics and Risk Analytics groups that operate across our mortgage insurance business.
1. Risk Origination
We believe that understanding our business partners and customers is a key component of managing risk. Accordingly, we assign individual risk managers to specific lender accounts so that they can more effectively perform ongoing business-level due diligence and to better customize our credit policy to address individual lender-specific strengths and weaknesses.
2. Portfolio Management
Our Portfolio Management group oversees the allocation of economic capital within our mortgage insurance business. This group establishes the portfolio limits for product type, loan attributes, geographic concentration and counterparties, and also is responsible for the evaluation of potential insurance terminations (among other items, based on aging of a portfolio) and distribution of risk using risk transfer mechanisms such as captive reinsurance or the Smart Home arrangements discussed below under ReinsuranceCeded.
Our Surveillance group, within Portfolio Management, monitors and analyzes the performance of various risks in our mortgage portfolio. Our Credit Analytics and Risk Analytics groups then use this information to develop our credit policy and as input to our proprietary default and prepayment models. Our Valuation group, within Portfolio Management, analyzes the current composition of our mortgage insurance portfolio and monitors for compliance with our internally defined risk parameters. This analysis involves assessing risks to the portfolio from the market (e.g., the effects of changes in home prices and interest rates) and analyzing risks from particular lenders, products and geographic locales.
3. Credit Analytics
Our Credit Analytics group establishes and maintains mortgage related, credit risk policies regarding risk acceptance and counterparty, portfolio, operational and structured risks involving mortgage collateral. Credit Analytics also is responsible for establishing insurable risk guidelines for product types and loan attributes.
4. Risk Analytics
Our Risk Analytics group is responsible for all modeling functions in our mortgage insurance business. Risk Analytics estimates, implements and controls our proprietary models used in pricing our flow business and structured transactions. Our proprietary models jointly estimate default and prepayment risk on all of our major product lines. Risk Analytics also reviews and approves all third party models used to approve loans for delegated mortgage insurance and is also responsible for our economic capital model and risk-adjusted returns on our capital (RAROC) pricing tools, and oversees economic research.
We use reinsurance in our mortgage insurance business as a capital and risk management tool.
Smart Home. In 2004, we developed a program, referred to as Smart Home, for reinsuring risk associated with non-prime mortgages and riskier loan products. These reinsurance transactions, through the use of special purpose entity (SPE) structures, effectively transfer risk from our portfolio to investors in the capital markets. We have entered into a total of four Smart Home transactions.
Each transaction began with the formation of an unaffiliated, offshore reinsurance company. We then entered into an agreement with the Smart Home reinsurer to cede to the reinsurer a portion of the risk (and premium) associated with a portfolio of loans, consisting mostly of non-prime residential mortgages insured by us. The Smart Home reinsurer was funded in the capital markets through the issuance to investors of a series of separate classes of credit-linked notes. Each class relates to the loss coverage levels on the reinsured portfolio and is assigned a rating by one or more rating agencies.
We typically retain the risk associated with the first-loss coverage levels, and the risk associated with the senior most tranche of coverage. Holders of the Smart Home credit-linked notes bear the risk of loss from losses that would be paid to us under the reinsurance agreement, which consists of the layers of risk in between those we retain. The Smart Home reinsurer invests the proceeds of the notes in high-quality short-term investments approved by the rating agencies. Income earned on those investments and a portion of the reinsurance premiums that we pay are applied to pay interest on the notes as well as certain of the Smart Home reinsurers expenses. The rate of principal amortization of the credit-linked notes is intended to approximate the rate of principal amortization of the underlying mortgages.
At December 31, 2010, $1.0 billion, or approximately 3.2% of our primary risk in force, was included in Smart Home reinsurance transactions, compared to $1.1 billion, or approximately 3.4% at December 31, 2009. We exercised our option to terminate two of our four transactions in February 2011 with risk in force of approximately $41 million.
Captive Reinsurance. We and other companies in the mortgage insurance industry have participated in reinsurance arrangements with mortgage lenders commonly referred to as captive reinsurance arrangements. Under captive reinsurance arrangements, a mortgage lender typically establishes a reinsurance company that assumes part of the risk associated with the portfolio of that lenders mortgages insured by us on a flow basis (as compared to mortgages insured in structured transactions, which typically are not eligible for captive reinsurance arrangements). In return for the reinsurance companys assumption of a portion of the risk, we cede a portion of the mortgage insurance premiums paid to us to the reinsurance company. We have also offered, on a limited
basis, quota share captive reinsurance arrangements under which the captive reinsurance company assumes a pro rata share of all losses in return for a pro rata share of the premiums collected.
In most cases, the risk assumed by the reinsurance company is an excess layer of aggregate losses that would be penetrated only in a situation of adverse loss development. During the recent housing and related credit market downturn in which losses have increased significantly, many captive reinsurance arrangements have attached, meaning that losses have exceeded the level beyond which we are entitled to cash recoveries from the captive. We expect that most of the actual cash recoveries from these captives will be received over the next few years. In all cases, the captive reinsurer establishes a trust to secure our potential cash recoveries. We generally are the sole beneficiary under these trusts, and therefore, have the ability to initiate disbursements under the trusts in accordance with the terms of our captive reinsurance agreements. Ceded losses recoverable related to captives at December 31, 2010 were $151.7 million.
In the fourth quarter of 2010, we terminated two large captive reinsurance arrangements representing $6.0 billion of risk in force. In connection with these terminations, we received $321 million of cash and investments from the captive trust account, which are accounted for as claims recoveries. As of December 31, 2010, we have received total cash reinsurance recoveries (including recoveries from the termination of captive arrangements) from Smart Home and captive reinsurance arrangements of approximately $673.2 million, since inception of the program. In some instances, we anticipate that the ultimate recoveries from the captive reinsurers will be greater than the assets currently held by the segregated trusts established for each captive reinsurer. Recorded recoverables, however, are limited to the current trust balances.
All of our existing captive reinsurance arrangements are operating on a run-off basis, meaning that no new business is being placed in these captives. In 2010, we terminated a significant portion of our remaining captive reinsurance arrangements on a cut-off basis, meaning that the terminated captive arrangements were dissolved and all outstanding liabilities were settled.
GSE Arrangements. We also have entered into risk/revenue-sharing arrangements with the GSEs whereby the primary insurance coverage amount on certain loans is recast into primary and pool insurance and our overall exposure is reduced in return for a payment made to the GSEs. Ceded premiums written and earned for the year ended December 31, 2010 were each $4.0 million under these programs and are expected to decline over time.
Other Reinsurance. Certain states limit the amount of risk a mortgage insurer may retain on a single loan to 25% of the indebtedness to the insured. Radian Guaranty currently uses reinsurance from affiliated companies to remain in compliance with these insurance regulations. See RegulationState RegulationReinsurance below. In February 2010, Radian Guaranty, in order to support its capital position, entered into an excess-of-loss reinsurance agreement with Radian Insurance. Under this agreement, Radian Guaranty transferred approximately $1 billion of risk in force to Radian Insurance. This pool of loans consists of a higher concentration of fixed-rate, prime, high FICO loans than our overall mortgage insurance portfolio.
The principal customers of our mortgage insurance business are mortgage originators such as mortgage bankers, mortgage brokers, commercial banks, savings institutions, credit unions and community banks.
Our mortgage insurance business depends to a significant degree on a small number of large lending customers. Our top 10 mortgage insurance customers, measured by primary new insurance written, represented 54.4% of our primary new insurance written in 2010, compared to 62.3% and 62.6% in 2009 and 2008, respectively. The largest single mortgage insurance customer (including branches and affiliates), measured by primary new insurance written, accounted for 15.5% of new insurance written during 2010, compared to 16.1% and 26.4% in 2009 and 2008, respectively. In 2010 and 2009, the premiums paid to us by each of Bank of America and Wells Fargo, exceeded 10% of our consolidated revenues. In an effort to diversify our customer
base, beginning in 2009, we increased the amount of business we are conducting with credit unions, and in 2010, we have increased the amount of business done with community banks that meet our underwriting guidelines.
G. Sales and Marketing
Our sales and account management team consists of 65 persons, organized in various geographic regions across the United States. Our Sales and Business Development group focuses on the creation of new mortgage insurance relationships, while our Account Management group is responsible for supporting all existing mortgage insurance relationships. Mortgage insurance sales and account management personnel are compensated by salary, commissions on new insurance written and other incentive-based pay tied to the achievement of certain sales goals. These incentive-based awards are reviewed to prevent excessive risk taking.
We operate in a highly competitive and rapidly changing market and compete with a variety of organizations, including other private mortgage insurers and federal and state governmental and quasi-governmental agencies. We compete directly with seven other private mortgage insurers, including: CMG Mortgage Insurance Company, Essent Guaranty, Genworth Financial Inc., Mortgage Guaranty Insurance Corporation (MGIC), PMI Mortgage Insurance Co., Republic Mortgage Insurance Company, and United Guaranty Corporation. Some of these competitors have significantly greater financial and marketing resources and stronger financial strength ratings than ours. We compete for flow business with other private mortgage insurance companies on the basis of both service and price. The service-based component includes risk management services, timeliness of claims payments, training, loss mitigation efforts and management and field service organization and expertise.
We also compete with various federal and state governmental and quasi-governmental agencies, principally the FHA, the Veterans Administration (VA) and state-sponsored mortgage insurance funds. The FHA, which historically was not viewed by us as a significant competitor, substantially increased its market share of the insured mortgage market to as high as 85.4% in both the fourth quarter of 2009 and the first quarter of 2010. During the last three quarters of 2010, the private mortgage insurance industry has begun to steadily recapture market share from the FHA. The FHAs market share was down to 76.0% of the insured market for the fourth quarter of 2010. Despite this progress, the FHAs market share remains historically high and could increase in the future due to regulatory and other factors. See Risk FactorsOur mortgage insurance business faces intense competition.
Our financial guaranty segment has mainly provided direct insurance and reinsurance on credit-based risks through Radian Asset Assurance, a wholly-owned subsidiary of Radian Guaranty. In the past, we also wrote financial guaranty business internationally through Radian Asset Assurance Limited (RAAL), an insurance company licensed in the United Kingdom and a subsidiary of Radian Asset Assurance. All of our exposure written through RAAL has been novated to Radian Asset Assurance or commuted, and we placed RAAL into liquidation in 2010. We expect the liquidation of RAAL to be completed during 2011.
Financial guaranty insurance typically provides an unconditional and irrevocable guaranty to the holder of a financial obligation of full and timely payment of principal and interest when due. Financial guaranty insurance may be issued at the inception of an insured obligation or may be issued for the benefit of a holder of an obligation in the secondary market. Historically, financial guaranty insurance has been used to lower an issuers cost of borrowing when the insurance premium is less than the value of the spread (commonly referred to as the credit spread) between the market yield required to be paid on the insured obligation (carrying the credit rating of the insurer) and the market yield required to be paid on the obligation if sold on the basis of its uninsured credit risk. Financial
guaranty insurance also has been used to increase the marketability of obligations issued by infrequent or unknown issuers or obligations with complex structures. Traditionally, investors have benefited from financial guaranty insurance through increased liquidity in the secondary market, reduced exposure to price volatility caused by changes in the credit quality of the underlying insured issue, and added protection against loss in the event of the obligors default on its obligation. Market developments, including ratings downgrades of most financial guaranty insurance companies (including Radian Asset Assurance), have significantly reduced the benefits of financial guaranty insurance, particularly certain forms of financial guaranty structured finance transactions.
We have provided direct financial guaranty credit protection through the issuance of a financial guaranty insurance policy or a CDS. Both forms of credit enhancement provide the purchaser of such credit protection with a guaranty of the timely payment of interest and scheduled principal when due on a covered financial obligation. By providing protection through CDS, we were able to participate in transactions involving asset classes (such as corporate collateralized debt obligations (CDOs)) that may not have been available to us through the issuance of a traditional financial guaranty insurance policy. Either form of credit enhancement requires similar underwriting and surveillance.
We have historically offered the following financial guaranty products:
In 2008, in light of market conditions and the downgrade of the financial strength ratings of our financial guaranty insurance subsidiaries, we discontinued writing new financial guaranty business, including accepting new financial guaranty reinsurance, other than as necessary to commute, restructure, hedge or otherwise mitigate losses or reduce exposure in our existing portfolio. Following this decision, we reduced our financial guaranty operations, including a significant reduction in our financial guaranty workforce. Since 2008, we have also reduced our financial guaranty exposures through commutations in order to eliminate uncertainty, maximize the ultimate capital available for our mortgage insurance business and accelerate the potential access to that capital.
We continue to explore ways to maximize the value of our existing insured financial guaranty portfolio, including the possibility of partnering with third-parties to utilize all or a portion of the portfolio as a platform for writing new public finance and infrastructure business, as well as other possible ways to leverage this portfolio. On February 1, 2011, Radian Asset Assurance signed an agreement to purchase the FG Insurance Shell, a New York domiciled financial guaranty insurance company that has not written any business, but has obtained licenses to do so in 36 states and the District of Columbia. The acquisition, which remains subject to regulatory approval, provides Radian Asset Assurance with the flexibility to consider using the FG Insurance Shell to pursue strategic alternatives in the public finance market, including possibly partnering with third-party investors to write new public finance insurance and/or
reinsuring all or a portion of Radian Asset Assurances existing public finance business. We are in the early stages of exploring these potential uses, and expect that any new initiative for the FG Insurance Shell would be consistent with our ultimate goal of reducing our financial guaranty exposure. The expected purchase price of approximately $82 million is $7 million above the value of the statutory capital base of the FG Insurance Shell, consisting of approximately $75 million of cash, cash equivalents and treasury securities.
1. Public Finance
Our public finance business has provided credit enhancement of bonds, notes and other evidences of indebtedness issued by states and their political subdivisions (e.g., counties, cities or towns), school districts, utility districts, public and private non-profit universities and hospitals, public housing and transportation authorities, and authorities and other public and quasi-public entities such as airports, public and private higher education institutions and healthcare facilities. Public finance transactions may also include project finance and public finance initiatives, which are transactions in which public or quasi-public infrastructure projects are financed through the issuance of bonds that are to be repaid from the expected revenues from the projects being built. These types of bonds may be backed by governmental guarantees or other support.
Municipal bonds can be categorized generally into tax-backed bonds and revenue bonds. Tax-backed bonds, which include general obligation bonds, are backed by the taxing power of the governmental agency that issues them, while revenue bonds are backed by the revenues generated by a specific project such as bridge or highway tolls, or by rents or hospital revenues. Credit enhancement of public finance obligations can also take the form of CDS, where we provide credit protection on a pool of public finance obligations or credit protection on the timely payment of principal and interest on a specified public finance or project finance obligation.
2. Structured Finance
Our structured finance business has included ABS and other asset-backed or mortgage-backed obligations, including funded and synthetic CDOs.
Funded asset-backed obligations usually take the form of a secured interest in a pool of assets, often of uniform credit quality, such as credit card or auto loan receivables, commercial or residential mortgages or life insurance policies. Funded ABS also may be secured by a few specific assets such as utility mortgage bonds and multi-family housing bonds. In addition, we have insured future flow DPRs transactions, where our insured obligations are backed by electronic payment orders intended for third-party beneficiaries (e.g. trade-related payments, individual remittances, and foreign direct investments).
The performance of synthetic asset-backed obligations is tied to the performance of specific pools of assets, but the obligations are not secured by those assets. Most of the synthetic transactions we insure are CDOs. In many of these transactions, primarily our corporate CDOs, we generally are required to make payments to our counterparty upon the occurrence of credit-related events related to the borrowings or bankruptcy of obligors contained within pools of corporate obligations or, in the case of pools of mortgage or other asset-backed obligations, upon the occurrence of credit-related events related to the specific obligations in the pool. When we provide synthetic credit protection on a specific credit, our payment obligations to our counterparties are generally the same as those we have when we insure credits through a financial guaranty insurance policy. However, unlike most of our financial guaranty insurance policy obligations, where we have subrogation and other rights and remedies, we generally do not have recourse or other rights and remedies against the issuer and/or any related assets for amounts we may be obligated to pay under these transactions. Even in those cases where we have recourse or any rights and remedies, such recourse, rights and remedies are generally much more limited than the recourse, rights and remedies we generally have in our more traditional financial guaranty transactions, and frequently need to be exercised indirectly through our counterparty.
A CDO pool typically is composed of assets of various credit quality or that possess different characteristics with respect to interest rates, amortization and level of subordination. We primarily have provided credit
protection in our CDO portfolio with respect to the following types of collateral: corporate debt obligations, TruPs, commercial mortgage-backed securities (CMBS), ABS (which includes RMBS), collateralized loan obligations (CLOs) and CDOs containing a combination of such collateral types.
In our corporate CDO transactions, we provide credit protection for certain specified credit-related events related to the borrowings or bankruptcy of obligors contained within pools of corporate obligations. In our TruPs transactions, we provide credit protection for the timely payment of interest and principal when due on a bond (a TruPs bond) representing a senior tranche of a CDO comprised mainly of TruPs. The collateral for TruPs CDOs generally consists of subordinated debt obligations or preferred equity issued by banks, insurance companies, real estate investment trusts and other financial institutions. TruPs are subordinated to substantially all of an issuing institutions debt obligations, but are senior to payments on equity securities of such issuer (including equity securities purchased by the U.S. government under the Troubled Asset Relief Program (TARP)).
In our CDOs of CMBS transactions, we provide credit protection for the timely payment of interest and principal when due on these pools of securities. In our CDO of ABS transaction and our CDOs of CLOs, we insure the timely payment of current interest and the ultimate payment of principal on a senior class of notes whose payment obligations are secured by pools of ABS, predominantly mezzanine-tranches of RMBS securities and corporate loans, respectively.
In some circumstances, we have provided second-to-pay credit protection in which we are not required to pay a claim unless both the underlying obligation defaults and another insurer defaults on its primary insurance obligation to pay a valid claim.
We reinsure direct financial guarantees written by other primary financial guaranty insurers or ceding companies. Reinsurance allows a ceding company to write larger single risks and larger aggregate risks while remaining in compliance with the risk limits and capital requirements of applicable state insurance laws, rating agency guidelines and internal limits. State insurance regulators allow a ceding company to reduce the liabilities appearing on its balance sheet to the extent of reinsurance coverage obtained from licensed reinsurers or from unlicensed reinsurers meeting certain solvency and other financial criteria. Similarly, the rating agencies may permit a reduction in both exposures and liabilities ceded under reinsurance agreements, with the amount of reduction permitted dependent on the financial strength rating of the insurer and reinsurer.
As a result of multiple downgrades of the financial strength ratings of our financial guaranty insurance subsidiaries beginning in June 2008, all of our financial guaranty reinsurance treaties have been terminated on a run-off basis, which means that none of our ceding companies may cede additional business to us under our reinsurance agreements with them. The business they previously ceded to us under these agreements currently remains outstanding (and a part of our risk in force). In addition, as a consequence of the downgrades, our ceding companies currently have the right to take back or recapture their business.
Treaty and Facultative Agreements. The principal forms of reinsurance agreements are treaty and facultative. Under our treaty agreements, the ceding company was obligated to cede to us, and we were obligated to assume, a specified portion of all risks, within ranges, of transactions deemed eligible for reinsurance by the terms of the negotiated treaty. Limitations on transactions deemed eligible for reinsurance typically focused on the size, security and ratings of the insured obligation. Each treaty was entered into for a defined term, generally one year, with renewals upon mutual consent and rights to early termination under certain circumstances.
In treaty reinsurance, there is a risk that the ceding company may select weaker credits or proportionally larger amounts to cede to us. We have attempted to mitigate this risk by requiring the ceding company to retain a portion of each ceded risk, and we included limitations on individual transactions and on aggregate amounts within each type of transaction.
Under a facultative agreement, the ceding company had the option to offer to us, and we had the option to accept, a portion of specific risks, usually in connection with particular obligations. Unlike under a treaty agreement, where we generally relied on the ceding companys credit analysis, under a facultative agreement, we often performed our own underwriting and credit analysis to supplement the ceding companys analysis in order to determine whether to accept the particular risk. The majority of our financial guaranty reinsurance was provided under treaty arrangements.
Proportional or Non-Proportional Reinsurance. We typically have accepted our reinsurance risk on either a proportional or non-proportional basis. Proportional relationships are those in which we and the ceding company share a proportionate amount of the premiums and the losses on the risk subject to reinsurance. In addition, we generally pay the ceding company a commission, which typically is related to the ceding companys underwriting and other expenses in connection with obtaining the business being reinsured, as well as to compensate it for its surveillance of such obligations. Non-proportional relationships are those in which the losses, and consequently the premiums paid, are not shared by the ceding company and us on a proportional basis. Non-proportional reinsurance can be based on an excess-of-loss or first-loss basis. Under excess-of-loss reinsurance agreements, we provide coverage to a ceding company up to a specified dollar limit for losses, if any, incurred by the ceding company in excess of a specified threshold amount. A first-loss reinsurance agreement provides coverage to the ceding company on the first dollar of loss up to a specified dollar limit of losses. Generally, we do not pay a commission for non-proportional reinsurance. However, the same factors that affect the payment of a ceding commission in proportional agreements also may be taken into account with respect to non-proportional reinsurance to determine the proportion of the aggregate premium paid to us. The majority of our financial guaranty reinsurance business was written on a proportional basis.
4. European and Bermuda Operations
Through RAAL, we wrote financial guaranty insurance in the United Kingdom, France, the Netherlands and the Republic of Ireland. RAAL primarily insured synthetic CDS. In addition, until we ceased writing such business in 2005, we wrote trade credit reinsurance through RAAL and Radian Reinsurance (Bermuda) Limited (Radian Re Bermuda). In 2008, we ceased writing any new business through RAAL or Radian Re Bermuda, and since then, we have either: (i) novated, cancelled or transferred existing business to Radian Asset Assurance or (ii) commuted their remaining exposures. RAAL was placed into liquidation in 2010. We expect the liquidation of RAAL to be completed during 2011.
5. Premium Rates
In our financial guaranty business, the issuer of an insured obligation generally pays the premiums for our insurance, either in full at the inception of the policy, in the case of most public finance transactions, or, in the case of most non-synthetic structured finance transactions, in regular monthly, quarterly, semi-annual or annual installments from the cash flows of the related collateral. Premiums for synthetic CDS are generally paid in periodic installments (i.e. monthly, quarterly, semi-annually or annually) directly from our counterparty, and such payments are not dependent upon the cash flows of the insured obligation or the collateral supporting the obligation. In such cases, the corporate creditworthiness of our counterparty is a more important factor than the cash flows from the insured collateral in determining whether we will receive payment. In addition, we generally have a right to terminate our synthetic transactions without penalty if our counterparty fails to pay us, or is financially unable to make timely payments to us under the terms of the CDS transaction. On occasion, all or a portion of the premium for structured products transactions is paid at the inception of the protection.
For public finance transactions, premium rates typically have been stated as a percentage of debt service, which includes total principal and interest. For structured finance obligations, premium rates are typically stated as a percentage of the total par outstanding. Premiums are generally non-refundable. Premiums paid in full at inception are recorded initially as unearned premiums and earned over the life of the insured obligation (or the coverage period for such obligation, if shorter).
B. Net Par Outstanding
Our business has traditionally involved taking credit risk in various forms across various asset classes, products and geographies. Credit risk is measured in our financial guaranty business as net par outstanding, which represents our proportionate share of the aggregate outstanding principal exposure on insured obligations, other than our insured corporate CDOs. We are also responsible for the timely payment of interest on insured financial guaranty obligations. Our total financial guaranty net par outstanding was $78.8 billion as of December 31, 2010, compared to $87.4 billion as of December 31, 2009.
The following tables show the distribution of our financial guaranty segments net par outstanding by type of exposure, as a percentage of financial guarantys total net par outstanding and the related net claim (asset) liability and derivative net (asset) liability as of the dates indicated. See Note 2 of Notes to Consolidated Financial Statements.
1. Credit Quality of Insured Portfolio
The following table identifies the internal credit ratings we have assigned to our net par outstanding as of December 31, 2010 and 2009:
2. Geographic Distribution of Insured Portfolio
The following table shows the geographic distribution of our financial guaranty net par outstanding as of the dates indicated:
3. Largest Single Insured Risks
The following table represents our 10 largest public finance single risks by net par outstanding (together representing 4.7% of financial guarantys total net par outstanding) as of December 31, 2010, along with the internal credit rating assigned as of that date to each credit:
Our 10 largest structured finance single risks by net par outstanding represented $5.7 billion, or 7.2% of financial guarantys aggregate net par outstanding as of December 31, 2010. We have entered into each of these transactions through the issuance of a CDS. These risks include the following exposures:
For additional information regarding the CDOs of CMBS and the CDO of ABS transactions included above, see Directly Insured CDOs of CMBS and ABS below.
4. Structured Finance Insured CDO Portfolio
The following table shows the distribution of our CDO net par outstanding as of December 31, 2010:
The following table sets forth the internal credit ratings assigned to our CDO exposures as of December 31, 2010:
Directly Insured Corporate CDO Portfolio
As of December 31, 2010, our aggregate net par outstanding in our directly insured corporate CDO portfolio was $33.5 billion. All of our outstanding corporate CDOs are static pools, which means the covered reference entities generally cannot be changed without our consent.
The same corporate obligor may exist in a number of our corporate CDO transactions and in our other structured finance obligations. However, the pool of corporate entities in our directly insured corporate CDO portfolio is well diversified with no individual exposure to any corporate entity exceeding 1.0% of our notional
exposure to corporate entities in our directly insured corporate CDOs as of December 31, 2010. As of December 31, 2010, our exposure to the five largest corporate entities represented approximately 4.1% of our total aggregate notional exposure to corporate entities in our directly insured corporate CDO portfolio.
The number of corporate entities in our directly insured corporate CDO transactions range between 77 and 126 per transaction, with the concentrations of each corporate entity averaging 1.0% per transaction. No corporate entity represented more than 2.6% of any one transaction. Our exposure to any single corporate entity in any one transaction ranges from $3.3 million to $120.0 million, with an average of $29.5 million per transaction.
The following table summarizes the five largest industry concentrations (according to Standard & Poors Rating Service (S&P)) in our financial guaranty directly insured corporate CDO portfolio as of December 31, 2010:
Because each transaction has a significant level of subordination, credit events would typically have to occur with respect to numerous entities in a collateral pool before we would have a claim payment obligation in respect of any particular transaction, meaning that our risk adjusted exposure to each corporate entity in a CDO pool is significantly less than our notional exposure. In the unlikely event that all of our five largest corporate obligors were to have defaulted at December 31, 2010, absent any other defaults in the CDOs in which these obligors were included, we would not have incurred any losses due to the significant subordination remaining in each transaction in which these entities were included.
Using our internal ratings, 90.1% of the aggregate net par exposure of our directly insured corporate CDO portfolio had subordination at or above the level of subordination necessary to warrant an internal AAA rating, and only 0.6% of such aggregate net par exposure was internally rated BIG as of December 31, 2010. Our internal ratings for our corporate CDOs differ from those derived using S&Ps most recent version of its CDO Evaluator tool (published as of December 31, 2009). Using the CDO Evaluator, 54.8% of the aggregate net par exposure to our directly insured corporate CDO portfolio continued to have subordination at or above the level of subordination necessary to warrant a AAA rating from S&P.
The number of sustainable credit events, which is the number of credit events on different corporate entities that would have to occur before we are obligated to pay a claim (i.e., the remaining subordination in our transaction measured in credit events), is another measure that is helpful in evaluating the credit strength of a transaction. The following table provides this information for our directly insured corporate CDO portfolio as of December 31, 2010, by year of scheduled maturity. In order to determine the number of different corporate entities that would be required to experience a credit event before we pay a claim, we calculate the weighted average net par exposure per corporate entity, then reduce such amount by an assumed recovery value (30%, except with respect to transactions where we have agreed to a set fixed recovery, in which case we assume such fixed recovery), which then determines the reduction of subordination that would occur for each applicable credit event. We then divide the aggregate subordination for the applicable transaction by the related reduction of subordination per credit event to determine the applicable number of corporate entities that would need to experience a credit event before subordination in such transactions would be reduced to zero. One corporate
CDO with net par outstanding of $0.1 billion is not included in the table below, since the payments of principal and interest on this CDO depend on the cash flows actually generated from the CDOs underlying collateral and the likelihood that we would have to pay a claim is not measurable in terms of sustainable credit events.
The following table sets forth the credit ratings of the underlying collateral for our financial guaranty directly insured corporate CDO portfolio as of December 31, 2010:
Directly Insured Trust Preferred CDO Portfolio
As of December 31, 2010, we provided credit protection on 16 TruPs bonds. TruPs are subordinated securities issued by banks and insurance companies, as well as by real estate investment trusts and other financial institutions, to supplement their regulatory capital needs. Generally, TruPs are subordinated to substantially all of an issuers debt obligations, but rank senior to the equity securities of such issuer (including equity securities issued to the U.S. government under TARP).
Our credit protection on these TruPs bonds was conducted through 20 separate CDS contracts, meaning that with respect to four of the TruPs bonds we insured at December 31, 2010, we entered into two separate CDS contracts (each with a different counterparty) covering the same TruPs bond.
As of December 31, 2010, the collateral underlying our insured TruPs bonds included 730 separate issuers, including 611 banking institutions (comprising 76.2% of the total TruPs collateral based on notional amount) and 90 insurance companies (comprising 22.8% of the total TruPs collateral based on notional amount). In addition, the TruPs collateral included a small percentage of middle market loans, real estate investment trusts and other CDO tranches. We believe the banking institutions in our total collateral pool are geographically well diversified.
The collateral underlying our insured TruPs bonds consists of between 25 and 114 issuers per TruPs bond, with the concentration of each issuer averaging 1.7% per TruPs bond. As of December 31, 2010, our exposure to any one issuer in our insured TruPs bonds ranges from $70,000 to $42 million per bond, with an average exposure of $9 million. No issuer represented more than 9.0% of the total collateral underlying any one TruPs bond.
The following table provides additional detail regarding the scheduled maturity, net par outstanding, remaining principal subordination and interest coverage ratio for each of our insured TruPs bonds as of the dates indicated:
Many of the issuers in our insured TruPs bonds have been negatively affected by the recent U.S. economic recession. Certain of these issuers have defaulted on their obligation to pay interest on their TruPs or have voluntarily chosen to defer interest payments, which is permissible for up to five years. Since we believe there is a significant likelihood that TruPs subject to interest deferrals will ultimately result in a default, we closely monitor deferrals as well as defaults in assessing the subordination remaining beneath our insured TruPs bonds. Nine of the TruPs bonds that we insure (representing a net par outstanding of $1.4 billion) were internally rated BIG as of December 31, 2010, and the weighted average internal rating for all of our insured TruPs bonds was B+ as of December 31, 2010. The fair value liability of our insured TruPs transactions, which are accounted for as derivatives, was $368.0 million as of December 31, 2010.
One of our insured TruPs bonds began experiencing interest shortfalls in October 2009. In January 2010, we eliminated $96.6 million of our exposure to this TruPs bond by commuting one of the CDS contracts covering this bond. Our aggregate net loss with respect to such commutation approximated the fair value of this derivative liability at December 31, 2009. As of December 31, 2010, we had paid an aggregate of $0.5 million in interest shortfall claims on the $115.9 million of net par exposure on the remaining TruPs CDS contract, and we expect to continue to pay additional interest shortfall claims on this CDS contract. In addition, we may be required to pay a liquidity claim (as defined below) on this CDS contract.
Based on current projections, we expect to experience ultimate net credit losses on two of our TruPs bonds with an aggregate of $245.6 million in net par outstanding (the TruPs bond described above representing $115.9 million in exposure and one other TruPs bond representing $129.7 million in exposure). Based on our current cash flow projections for these TruPs bonds, we believe that, in addition to interest claims that we may be
required to pay over time, we will be required to pay aggregate principal claims totaling a majority of the current net par outstanding for these bonds. It should be noted that even relatively small changes in TruPs default rates or economic conditions from current projections could have a material impact on the timing and amount of cash available to make interest and principal payments on the underlying TruPs bonds. Therefore, the occurrence, timing and duration of any event of default and the amount of any ultimate principal or interest shortfall payments are uncertain and difficult to predict.
In addition to credit risk, we also potentially face liquidity risk with respect to certain of our CDS contracts. As of December 31, 2010, we have eight CDS contracts with respect to seven TruPs bonds (representing a total net par outstanding of $845.1 million as of December 31, 2010) pursuant to which we may be required, under certain circumstances, to pay our counterparty the outstanding par amount of our insured TruPs bonds (a liquidity claim). A liquidity claim may arise if an event of default under the TruPs bond (e.g., a failure to pay interest or a breach of covenants requiring the maintenance of a certain level of performing collateral) existed as of the termination date of the CDS contract. The termination dates of these CDS contracts currently range between 2015 and 2017, but automatically extend for additional one year increments (but no later than the maturity date of the TruPs CDO) unless terminated by our counterparty. If we are required to pay a liquidity claim, our counterparty would be obligated under the CDS to either deliver the insured TruPs bond to us or to periodically pay us cash in an amount equal to any future amounts paid in respect of principal and interest on the insured TruPs bond. We may be required to pay a liquidity claim on the $115.9 million CDS contract referred to above. This CDS contract is currently scheduled to terminate in July 2016. We are exploring loss mitigation alternatives with respect to this TruPs bond, including the possibility of commuting our remaining risk on this bond. We can provide no assurance that we will be successful in such loss mitigation efforts.
Directly Insured CDOs of CMBS and ABS
We have directly insured four CDOs of CMBS transactions, containing 127 CMBS tranches that were issued as part of 88 securitizations. Of the 127 CMBS tranches constituting the collateral for our CDOs of CMBS transactions, 58 of them have been downgraded by Moodys from Aaa to between Aa1 and Caa1 and 76 have been downgraded from AAA to between AA+ and B by S&P. Despite this deterioration, the transactions as a whole remain highly rated.
The following table provides information regarding our directly insured CDOs of CMBS exposure as of December 31, 2010:
The total balance of the reference CMBS tranches in these collateral pools is $6.8 billion. The underlying loan collateral pool supporting the CMBS tranches consists of approximately 14,000 loans with a balance of approximately $180 billion. The underlying loan collateral is reasonably well diversified both geographically and by property type. Approximately 33.3%, 32.2% and 14.7% of the underlying loan collateral was for office space, retail space and multi-family property, respectively. Approximately 23.0% of the underlying loans are scheduled to come due by the end of December 2014, an additional 44.1% and 30.0% are scheduled to come due in the years ending December 31, 2015 and 2016, respectively, and the remaining 2.9% are scheduled to come due thereafter. If such underlying loans cannot be refinanced when due and such loans default, we may be required to pay a principal claim on our insured CDOs of CMBS, subject to applicable subordination, if the amount recovered upon the foreclosure of the underlying property, or otherwise, is insufficient to cover the defaulted loan balance and related expenses.
We have exposure to RMBS, including exposure to subprime RMBS, through one directly insured CDO of ABS with a net par outstanding of $453.6 million as of December 31, 2010. Approximately 54.6% of the collateral for this transaction is RMBS, including 38.1% subprime RMBS; 18.5% is CMBS; 17.0% is CDOs of ABS, including CDOs which contain RMBS and CMBS; 4.6% is CDOs of CDO and the remaining 5.3% is in other asset classes. This transaction is currently rated CC internally, CC by S&P and Ca by Moodys. In this transaction, we provide credit protection through a CDS on the senior most tranche of a CDO of ABS transaction with the underlying collateral consisting predominantly of mezzanine tranches of MBS. As of December 31, 2010, $381.8 million (or 83.8%) of the collateral pool was rated BIG, and $248.3 million (or 54.5%) of the collateral pool had defaulted. Due to the substantial deterioration of the underlying collateral, we currently expect to begin paying claims related to interest shortfalls on this transaction in 2012. However, due to the structure of this transaction, we do not expect to pay claims related to principal shortfalls until sometime between 2036 and the legal final maturity date for this transaction in 2046. Although losses for this transaction are difficult to estimate, we currently believe the ultimate claim payments in respect of principal for this transaction will be substantially all of our total principal exposure.
Directly Insured CLO Exposure
We also have $0.6 billion in exposure related to four CLO transactions. Three of these transactions are second-to-pay transactions in which we will not be obligated to pay a claim unless both the underlying obligation defaults and another insurer defaults on its primary insurance obligation to pay such claim. These second-to-pay transactions are internally rated between AA- and BB+ and are scheduled to mature between 2016 and 2018. We are in a first-to-pay position with respect to the remaining CLO transaction (representing $7.8 million of exposure), which is internally rated AAA.
5. Non-CDO ABS Risk
We have an aggregate of $1.1 billion of net par outstanding related to ABS obligations (which does not include any exposure to CMBS) outside of our insured CDO portfolio. The following table shows the distribution of such ABS obligations.
We have no direct exposure to home equity lines of credit. We have assumed from our primary insurance customers an aggregate of $174.9 million of exposure to 2006 and 2007 vintage RMBS outside our insured CDO portfolio (2006/2007 Vintage), which we consider to be particularly high risk RMBS exposure due to the historically high default rates and aggregate losses on RMBS originated in those years. As of December 31, 2010, 44.3% of our total RMBS net par outstanding remains investment-grade (at least BBB), including 41.4% of our 2006/2007 Vintage.
The following table provides additional information regarding our exposure to RMBS in our non-CDO portfolio as of December 31, 2010: