Radian Group Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2014. The unaudited filing covers a mortgage insurer and financial guaranty provider, with mortgage and real estate services added following Radian’s June 30 acquisition of Clayton.
Key financial results
- Third-quarter revenue: $309.3 million, up from $244.6 million a year earlier. Net income was $153.6 million, versus a $12.7 million loss; diluted EPS was $0.67 versus a $0.07 loss.
- Nine-month revenue: $1.00 billion, versus $487.4 million. Net income was $531.2 million, versus a $233.4 million loss; diluted EPS was $2.37 versus a $1.43 loss. Results included substantial market-value gains: nine-month investment gains of $103.8 million and derivative fair-value gains of $126.9 million, compared with losses in 2013. These items are volatile and should not be treated as recurring operating earnings.
- Insurance premiums: Net premiums earned were $227.2 million for the quarter and $646.9 million year to date, increases of 7.2% and 4.7%, respectively. Mortgage insurance adjusted pretax operating income was $132.6 million for the quarter and $326.9 million year to date, substantially improved from the comparable periods.
- Mortgage and real estate services: Clayton contributed $42.2 million of third-quarter revenue and $5.3 million of adjusted pretax operating income. Gross profit on services was $18.3 million, or 43.4% of revenue. Clayton’s results are included only from the acquisition date.
- Cash flow: Operating cash flow was negative $223.3 million for the first nine months, compared with negative $567.6 million in 2013. Investing cash flow was negative $251.1 million, including $294.9 million for acquisitions; financing cash flow was positive $482.5 million. Ending cash was $31.9 million.
- Balance sheet and liquidity: At September 30, assets were $6.0 billion, liabilities $4.2 billion and stockholders’ equity $1.7 billion. Long-term debt was $1.20 billion, up from $930.1 million at year-end 2013. Radian Group reported approximately $762 million of unrestricted holding-company cash and liquid investments. Total investments were $5.0 billion.
- Insurance reserves and capital: Loss and LAE reserves were $1.62 billion, down from $2.19 billion at year-end 2013, mainly reflecting payments, cures and favorable prior-period development. Radian Guaranty’s statutory Risk-to-capital ratio was 18.4:1, versus 19.5:1 at year-end, and it remained within applicable state requirements.
Material changes versus the prior comparable period
- Mortgage insurance provision for losses fell to $42.5 million in the quarter from $154.8 million, and to $167.5 million for nine months from $427.8 million. Management cited fewer new defaults and favorable development on older defaults, including higher cures and lower estimated claim severity.
- New primary mortgage insurance written declined to $11.2 billion for the quarter from $13.7 billion, and to $27.3 billion year to date from $38.0 billion. Management attributed the decrease to lower mortgage originations and increased competition. Persistency increased to 83.5% from 80.5% at September 30, 2013; primary insurance in force was $169.2 billion.
- Primary default inventory fell 23.1% from year-end 2013 to 46,843 loans. New primary defaults declined 20% year over year for the first nine months.
- Radian acquired Clayton for approximately $312 million, funded with proceeds from May debt and equity offerings. The acquisition added $191.9 million of goodwill and $102.8 million of identifiable intangible assets. Radian issued $300 million of 5.5% notes due 2019 and 17.825 million shares, receiving aggregate net proceeds of approximately $541 million; it also redeemed the remaining 2015 notes.
- Financial guaranty net par outstanding declined 18.8% to $19.4 billion, primarily through terminations, commutations and maturities. The segment reported a $9.3 million adjusted pretax operating profit for the quarter but a $19.6 million adjusted pretax operating loss year to date.
Outlook, risks and unusual items
- Management outlook: Radian estimated 2014 new business volume of $35–$40 billion and claims paid of $900 million–$1.0 billion; it expected claims paid to decline materially in 2015. The filing provides no full-year earnings guidance.
- PMIERs capital exposure: Based on proposed FHFA requirements, Radian estimated that Radian Guaranty would have had $4.8 billion of Minimum Required Assets against $3.1 billion of Available Assets at September 30, leaving an estimated net shortfall of approximately $900 million after holding-company cash. The rules were not final; management expected a compliance transition period through January 1, 2017, based on its assumed publication timing. Planned responses include monetizing or otherwise using Radian Asset Assurance capital and obtaining reinsurance. Compliance and continued GSE eligibility are not assured.
- BofA settlement: The September 2014 agreement covering disputed mortgage-insurance claims was subject to GSE consent, with a November 15, 2014 termination date unless extended under its terms. Radian’s reserves assumed implementation; the company said failure to implement could require additional reserves, but it could not estimate a reasonably possible additional loss.
- Loss-reserve sensitivity: Management estimated that a one-percentage-point change in primary claim severity would change reserves by approximately $12 million, and a one-point change in the net default-to-claim rate by approximately $23 million. Reserve estimates also reflect elevated rescissions and denials; the filing warns that faster-than-expected declines in these loss-mitigation outcomes could increase losses.
- Tax contingency: The IRS issued deficiency notices for 2000–2007 asserting approximately $157 million in taxes and penalties, plus approximately $113 million of interest; potential state amounts were estimated at approximately $30 million. Notices also included approximately $105 million primarily related to a disputed 2008 NOL carryback. Radian intended to petition Tax Court by the December 3, 2014 deadline and said resolution could take years. The company stated it believed its tax provision was adequate, but a materially different outcome could affect earnings and cash flow.
- Other risks and unusual items: Puerto Rico exposure was $422.6 million, including obligations subject to the Recovery Act; deterioration could lead to material losses. RESPA class actions and Minnesota regulatory inquiries concerning captive reinsurance remained unresolved; Radian said losses could not be estimated for the class actions. A separate Spanish surety dispute had a stated maximum potential exposure of €21.3 million, which Radian disputed and had not reserved. Financial results also remain sensitive to interest rates, credit spreads, investment valuations, housing conditions and mortgage originations.
Most important facts for investors to verify
- Whether the BofA settlement received required GSE consent and whether the recorded reserve assumptions remain appropriate.
- The final PMIERs requirements, the resulting capital shortfall, and whether Radian can achieve compliance through asset monetization, reinsurance or capital contributions without impairing holding-company liquidity.
- Mortgage default, cure, claim severity, rescission and denial trends, and how changes in these assumptions affect reserves and paid claims.
- The status and potential financial impact of the IRS dispute, RESPA and Minnesota matters, Puerto Rico exposure and Spanish surety arbitration.
- Whether reported earnings growth is supported by recurring insurance and services operations, rather than volatile investment and derivative fair-value gains; also monitor Clayton customer concentration, since its top 10 customers generated approximately 66% of third-quarter segment revenue.