Radian Group Inc. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. Unaudited consolidated results cover mortgage insurance and financial guaranty; the former financial services segment had no ongoing activity in 2011. Radian’s primary strategic focus is domestic first-lien residential mortgage insurance. It stopped writing new financial guaranty business in 2008.
Financial results and position
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Total revenues | $508.1 million | $581.3 million | $1,583.3 million | $463.4 million |
| Net income (loss) | $183.6 million | $112.2 million | $423.7 million | $(673.3) million |
| Diluted earnings (loss) per share | $1.37 | $0.84 | $3.16 | $(6.20) |
| Net premiums earned—insurance | $179.7 million | $203.9 million | $571.6 million | $605.7 million |
| Provision for losses | $249.6 million | $344.4 million | $940.5 million | $1,323.4 million |
| Operating cash flow | Not stated for quarter | $(766.1) million | $(947.5) million |
- Net income included substantial fair-value gains: derivative gains were $126.0 million in Q3 and $558.6 million for the first nine months; gains on other financial instruments were $80.6 million and $160.9 million, respectively. Management attributed much of the derivative benefit to widening Radian credit spreads, which lowered recorded liabilities; these gains are volatile and not necessarily indicative of ultimate claims.
- Mortgage insurance reported net losses of $42.2 million in Q3 and $375.8 million for the nine months. Financial guaranty reported net income of $225.8 million and $799.5 million, respectively. The filing does not provide a consolidated operating-margin measure.
- At September 30, total assets were $7.25 billion, total liabilities $5.96 billion, and stockholders’ equity $1.29 billion, compared with equity of $859.8 million at year-end 2010. Investments totaled $5.89 billion.
- Long-term debt was $814.9 million, down from $964.8 million at December 31, 2010; Radian repaid $160 million of 7.75% debentures at maturity in June. Remaining principal maturities include about $250 million in each of 2013 and 2015 and $450 million in 2017.
- Radian Group had $726.4 million of immediately available unrestricted cash and liquid investments at quarter-end, including $150 million in CPS trusts. Operating cash outflow was more than offset by $928.6 million of investing cash inflow; cash ended at $21.9 million. The holding company subsequently paid about $84 million to subsidiaries under tax-sharing agreements and made capital contributions to insurance subsidiaries.
Changes versus comparable periods
- Q3 net income increased 63.6% year over year despite lower total revenue, principally reflecting lower loss provisions, higher gains on other financial instruments, and lower income tax expense. Derivative gains were lower than in Q3 2010.
- Nine-month results swung from a $673.3 million loss in 2010 to $423.7 million income in 2011. The comparison is heavily affected by derivative and other financial-instrument fair-value movements, including 2010 losses versus 2011 gains, and the 2010 gain on sale of Sherman.
- Insurance premiums earned fell 11.9% in Q3 and 5.6% for the nine months year over year, while the loss provision declined 27.5% and 28.9%, respectively. Net investment income also declined, reflecting a smaller portfolio and a shift toward lower-yielding, shorter-duration investments.
- Mortgage insurance primary defaults declined to 110,740 loans from 125,470 at year-end 2010; the reported primary default rate was 15.2%, versus 16.5%. Loss reserves fell to $3.21 billion from $3.52 billion, but estimates remain sensitive to loan aging, claims, and rescissions or denials.
- Financial guaranty net par outstanding declined to $71.9 billion from $78.8 billion at year-end, mainly through terminations, commutation, amortization, and refundings. The reported risk mix improved, although specific exposures remained stressed.
Outlook, risks, contingencies, and unusual items
- Management expected mortgage insurance claims paid of approximately $1.6 billion for 2011 and $1.3 billion for 2012. It noted that new mortgage insurance written increased year over year, was almost entirely prime, and remained constrained by weak originations and FHA competition. October 2011 workforce reductions affected approximately 9.8% of corporate and mortgage insurance staff.
- Radian Guaranty’s risk-to-capital ratio was 21.4:1 at September 30. Management projected it could exceed the common 25:1 state threshold in the near term without further capital contributions. The company was pursuing state waivers and GSE approval for Radian Mortgage Assurance as an additional mortgage insurer; approvals and required capital were uncertain.
- A subsequent event: an insured CDO of ABS experienced an approximately $36,000 interest shortfall in November. Radian expected a fourth-quarter statutory reserve with an estimated $88–$109 million negative impact on Radian Guaranty’s statutory capital. Management said this would not significantly affect the GAAP fair-value liability or equity. A $30 million contribution to Radian Guaranty and about $20.6 million to CMAC of Texas were made after quarter-end.
- Mortgage loss reserves incorporate estimated rescissions and claim denials that reduced reserves by approximately $646 million at September 30; estimated future reinstatements increased reserves by about $103 million. Lender challenges, litigation, or a faster-than-expected decline in rescissions and denials could increase claims and reserves. Management estimated a $69 million reserve change for each one-percentage-point change in the overall default-to-claim rate.
- Housing weakness, unemployment, home-price declines, foreclosure and servicing delays, and the performance of older 2005–2008 loan vintages remain key risks. Regulatory and GSE changes could reduce mortgage insurance demand or restrict Radian’s ability to write business. Competitor insurer distress adds uncertainty to the market and approval process.
- Fair-value gains are unusually sensitive to Radian’s own credit spread. The five-year CDS spread widened to 2,238 basis points from 465 at year-end 2010; the filing states this implied a market-estimated five-year default probability of 79%, versus 32% at year-end. Radian cautions that fair values may differ materially from settlement amounts.
- Additional risks include potential collateral requirements under Dodd-Frank, TruPS liquidity claims, municipal and healthcare credit deterioration, litigation over coverage rescissions, and the ability to realize deferred tax assets. Of approximately $752.5 million of net deferred tax assets before valuation allowance, $733.3 million was reserved.
- The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It had a tentative IRS settlement for tax years 2000–2007 awaiting Joint Committee on Taxation approval.
Important facts for investors to verify
- How much of reported earnings and equity reflects non-cash fair-value gains tied to Radian’s own credit spread, and how much reflects underlying insurance performance?
- Whether mortgage loss assumptions, especially default-to-claim rates, claim severity, rescission/denial levels, and reinstatements, remain adequate as claims develop.
- Radian Guaranty’s current statutory capital and risk-to-capital ratio after the CDO reserve and post-quarter contributions, plus the status and conditions of state waivers and GSE approvals.
- Actual 2011 and 2012 claim payments, operating cash needs, and the holding company’s remaining liquidity after subsidiary tax and capital transfers.
- Whether the CDO of ABS and other financial guaranty exposures generate statutory reserves, cash claims, or restrictions on dividends to mortgage insurance subsidiaries.
- The outcome of the AHMSI and Quicken disputes, challenges to rescissions and denials, and the pending IRS settlement approval.