Radian Group Inc. — 2016 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2016. This is an annual report, not a fourth-quarter-only filing. Radian provides private mortgage insurance and mortgage- and real-estate-related services through its Mortgage Insurance and Services segments. Financial Guaranty was sold in April 2015 and is reported as discontinued operations.
Financial and operating results
| Metric | 2016 | 2015 | Change or context |
|---|---|---|---|
| Total revenue | $1.238 billion | $1.193 billion | Up about 4% |
| Pretax income from continuing operations | $483.7 million | $437.8 million | Up 10% |
| Net income | $308.3 million | $286.9 million | Up about 7%; 2016 had no discontinued-operations income |
| Diluted earnings per share | $1.37 | $1.22 | Up $0.15 |
| Adjusted pretax operating income | $541.8 million | $510.9 million | Up 6%; non-GAAP measure |
| Operating cash flow | $381.7 million | $11.7 million | Improved substantially, primarily as claims paid declined |
| Long-term debt | $1.070 billion | $1.219 billion | Down about $150 million |
| Stockholders’ equity / book value per share | $2.872 billion / $13.39 | $2.497 billion / $12.07 | Book value per share up 11% |
- Mortgage Insurance: Net premiums earned were $921.8 million, up slightly. The segment reported adjusted pretax operating income of $561.9 million, versus $511.0 million. Its loss ratio was 22.2%, compared with 21.7%; its expense ratio was 22.7%, compared with 23.7%.
- Services: Consolidated Services revenue was $168.9 million, up from $157.2 million. Segment revenue, including intersegment activity, was $177.2 million; adjusted pretax operating loss widened to $20.2 million from $0.2 million. Gross profit margin fell to 35% from 40%.
- Mortgage insurance portfolio: Primary new insurance written rose 22% to $50.5 billion, a company record; primary insurance in force reached $183.5 billion, up from $175.6 billion. Post-legacy business and HARP refinancings were 88% of primary risk in force.
- Credit and claims: Primary defaults in inventory fell 17.6% to 29,105 loans; the primary default rate declined to 3.2% from 4.0%. Total mortgage insurance claims paid decreased to $417.6 million from $764.7 million, with 2015 elevated by the Bank of America settlement. The average primary claim severity remained high at 104.1%.
- Investments and liquidity: Investments totaled $4.462 billion, with 99.8% reported as investment grade and a weighted-average duration of 5.1 years. Holding-company unrestricted cash and liquid investments were approximately $460 million at year-end, including an $89 million IRS deposit; $110.1 million was used in January 2017 to settle the remaining 2019 convertible notes. Consolidated cash and restricted cash were $61.8 million.
- Capital and debt actions: Radian issued $350 million of 7.0% notes due 2021, redeemed its remaining $195.5 million of 9.0% notes due 2017, and repurchased or settled portions of convertible notes. These transactions generated a $75.1 million pretax loss on induced conversion and debt extinguishment. The 2016 cash dividend was $0.01 per share.
Material changes versus 2015
- Earnings and book value increased, while reported operating cash flow strengthened sharply as claims paid fell.
- Mortgage insurance production and insurance in force expanded; the portfolio continued shifting toward newer, predominantly prime vintages. Radian’s stated 18% decline in total defaults refers to a different measure than the 4.9% decline in new primary defaults; the default inventory declined 17.6%.
- Net premiums written declined to $733.8 million from $968.5 million, mainly because of the new Single Premium quota-share reinsurance arrangement, despite higher new insurance written. Net premiums earned were nearly flat.
- Services revenue grew, in part from a full year of Red Bell and ValuAmerica, but lower service gross margins and higher operating expenses drove a larger segment operating loss.
- Debt declined and maturities were extended, although the 2021 notes carry a 7.0% coupon. The 2016 capital actions reduced diluted shares on a transaction-date basis, while actual year-end shares outstanding increased from 2015.
Outlook, risks, contingencies, and unusual items
- Management expected the 2017 mortgage origination market to be smaller, primarily because of lower refinancing volume and anticipated higher interest rates. It expected the private mortgage insurance market to be only modestly smaller and Radian’s 2017 new insurance written to be comparable to 2016’s $50.5 billion. Management forecast approximately $325 million of claims paid in 2017.
- Management projected returns on required capital for new business of approximately 13%–14% unlevered and 16%–17% levered, subject to economic conditions, business mix, production and reinsurance. These are projections, not guarantees.
- Radian Guaranty was eligible under PMIERs and compliant at year-end, with approximately $4.0 billion of Available Assets against $3.8 billion of Minimum Required Assets, a cushion of about $210 million. The GSEs’ planned 2017 review of PMIERs factors, their discretion to revise requirements, and the treatment of reinsurance could affect future capital needs and eligibility.
- Mortgage insurance subsidiaries’ negative unassigned surplus restricts ordinary dividends without regulatory approval. Management said it did not expect ordinary dividends from Radian Guaranty for the foreseeable future. Services had not generated enough cash to reimburse Radian Group for $35.3 million of allocated operating and interest expenses; management expected to bring those obligations current over four to five years.
- The IRS dispute concerns 2000–2007 tax returns. Notices asserted $157 million of taxes and penalties, with approximately $136 million of interest and an estimated $35 million of additional state taxes, penalties and interest at year-end 2016; separate notices also included $105 million, primarily relating to a disputed 2008 NOL carryback. In January 2017, the parties reported a basis for a possible compromise, subject to Joint Committee and IRS review; no final settlement was assured.
- Ocwen filed litigation and an arbitration petition alleging breach of contract and bad faith concerning claims handling, covering 9,420 certificates. Radian said it would defend the claims; it could not estimate a reasonably possible loss.
- Other notable risks include competition from the FHA, VA and private insurers; housing-market and interest-rate sensitivity; claims-reserve estimation and foreclosure delays; customer concentration; regulatory and GSE changes; technology and cybersecurity risks; and possible impairment of Services goodwill. The Services reporting unit’s estimated fair value exceeded carrying value by about $50 million, or 18%, at year-end, but depended on projected growth and cash flows.
- Auditor PricewaterhouseCoopers LLP issued an unqualified opinion and concluded internal control over financial reporting was effective as of December 31, 2016.
Important facts for investors to verify
- Whether 2017 production and claims track management’s outlook, and whether the lower default inventory translates into sustained underwriting results.
- How the 2017 PMIERs review and evolving reinsurance credit affect the approximately $210 million capital cushion and holding-company liquidity.
- Services’ ability to restore margins, generate cash and reimburse intercompany expenses, alongside the assumptions supporting its goodwill valuation.
- The final IRS resolution, including the treatment of the asserted tax amounts and NOL carryback, and any resulting cash or tax impact.
- Developments in the Ocwen matter, other claims-handling disputes, and the $57.4 million Freddie Mac-related reserve/payment exposure identified for 2017.
- Debt service and liquidity after the January 2017 convertible-note settlement, including the remaining $22.2 million principal due on the 2017 convertible notes and any share repurchases under the $125 million authorization.