Radian Group Inc. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; comparative period is Q1 2011. Radian is a credit-enhancement company focused primarily on U.S. first-lien mortgage insurance, with a legacy financial-guaranty business that no longer writes new business.
Financial performance
| Metric | Q1 2012 | Q1 2011 |
|---|---|---|
| Total revenue | $180.4 million | $603.3 million |
| Net premiums earned | $167.4 million | $203.0 million |
| Net investment income | $34.7 million | $42.2 million |
| Net gains on investments | $67.5 million | $37.4 million |
| Change in fair value of derivatives | Loss of $72.8 million | Gain of $243.9 million |
| Provision for losses | $266.2 million | $427.4 million |
| Pretax result | Loss of $178.1 million | Income of $100.0 million |
| Net result | Loss of $169.2 million; $1.28 per share | Income of $103.0 million; $0.78 basic per share |
| Operating cash flow | Used $154.4 million | Used $260.9 million |
Revenue and earnings were highly affected by fair-value movements in financial-guaranty derivatives and VIE debt. Management attributed the derivative losses chiefly to tightening in Radian’s credit spreads; these accounting marks are volatile and do not necessarily represent expected ultimate claims. Lower mortgage-insurance loss provisions partly offset the adverse comparison. No conventional operating margin measure is presented in the filing.
Financial position and business changes
- At March 31, total assets were $6.45 billion, total liabilities $5.43 billion, and stockholders’ equity $1.02 billion, down from $1.18 billion at year-end 2011. The quarterly net loss was the main driver of the equity decline.
- Consolidated investments were $5.59 billion; consolidated cash was $31.8 million. Separately, the holding company had $363.7 million of immediately available unrestricted cash and liquid investments, down from $482.8 million at year-end.
- Long-term debt carrying value was $674.9 million. Radian repurchased $146.5 million principal of its 5.625% notes due February 2013 for $900 per $1,000 face value, recognizing a $15.2 million gain. $103.5 million principal remained due in February 2013; additional principal maturities are approximately $250 million in 2015 and $450 million in 2017.
- Mortgage-insurance net premiums written rose to $196.9 million from $180.8 million, while earned premiums declined to $173.5 million from $186.1 million. New insurance written increased to $6.5 billion from $2.6 billion. Mortgage-insurance segment net loss narrowed to $45.2 million from $236.0 million, mainly because its loss provision declined to $234.7 million from $414.0 million.
- Financial-guaranty segment net loss was $124.0 million versus income of $339.0 million in Q1 2011. Its net par outstanding declined to $44.6 billion from $69.2 billion at year-end, principally following transactions and counterparty terminations.
- Radian Guaranty’s risk-to-capital ratio improved to 20.6:1 from 21.5:1, helped by capital actions, including a $100 million holding-company contribution. Its statutory surplus was $919.9 million. The company projected that, without further capital support, the ratio could exceed 25:1 in the second half of 2012.
Outlook, risks and unusual items
- Management expected improved mortgage-insurance operating results in 2012 versus 2011, but still an operating loss for 2012, and marginal operating profitability in 2013. It projected new defaults to fall 15% in 2012; first-quarter new defaults were down 20% year over year. Total mortgage-insurance claims paid were expected to reach approximately $1.1 billion in 2012.
- Mortgage-insurance default inventory fell to 103,027 loans from 110,861 at year-end, but remained elevated. The assumed aggregate default-to-claim rate rose to 46% from 43%; each one-percentage-point change was estimated to affect reserves by about $61 million. Rescissions and denials reduce reserves, but lender challenges and expected reinstatements or resubmissions create material uncertainty.
- In January, the Assured transaction reduced financial-guaranty net par by 22.5% and provided an approximately $93.5 million statutory capital benefit, but reduced Q1 pretax income by $36.5 million under GAAP. Sale of the insurance shell remained subject to regulatory approval.
- After quarter-end, Radian agreed to pay $210 million to commute a distressed CDO of ABS exposure and six TruPs CDO exposures. It expected a GAAP loss of approximately $108 million in Q2 2012; projected salvage recovery of about $75 million remained exposed to future performance of the underlying bonds. A separate April reinsurance agreement was expected to cede $1.25–$1.6 billion of risk and provide an equivalent capital benefit of $50–$62.5 million.
- Holding-company liquidity must cover operating costs, interest, capital support and the remaining 2013 notes. Management expected subsidiary expense-sharing reimbursements, but said additional capital needs could exceed remaining holding-company liquidity. Radian Guaranty was not expected to pay dividends to the parent for the foreseeable future. Freddie Mac approval required at least $700 million of specified liquid assets at Radian Guaranty; it reported about $1.4 billion at quarter-end, which management expected to decline materially during 2012.
- The IRS was challenging tax positions for 2000–2007; proposed adjustments could increase tax liability by approximately $128 million plus penalties and interest. Settlement discussions were uncertain. The company had about $1.9 billion of tax NOL carryforwards and recorded an $879.9 million valuation allowance against net deferred tax assets.
- Moody’s downgraded Radian Group to Caa2 on April 17, 2012; Moody’s and S&P outlooks were negative. Risks include housing-market weakness, claim-reserve estimation, regulatory capital and GSE eligibility, financing the debt maturities, litigation over rescissions and denials, and volatility in Level III fair values. The filing also describes pending lender disputes, RESPA class actions and other litigation; management did not expect the described litigation to materially affect consolidated results, based on its then-current assessment.
Investor verification priorities
- Track actual claims, new defaults, cures and the accuracy of reserve assumptions—especially the 46% default-to-claim assumption and expected rescission/denial reinstatements.
- Confirm Radian Guaranty’s capital ratio, required capital contributions, waiver status, GSE approvals and liquid-asset levels against the stated thresholds.
- Reconcile holding-company liquidity and subsidiary reimbursements with the $103.5 million 2013 note maturity and potential tax and capital-support obligations.
- Review Q2 recognition and cash effects of the $210 million commutation, the expected $108 million GAAP loss, and the recoverability of the estimated salvage.
- Monitor resolution of the IRS examination and litigation challenging insurance rescissions and claim denials, and assess their potential effect on reserves, earnings and cash flows.