Radian Group Inc. — 2011 First-Quarter Form 10-Q
Reporting period: Three months ended March 31, 2011; unaudited. Unless stated otherwise, financial figures are in U.S. dollars and millions. Radian provides mortgage insurance and financial guaranty coverage.
Financial results and position
| Metric | Q1 2011 | Q1 2010 or prior date |
|---|---|---|
| Total revenue | $603.3 | $127.8 |
| Net income (loss) | $103.0 | $(310.4) |
| Diluted earnings (loss) per share | $0.77 | $(3.77) |
| Operating cash flow | $(260.9) | $(287.0) |
| Investment cash flow | $258.3 | $308.1 |
| Mortgage insurance segment net loss | $(236.0) | $(236.5) |
| Financial guaranty segment net income (loss) | $339.0 | $(79.0) |
Q1 2011 earnings reflected $243.9 million of gains from changes in derivative fair values and $75.3 million of gains on other financial instruments, versus losses on both items in Q1 2010. Management attributed much of the improvement to widening in Radian Group’s credit-default-swap spread, which reduced recorded fair-value liabilities. These gains are market-sensitive and do not necessarily indicate lower expected ultimate claims. The filing does not provide a single comparable operating-margin measure.
- Net insurance premiums earned were $203.0 million, up 2.4%; net premiums written were $182.7 million, up 17.5%. Net investment income was $42.2 million, down 7.0%, and investment gains were $37.4 million, down 35.5%.
- Provision for losses was $427.4 million, down from $543.9 million. Mortgage insurance incurred $414.0 million of loss provision; financial guaranty incurred $13.4 million.
- At March 31, total assets were $7.35 billion, total liabilities $6.38 billion, and stockholders’ equity $972.9 million, up from $859.8 million at year-end. Long-term debt was $968.2 million; separately reported VIE debt was $373.0 million. Consolidated cash was $19.2 million.
- Radian Group reported $819.2 million of immediately available unrestricted cash and marketable securities, including $150 million in committed preferred custodian trust securities. Radian Guaranty’s statutory policyholders’ surplus was $1.1 billion, down from $1.3 billion at year-end; its regulatory risk-to-capital ratio was 20.3:1.
Material changes and business performance
- Mortgage insurance default inventory declined 6.8% in Q1; the primary default rate was 15.5%, versus 16.5% at December 31, 2010. Primary loans in default numbered 116,896, down from 125,470.
- Despite the lower default inventory, mortgage loss reserves increased to $3.54 billion. The weighted-average estimated default-to-claim rate rose to 43% from 40%, reflecting aging delinquent loans and revised assumptions. The reserve also includes an estimated $783 million reduction for rescissions and claim denials; reinstatements and challenges could increase future claims.
- New mortgage insurance written was $2.6 billion, versus $1.9 billion a year earlier, with almost all new production prime business. Primary insurance in force declined to $128.0 billion from $139.4 billion a year earlier.
- Financial guaranty net par outstanding declined to $77.5 billion from $78.8 billion at year-end. About 52.6% was structured finance, including CDO exposure; about 73.7% of segment net par was subject to recapture or termination rights.
- Net fair-value liabilities for derivatives were $462.7 million, compared with $697.4 million at year-end. The $41.3 billion notional derivative portfolio and fair values are subject to significant valuation uncertainty; all fair-value liabilities were classified as Level III.
Outlook, risks, contingencies and unusual items
- Management expected mortgage insurance to remain unprofitable for the rest of 2011 and forecast approximately $1.7 billion of mortgage insurance claims paid in 2011. It expected new primary first-lien defaults to continue declining, but noted continued elevated defaults, foreclosure delays, high unemployment and housing-market weakness. No consolidated earnings guidance was provided.
- First-lien insurance did not require a premium-deficiency reserve at quarter-end; the second-lien premium-deficiency reserve was $9.4 million. The first-lien assessment depends on assumptions about defaults, claims, recoveries, rescissions and denials.
- Radian Group anticipated about $160 million of debt principal due in June 2011, a $77 million tax-sharing payment to Radian Guaranty in October, and potential further capital support for mortgage insurance subsidiaries. It expected to use more cash than it generated from operations over the next 12 months. Expense-sharing reimbursements and subsidiary dividends are subject to regulatory and other limits.
- Key risks include further housing and credit deterioration; inaccurate loss-reserve assumptions; challenges to insurance rescissions and claim denials; GSE eligibility, capital and risk-to-capital constraints; reduced mortgage originations and FHA competition; housing-finance reform and Dodd-Frank rulemaking; possible collateral requirements on derivatives; and financial guaranty credit deterioration or counterparty actions.
- Financial guaranty exposures warrant attention: Radian expected substantial principal losses on a mortgage-backed CDO with $452.1 million net par outstanding; it had a $28.1 million claim liability for Jefferson County sewer bonds; and it reported potential liquidity claims on seven TruPS bonds with $840 million net par outstanding. One $115.9 million TruPS bond had experienced an event of default and interest-shortfall claims.
- Subsequent to quarter-end, a counterparty terminated five corporate CDO transactions, reducing net par by about $1.7 billion. A reinsurance commutation of about $0.5 billion was expected to increase Q2 pretax income by $8.0 million. Radian also paid about $39 million to terminate a mortgage-insurance transaction, with an expected $6.5 million Q2 pretax reserve benefit.
- Litigation includes an amended AHMSI action seeking reinstatement of coverage on approximately 256 loans; motions were pending with oral argument scheduled for May 16, 2011. Radian also reported a proposed settlement in principle on the remaining IndyMac-related pool policy dispute. The filing says unsuccessful defense of rescissions or denials could require added reserves, reassumption of risk or claim payments.
- Radian agreed to buy an unoperated financial guaranty insurer for approximately $82 million, subject to regulatory approval. The company said any strategy using it would depend on further approvals, ratings and third-party capital.
Important facts for investors to verify
- Whether mortgage defaults, claim payments and reserve assumptions—including the 43% default-to-claim rate and expected reinstatements—track management’s estimates.
- Whether rescissions and denials withstand lender challenges and litigation, and how changes affect reserves and cash claims.
- Whether Radian Guaranty maintains regulatory and GSE eligibility and sufficient capital, and whether the holding company can meet its debt, tax-sharing and capital-support needs.
- How fair-value gains and losses change with Radian’s own credit spread and underlying asset spreads, and how those marks compare with realized settlements and expected credit losses.
- Developments in the TruPS, mortgage-backed CDO, Jefferson County and Reliance Rail exposures, including claims, commutations, termination rights and potential liquidity demands.