Notes to Unaudited Condensed Consolidated Financial Statements

1—Condensed Consolidated Financial Statements—Basis of Presentation

Our condensed consolidated financial statements include the accounts of Radian Group Inc. and its subsidiaries, including its principal mortgage guaranty operating subsidiaries, Radian Guaranty Inc. (“Radian Guaranty”), Amerin Guaranty Corporation (“Amerin Guaranty”) and Radian Insurance Inc. (“Radian Insurance”). These subsidiaries also include our principal financial guaranty operating subsidiaries, Radian Asset Assurance Inc. (“Radian Asset Assurance,” which includes Radian Reinsurance Inc. (“Radian Reinsurance”), which was merged, into Radian Asset Assurance effective June 1, 2004) and Radian Asset Assurance Limited (“RAAL”). We refer to Radian Group Inc. together with its consolidated subsidiaries as “we,” “us” or “our,” unless the context requires otherwise. We also have a 46.0% interest in Credit-Based Asset Servicing and Securitization LLC (“C-BASS”) and a 41.5% interest in Sherman Financial Group LLC (“Sherman”), each of which are active credit-based asset businesses.

On June 24, 2005, we entered into agreements to restructure our ownership interest in Sherman. Before the restructuring, Sherman was owned 41.5% by us, 41.5% by Mortgage Guaranty Insurance Corporation (“MGIC”) and 17% by an entity controlled by Sherman’s management team. As part of the restructuring, we and MGIC each agreed to sell a 6.92% interest in Sherman to a new entity controlled by Sherman’s management team, thereby reducing our ownership interest and MGIC’s ownership interest to 34.58% for each of us. In return, the new entity controlled by Sherman’s management team will pay approximately $15.65 million (which is the approximate book value of the ownership interest plus an additional $1 million) to us and the same amount to MGIC. This aspect of the restructuring is contingent upon the receipt of regulatory approval and is expected to close before the end of 2005. If and when this approval is obtained, our ownership interest will be reduced to 34.58%, retroactive to May 1, 2005. Our equity in net income of affiliates for the second quarter of 2005 includes approximately $2.7 million attributable to the 6.92% interest. In addition, effective June 15, 2005, Sherman’s employees were transferred to the new entity controlled by Sherman’s management team, and this entity agreed to provide management services to Sherman. Sherman’s management team also agreed to reduce significantly its maximum incentive payout under its annual incentive plan for periods beginning on or after May 1, 2005, resulting in an increase in Sherman’s net income, which will be greater than it would have been without this reduction in the maximum incentive payout. Following the restructuring, and assuming that regulatory approval is obtained before the end of 2005, we expect that our and MGIC’s share of Sherman’s net income will be similar to our respective shares before the restructuring because, although our percentage interest in Sherman will be smaller than it was before the restructuring, Sherman’s net income will be greater than it would have been if the restructuring had not occurred.

In connection with the restructuring, we and MGIC each also paid $1 million for the right to purchase, on July 7, 2006, a 6.92% interest in Sherman from an entity controlled by Sherman’s management team for a price intended to approximate current fair market value. If either we or MGIC exercise our purchase right but the other fails to exercise its purchase right, the exercising party also may exercise the purchase right of the non-exercising party. Radian and MGIC’s representation on Sherman’s Board of Managers would not change regardless of which party or parties exercise the purchase right.

In September 2004, Primus Guaranty, Ltd. (“Primus”), a Bermuda holding company and parent to Primus Financial Products, LLC, issued common stock in an initial public offering of its common shares. We owned an approximate 15% interest in Primus before the offering, and sold 177,556 shares of our Primus common stock in the offering, receiving approximately $2.2 million and recording a gain of $1.0 million. We now own 4,744,506 shares of Primus or approximately 11% of the common shares outstanding. Our investment in Primus, which previously had been included in investment in affiliates on our condensed consolidated balance sheets, was reclassified to the equity securities available for sale category of investments beginning with the third quarter of 2004. Also beginning with the third quarter of 2004, we no longer report earnings or loss from Primus as equity

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in earnings of affiliates. All changes in the fair value of the Primus stock are recorded as accumulated other comprehensive income. We believe this treatment and presentation is appropriate because, after the public offering, we no longer have significant influence over Primus disproportionate to our percentage of equity ownership.

We have presented our condensed consolidated financial statements on the basis of accounting principles generally accepted in the United States of America (“GAAP”). We have condensed or omitted certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with GAAP pursuant to the SEC’s rules and regulations.

The financial information presented for interim periods is unaudited; however, such information reflects all adjustments that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations, and cash flows for the interim periods. These interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2004. The results of operations for interim periods are not necessarily indicative of results to be expected for the full year or for any other period.

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results may differ from these estimates and assumptions.

Basic net income per share is based on the weighted average number of common shares outstanding, while diluted net income per share is based on the weighted average number of common shares outstanding and common share equivalents that would be issuable upon the exercise of stock options, the vesting of restricted stock and the conversion of our senior convertible debentures. These senior convertible debentures were redeemed on August 1, 2005, as discussed in Note 7.

We classify items of other comprehensive income by their nature and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid in capital in the equity section of the condensed consolidated balance sheets. Amounts categorized as other comprehensive income represent net unrealized gains or losses on investment securities available for sale, net of income taxes and unrealized foreign currency translation adjustments, net of income taxes. Total comprehensive income for the three months ended June 30, 2005 and 2004 amounted to $194.1 million and $23.1 million, respectively. Total comprehensive income for the six months ended June 30, 2005 and 2004 amounted to $240.0 million and $154.5 million, respectively.

The presentation of prior period financial information includes changes from those previously reported that are consistent with the SEC’s interpretation of its rules regarding presentation. In particular, gains and losses on sales of investments and change in fair value of derivative instruments have been moved to revenues, and equity in net income of affiliates has been moved from revenues to a separate item following total expenses. These changes affect the presentation of our condensed consolidated statements of income, but do not alter net income.

2—Derivative Instruments and Hedging Activities

We account for derivatives under Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted. In general, SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at their respective fair values. All derivative instruments are recognized in our condensed consolidated balance sheets as either assets or

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liabilities depending on the rights or obligations under the contracts. Transactions that we have entered into that are accounted for under SFAS No. 133 include investments in fixed-maturity securities, interest rate swaps, selling credit protection in the form of credit default swaps and certain financial guaranty contracts that are considered credit default swaps. Credit default swaps and certain financial guaranty contracts that are accounted for under SFAS No. 133 are part of our overall business strategy of offering financial guaranty protection to our customers. The interest rate swaps qualify as hedges and are accounted for as fair value hedges. The embedded equity derivatives contained within the investment in fixed-maturity securities and the sale of credit protection in the form of credit default swaps do not qualify as hedges under SFAS No. 133, so changes in their fair value are included in current earnings in our condensed consolidated statements of income. Net unrealized gains and losses on credit default swaps and certain other financial guaranty contracts are included in other assets or accounts payable and accrued expenses on our condensed consolidated balance sheets. We do not recognize a reserve for losses on derivative contracts. Any equivalent reserve would be embedded in the unrealized gains and losses. Settlements under derivative financial guaranty contracts are charged to other assets or accounts payable and accrued expenses. On a limited basis, we engage in derivative settlements to mitigate counterparty exposure and to provide additional capacity to our customers. During the first six months of 2005, we received $4.4 million as settlement proceeds on derivative financial guaranty contracts. During the first six months for 2004, we received $2.9 million as settlement proceeds on derivative financial guaranty contracts and paid $2.9 million as settlement on derivative finance guaranty contracts. We did not pay any amounts as settlements on derivative financial guaranty contracts during 2005.

SFAS No. 133 requires that we split the convertible fixed-maturity securities in our investment portfolio into their derivative and fixed-maturity security components. Over the term of the securities, changes in the fair value of fixed-maturity securities available for sale are recorded in our condensed consolidated statement of changes in common stockholders’ equity through accumulated other comprehensive income or loss. Concurrently, a deferred tax liability or benefit is recognized as the recorded value of the fixed-maturity security increases or decreases. A change in the fair value of the derivative is recorded as a gain or loss in our condensed consolidated statements of income.

A summary of our derivative information, as of and for the periods indicated, is as follows:

The components of the change in fair value of derivative instruments are as follows:

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The following table presents information at June 30, 2005 and December 31, 2004 related to net unrealized gains or losses on derivative financial guaranty contracts (included in other assets or accounts payable and accrued expenses on our condensed consolidated balance sheets).

The application of SFAS No. 133, as amended, could result in volatility from period to period in gains and losses as reported on our condensed consolidated statements of income. These gains and losses result primarily from changes in corporate credit spreads, changes in the creditworthiness of underlying corporate entities, and the equity performance of the entities underlying convertible investments. Any incurred losses on such contracts would run through the change in the fair value of derivatives. We are unable to predict the affect this volatility may have on our financial position or results of operations.

In accordance with our risk management policies, we have entered into derivative instruments to hedge the interest rate risk related to the issuance of certain long-term debt. As of June 30, 2005, we were a party to interest rate swap contracts. These interest rate swaps are designed as fair value hedges that hedge the change in fair value of the debt arising from interest rate movements. During 2005 and 2004, the fair value hedges were 100% effective. Therefore, the changes in fair value of derivative instruments in our condensed consolidated statements of income were offset by the change in the fair value of the hedged debt. These interest-rate swap contracts mature in February 2013. Terms of the interest rate swap contracts at June 30, 2005 were as follows (dollars in thousands):

In October 2004, we entered into transactions to lock in treasury rates that would have served as a hedge if we had issued long-term debt. The notional value of the hedges was $120 million at a blended rate of 4.075%. At December 31, 2004, we had a $1.5 million unrealized gain recorded on the hedges. In January 2005, we discontinued the hedge arrangements and received payments from our counterparties. We realized a gain of $1.0 million at termination in 2005.

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3—Accounting for Stock-Based Compensation

We account for stock-based compensation in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123 requires expanded disclosures of stock-based compensation arrangements with employees and encourages, but does not require, the recognition of compensation expense for the fair value of stock options and other equity instruments granted as compensation to employees and directors. We have chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of our stock at the date of the grant over the amount an employee must pay to acquire the stock. To date, there have been no options issued at a price that was less than the market price at the date of issuance.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement 123 (revised 2004) (“SFAS No. 123R”) that will require compensation costs related to share-based payment transactions to be recognized in the financial statements. The compensation costs, with limited exceptions, will be measured based on the grant-date fair value of the equity or liability instrument issued. Liability awards will be required to be re-measured each reporting period. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. SFAS No. 123R replaces SFAS No. 123 and supersedes APB 25. This statement is effective beginning with the first quarter of a registrant’s fiscal year that begins after June 15, 2005 (the quarter ending March 31, 2006 for us) and applies to all awards granted after the effective date. It is our intention to use the modified prospective method in implementing SFAS No. 123R, which requires the reporting of the cumulative effect of applying this statement as of that date. Management is in the process of reviewing this statement and assessing the impact it will have on our financial statements.

The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation (in thousands, except per share amounts).

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The Radian Group Inc. Equity Compensation Plan (the “Plan”) provides for the grant of restricted stock to selected key employees of the Company and its affiliates. In May 2005, the Company granted 40,000 shares of restricted stock which vest over three years. Deferred compensation was recorded based on the market price at the date of grant. Compensation expense on the restricted stock is recognized over the vesting period of the shares.

4—Investments

We are required to group assets in our investment portfolio into one of three categories: held to maturity, available for sale or trading securities. Fixed-maturity securities for which we have the positive intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost. Investments classified as available for sale are reported at fair value, with unrealized gains and losses (net of tax) reported as a separate component of stockholders’ equity as accumulated other comprehensive income. Investments classified as trading securities are reported at fair value, with unrealized gains and losses (net of tax) reported as a separate component of income. For securities classified as either available for sale or held to maturity, we conduct a quarterly evaluation of declines in market value of the investment portfolio asset basis to determine whether the decline is other-than-temporary. This evaluation includes a review of (1) the length of time and extent to which fair value is below amortized cost; (2) issuer financial condition; and (3) our intent and ability to retain our investment over a period of time to allow recovery in fair value. We use a 20% decline in price over four continuous quarters as a guide in identifying those securities that should be evaluated for impairment. For securities that have experienced rapid price declines or unrealized losses of less than 20% over periods in excess of four consecutive quarters, classification as other-than-temporary is considered. Factors influencing this consideration include an analysis of the security issuer’s financial performance, financial condition and general economic conditions.

If the decline in fair value is judged to be other-than-temporary, the cost basis of the individual security is written down to fair value through earnings as a realized loss and the fair value becomes the new basis. At June 30, 2005 and 2004, there were no investments held in the portfolio that met these criteria. Realized gains and losses are determined on a specific identification method and are included in income. Other invested assets consist of residential mortgage-backed securities and forward foreign currency contracts and are carried at fair value.

In March 2004, the FASB Emerging Issues Task Force (“EITF”) reached a consensus regarding EITF 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The consensus provides guidance for evaluating whether an investment is other-than-temporarily impaired and was effective for other-than-temporary impairment evaluations made in reporting periods beginning after June 15, 2004.

However, the guidance contained in paragraphs 10-20 of this Issue has been delayed by FASB Staff Position (“FSP”) EITF Issue 03-1-1, “Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” posted September 30, 2004. The delay of the effective date for paragraphs 10-20 will be superseded concurrent with the final issuance of proposed FSP EITF Issue 03-1-a, “Implication Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The proposed FSP would provide implementation guidance with respect to debt securities that are impaired solely due to interest rates and/or sector spreads and analyzed for other-than-temporary impairment. The disclosures continue to be effective for our condensed consolidated financial statements for fiscal years ending after December 15, 2003, for investments accounted for under SFAS No. 115 and No. 124. For all other investments within the scope of this Issue, the disclosures continue to be effective for fiscal years ending after June 15, 2004. The additional disclosures for cost method investments continue to be effective for fiscal years ending after June 15, 2004.

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At June 30, 2005, fixed-maturity investments available for sale had gross unrealized losses of $16.8 million. At June 30, 2005, equity securities available for sale had no gross unrealized losses. The length of time that those securities in an unrealized loss position at June 30, 2005 have been in an unrealized loss position, as measured by their June 30, 2005 fair values, was as follows:

Of the 104 securities that have been in an unrealized loss position for more than 12 months, in our judgment none has an unrealized loss of more than 20% of that security’s amortized cost and none of the losses required recognition as other-than-temporary.

The contractual maturity of securities in an unrealized loss position at June 30, 2005 was as follows:

5—Segment Reporting

We have three reportable segments: mortgage insurance, financial guaranty and financial services. The mortgage insurance segment provides mortgage credit protection, primarily via private mortgage insurance, and risk management services to mortgage lending institutions located throughout the United States and globally. Private mortgage insurance primarily protects lenders from all or part of default-related losses on residential first-mortgage loans made primarily to homebuyers who make down payments of less than 20% of the home’s purchase price. Private mortgage insurance also facilitates the sale of these mortgages in the secondary market. The financial guaranty segment provides credit-related insurance coverage, credit default swaps and certain other financial guaranty contracts to meet the needs of customers in a wide variety of domestic and international markets. Our insurance businesses within the financial guaranty segment include the assumption of reinsurance from monoline financial guaranty insurers for both public finance bonds and structured finance obligations, direct financial guaranty insurance for public finance bonds and structured finance obligations, and trade credit reinsurance. The financial services segment consists of our equity interest in C-BASS and Sherman, which deal primarily with credit-based servicing and securitization of assets in underserved markets, in particular, the purchase, servicing and securitization of special assets, including sub-performing/non-performing mortgages and

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delinquent consumer assets. In addition, until the discontinuance of our RadianExpress operations during the first quarter of 2004 and final processing of all remaining transactions, the financial services segment included the results of RadianExpress, an Internet-based settlement company that provided real estate information products and services to the first- and second-lien mortgage industry. Our reportable segments are strategic business units that are managed separately because each business requires different marketing and sales expertise. Certain corporate income and expenses have been allocated to the segments. For the quarters ended June 30, 2005 and 2004, our revenue attributable to foreign countries was approximately 8.0% and 5.4%, respectively. For the six months ended June 30, 2005 and 2004, our revenue attributed to foreign countries was approximately 8.3% and 7.6% respectively. In addition, long-lived assets located in foreign countries were immaterial for the periods presented.

In the mortgage insurance segment, the highest state concentration of risk in force at June 30, 2005 was California at 10.3%, compared to 13.4% at June 30, 2004. At June 30, 2005, California also accounted for 10.7% of the mortgage insurance segment’s total direct primary insurance in force, compared to 13.4% at June 30, 2004, and 12.9% of the mortgage insurance segment’s total direct pool risk in force, compared to 16.5% at June 30, 2004. California accounted for 13.6% of the mortgage insurance segment’s direct primary new insurance written in the first six months of 2005, compared to 13.3% in the first six months of 2004. The percentage of risk in California has been falling due to the high cancellation rate as compared to new business written. The largest single customer of the mortgage insurance segment (including branches and affiliates of such customer), measured by new insurance written, accounted for 21.5% of new insurance written in the first six months of 2005, compared to 11.5% in the first six months of 2004. The amount reported in 2005 includes a large structured transaction originated in the second quarter of 2005 composed of prime and non-prime mortgage loans originated throughout the United States.

The financial guaranty segment derives a substantial portion of its premiums written from a small number of direct primary insurers. In the first six months of 2005, the financial guaranty segment generated gross written premiums from four customers. Gross written premiums from one of these customers were more than offset by the impact of gross written premiums recaptured by this customer. In the first six months of 2004, the financial guaranty segment generated gross written premiums from four customers. Gross written premiums from one of these customers in the first six months of 2004 were more than offset by the impact of gross written premiums recaptured by this customer. Five primary trade credit insurers were responsible for 13.8% of the financial guaranty segment’s gross premiums written (including the impact of the recapture of business previously ceded to the Company by one of the primary insurer customers in the first quarter of 2005) and 23.5% (excluding this impact) in the first six months of 2005. Five primary trade credit insurers were responsible for 42.9% of the financial guaranty segment’s gross written premiums (including the impact of the recapture of business previously ceded to the company by one of the primary insurer customers in the first quarter of 2004) in the first six months of 2004 and 18.5% (excluding this impact).

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