Radian Group Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014; filed August 8, 2014. Radian provides mortgage insurance, legacy financial guaranty coverage and, following its June 30 acquisition of Clayton Holdings, mortgage and real estate services. Clayton contributed no operating results in Q2; its results were to be included beginning in Q3.
Financial results and position
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $344.5 million | $200.4 million | $690.7 million | $242.8 million |
| Net income (loss) | $174.8 million | $(33.2) million | $377.6 million | $(220.7) million |
| Diluted EPS | $0.78 | $(0.19) | $1.71 | $(1.40) |
| Adjusted pretax operating income | $74.2 million | $16.2 million | $165.3 million | $0.9 million |
| Cash used in operating activities | Not separately presented for Q2 | $(261.0) million | $(291.6) million |
- Drivers and earnings quality: Improved GAAP results reflected investment gains and lower loss provisions; Q2 investment gains were $47.2 million versus losses of $130.3 million a year earlier. Derivative fair-value gains were $57.5 million in Q2 and $107.6 million for the half year. These marks can be volatile and management says many are expected to reverse over time. The non-GAAP adjusted pretax measure excludes investment and other financial instrument gains and certain derivative fair-value changes.
- Mortgage insurance: Adjusted pretax operating income was $93.0 million in Q2 and $194.3 million for the first half, substantially above comparable 2013 periods, primarily because of lower loss provisions. Q2 net premiums earned rose 2.8% to $203.6 million, while net premiums written fell 11.7% to $221.9 million. First-half new insurance written declined to $16.1 billion from $24.3 billion.
- Financial guaranty: Adjusted pretax operating loss was $18.7 million in Q2 and $29.0 million for the first half. The business is closed to new underwriting and continues to run off legacy exposures.
- Balance sheet at June 30: Assets were $5.93 billion, liabilities $4.35 billion, and stockholders’ equity $1.58 billion, compared with $5.62 billion, $4.68 billion and $0.94 billion at December 31, 2013. Loss and LAE reserves declined to $1.75 billion from $2.19 billion. Long-term debt rose to $1.19 billion from $0.93 billion.
- Liquidity and cash flows: Parent-level unrestricted cash and liquid investments were approximately $790 million at quarter-end; consolidated cash was $45.1 million. First-half operating cash use was $261.0 million. Financing provided $483.8 million, including net proceeds from debt and equity offerings. The filing does not provide a clear consolidated margin measure.
Material changes and management outlook
- Radian acquired Clayton for approximately $312 million, funded with proceeds from a $300 million senior-note issuance and a public offering of 17.825 million shares that generated approximately $247.4 million net proceeds. The acquisition added approximately $191.9 million of goodwill and $102.8 million of intangible assets.
- Radian issued 5.5% senior notes due 2019 and redeemed the remaining 2015 senior notes, recording a $2.8 million redemption loss. The stock offering increased share count and equity.
- Management estimated 2014 new mortgage insurance business volume of $35–$40 billion, citing a smaller mortgage origination market and increased competition, partly offset by home-purchase activity. It expected 2014 new defaults to decline approximately 19% versus 2013 and claims paid to be $900 million–$1.0 billion.
- Proposed PMIERs requirements were a key capital uncertainty. On management’s estimate, the proposal implied $4.8 billion of minimum required assets versus $3.0 billion of available assets for Radian Guaranty, with an estimated net shortfall of approximately $850 million after considering holding-company liquidity and a July dividend. Radian expected to comply within the anticipated transition period, potentially by contributing holding-company resources, monetizing or otherwise using Radian Asset Assurance capital, and/or obtaining reinsurance. The rules were not final, and the estimates were not verified by the GSEs.
- Radian Asset Assurance paid a regulator-approved $150 million extraordinary dividend to Radian Guaranty in July 2014; it expected to seek approval for another in 2015, with no assurance of approval. Radian Guaranty’s statutory risk-to-capital ratio was 18.7:1 and it reported compliance with applicable state requirements.
Risks, contingencies and unusual items
- Mortgage loss estimates depend on default-to-claim, severity, rescission, denial and reinstatement assumptions. Management estimated that a one-percentage-point change in primary claim severity could change reserves by about $44 million; a one-point change in the overall net default-to-claim rate could change them by about $29 million.
- Disputes with lenders and servicers over rescissions, denials and claim curtailments could lead to additional claims and reserve increases. A significant portion of the $269.1 million IBNR estimate related to settlement discussions with one servicer; additional loss was reasonably possible but not estimable.
- Radian had $445.8 million of Puerto Rico net par exposure, including $212.8 million potentially affected by Puerto Rico’s debt-restructuring legislation. The filing cites heightened credit risk and downgrades; reserves were increased for certain PREPA and PRHTA bonds.
- The IRS was challenging tax positions for 2000–2007. If sustained, proposed adjustments would mean approximately $128 million of additional tax, $42 million of penalties and interest. Radian contested the adjustments and stated it believed its tax provision was adequate.
- Other exposures include RESPA captive-reinsurance class actions, Minnesota regulatory discussions, and Spanish surety claims. The company had not recorded a liability for the surety claims, which it disputed; its stated possible range before defenses was $13.9 million–$23.1 million. A CFPB settlement had ended its investigation without findings of wrongdoing and included a $3.75 million penalty and a ten-year restriction on new captive reinsurance arrangements.
- Clayton integration, customer concentration, potential goodwill impairment, market-sensitive investment and derivative valuations, and parent-company liquidity are additional risks. Radian reported disclosure controls effective as of June 30; Clayton was not yet integrated into internal controls.
Important facts for investors to verify
- Whether final PMIERs requirements and the GSEs’ calculation of available assets materially change the estimated capital shortfall, and whether planned capital or reinsurance actions are completed on acceptable terms.
- Whether the decline in defaults and loss provisions persists, and whether claim payments, rescissions, denials and reinstatements track management’s assumptions and 2014 outlook.
- Whether Clayton retains key customers and employees, delivers expected cash flows, and supports the recorded goodwill and intangible-asset values.
- Developments in Puerto Rico exposures, the servicer settlement discussions, the IRS examination, RESPA litigation and the Spanish surety arbitration.
- Debt maturities and conversion-related cash requirements, and the effect of any capital transfers to Radian Guaranty on holding-company liquidity.