RADIAN GROUP INC annual report, FY2011

Radian Group Inc. — 2011 Form 10-K

Reporting period: Fiscal year ended December 31, 2011; filed February 29, 2012. Radian is a credit-enhancement company focused primarily on U.S. first-lien residential mortgage insurance. Its other major business is a legacy financial-guaranty portfolio; it stopped writing new financial-guaranty business in 2008. The former financial-services segment ended in 2010.

Financial performance and key metrics

Metric	2011	2010
Total revenue	$1.948 billion	$417.5 million
Net income (loss)	$302.2 million	($1.806 billion)
Net premiums earned	$756.0 million	$825.7 million
Provision for losses	$1.297 billion	$1.739 billion
Cash used in operating activities	$897.8 million	$862.6 million
Total assets	$6.657 billion	$7.621 billion
Stockholders’ equity	$1.182 billion	$859.8 million
Long-term debt, carrying value	$818.6 million	$964.8 million

2011’s reported profit chiefly reflected fair-value gains: $628.4 million on derivatives and $193.3 million on other financial instruments. Management said widening Radian’s own credit-default-swap spread was a principal driver; these gains are not equivalent to cash earnings or proof that expected claims have declined.
Mortgage insurance remained loss-making: segment net loss was $643.9 million, versus $1.143 billion in 2010. Its loss ratio was 189.8% and combined ratio 214.5%, both improved from 2010 but still indicating losses exceeded premiums and expenses.
Financial guaranty reported segment net income of $946.1 million, versus a $695.4 million loss in 2010, substantially reflecting fair-value movements. Net premiums earned declined to $75.1 million from $86.1 million.
Mortgage-insurance net premiums earned fell 7.9% to $680.9 million, while primary new insurance written rose to $15.5 billion from $11.6 billion. Primary risk in force declined to $30.7 billion from $31.5 billion.
Mortgage-insurance defaults improved but remained high: 110,861 primary loans were in default, 15.2% of insured loans, versus 125,470 and 16.5% a year earlier. Total mortgage-insurance net claims paid rose to $1.499 billion from $1.258 billion.
Investments totaled approximately $5.784 billion; 90.3% of the portfolio was investment-grade and $1.262 billion was in short-term investments. Consolidated cash was $35.6 million. These figures differ from parent-company liquidity: Radian Group reported $482.8 million of unrestricted cash and liquid investments after capital contributions, including $150 million held in CPS trust accounts.
Radian Group had $950 million of debt principal due from February 2013 through November 2017, including $250 million due in February 2013. The 2011 interest expense was $61.4 million, up from $41.8 million.

Material changes and unusual items

The swing to consolidated net income from a large 2010 loss was driven by fair-value gains, a lower loss provision and lower tax expense; it should not be read as a comparable improvement in recurring underwriting profitability.
Radian Guaranty’s statutory risk-to-capital ratio rose to 21.5:1 at year-end from 16.8:1 in 2010, after a $100 million contribution accrued in 2011. Management expected it to exceed the common 25:1 state limit in 2012 without further capital contributions. Radian Group’s $482.8 million of available liquidity may also be needed for debt, claims-related support, or taxes.
Expected rescissions and claim denials reduced mortgage-insurance loss reserves by approximately $631 million at year-end. However, reinstatements and resubmissions increased, and the IBNR estimate for future reinstatements and resubmissions rose to $170.6 million from $39.5 million. A 1 percentage-point increase in the estimated default-to-claim rate would increase incurred losses by about $67 million, all else equal.
Financial-guaranty fair-value liabilities are highly sensitive to Radian’s own credit spread. At year-end, the company’s five-year CDS spread was 2,732 basis points; the resulting non-performance-risk adjustment reduced derivative liability valuations by approximately $1.873 billion. Actual ultimate credit losses could materially exceed recorded fair values.
After year-end, the Assured transaction and February 2012 CDO terminations reduced financial-guaranty net par outstanding by a further $21.4 billion, to approximately $47.8 billion. The Assured transaction was expected to provide about $100 million of statutory capital benefit, but the company estimated it would reduce first-quarter 2012 GAAP pretax income by $28.8 million and cash by $92.3 million.
Other notable items included a $53.7 million realized loss from selling tobacco-settlement bonds, a $9.8 million reduction in debt following repayment of the 7.75% debentures at maturity, and a $91.8 million statutory-capital impact from a reserve on a troubled $450.6 million CDO of ABS exposure.

Outlook, risks and contingencies

Management projected 2012 new mortgage-insurance defaults to decline 15% from 2011 and total claims paid to be approximately $1.3 billion. It expected mortgage-insurance operating results to improve in 2012 and projected marginal operating profitability in 2013, while emphasizing substantial uncertainty. It also expected new insurance written to increase; no specific consolidated earnings or revenue guidance was provided.
Fannie Mae and Freddie Mac temporarily approved Radian Mortgage Assurance to write in certain states where Radian Guaranty may be constrained by capital rules. The approvals have conditions, including capital and liquidity requirements, a 20:1 maximum risk-to-capital ratio for Radian Mortgage Assurance, and expiration dates in 2012 and 2013. Freddie Mac’s approval requires Radian Guaranty to maintain at least $700 million in defined liquid assets and provides for a further $50 million capital contribution when specified conditions arise.
Key risks include housing-market weakness, unemployment, falling home prices, foreclosure and servicing delays, concentration in troubled legacy loan vintages, and loss severity. Florida’s share of mortgage-insurance defaults was disproportionately high; California and Florida together represented about 19.5% of primary risk in force.
Rescissions and denials face increasing lender challenges, litigation and possible GSE intervention. The filing discusses Radian’s Quicken litigation, an AHMSI coverage dispute, and putative RESPA class actions. The CFPB also requested information about captive reinsurance arrangements. Outcomes and any resulting reserve or customer effects are uncertain.
The IRS’s examination of 2000–2007 returns could result in approximately $128 million of additional tax, plus potential penalties and interest. A tentative settlement was under reconsideration after objections from the Congressional Joint Committee on Taxation. The company reported $813.7 million of net deferred tax assets with a $797.7 million valuation allowance, and approximately $1.9 billion of federal NOL carryforwards.
Liquidity risks include operating cash outflows, the February 2013 debt maturity, possible further capital support for insurers and restrictions on subsidiary dividends. The company reported that it expected to use more cash than it generated from operations over the following 12 months. The independent auditor’s report highlighted risks and uncertainties, but gave an unqualified opinion on the financial statements and internal control over financial reporting.

Important facts for investors to verify

Whether 2012 claims, default trends and cures support management’s projections, and whether reserve assumptions for severity, default-to-claim rates, rescissions and denials prove adequate.
Radian Guaranty’s actual risk-to-capital ratio, state waiver status, remaining capital needs and compliance with GSE conditions; also confirm Radian Group’s liquidity after the debt tender offer and any further capital contributions.
The cash, statutory-capital and GAAP earnings effects of the Assured transaction and CDO terminations, and the remaining financial-guaranty exposure and termination rights.
Developments in challenged rescissions and denials, customer relationships, the CFPB inquiry and material litigation, including any reserve adjustments or settlements.
The resolution and cash timing of the IRS examination, the realizability of deferred tax assets and the potential effect of ownership-change rules on NOLs.