Radian Group Inc. — FY 2012 Form 10-K
Business context and reporting period. This filing covers the fiscal year ended December 31, 2012, not only the fourth quarter. Radian is a credit-enhancement company with mortgage insurance and financial guaranty segments. It stopped writing new financial guaranty business in 2008; its strategy is to grow higher-quality U.S. mortgage insurance, manage legacy losses, reduce financial guaranty exposure, and preserve liquidity and insurance-subsidiary capital.
Financial performance and position
| Metric | FY 2012 | FY 2011 |
|---|---|---|
| Total revenue | $825.4 million | $1,947.8 million |
| Net premiums earned | $739.0 million | $756.0 million |
| Net investment income | $114.3 million | $163.5 million |
| Provision for losses | $959.2 million | $1,296.5 million |
| Net income (loss) | $(451.5) million | $302.2 million |
| Diluted earnings (loss) per share | $(3.41) | $2.26 |
| Cash used in operating activities | $510.5 million | $897.8 million |
| Stockholders’ equity at year-end | $736.3 million | $1,182.3 million |
| Long-term debt at year-end | $663.6 million | $818.6 million |
Revenue and earnings were substantially affected by fair-value movements: the change in fair value of derivative instruments was a $144.0 million loss in 2012, versus a $628.4 million gain in 2011. Net losses on other financial instruments were $82.3 million, versus gains of $193.3 million. The filing cautions that these marks, particularly on financial guaranty contracts, can be volatile and model-dependent.
Mortgage insurance. The segment reported a $214.6 million net loss, improved from a $643.9 million loss in 2011. Net premiums earned rose 3.2% to $702.4 million; provision for losses fell 28.8% to $921.5 million. Its loss ratio improved to 131.2% from 189.8%, while its combined ratio improved to 157.8% from 214.5%; both remained above 100%. Primary new insurance written rose to $37.1 billion from $15.5 billion. Primary risk in force was $34.4 billion, up from $30.7 billion, and the year-end primary default inventory fell 16% to 93,169 loans. Claims paid were approximately $1.0 billion, down from $1.5 billion.
Financial guaranty. The segment reported a $236.9 million net loss, compared with $946.1 million net income in 2011. Net par outstanding fell 51% to $33.7 billion from $69.2 billion, driven by commutations, terminations, and portfolio runoff. The segment’s loss ratio rose to 102.9% from 3.5%; the filing attributes the deterioration in part to public-finance loss developments, the $23.5 million Greece settlement, and increased structured-finance severity.
Liquidity and capital. Consolidated cash was $31.6 million at year-end; cash and liquid investments available at the holding company were $375.6 million before the February 2013 repayment of $79.4 million of 2013 notes. The company reported approximately $296.2 million of immediately available unrestricted holding-company cash and liquid investments after that repayment. Operating cash use was partly offset by $661.1 million of investing cash inflows; financing cash outflow was $154.6 million. Radian Guaranty’s statutory risk-to-capital ratio was 20.8:1, improved from 21.5:1, but management projected it could exceed the common 25:1 threshold during 2013 without capital contributions or other support. Year-end investment portfolio carrying value was $5.15 billion, with 90.3% rated investment grade.
Material changes versus the prior comparable period
- Mortgage-insurance losses improved considerably as new defaults declined 22% and claims paid fell, but the legacy 2005–2008 books continued to drive substantial losses and reserves.
- Primary insurance written more than doubled, while the share of prime loans in primary risk in force rose to 88.3% from 84.8%. Persistency declined to 81.8% from 85.4%, largely due to refinancing activity.
- Financial guaranty exposure contracted sharply. The Assured transaction, CDO commutations, and counterparty early terminations reduced exposure; the 2012 CDO commutation involved a $210 million payment.
- Stockholders’ equity declined by $446.0 million, primarily reflecting the annual net loss. Investment income also decreased, reflecting lower investment balances and yields.
- The company exchanged $195.2 million of 5.375% notes due 2015 for 9.000% notes due 2017 in January 2013, extending maturities but increasing the coupon on the exchanged debt.
Outlook, risks, contingencies, and unusual items
- Management expected marginal mortgage-insurance operating profitability in 2013, a further decline of approximately 24% in new defaults, and claims paid of $900 million to $1 billion. These are projections dependent on economic, housing, reserve, and claims assumptions; management gave no assurance they would be achieved.
- Insurance rescissions and claim denials reduced year-end loss reserves by an estimated $455 million. Radian expects some denied claims to be resubmitted and paid and some rescissions to be challenged. Litigation or settlements that reverse these actions could increase losses; the company’s claims-management practices may also affect customer relationships.
- Radian Guaranty operated with waivers in states with minimum-policyholder-position requirements. Several waivers had expired or were being pursued for renewal, and GSE approvals allowing subsidiary RMAI to write in certain states expired December 31, 2013. The approvals impose capital, liquidity, and operating conditions.
- Holding-company liquidity faces demands from insurance-subsidiary capital support, debt service, and a disputed IRS examination. The IRS proposed approximately $128 million of additional taxes plus $42 million of penalties, before interest; Appeals rejected the latest settlement offer and planned a notice of deficiency. The company may litigate.
- Radian reported approximately $989.7 million of net deferred tax assets, fully offset by a valuation allowance. It also reported approximately $1.9 billion of federal net operating loss carryforwards, whose use could be limited by an ownership change or other tax-law restrictions.
- The CFPB is investigating captive mortgage-insurance reinsurance arrangements under RESPA and related laws; Radian is cooperating and disputes the allegations. Related putative class actions are pending, and the company could not estimate a reasonably possible loss range. A separate Quicken dispute concerns rescissions on approximately 220 loans.
- Financial guaranty results and capital support remain exposed to stressed public-finance and structured-finance credits, second-to-pay obligations involving troubled insurers, and potential liquidity claims on certain TruPS contracts. Fair-value liabilities depend materially on estimates and Radian’s own credit spread; management noted that a change in that spread can materially affect reported earnings.
- The filing identifies housing-finance reform, GSE and FHA policy, Basel III capital rules, Dodd-Frank implementation, mortgage-origination volumes, interest rates, home prices, unemployment, servicing delays, and reserve-estimation uncertainty as significant risks.
Important facts for investors to verify
- Whether mortgage defaults, cures, claim severity, and rescission or denial reversals support management’s 2013 loss and claims projections; assess reserve sensitivity, including the disclosed approximate $55 million reserve effect per one-percentage-point change in the default-to-claim rate.
- Whether Radian Guaranty can remain within capital requirements, renew state waivers and GSE approvals, and obtain any required parent-company capital without impairing holding-company liquidity.
- Holding-company cash and debt maturities after the 2013 repayment and 2015-to-2017 exchange, and the timing and amount of any IRS liability or capital contributions.
- Progress and outcomes in the CFPB investigation, RESPA class actions, Quicken litigation, and servicer disputes; the filing does not provide a clear loss estimate for these matters.
- How the financial guaranty portfolio performs and whether expected recoveries, TruPS salvage value, and future dividends from Radian Asset Assurance materialize.
- How much reported earnings volatility reflects fair-value assumptions and Radian’s own credit spread rather than realized cash claims. The filing states that PwC audited the financial statements and management reported effective internal control over financial reporting.