RADIAN GROUP INC annual report, FY2013

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Business context and reporting period

Radian Group Inc. filed this Form 10-K for the fiscal year ended December 31, 2013. The company provides credit enhancement through two segments: U.S. residential mortgage insurance and a financial guaranty portfolio that has been in runoff since 2008. Management’s strategy is to grow mortgage insurance on higher-quality loans, manage legacy claims, reduce older exposures, and preserve capital and liquidity.

Financial results and key metrics

  • Revenue and earnings: Total revenue was $759.0 million, down 8.0% from $825.4 million in 2012. Net premiums earned rose 12.4% to $830.9 million, while net investment income fell 5.4% to $108.1 million. A $149.7 million net investment loss, versus a $184.9 million gain in 2012, weighed on results. Pretax loss was $207.1 million and net loss was $197.0 million, or $1.18 per diluted share, compared with a $451.5 million net loss in 2012.
  • Operating measure: Mortgage insurance reported a $93.2 million pretax loss; its GAAP loss, expense, and combined ratios were 72.3%, 34.0%, and 106.3%, respectively. Consolidated adjusted pretax operating loss, a non-GAAP measure, was $2.4 million. These measures are not substitutes for GAAP results.
  • Mortgage insurance: Primary new insurance written increased to $47.3 billion from $37.1 billion. Primary risk in force was $40.0 billion, up from $34.4 billion; about 60% was from loans written after 2008. The primary default rate fell to 7.3% from 12.1%, and default inventory declined 34.6% to 60,909 loans. Claims paid rose to $1.4 billion, largely reflecting the Freddie Mac agreement and faster claim processing.
  • Financial guaranty: Net par outstanding fell 29% to $23.9 billion. The segment reported a $113.9 million pretax loss, compared with a $199.6 million loss in 2012; fair-value changes and investment losses affected reported results.
  • Cash flow and liquidity: Cash used in operating activities was $664.9 million, compared with $510.5 million used in 2012. Financing provided $596.9 million, including approximately $299.4 million of net common-stock proceeds and debt transactions. Year-end cash was $23.9 million; total investments were $4.93 billion, including $1.43 billion of short-term investments. Holding-company immediately available unrestricted cash and liquid investments were approximately $615 million after a $100 million capital contribution to Radian Guaranty in February 2014.
  • Balance sheet and capital: Total assets were $5.62 billion, total liabilities $4.68 billion, and stockholders’ equity $939.6 million, up from $736.3 million. Long-term debt carrying value was $930.1 million; principal debt outstanding was $1.10 billion. Radian Guaranty’s risk-to-capital ratio improved to 19.5:1 from 20.8:1 and it reported compliance with applicable state requirements. Mortgage insurance claims-paying resources were $2.9 billion.

Material changes versus prior year

  • Net loss narrowed by $254.5 million, principally as the provision for losses declined 40.9% to $567.1 million and mortgage insurance premiums grew; investment results shifted from gains to losses and other operating expenses increased 44.6% to $284.5 million.
  • The mortgage insurance loss provision fell to $564.6 million from $921.5 million. Management cited fewer new defaults and more favorable development on existing defaults, including cures and claim curtailments. The total reserve for losses and loss adjustment expenses declined to $2.19 billion from $3.15 billion.
  • The Freddie Mac agreement covered 25,760 loans and capped Radian Guaranty’s total exposure at $840 million. Radian paid $255 million at closing and deposited $205 million in collateral for future loss-mitigation activity; the collateral remains subject to release conditions.
  • Radian issued $400 million of 2.25% convertible notes due 2019 and raised about $299.4 million net from a common-stock offering. It also exchanged $195.5 million of 5.375% notes due 2015 for 9.0% notes due 2017, increasing the rate on the exchanged debt.
  • Cash-settled incentive-award expense rose to $96.9 million from $29.5 million, driven largely by the increase in Radian’s share price.

Outlook, risks, contingencies, and unusual items

  • Management expected 2014 primary new insurance written to exceed $40 billion, total new defaults to decline approximately 18%, and claims paid to be $900 million to $1.0 billion. These are estimates subject to significant uncertainty, not guarantees.
  • Management expected $50 million to $100 million of additional capital contributions to Radian Guaranty over the next 12 months to maintain a risk-to-capital ratio at or below 20:1. If requirements were instead set at 18:1, management estimated $200 million to $300 million could be needed absent other capital relief. Proposed GSE eligibility standards could require more capital or limit credit for subsidiary capital; loss of GSE eligibility would materially harm the mortgage insurance franchise.
  • Loss estimates depend on legacy-loan performance, housing prices, unemployment, foreclosure timelines, claim severity, and assumptions about rescissions, denials, reinstatements, and curtailments. Estimated future rescissions and denials reduced reserves by $247 million at year-end; challenges by lenders or servicers could increase claims and reserves.
  • Other significant risks include housing-finance and Dodd-Frank/QM/QRM rule changes, competition from the FHA and private insurers, reliance on mortgage servicers, access to holding-company liquidity, and volatility in Level III fair values. Investment and derivative marks are sensitive to interest rates, credit spreads, and Radian’s own credit spread.
  • The IRS is contesting tax positions for 2000–2007; proposed adjustments could require about $128 million in additional tax plus $42 million in penalties and interest. Radian is contesting the matter. Federal and state proceedings relating to captive reinsurance remain, including Minnesota regulatory discussions. The CFPB settlement ended its Radian Guaranty investigation without findings of wrongdoing, but imposed a $3.75 million penalty and a 10-year restriction on new captive reinsurance arrangements.
  • Auditors issued an unqualified opinion on the financial statements and internal control over financial reporting; management also concluded disclosure controls were effective.

Most important facts for investors to verify

  • Whether 2014 new-business, default, and paid-claim expectations were achieved, and whether legacy reserves developed as estimated.
  • Final GSE and state capital rules, Radian Guaranty’s eligibility and risk-to-capital position, and the amount and source of any further capital support.
  • Whether the $205 million Freddie Mac collateral is released to Radian or paid to Freddie Mac, and the final cost of the agreement.
  • Cash available at the holding company, subsidiary dividend restrictions, debt maturities and refinancing capacity, and any material change in liquidity needs.
  • Outcomes of the IRS dispute, RESPA-related litigation and Minnesota inquiry, and challenges to rescissions, denials, or claim curtailments.
  • How much of reported earnings and equity changes reflects recurring underwriting performance versus investment marks, derivatives, and share-price-sensitive compensation.