RADIAN GROUP INC quarterly report, Q3 FY2013

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Radian Group Inc. — Q3 2013 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2013; unaudited. Radian is a credit enhancement company focused primarily on U.S. residential mortgage insurance, with a runoff financial guaranty business. Comparisons below are against the same 2012 periods unless stated otherwise.

Financial performance and position

  • Third quarter: Total revenue was $244.6 million, down from $260.8 million. Net loss was $12.7 million, versus net income of $14.3 million; diluted loss per share was $0.07, versus diluted income per share of $0.11.
  • First nine months: Revenue was $487.4 million, versus $599.3 million. Net loss was $233.4 million, compared with a $274.2 million loss; diluted loss per share improved to $1.43 from $2.07.
  • Revenue and losses: Nine-month insurance premiums earned increased 13% to $617.7 million. Nine-month provision for losses fell 34% to $429.5 million. Investment results moved from gains of $178.5 million to losses of $142.9 million, contributing to weaker revenue.
  • Segments: Mortgage insurance recorded pretax losses of $7.9 million in Q3 and $91.8 million in the first nine months, compared with Q3 income of $11.1 million and a nine-month loss of $79.2 million in 2012. Financial guaranty pretax losses were $0.9 million for Q3 and $150.7 million for nine months, improving from respective losses of $3.5 million and $208.2 million.
  • Cash flow: Operating cash flow was negative $567.6 million for the first nine months, versus negative $441.8 million. Investing cash flow was negative $29.3 million; financing provided $600.8 million. Cash at period-end was $35.3 million.
  • Balance sheet and debt: Total assets were $5.76 billion and total liabilities $4.86 billion at September 30. Stockholders’ equity was $894.5 million, up from $736.3 million at year-end 2012. Long-term debt was $921.9 million, up from $663.6 million.
  • Liquidity and statutory capital: Holding-company unrestricted cash and liquid investments were $822.1 million, or $702.6 million net of subsidiary advances for expected expenses and interest. Radian Guaranty’s risk-to-capital ratio was 19.8:1, versus 20.8:1 at year-end; Radian reported $1.24 billion of statutory surplus.
  • Margins: The filing does not provide a single consolidated margin measure; results are reported principally by segment and on a pretax basis.

Material changes versus the prior period

  • Primary mortgage insurance new insurance written rose to $38.0 billion for the first nine months, from $25.4 billion. New primary defaults declined 19%, and default inventory fell 31% year over year to 65,239 loans.
  • Mortgage insurance loss reserves declined to $2.31 billion from $3.08 billion at year-end 2012. The reduction reflected the Freddie Mac agreement, claim payments, cures, and rescissions and denials; estimates of future rescissions and denials continue to reduce reserves.
  • Trading and other investment results were adversely affected by market movements, including higher interest rates. Nine-month investment losses contrasted with substantial gains in 2012.
  • Other operating expenses increased 51% to $212.1 million for nine months, largely reflecting $85.0 million of expense for cash-settled long-term incentive awards, compared with $16.0 million in 2012. Interest expense rose 40% to $54.9 million.
  • Radian raised capital through a $299.4 million net common-stock offering and a $400 million convertible-note issuance. It also exchanged $195.5 million of 2015 notes for 9% notes due 2017 and repaid $79.4 million of notes due 2013.

Outlook, commentary, risks, and unusual items

  • Management continued to expect marginal mortgage-insurance segment profitability in 2013, excluding stock-price-related compensation changes and unrealized investment gains or losses. It expected mortgage-insurance new business to decline in Q4 2013 and to face a smaller origination market and increased competition in 2014.
  • Management cited improving home prices and falling new defaults, but emphasized uncertainty in legacy mortgage losses. The legacy portfolio was 43% of primary mortgage insurance risk in force, down from 55% at year-end 2012.
  • The August Freddie Mac agreement capped exposure on the covered loan population at $840 million, including $625 million in claim payments and $215 million for loss-mitigation activity. Radian Guaranty paid $255 million and placed $205 million in collateral; some collateral may be returned, depending on final loss-mitigation outcomes.
  • Radian expected to contribute $75 million to $200 million of additional capital to Radian Guaranty over the next 12 months to maintain a risk-to-capital ratio at or below 20:1, absent other support. New, potentially stricter GSE insurer eligibility and capital requirements were expected by year-end 2013.
  • Loss-reserve assumptions are sensitive: a one-percentage-point change in primary claim severity was estimated to change reserves by about $63 million; a one-point change in the net default-to-claim rate by about $39 million. Challenges to rescissions and claim denials, reinstatements, servicing delays, and economic conditions could increase losses.
  • Derivative and other fair-value results are volatile and sensitive to credit spreads and Radian’s own perceived credit risk. The company reported a 27.3% market-implied five-year default probability at September 30, based on its CDS spread; this is a market-derived measure, not management’s forecast.
  • Contingencies include an IRS dispute over 2000–2007 tax years, with proposed additional tax of about $128 million plus $42 million in penalties and interest. The company was contesting the proposed adjustments. A Minnesota regulator’s draft consent order on captive reinsurance included unspecified penalties; the outcome was uncertain. RESPA class-action matters and other litigation also remained, with potential losses not estimable for certain cases.
  • The CFPB investigation into captive reinsurance was settled without findings of wrongdoing; Radian Guaranty agreed to pay a $3.75 million penalty and not enter new captive reinsurance arrangements for ten years.
  • Management stated disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

  • Whether falling defaults and legacy-portfolio runoff translate into sustainable mortgage-insurance profitability, particularly as originations and new business fluctuate.
  • The adequacy of loss reserves, including assumptions for claim severity, rescissions, denials, reinstatements, and the Freddie Mac agreement’s final collateral treatment.
  • Radian Guaranty’s ability to meet state and GSE capital requirements and the amount of further parent-company capital support required.
  • Holding-company liquidity after debt service, operating costs, subsidiary support, and any IRS settlement or litigation payments; also review debt maturities and refinancing capacity.
  • Developments in GSE eligibility rules, mortgage-market regulation, the Minnesota captive-reinsurance inquiry, tax litigation, and pending lawsuits.
  • The effects of fair-value volatility and stock-price-linked compensation on reported earnings, cash needs, and comparisons between periods.