Business context and reporting period
Radian Group Inc. filed this unaudited Form 10-Q for the quarter ended March 31, 2016. The company operates Mortgage Insurance and Services segments; the prior-year comparison is the three months ended March 31, 2015. Radian Asset Assurance was sold on April 1, 2015, and is reported as discontinued operations.
Financial performance and position
| Metric | Q1 2016 | Q1 2015 / comparison |
|---|---|---|
| Total revenue | $313.0 million | $290.7 million; up 7.7% |
| Pretax income from continuing operations | $102.4 million | $137.5 million |
| Net income | $66.2 million | $92.3 million |
| Diluted EPS | $0.29 | $0.39 |
| Adjusted pretax operating income (non-GAAP) | $130.2 million | $123.9 million |
| Operating cash flow, continuing operations | $41.9 million | $0.7 million |
| Long-term debt, March 31 | $1.286 billion | $1.219 billion at Dec. 31, 2015 |
Revenue growth reflected higher investment income and investment gains, while GAAP pretax income and net income fell primarily because of a $55.6 million pretax charge on early purchases of convertible notes. Net investment income was $27.2 million, up from $17.3 million; net gains on investments and other financial instruments were $31.3 million, up from $16.8 million. The income tax provision was $36.2 million.
Total assets were $5.97 billion and stockholders’ equity was $2.66 billion at March 31, 2016, versus $5.64 billion and $2.50 billion, respectively, at year-end 2015. Consolidated cash was $64.8 million; separately, holding-company unrestricted cash and liquid investments were approximately $393 million, including an $89 million IRS deposit that Radian says it can recall. Mortgage Insurance adjusted pretax operating income improved to $140.1 million from $125.9 million. Services reported an adjusted pretax operating loss of $9.9 million, compared with a $2.0 million loss.
Insurance claims and loss-adjustment reserves were $891.3 million, down from $976.4 million at year-end. Cash flow from investing activities was negative $74.6 million, while financing activities provided $50.7 million. Services gross profit was $10.1 million, or 32% of Services revenue, compared with $12.3 million, or 39%, a year earlier.
Material changes versus the prior comparable period
- Primary new insurance written was $8.1 billion, down 14% from $9.4 billion, mainly due to lower refinance and single-premium volumes.
- Primary defaults declined about 7% year over year; the primary default rate was 3.5%, versus 4.6% a year earlier. Default inventory was 30,869 loans, down from 40,440.
- Claims paid were $127.7 million, versus $207.1 million in Q1 2015, when $98.5 million related to the BofA settlement. Management expects full-year 2016 claims paid of approximately $400–$450 million.
- Services revenue rose modestly to $32.2 million from $31.5 million, but segment operating losses widened, reflecting lower SFR-related activity, higher costs and severance.
- Available assets under PMIERs exceeded minimum required assets by approximately $500 million at March 31; Radian Guaranty reported full PMIERs compliance. Its risk-to-capital ratio improved to 12.5:1 from 14.3:1 at year-end.
Outlook, management commentary, risks and unusual items
Management expects the 2016 mortgage-insurance market to be comparable to 2015 and anticipates new business volume at a similar level to 2015’s $41 billion of NIW. It estimates returns on required capital for new business of approximately 13%–14% unlevered and 16%–17% levered, subject to business mix, volume and reinsurance. Management expects defaults to continue declining, though the pace may moderate, and expects the decline in SFR activity to continue through the rest of 2016.
In Q1, Radian issued $350 million of 7.0% notes due 2021, repurchased portions of its 2017 and 2019 convertible notes, and repurchased 9.4 million shares for $100.2 million. It also entered a single-premium quota-share reinsurance agreement effective January 1, 2016, ceding specified existing and new single-premium risks. The transaction supports PMIERs capital; its Q1 net pretax impact was a decrease of approximately $2.4 million. Management said Radian Guaranty could seek approval to redeem some or all of its $325 million zero-interest surplus note as early as June 30, 2016; any redemption requires Pennsylvania regulatory approval.
Key uncertainties include the IRS dispute over 2000–2007 tax years: notices assert approximately $157 million of taxes and penalties, with approximately $127 million of related interest and an estimated additional $33 million of state taxes, penalties and interest. A separate approximately $105 million amount relates primarily to disallowance of a 2008 NOL carryback, which Radian believes it will ultimately retain. The case is in Tax Court, has been consolidated for trial with a similar case, and may take years to resolve. Other risks include mortgage-insurance reserve assumptions, challenges to loss-mitigation decisions, regulatory and GSE capital requirements, competitive pricing, interest-rate exposure, and Services customer and transaction volumes. Radian reported no material changes to its previously disclosed risk factors.
The $55.6 million debt-purchase charge was unusual and reduced GAAP earnings; the company excludes it from its non-GAAP adjusted operating measure. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether forecast 2016 NIW and claims paid track management’s expectations, and how mortgage-market competition affects pricing and returns.
- Whether reserve releases, cure rates, claim severity and default-to-claim assumptions remain supportable; reserve sensitivities were approximately $16 million per percentage-point change in net default-to-claim rate and $7 million per point in severity.
- Whether PMIERs compliance and the approximately $500 million asset cushion persist, including the treatment of reinsurance by the GSEs and any surplus-note redemption.
- The progress and ultimate cash, tax and earnings consequences of the IRS litigation and NOL carryback dispute.
- Whether Services profitability recovers as SFR activity and loan-review volumes change, given lower gross margin and customer concentration.
- The effect of debt maturities, refinancing or conversion settlements, and interest-rate movements on holding-company liquidity; a 100-basis-point rate increase was estimated to reduce fixed-income portfolio market value by $218.3 million.