Radian Group Inc. — 2012 Q3 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012; filed November 9, 2012. Unaudited results. Radian is a credit-enhancement company focused primarily on U.S. first-lien mortgage insurance, with a legacy financial-guaranty segment.
Financial performance and position
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Total revenue | $260.8 million | $508.1 million | $599.3 million | $1,583.3 million |
| Net premiums earned | $191.0 million | $179.7 million | $545.1 million | $571.6 million |
| Net investment income | $25.6 million | $38.8 million | $91.2 million | $124.8 million |
| Provision for losses | $176.4 million | $249.6 million | $653.4 million | $940.5 million |
| Net income (loss) | $14.3 million | $183.6 million | $(274.2) million | $423.7 million |
| Basic earnings (loss) per share | $0.11 | $1.39 | $(2.07) | $3.20 |
| Cash flow from operations | Not provided for the quarter | $(441.8) million | $(766.1) million |
- Q3 pretax income was $7.6 million, compared with $189.6 million a year earlier. Nine-month pretax loss was $287.3 million, versus income of $424.7 million.
- Reported earnings were highly affected by fair-value movements: derivatives produced losses of $41.0 million in Q3 and $146.9 million for the first nine months, versus gains of $126.0 million and $558.6 million in the corresponding 2011 periods. Other financial instruments also shifted from gains to losses year over year.
- Mortgage insurance earned $31.4 million in Q3, compared with a $42.2 million loss; its nine-month loss was $36.8 million, improving from a $375.8 million loss. Financial guaranty lost $17.1 million in Q3 and $237.3 million year to date, versus respective profits of $225.8 million and $799.5 million in 2011.
- At September 30, total assets were $6.04 billion, investments $5.24 billion, total liabilities $5.13 billion, and stockholders’ equity $915.3 million, down from $1.18 billion at December 31, 2011. Consolidated cash was $28.2 million; holding-company unrestricted cash and liquid investments were $368.3 million.
- Long-term debt was $659.1 million, down from $818.6 million at year-end 2011; additional VIE debt was $109.7 million. The remaining 2013 Notes principal was $79.4 million, due February 2013; further principal amounts of $250 million and $450 million are due in 2015 and 2017.
- Mortgage insurance loss reserves were $3.05 billion; total insurance loss and LAE reserves were $3.12 billion. No first-lien premium-deficiency reserve was required, but a $5.1 million reserve remained for second-lien business.
Material changes and operating trends
- Mortgage insurance new business written increased to $25.4 billion for the first nine months, from $9.0 billion. Nearly all new production was prime. Primary risk in force was $33.0 billion; 40.3% of primary risk in force was from loans originated since 2009.
- Primary defaults fell to 94,831 loans at September 30 from 110,861 at December 31, 2011; the primary default rate declined to 12.6% from 15.2%. New primary defaults were down 21% year to date versus 2011.
- Financial-guaranty net par outstanding fell to $39.0 billion from $69.2 billion at year-end 2011, mainly reflecting the Assured transaction, counterparty terminations, commutations, maturities and prepayments.
- The Assured transaction reduced financial-guaranty net par by 22.5% and provided a reported $100.7 million statutory-capital benefit, but reduced nine-month pretax income by $28.8 million under GAAP.
- Radian paid $210 million in second-quarter commutations of distressed financial-guaranty exposures and recorded a $108 million GAAP loss. The company expects approximately $75.9 million of statutory salvage recovery from related funds, which remains exposed to future losses.
- Operating cash use improved from the prior-year period, largely because mortgage-insurance claim payments were lower. Investment income declined, which management attributed to reduced investment balances and a shift toward shorter-duration, lower-yielding assets.
Outlook, liquidity, and principal risks
- Management expected a mortgage-insurance operating loss for full-year 2012, but marginal operating profitability in 2013, subject to significant uncertainty. It projected a 20%–25% decline in 2012 new primary defaults versus 2011 and approximately $1.0 billion in 2012 claims paid. Management expected seasonal effects to increase incurred losses in Q4 2012.
- Radian Guaranty’s risk-to-capital ratio was 20.1:1, improved from 21.5:1 at year-end. Without additional support, management expected it to exceed the common 25:1 state threshold during 2013 and the minimum policyholder position requirement in two states as early as year-end 2012. Waivers, alternative underwriting through RMAI, and reinsurance are subject to conditions and approvals.
- Holding-company liquidity must cover debt service, operating expenses, potential subsidiary capital contributions, the 2013 Notes repayment and possible IRS payments. Management said subsidiary dividends to the parent were not expected for the foreseeable future. It expected subsidiary reimbursements under expense-sharing arrangements, but these arrangements and approvals may change.
- Radian Guaranty had approximately $1.4 billion of qualifying liquid assets under Freddie Mac requirements, against a $700 million minimum. Management expected the amount to decline as claims and other cash uses exceeded operating cash generation.
- Loss estimates depend materially on rescissions, denials, claim curtailments and future reinstatements. Estimated future rescissions and denials reduced loss reserves by about $477 million; management cautioned that faster-than-expected declines in these practices or successful challenges could increase claims and reserves. A one-percentage-point increase in the assumed default-to-claim rate was estimated to increase losses by about $56 million.
- Deferred tax assets were $934.2 million before a $918.2 million valuation allowance. Radian reported approximately $1.8 billion in federal NOL carryforwards. The IRS is contesting tax positions for 2000–2007; proposed adjustments could increase tax liability by about $128 million, plus penalties and interest. Settlement terms remained uncertain.
- Other risks include weak housing and credit markets, unemployment, foreclosure and servicing delays, regulatory capital intervention, ratings below investment grade, changes to GSE or housing-finance rules, and litigation or regulatory inquiries concerning captive reinsurance and RESPA. The company could not estimate a reasonably possible loss range for the putative class actions or CFPB investigation.
- Subsequent event: Radian agreed to commute $827 million of remaining reinsured par with FGIC for approximately $52.4 million, subject to court approval. The transaction included $196 million of Jefferson County sewer-warrant exposure; completion was not assured.
Important facts for investors to verify
- Whether mortgage-insurance loss experience, claim payments, default inventory and reserve assumptions track management’s projections, particularly as rescissions and denials are challenged or reinstated.
- Whether Radian Guaranty can maintain required statutory capital and GSE eligibility through waivers, RMAI, reinsurance and any parent-company capital contributions.
- Whether holding-company liquidity remains adequate after the 2013 Notes repayment, subsidiary support, ongoing expenses and any IRS settlement or payment.
- How much future earnings volatility comes from derivative and VIE fair-value changes versus underlying credit losses and cash claims.
- Whether financial-guaranty commutations and the proposed FGIC agreement are completed on expected terms, and whether the projected salvage recovery is realized.
- Developments in the IRS examination, RESPA/captive-reinsurance proceedings, lender disputes, ratings and applicable housing-finance regulations.