Radian Group Inc. (RDN) Q3 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to Radian's Third Quarter 2012 Earnings Call. [Operator Instructions] And as a reminder, today's call is being recorded. With that being said, I'll turn the conference now over to the Vice President of Financial Communications, Ms. Emily Riley. Please go ahead.

Thank you, and welcome to Radian's Third Quarter 2012 Conference Call. Our press release, which contains Radian's financial results for the quarter, was issued earlier today, and it's posted to the Investors section of our website at www.radian.biz. During today's call, you will hear from S.A. Ibrahim, Radian's Chief Executive Officer; and Bob Quint, Chief Financial Officer. Also on hand for the Q&A portion of the call are Teresa Bryce Bazemore, President of Radian Guaranty; David Beidler, President of Radian Asset Assurance; Scott Theobald, Executive Vice President and Chief Risk Officer of Radian Guaranty; and Derek Brummer, Chief Risk Officer and General Counsel of Radian Asset. Before we begin, I would like to remind you that comments made during this call will include forward-looking statements. These statements are based on current expectations, estimates, projections and assumptions that are subject to risks and uncertainties, which may cause actual results to differ materially. For a discussion of these risks, please review the cautionary statements regarding forward-looking statements included in our earnings release and the Risk Factors included in our 2011 Form 10-K and subsequent reports and registration statements filed with the SEC. These are also available on our website. Now I would like to turn the call over to S.A.

Thank you, Emily, and thank you all for joining us and for your interest in Radian. I will start off today offering highlights of our quarterly results, and the strong progress we've made against our goals and then focus my comments on the topics we believe are most important to you. First, how we, at Radian, continue to grow our mortgage insurance franchise and capture a larger amount of new high-quality business, while effectively mitigating losses in our legacy portfolio. Second, what we are doing to mitigate our mortgage insurance legacy losses and reduce risk exposure in financial guaranty to provide important capital support to our mortgage insurance business. And third, how we are managing our capital and positioning Radian for success and a return to operating profitability. Bob will then cover the details of our financial position, and I will provide a few closing comments before we open the call to your questions. Earlier today, we reported a net income for the third quarter of $14 million or $0.11 per diluted share, which is comprised of $31 million of income in the mortgage insurance segment and a $17 million loss in the financial guaranty segment. This includes the impact of fair value and other financial instrument losses of $42 million, as well as net gains on investments of $85 million. At September 30, 2012, our book value per share was $6.85. In the third quarter, Radian Guaranty's risk-to-capital ratio improved to 20.1:1. The improvement in our risk-to-capital ratio this quarter was primarily driven by investment gains, partially offset by a small level of operating loss. We have taken and continue to take many actions to maintain a competitive risk-to-capital position, including internal and external reinsurance, reductions and commutations of risk exposure and by realizing investment gains. As a result, in 2012, we do not expect to exceed the 25:1 risk-to-capital limit imposed by certain states and believe that Radian is positioned to continue writing new high-quality mortgage insurance business uninterrupted. Now, let me turn to the topics that we believe are top of mind. First, we continued to write more new high-quality mortgage insurance business that can generate strong returns. We have successfully drawn and diversified our customer base, which is evident in our new business volume. In the third quarter, we wrote $10.6 billion of new business and $25.4 billion year-to-date. This is projected to generate $7.5 million in positive after-tax contribution over its slide for each billion dollars in NIW. Our volume has increased substantially over the past year. In fact, we wrote more new business in the third quarter alone than we did for the entire first 9 months of 2011. In October, we received more requests for mortgage insurance than in any other month this year, reaching a 5-year monthly record NIW of $4 billion. And here, I need to take a moment to thank our customers for choosing to do business with Radian. We are attracting new customers and increasing our market penetration, particularly among community banks and independent mortgage lenders and by expanding our geographical presence. In 2012 alone, more than 250 new customers chose Radian as their MI partner. And new customers bring new volume. 20% of our NIW in 2012 came from customers new to Radian beginning in 2011. Last quarter, I mentioned our outstanding sales team as one of the drivers behind our NIW success. This quarter, let me mention another driver: our unmatched customer training capability. Radian has trained more than 44,000 customers since 2009, with a focus on product and technical training that anticipates and addresses trends in the industry. Our training has gained popularity over the past few years as our customers discover the value of our courses and knowledgeable training team. In 2009, we had nearly 7,000 individuals take advantage of our training. In 2012, so far this year, we've trained more than 12,000. Turning now to Radian's mortgage insurance book of business in Slide 19 on our webcast presentation. It is important to note that as of the third quarter, the 2009 to 2012 books grew to more than 40% of our primary risk in force, and the most problematic 2006 and '07 books are now down to under 28%. If the pace of our new business volume continues, we expect that by mid-2013, our book of business written after 2008 will be larger than the book written in 2008 and prior. In addition, the success of the latest HARP program has helped to further improve the credit profile of our legacy book. Approximately 8% of our risk in force has been improved through a HARP refinance, and this, combined with our newer quality book of business, represents a strong portfolio that has grown to 48% of our total primary mortgage insurance risk in force. By the end of this year, this combination of HARP plus the 2009 to 2012 book will represent more than 50% of our total risk in force. This is one of the primary drivers of our expected return to MI operating profitability in 2013. Second, we continued to focus on mitigating losses in our mortgage insurance portfolio. There are positive trends and improving results in our legacy book as the total number of defaulted loans continues to decline, as you can see on Slide 24. The default rate on our primary book fell further in the third quarter to 12.6%. Loss mitigation remains a top priority at Radian. With regard to loan modifications, while the reporting we receive from servicers remains limited, we have seen a steady number of completed loan mods. Although the HAMP program peaked last year, many of those borrowers who did not complete HAMP instead transitioned to a private modification program and achieved success. In fact, one quarter of the completed private modifications that were reported to us began at the HAMP trial. Our loss management team works track tirelessly to increase these numbers, helping to educate and connect borrowers with servicers that can offer a loan modification or other program to increase their likelihood of home ownership success. For example, earlier this month, we began operating a unique program called the Responsible Homeowner or RH Reward, designed to encourage borrowers who recently modified their mortgages to remain current on the new mortgage payments. This program is administered by Loan Value Group and pays rewards to eligible homeowners for making their mortgage payments on time. The reward is paid in cash when the mortgage is refinanced or paid off, and participation is free. Loan Value Group has demonstrated success with this program, and we are pleased to be a partner. We remain committed to supporting efforts focused on responsible, sustainable homeownership. As we continue to work through our legacy books of business, we maintained $3 billion in loss reserves, representing 3x the claims we expect to pay in 2012, and our primary reserve for default increased slightly this quarter to $28,561. You'll find the details of our rescission and denial activity on Slide 20 of our webcast presentation. These rates remain elevated as we work through the legacy books, for errors in underwriting are common. We also continue to review each claim carefully to ensure that the servicing standards referenced in our master policy have been followed. Where warranted, we may curtail the claim payment based on servicing negligence. What is most important to remember, however, is that we continue to pay appropriate claims and have paid in excess of $5 billion in -- since 2008 while enforcing our rights on poorly underwritten, fraudulent or negligently serviced loans. Third, our financial guaranty business continues to serve as an important and unique source of capital for Radian Guaranty. Our financial guaranty team in New York is solely focused on surveilling our existing exposure and pursuing opportunities for commutation and risk reduction. Based on the tenacity and strong relationships, we have successfully reduced our net par exposure from a peak of $115 billion in June 2008 when Radian Asset stopped writing new business to $39 billion in the third quarter of 2012, primarily through a series of successful commutations. This represents a reduction of our total financial guaranty risk exposure of 66% or 2/3, including many of the riskier segments of the portfolio, as you can see on Slide 27. Since 2008, Radian Asset has paid Radian Guaranty a total of $384 million in dividends, and expects to pay another dividend of approximately $40 million to Radian Guaranty next year. An additional $291 million in contingency reserves remains to support Radian Asset's existing risk. This represents an opportunity over time to act on Radian Guaranty's statutory capital as the exposure is ultimately reduced and contingency reserves are released. As of September 30, 2012, Radian Asset maintains statutory surplus of $1.1 billion. Fourth, while the challenge and volatility of our economy and legacy portfolio clearly remains, based on our performance and trends, we continued to project a return to a very small level of MI operating profitability in 2013, with our updated forecast projecting close to breakeven on a consolidated basis. Our industry continues to slowly but steadily regain share from the FHA, as the FHA has increased prices and tightened guidelines to help our industry return to a more traditional and sustainable balance between government and private mortgage insurance. On Capitol Hill, we continued to hear resounding support in Congress for a larger role for private capital, including private mortgage insurance. In the future, as the -- as Capitol takes on the future of housing finance. The qualified mortgage definition outlined in Dodd-Frank is still expected to be released no later than mid-January with QRM to follow. Now, I would like to turn the call over to Bob for details of our financial position.

Thanks, S.A. I'll be updating you on our P&L activity and trends for the third quarter of 2012 and our capital and liquidity positions as of September 30, 2012. The MI provision for losses was down to $172 million this quarter compared to $208 million last quarter and $277 million a year ago. The improved loss development this quarter continues to be driven by the lower level of new defaults as the credit composition of our in force book keeps improving. The credit composition has been helped by the significant volumes of very high quality new business, plus a continuation of the recent surge in HARP volume. Primary new defaults, which are the main driver for incurred losses, were down by 23% for the third quarter compared to the third quarter of 2011. In addition, the impact to net incurred losses resulting from the composition changes and other items in our default inventory was minimal this quarter. For the fourth quarter, we are expecting a larger MI operating loss, as the negative impact of seasonality on both new defaults and cures is expected to result in significantly higher incurred losses for the quarter. The amount in our September 30 balance sheet, representing future expected denials and rescissions, is $477 million. We account for approximately 50% of currently outstanding denials as anticipated reinstatement. And to quantify the sensitivity to this number like we did last quarter, if the reinstatement percentage unexpectedly shifted significantly to 75%, the resulting addition to our total loss reserves would be about $121 million. We have disclosed a historical reinstatement rate by denial quarter in a new webcast Slide #21. While some quarters have been below the 50% average and some above, our overall estimate is based on this actual experience, which is updated quarterly. Please note that when denials are subsequently reinstated, the majority of these reinstatements take place in the first 6 months after denial. Radian Guaranty's risk-to-capital ratio is estimated to be 20.1:1, with approximately $200 million of excess statutory surplus above the 25:1 risk-to-capital ratio as of September 30. The primary driver of the improvement on our risk-to-capital ratio this quarter was the statutory investment gains we booked during the quarter, partially offset by a small MI operating loss and an FG operating loss and an increase in net MI risk in force. In the financial guaranty segment, we booked a $24 million statutory loss in the quarter for the final settlement of all of our Greek exposure. Radian Guaranty ended the quarter with $1 billion of statutory capital, up 11% from last quarter. Our current projections have Radian Guaranty remaining at a risk-to-capital ratio below 25:1 through year-end without any capital contribution. For the fourth quarter, we expect our strong new insurance volumes will continue to increase Radian Guaranty's gross risk in force, with net risk in force decreasing as a result of additional internal and external reinsurance that is planned, of which is still subject to regulatory approval. Operating losses in the fourth quarter are expected to decrease our capital levels. There are minimal remaining embedded investment gains in our current portfolio. As always, Slide 9 depicts our current balance sheet fair value position, along with our expected net credit losses or recoveries on fair value exposures. The net credit recovery, again, consists mainly of the amount we expect to ultimately recover with regard to the TruPS commutation. If our projections are correct regarding the future credit loss payments and recoveries, we will see an addition of approximately $245 million or $1.83 to pre-tax book value over time as the exposures mature or are otherwise eliminated. That number is derived by taking the net balance sheet liability of $187 million and adding the present value of credit loss recoveries of $58 million. Both of these numbers are shown on Slide 9. As of September 30, 2012, the valuation allowance against our deferred tax asset is approximately $918 million or $6.87 per share. We believe this amount will be realized in the future. However, the realistic timeframe when we can potentially reverse some or all of the valuation allowance is expected to be sometime in 2015. We are projecting a very small MI operating profit in 2013 based in part on our expectation that new defaults will continue to decline significantly in 2013. Operating expenses for the third quarter are up from last quarter, primarily due to a decrease in our stock-based compensation accrual. We have approximately $330 million currently available at the holding company, and remaining -- our remaining 2013 debt outstanding of $79.4 million, which is due in February. As mentioned earlier, we expect that Radian Guaranty will not breach 25:1 this year. Nonetheless, contributions from the holding company are still possible during the rest of 2012 and beyond. The results of potential use of some holding company cash when our IRS issue is finalized, which is now unlikely to occur in 2012. And we have $250 million of debt maturing in June of 2015. I'd now like to turn the call back over to S.A.

Thank you, Bob. Before we turn to the operator, I would like to summarize 4 important points. First, we wrote $10.6 billion in NIW in the third quarter, which was more business than we wrote in the first 9 months of last year. Our momentum continued in October as we recorded our highest month of NIW in 5 years of $4 billion. Second, since 2008, we've reduced our Radian Asset risk exposure by 66% while paying $384 million in dividends to Radian Guaranty and releasing $270 million in contingency reserves. Our statutory surplus stands at $1.1 billion. Third, at the end of the third quarter, we improved our risk-to-capital ratio to 20.1:1, and we do not expect to breach the 25:1 risk-to-capital ratio this year. Fourth, we maintained $330 million of currently available holding company liquidity after taking advantage of opportunities to continue reducing our 2013 debt, which now has a remaining balance of $80 million. And finally, what excites us at Radian is that we are building towards what we expect will be a profitable future that will be fueled in part by the size and the earnings power of the profitable new MI business we are writing. And now, operator, I'd like to open the call to questions.

[Operator Instructions] And we'll go to Mark DeVries with Barclays.

So, S.A., it sounds like your NIW is growing quite fast, faster than overall mortgage activity. I guess, you pointed out 20% of that is coming from new customers, but it also seems like part of that's also gaining market share with existing customers. Can you give us a little better sense of what these customers are saying to you, why they're bringing you new business, or why they're bringing you a larger share of their existing business?

Well, as you know, Mark, one of the factors has been that there's been a reduced number of suppliers or mortgage insurance providers in the industry in the short term. But more importantly, on a long-term basis, we've been building deliberately for this sector's success by continuing to find ways in which we can improve our relationships with customers, add more value and, as Teresa's fond of saying, positioning ourselves as a must-do business with MI player. In addition to that, as I mentioned and we are just getting -- moving on it in a bigger way, we're expanding into geographies that hitherto were geographies that we're very strongly dominated by Old Republic and some of the other players such as Texas and Oklahoma and so on. And we continue to hire more mortgage insurance salespeople. In fact, even as we speak, we're looking for strong people to hire. So this is part of a sustained momentum and strategy with a training program with our investment in the operational side with the 2 principles that we have, which is, we will not compromise credit quality, and we expect to get an acceptable and attractive return. I don't know if, Teresa, you'd like that to add more to that?

I think that says it very well.

Okay, great. Another question, Bob, what -- do you know what the remaining unrealized gain position in your securities portfolio right now?

Yes. I said it was minimal.

Minimal? What caused the rescissions to increase in the third quarter? It kind of upped a decent amount mortgage in the prior 3 quarters.

Scott?

Hi, Mark. It's Scott Theobald. The majority of the claims we resolve continue to come from the problematic 2006 and 2007 vintages. As such, we continue to ask originations and servicing docs, and that's to support our investigation process. IF service is unable to provide the documentation, a denial results. If we receive the docs, we investigate and pay all appropriate claims. We rescind when we have corroborated evidence of underwriting negligence or misrepresentation. Having said that, we do expect rescissions and denials to recede over time as the problematic vintages age and run off.

And Mark, remember, because of the process-intensive nature of rescissions, it inherently is a lumpy process. So you'll see months where that number goes up and months that -- where that number goes down.

Okay, got it. And just one last thing. I mean, you guys indicated you expect to -- you do not expect to exceed 25:1 on risk/capital in 2012 and also, are looking for an operating profit in 2013. What's to stop you from extending that and saying we realistically just don't expect to exceed 25:1?

Well, that's only part of the equation, Mark. You also have to look at the risk in force, and thankful for us, we're lighting -- writing a lot and creating new business. That's increasing our risk in force, so that's going to be part of the equation in capital and the risk-to-capital.

Okay. And then, could you, Bob, talk about how the -- your new reinsurance agreement is impacting the growth in risk in force relative to growth in insurance in force?

Well, it's going to be the 20% quarter share. So the net risk in force is going to be 80% essentially, and that's the way it works, so -- which I think is a fairly easy calculation. This is something that we use to manage the liquid capital, which is very important to our success in writing it.

And Mark, as we look at ways in which we continue to manage our risk-to-capital ratio, we are very focused on not stopping the momentum we have in writing new business because we believe that eventually, when the legacy wears off, our company's valuation will be based on its franchise valuation. So it is very important to -- for us, while we are dealing -- still dealing with the legacy issues, to continue to deal with and focus on building as strong a franchise as possible because that's what's going to fuel our future success in valuation.

Okay, got it. And then just finally, is that netting impact of the reinsurance reflected in the risk in force numbers reported in the earnings release?

Not the -- there's a gross risk in force that -- the primary risk in force data. That's going to be the gross. And then the net risk in force would be the risk in force that we calculate versus the capital baseline.

Our next question is from Jason Stewart with Compass Point. Jason Stewart - Compass Point Research & Trading, LLC, Research Division: S.A., you -- in your prepared remarks, you talked a little bit about the FHA. And I was wondering if you could expand on your comments and talk maybe more specifically about what the impact to private mortgage insurance would be if the FHA was required to draw more capital?

Okay, Teresa is in the best position to answer that.

Yes, I mean, I think that as we look at that issue, I -- there has been clearly a focus on trying to move more business to the private sector, in particular, private mortgage insurance versus FHA. And you've seen that during number of moves that the FHA has made over the last couple of years in terms of increasing their price. We do think that if the FHA has issues in terms of not only having kind of not reach their cushion requirement, but being under the -- having a negative in their insurance fund, that should benefit us in terms of seeing more business come our way, and also even bolster the view that private capital to mortgage insurance is a better solution going forward for low down payment loans. Jason Stewart - Compass Point Research & Trading, LLC, Research Division: Okay. And then just a follow-up on the previous question about net risk in force. Is that -- just to clarify, does that include the existing reinsurance contract or the new one that is still subject to approval?

No, it wouldn't be netted until the business is written and ceded.

And next, we'll go to Jack Micenko with SIG.

Wondering if you could talk a little bit about the transition or the mix shift from single pay to monthly over the last year or so in the midst of some of the market share take you've been seeing?

Sure. So we've been very focused, as you know, on increasing the amount of monthly pay that we receive. And one of the things we did was we improved our pricing on the monthlies in the summer of 2011, increased some of our singles pricing after that. We've also changed our incentive plan so that our sales folks are incented to bring in monthlies. And so, I think you'd see that shift based on all the actions that we took to bring that share down.

However, our position remains that the best strategies is to have a piece of both. It's just that with the view that interest rates may finally be going up, we are positioning ourselves to do, on the margins, few less singles and few more monthlies. And we have gotten to our strategy to a point where there's a number of levers we can push, including the new lever we have, which is changing sales commissions to incent products that we believe are attractive to us from time to time.

I would just say one other thing, which is that we do believe that the return on that business, the singles business, is an appropriate return. And I think that's an important point as well.

Great. And then, on past calls, we've talked about cure assumptions on that late-stage bucket, and I think there were some slides. Historically, I mean, I've overlooked and I don't know if some of those were included. Just kind of update your thoughts for us on what your assumptions on the curers for that late-stage default bucket would be?

Yes, I mean, I think the ultimate cure rate on the -- with the nonpayment of claims on a late stage has not changed. We've been consistent. You can see on the 12 payments or more, where we're expecting a 57% gross roll rate, which means that 43% will not be submitted claims for a variety of reasons. We did see a tick-up in the cure percentage coming from the 12 payments or more this quarter. But ultimately, we expect a lot of those not to be paid claims for a variety of reasons that we've detailed in the past.

Our next question is from Ian Glastein with Monarch.

S.A., just a question to follow up on Mark's question about gross versus net risk in force. It looks like the gross total risk in force is around $35 billion and the net risk in force this quarter is around $20 billion. So it seems it's around a $15 billion difference between gross and net. I understand that $1.4 billion of that is the quarter share and around $4.4 billion of that is the delinquent risk in force. But can you tell me where the other $9 billion is hiding?

Yes. Bob?

Yes, the -- I mean, it's going to be -- the growth in that is going to be the external reinsurance, which is not limited to the quarter share because we have capped every insurance, and we have Smart Home Reinsurance still outstanding. We also have the delinquent risk in force, as you pointed out. And then the third component would be internal reinsurance, where we routinely reinsure a business that we write in Radian Guaranty with other internal MI subsidiaries.

So does that mean $9 billion of internally reinsured as well?

It doesn't because your $1.4 billion on external reinsurance was only the quota-share treaty and doesn't include some of the other stuff. So it's approaching that, but it's closer to $8 billion.

So $8 billion is internally reinsured?

A little less, yes.

And can you talk a little bit about where the risk-to-capital is on the internal cap is? So your internal reinsurance, obviously, has special rate guidelines as well and risk limits. Can you talk about where the [indiscernible]?

Well, all of the subsidiaries to which we reinsure internally meet the necessary surplus requirements in the state fair domicile. Obviously, that's something that we pay very careful attention to. We also work with Pennsylvania or domicile state where most our subsidiaries are domiciled to make sure that those subs also have appropriate risk-to-capital ratios that are not within the Pennsylvania law, but something that we arrange with them to keep the risk-to-capitals at an appropriate level.

Okay, great. And then just a question on the projected default to claim rate, just a follow-up. It looks like the net rate for your 12 payments and more is 47% and for pending claim is 86%. Can you help us reconcile that with the 3.9% cure during the quarter? Is it just going to take years for the 53% to cure? Or how do you see that playing out?

Part of it is -- and we've gone through this in the past, part of it is going to be the cures, which are going to take a long time, obviously. We've talked about modification programs and situations where the borrowers will ultimately not be in a situation where there'll be a foreclosure on the claim. There are also situations where there are foreclosure that are not submitted to us as claims. There are also the documentation issues and the servicing issues that are very well-publicized that we believe will result in some of these claims not being claimed. So we do have some slides that we've begun to show you that depict the number of delinquent loans for which borrowers made payments but remain delinquent, that's a fairly significant level, the aging of the delinquent loans, there's a lot of evidence that leads us to conclude that many of these won't become claimed.

Okay. And then just a final question. Do you expect RMAI to receive approval from Freddie Mac to continue -- to be able to write insurance before December 2012? It seems like they're sort of leaving you to the last minute here. Do you expect anything to happen like what happened with MGIC where they sort of forced more money from the holdco to the guaranty business?

This is Teresa. We've started engaging in conversations with Freddie to extend the approvals for RMAI. And at this point, we don't see any reason why we wouldn't get those approvals. And I can't address the issue around whether or not there would be any additional requirements.

Keep in mind that we've shared with you our risk-to-capital projections for the year. So we don't anticipate the crossing the 25:1 risk-to-capital limit. And the fact that we believe we continue to have very strong relationships with the GSCs, as well as our regulators, which have been very helpful and instrumental in having us continue growing our business and continue to serve the housing market.

And next, we'll go to the line of Howard Amster with Ramat Securities.

I was wondering, do you have ability to recapture some of this reinsurance business? I remember reading that. Could you maybe elaborate?

We do, Howard. The existing transaction, the first transaction, we have the ability to recapture 2/3 of the business within -- after 3 years. The new agreement, of which we've just agreed to terms and is subject to Freddie Mac approval, we'll disclose the terms of that when the deal is finalized.

[Operator Instructions] And we'll next go to Bose George with KBW. Ryan O'Steen - Keefe, Bruyette, & Woods, Inc., Research Division: Actually, this is Ryan O'Steen on for Bose. Just one quick question on denials. For the servicer that accounts for the bulk of your denials, do you use the same 50% expectation of reinstatements for that servicer? And also, how have actual reinstatements for that 1 servicer trended versus your expectations?

The reinstatements for that servicer are within the history that we need to calculate the numbers. So, yes.

And to the presenters, we have no additional questions in queue.

Okay. Well, in that case, operator, I'd like to thank everybody for participating on this call and look forward to seeing you all for our next quarter and full-year earnings call. Thanks.

And again, ladies and gentlemen, we do appreciate your participation on the call. You may now disconnect.