Radian Group Inc. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015; unaudited. Radian provides mortgage insurance and mortgage- and real-estate-related services. The filing reports Mortgage Insurance and Services as continuing segments; Radian Asset Assurance was sold on April 1, 2015, and is presented as discontinued operations.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total revenue | $330.4 million | $247.4 million | $621.1 million | $505.6 million |
| Net premiums earned | $237.4 million | $203.6 million | $462.0 million | $402.4 million |
| Services revenue | $43.5 million | None reported | $74.1 million | None reported |
| Pretax income from continuing operations | $80.0 million | $92.9 million | $217.4 million | $220.0 million |
| Net income from continuing operations | $45.2 million | $103.5 million | $136.9 million | $249.5 million |
| Net income, including discontinued operations | $50.0 million | $174.8 million | $142.3 million | $377.6 million |
| Diluted EPS | $0.22 | $0.78 | $0.61 | $1.71 |
- Q2 provision for losses was $32.6 million, versus $64.6 million; six-month provision was $77.6 million, versus $114.3 million. Favorable prior-year reserve development and fewer new defaults contributed to the decline.
- Adjusted pretax operating income, a company-defined non-GAAP measure, was $147.3 million in Q2 and $271.2 million for six months, compared with $74.1 million and $158.1 million, respectively.
- Services gross profit was $19.1 million in Q2 and $31.4 million for six months; gross margin was approximately 43% and 41%, respectively.
- Net cash used in operating activities was $68.6 million for six months, compared with $259.9 million used in 2014. Cash at period-end was $51.4 million. Investing cash flow included $784.9 million of net proceeds from the sale of an investment in an affiliate; financing cash flow included $202 million of ASR repurchases.
- At June 30, total assets were $5.74 billion, investments $4.31 billion, long-term debt $1.225 billion, and stockholders’ equity $2.35 billion. Holding-company cash and liquid investments available were approximately $735 million.
Material changes and business developments
- Continuing net income declined year over year despite stronger segment operating results, chiefly reflecting a $91.9 million pretax charge for purchases of convertible notes, higher income tax expense, and lower six-month investment gains. Discontinued-operations income also fell substantially following the financial-guaranty sale.
- Mortgage Insurance adjusted pretax operating income increased to $145.4 million for Q2 and $271.3 million for six months. Net premiums earned rose with higher new business, a larger insured portfolio, reduced reinsurance cessions, and accelerated recognition of premiums on prepaid single-premium policies.
- Primary new insurance written was $11.8 billion in Q2 and $21.1 billion for six months, up from $9.3 billion and $16.1 billion. Primary insurance in force was $172.7 billion; primary risk in force was $43.7 billion at June 30.
- The primary default rate was 4.3%, down from 5.8% a year earlier; defaulted primary loans declined to 37,676 from 48,904. The legacy portfolio represented about 28% of primary risk in force.
- Radian sold Radian Asset Assurance for approximately $810 million; net proceeds to Radian Guaranty were $789 million. Q2 included $4.9 million of discontinued-operations income; six-month income was $5.4 million.
- Capital transactions included issuing $350 million of 5.25% senior notes due 2020, purchasing $389.1 million principal of 2017 convertible notes for cash and shares, and funding a $202 million accelerated share repurchase. Approximately $60.9 million principal of the 2017 convertible notes remained outstanding.
Outlook, risks and contingencies
- Management expected 2015 new business volume to exceed 2014’s $37.3 billion, and expected total new defaults to continue declining. It estimated 2015 claims paid of $600–$700 million, including approximately $75 million of remaining payments under the Bank of America settlement.
- PMIERs requirements take effect for existing eligible mortgage insurers on December 31, 2015. Based on June estimates, management projected an approximately $330 million holding-company contribution to support Radian Guaranty’s compliance, assuming conversion of about $80 million in assets and GSE approval for approximately $145 million of reinsurance benefits. The contribution estimate was expected to decline by the effective date but remains subject to assumptions and approvals.
- PMIERs may require more capital, raise operating costs, affect product mix and returns, and constrain subsidiary actions. Failure to maintain GSE eligibility could materially harm the mortgage-insurance business. Competition, FHA pricing, housing and credit conditions, and prepayment trends also affect results.
- Mortgage loss reserves were $1.205 billion, down from $1.560 billion at year-end. Reserve estimates depend on default-to-claim, severity, cure, rescission and denial assumptions; management estimated that a one-percentage-point change in primary net default-to-claim rate would change reserves by about $19 million.
- The Bank of America settlement had commenced, but consent was still needed for approximately 12% of covered loans held by neither the insureds nor the GSEs; the consent deadline was extended to August 15, 2015. Six-month claims paid included $174.6 million related to this settlement.
- Radian is contesting IRS notices concerning 2000–2007 tax years. The notices assert about $157 million in taxes and penalties, with approximately $120 million of interest and potentially $31 million of state taxes, penalties and interest as of June 30, 2015; a separate $105 million amount primarily concerns a disputed NOL carryback. The company petitioned U.S. Tax Court and stated that resolution could take years.
- Minnesota’s captive-reinsurance inquiry was resolved without findings of wrongdoing; Radian Guaranty agreed not to enter new captive arrangements through June 2025. Wisconsin regulators requested information about customized rates; the outcome was uncertain. Other litigation and challenges to loss-mitigation decisions could increase claims or reserves.
Most important facts for investors to verify
- Whether Radian Guaranty meets PMIERs requirements by the deadline, including the actual holding-company contribution and GSE approval of reinsurance benefits.
- Whether the assumptions underlying loss reserves remain supported by claims, cures, defaults, severity, and the Bank of America settlement’s final scope and payments.
- The outcome and potential cash exposure of the IRS dispute, including the NOL carryback issue and related interest and state taxes.
- Whether mortgage-insurance pricing, single-premium mix, prepayments, competition, and persistency support expected returns and management’s new-business outlook.
- Final settlement of the $202 million ASR and the resulting diluted share count, as well as holding-company liquidity after subsidiary capital contributions and debt service.