Radian Group Inc. — Q3 2016 Form 10-Q
Business and period: Radian provides private mortgage insurance and mortgage- and real estate-related services through its Mortgage Insurance and Services segments. This unaudited filing covers the quarter and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $320.9 million | $297.3 million | $964.0 million | $918.4 million |
| Pretax income from continuing operations | $126.9 million | $115.7 million | $385.9 million | $333.1 million |
| Net income from continuing operations | $82.8 million | $70.1 million | $247.2 million | $207.0 million |
| Diluted EPS | $0.37 | $0.29 | $1.09 | $0.88 |
| Adjusted pretax operating income, non-GAAP | $139.9 million | $115.6 million | $401.5 million | $386.8 million |
- Revenue growth reflected higher insurance premiums earned and investment income. Nine-month results also included higher investment gains. The non-GAAP measure excludes, among other items, investment gains and debt transaction losses; it is not a substitute for GAAP pretax income.
- Mortgage Insurance: Segment adjusted pretax operating income was $142.5 million for Q3 and $419.9 million for nine months, versus $115.9 million and $387.2 million, respectively, in 2015. Q3 benefited from higher premiums and investment income and lower loss provision.
- Services: Revenue was $43.8 million for Q3 and $115.0 million for nine months. Adjusted pretax operating losses were $2.5 million and $18.4 million, respectively, compared with losses of $0.3 million and $0.4 million in 2015. Nine-month gross profit declined to $40.8 million from $48.6 million; gross margin was 35%, versus 41%.
- Cash flow: Nine-month operating cash flow was $290.1 million, versus cash used of $7.8 million in 2015, primarily reflecting lower claim payments. Investing activities used $87.1 million and financing activities used $203.2 million. Period-end cash was $46.4 million.
- Balance sheet at September 30: Total assets were $6.05 billion; stockholders’ equity was $2.89 billion. Long-term debt was $1.07 billion, down from $1.22 billion at December 31, 2015. Mortgage insurance loss reserves were $821.9 million, down from $976.4 million.
- Radian Group reported $483 million of immediately available holding-company cash and liquid investments, including an $89 million IRS deposit that it says it may recall. Radian Guaranty reported $4.1 billion of PMIERs Available Assets and a $249 million cushion over Minimum Required Assets.
Material changes versus the prior period
- Q3 net income from continuing operations rose to $82.8 million from $70.1 million; nine-month income rose to $247.2 million from $207.0 million. Nine-month 2015 also included $5.4 million of discontinued-operations income from the sale of Radian Asset Assurance, completed in April 2015.
- Mortgage insurance defaults and claims continued to decline: the primary default rate was 3.3% at September 30, 2016, versus 4.1% a year earlier; default inventory was 29,530 loans, down from 35,875. Claims paid for the first nine months were $301.1 million, versus $588.2 million, including $236.6 million of BofA settlement-related claims in 2015.
- Investment income increased to $84.5 million from $58.7 million for nine months, while investment gains were $69.5 million versus $49.1 million. The 2015 comparison included a $68.7 million realized gain from selling equity securities.
- Capital actions included issuing $350 million of 7% notes due 2021, redeeming the remaining $195.5 million of notes due 2017, and purchasing $352.1 million aggregate principal of convertible notes due 2017 and 2019. These actions contributed to a $75.1 million nine-month pretax loss on induced conversion and debt extinguishment. The company also completed a $100.2 million share repurchase program.
- A new share repurchase authorization of up to $125 million remained unused at September 30, 2016. The company said its capital transactions reduced holding-company liquidity by a net $204.6 million and long-term debt by $161.7 million, while improving the debt maturity profile.
Outlook, risks, and unusual items
- Management expected 2016 new insurance written to exceed $48 billion, compared with $41 billion in 2015, and estimated full-year 2016 claims paid of approximately $375 million. It projected new-business returns on required capital of approximately 13%–14% unlevered and 16%–17% levered; these are estimates dependent on market, business-mix, and reinsurance assumptions.
- Management expected the PMIERs cushion to remain in a targeted range of approximately 5%–8% above minimum requirements and did not expect additional capital contributions under current requirements. The GSEs were considering interim guidance that could change reinsurance and eligible-asset credits; PMIERs requirements were also scheduled for review in 2017.
- Management expected targeted expense-reduction initiatives to be substantially complete by year-end 2016. It revised its Q4 other operating expense expectation modestly upward from its prior estimate due to higher anticipated insurance volumes. It expected recent modest SFR securitization activity to continue through 2017.
- The IRS dispute concerns 2000–2007 returns. Notices asserted approximately $157 million of unpaid taxes and penalties, with approximately $133 million of related interest and an estimated $34 million of potential state taxes, penalties, and interest. The IRS also asserted approximately $105 million primarily related to a disputed 2008 NOL carryback. The case is in Tax Court; timing and outcome remain uncertain. The company stated it believes its tax provision is adequate.
- Other exposures include customer challenges to claim-handling practices, which could lead to arbitration or litigation; the company could not estimate a reasonably possible loss. Under the Freddie Mac agreement, $57 million was reserved for an expected payment from collateral funds at a 2017 measurement date. Services goodwill was $195.2 million; management reported no impairment conclusion at quarter-end but noted that weaker-than-projected revenues could trigger impairment.
- Key ongoing risks include mortgage-credit and housing-market conditions, competitive pricing, mortgage-insurance capital and PMIERs requirements, investment-market volatility, loss-reserve estimation, servicing performance, and restrictions on dividends from insurance subsidiaries. The filing reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether 2016 new insurance written and claims paid track management’s stated estimates, and how pricing competition affects returns and business mix.
- Whether loss-reserve assumptions remain supported by claim experience, particularly default-to-claim rates, severity, cures, and the declining contribution from rescissions and claim denials.
- How final GSE PMIERs guidance and the 2017 review affect Radian Guaranty’s $249 million cushion and reinsurance credits.
- Developments in the IRS litigation, including potential exposure, the disputed NOL carryback, and timing of any payment or settlement.
- Whether Services performance and cash generation improve sufficiently to address its operating losses and $29.1 million of unreimbursed allocated expenses and interest, and whether goodwill remains recoverable.
- Debt maturities and holding-company liquidity after capital actions, including any use of the $125 million repurchase authorization.