Radian Group Inc. — Q2 2013 Form 10-Q
Business context and period: Radian is a credit-enhancement company focused primarily on U.S. residential mortgage insurance, with a legacy financial guaranty portfolio in runoff. This unaudited filing covers the quarter and six months ended June 30, 2013; comparisons are to the corresponding 2012 periods unless noted.
Financial results and key metrics
| Metric | Q2 2013 | First half 2013 |
|---|---|---|
| Net premiums earned—insurance | $213.1 million | $405.7 million |
| Total revenues | $200.4 million | $242.8 million |
| Net loss | $33.2 million; $0.19 per share | $220.7 million; $1.40 per share |
| Cash flows used in operating activities | $291.6 million |
- Q2 net loss improved from $119.3 million in 2012; first-half net loss improved from $288.5 million. Lower loss provisions and higher insurance premiums helped, while investment losses and higher operating costs weighed on results.
- Q2 total revenues included $130.3 million of investment losses, partly offset by an $86.5 million gain from changes in derivative fair value. First-half investment losses were $135.8 million and derivative fair-value losses were $81.1 million. These market-sensitive marks materially affected reported earnings.
- Q2 consolidated pretax loss was $31.5 million. Mortgage insurance reported a $67.1 million pretax loss, versus $33.2 million in Q2 2012; financial guaranty reported $35.6 million pretax income, versus an $83.6 million loss.
- Mortgage insurance provision for losses fell 34.5% to $136.4 million in Q2 and 39.4% to $268.4 million in the first half. Mortgage insurance premiums earned increased 15.9% to $198.0 million in Q2 and 10.7% to $380.9 million in the first half.
- Other operating expenses rose 51.7% to $61.0 million in Q2 and 56.3% to $141.1 million in the first half, principally due to stock-price-sensitive incentive compensation. Related expense was $56.9 million in the first half, compared with $8.3 million in 2012.
- At June 30, total assets were $6.05 billion, total liabilities $5.15 billion, and stockholders’ equity $902.9 million. Loss reserves were $2.72 billion, down from $3.15 billion at year-end 2012.
- Long-term debt carrying value was $914.0 million, up from $663.6 million at year-end. Holding-company unrestricted cash and liquid investments were $918.6 million, or $816.0 million net of subsidiary advances for expected corporate expenses and interest.
- Radian Group raised approximately $299.5 million net from a March common-stock offering and approximately $389.8 million net from issuing $400 million of 2.25% convertible notes due 2019. Operating cash outflow was partly offset by $601.1 million of financing cash inflows; cash ended the half at $31.8 million.
- Radian Guaranty’s statutory risk-to-capital ratio was 19.7:1, compared with 20.8:1 at year-end 2012. Its statutory surplus was $1.14 billion. Management estimated $150–$300 million of additional capital contributions could be needed over the next 12 months to maintain a ratio of 20:1 or below.
Material changes versus the prior comparable period
- Primary mortgage-insurance new business written was $13.4 billion in Q2 and $24.3 billion in the first half, up from $8.3 billion and $14.8 billion, respectively. Nearly all new production was prime business.
- New primary defaults declined 18% in Q2 and 19% in the first half year over year. Primary defaulted loans fell to 78,257 from 98,450 a year earlier; the primary default rate declined to 9.7% from 13.3%.
- Mortgage claims paid increased to $326.4 million in Q2 and $636.3 million in the first half, from $263.4 million and $481.6 million. Management attributed the increase mainly to a more efficient claims-review process.
- Financial guaranty net par outstanding declined 19% in the first half to $27.3 billion from $33.7 billion at year-end, including $3.4 billion reduced through 2013 CDO terminations. The 2013 fair-value results were also affected by the CLO transaction’s rating-related mark-to-market volatility.
- Interest expense increased to $35.3 million in the first half from $26.7 million, reflecting debt issuance and exchange activity. The company exchanged $195.5 million of 2015 notes for 9% notes due 2017 and repaid $79.4 million of notes due 2013.
Outlook, risks, contingencies, and unusual items
- Management expected 2013 total new defaults, including pool insurance, to decline approximately 18% from 2012, and claims paid to be approximately $1.4 billion. It projected a marginal level of mortgage-insurance-segment profitability in 2013, excluding stock-price-related compensation changes and unrealized investment gains or losses; this outlook was conditional on improving macroeconomic trends.
- Loss estimates depend materially on rescissions, claim denials, reinstatements, cures, claim severity, and default-to-claim assumptions. Estimated future net rescissions and denials reduced reserves by approximately $334 million at June 30; a faster-than-expected decline in these mitigation effects could increase claims and reserves. Management estimated that a one-percentage-point change in primary claim severity could change reserves by about $76 million.
- Radian Guaranty’s GSE eligibility and capital remain central risks. The GSEs were developing potentially more stringent insurer capital requirements, expected by year-end 2013. Radian Guaranty operated under remediation plans and temporary approvals; waivers and approvals have conditions and may expire or be withdrawn.
- Radian Group said it did not expect Radian Guaranty to pay dividends to the holding company for the foreseeable future. Holding-company liquidity must support debt service and potential subsidiary capital needs; access to future debt or equity financing on favorable terms is not assured.
- The IRS proposed adjustments for 2000–2007 that, if sustained, could result in approximately $128 million of additional taxes plus $42 million of penalties and interest. The matter remained contested, with potential litigation and uncertain timing and outcome.
- The CFPB settlement, approved in April 2013, closed its captive-reinsurance investigation without findings of wrongdoing. Radian Guaranty agreed not to enter new captive-reinsurance arrangements for ten years and to pay a $3.75 million civil penalty.
- Mortgage-insurance rescissions and denials remain subject to customer challenges and litigation. The filing also describes putative RESPA class actions and other disputes; for the class actions, the company said a reasonably possible loss or range could not be estimated. Management expected the AHMSI dispute to resolve without a material financial impact.
- Fair-value estimates for derivatives and certain liabilities use significant unobservable inputs and Radian’s own credit spread. The filing cautions that reported fair values may differ materially from eventual settlement amounts. Higher interest rates also reduced fixed-income values; a 100-basis-point increase was estimated to reduce their market value by $213.1 million.
Most important facts for investors to verify
- Whether new defaults, cures, claims paid, and legacy-loan performance continue to track management’s 2013 expectations.
- How sensitive loss reserves are to reinstatements or challenges of rescissions and denials, and whether reserve development remains favorable.
- Whether Radian Guaranty can maintain its 19.7:1 risk-to-capital ratio and GSE eligibility, including the amount and timing of further capital support.
- Whether holding-company liquidity remains adequate after capital contributions, debt service, and any IRS-related payments.
- How much reported earnings continue to be driven by investment and derivative fair-value movements rather than underlying insurance operations.
- Developments in the IRS dispute, RESPA litigation, GSE capital rules, and financial guaranty portfolio exposures.