Radian Group Inc. — 2017 Third-Quarter Form 10-Q
Business and period: Radian provides private mortgage insurance and mortgage- and real-estate-related services through its Mortgage Insurance and Services segments. This unaudited filing covers the three and nine months ended September 30, 2017; comparisons are with the same periods in 2016 unless stated otherwise. Amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $312.1 million | $320.9 million | $903.7 million | $964.0 million |
| Pretax income | $102.8 million | $126.9 million | $182.0 million | $385.9 million |
| Net income | $65.1 million | $82.8 million | $114.3 million | $247.2 million |
| Diluted earnings per share | $0.30 | $0.37 | $0.52 | $1.09 |
| Adjusted pretax operating income (non-GAAP) | $155.6 million | $139.9 million | $444.6 million | $401.5 million |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $218.4 million | $287.4 million |
Revenue was lower year over year in both periods. Lower GAAP earnings reflect, among other items, a $184.4 million goodwill impairment and $15.8 million intangible-asset impairment recorded in the second quarter, lower investment gains year to date, and debt-extinguishment charges. Adjusted pretax operating income, a company-defined non-GAAP measure, increased in both periods.
- Mortgage Insurance: Adjusted pretax operating income was $168.5 million in Q3 and $473.5 million year to date, versus $141.8 million and $419.1 million, respectively. Lower loss provisions and interest expense and higher investment income supported the improvement.
- Services: Adjusted pretax operating losses widened to $12.9 million in Q3 and $28.9 million year to date, versus losses of $1.9 million and $17.6 million. Q3 services revenue fell to $41.1 million from $48.0 million.
- Margins and loss metrics: Services gross profit was 33% of services revenue in Q3 and 32% year to date, versus 38% and 35%. Mortgage Insurance loss ratios were 15.2% and 14.7%, versus 23.6% and 21.7%; its expense ratio was 22.9% in Q3 and 25.4% year to date, versus 22.7% in both prior-year periods.
At September 30, 2017, total assets were $5.84 billion, total liabilities $2.86 billion, stockholders’ equity $2.99 billion, and long-term debt $1.03 billion. Cash and restricted cash totaled $98.8 million. Holding-company unrestricted cash and liquid investments were approximately $300 million, including $89 million deposited with the IRS. Nine-month operating cash flow was $218.4 million; cash and restricted cash increased by $37.0 million.
Material changes and notable transactions
- Radian issued $450 million of 4.5% senior notes due 2024 and used the proceeds, together with additional cash, to repurchase portions of its 2019, 2020 and 2021 notes. The transactions produced a $45.8 million Q3 pretax charge; management estimated annual cash interest savings of $4.3 million and an almost two-year extension in weighted-average senior-note maturity.
- Mortgage Insurance insurance in force increased to $196.5 billion from $183.5 billion at year-end 2016; primary risk in force was $50.2 billion. The primary default rate declined to 2.5% from 3.2% at year-end 2016. Nine-month new insurance written was $39.5 billion, up from $36.6 billion.
- The reserve for losses and loss adjustment expenses declined to $556.5 million from $760.3 million at year-end. Favorable development on prior-period defaults and claim payments exceeding incurred losses contributed; the third-quarter Freddie Mac settlement included a $54.8 million payment.
- Book value per share was $13.88, up from $13.39 at December 31, 2016. Goodwill and other intangible assets fell substantially following the Services impairment charges.
Outlook, risks and contingencies
- Management expected 2017 new insurance written to be comparable to 2016’s $50.5 billion. It cited a smaller overall mortgage-origination market, offset by the greater use of mortgage insurance in home-purchase lending. Management estimated full-year 2017 claims payments of $350 million to $400 million, excluding any future commutation payments.
- Management projected returns on new mortgage insurance business of approximately 13%–14% unlevered and 17%–18% levered over policy life; actual returns depend on economic conditions, business mix, pricing and reinsurance.
- Radian Guaranty was compliant with PMIERs requirements. Available Assets were approximately $3.5 billion, a $237 million (7%) cushion over Minimum Required Assets. Management expected generally to maintain a cushion of at least approximately 5% under current requirements, but warned that anticipated PMIERs updates, expected in Q4 2018, could materially increase capital requirements.
- Hurricanes Harvey and Irma affected areas containing approximately $4.4 billion of RIF and $16.8 billion of IIF, or 8.8% of primary RIF. The company expected near-term defaults but did not expect material incremental paid claims; future reserve and PMIERs effects depend in part on recovery in affected areas.
- Following a strategic review, Radian began restructuring Services, focusing on core offerings and more recurring fee revenue. Q3 restructuring charges were $12.0 million; total charges were expected to be about $19.5 million, including approximately $6.0 million of additional cash payments within 12 months. Services had not generated enough cash to reimburse Radian Group for $59.5 million of allocated operating and interest expenses.
- In October 2017, Radian entered a three-year, $225 million unsecured revolving credit facility. It also agreed in principle with the IRS on a settlement of the dispute over 2000–2007 tax years, subject to review and finalization. The company said the amount it currently expected to pay under proposed terms would not exceed its $89 million IRS deposit; the settlement remained uncertain.
- An October 2017 agreement to commute certain pool-insurance exposure was expected to involve a payment below $20 million, approximately covered by reserves. A new single-premium quota-share reinsurance arrangement, expected to cede 65% of eligible new business beginning in 2018, remained subject to GSE approval.
- Other risks include the Ocwen litigation, for which Radian could not estimate a reasonably possible loss, and an SEC information request to a Services subsidiary concerning single-family-rental securitizations. Management said it was cooperating with the SEC. Investment values are exposed to interest-rate and credit-spread movements.
Key facts investors should verify
- Whether the IRS settlement was finalized, and the ultimate amount and timing of any tax payment.
- GSE approval and final terms of the 2018 single-premium reinsurance transaction, and the impact of future PMIERs changes on capital cushion.
- Whether Services restructuring delivers improved profitability and cash generation, given continued segment losses and customer-volume pressures.
- Mortgage-insurance reserve development, default and cure trends, claims payments, and the effects of hurricane-related defaults and any pool commutation.
- Debt maturity, liquidity and interest-cost effects of the 2017 refinancing, including use of the revolving credit facility and holding-company liquidity.