Welcome to the Radian First Quarter 2020 Earnings Call. My name is Jenny, and I'll be your operator for today's call. [Operator instructions] I will now turn the call over to Senior Vice President of Investor Relations, John Damian. You may begin.

Thank you and welcome to Radian's first quarter 2020 conference call. Our press release which contains Radian's financial results for the quarter, was issued last evening and is posted to the investors section of our website at www.radian.biz. This press release includes certain non-GAAP measures which we -- will be discussed during today's call including adjusted pre-tax operating income, adjusted diluted net operating income per share, adjusted net operating return on equity and real estate adjusted EBITDA. A complete description of these measures and a reconciliation to GAAP may be found in press release exhibits F and G and on the investors section of our website. In addition, we have also presented a related non-GAAP measure, real estate adjusted EBITDA margin which we calculate by dividing real estate adjusted EBITDA by GAAP total revenue for the real estate segment. This morning, you will hear from Rick Thornberry, Radian's Chief Executive Officer; and Frank Hall, Chief Financial Officer. Also on hand for the Q&A portion of the call is Derek Brummer, President of Radian Mortgage. Due to the current environment, all of our speakers this morning are remote. I would ask that you please excuse any sound quality or technical issues that may arise during the call. 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 2019 Form 10-K as updated in our quarterly report on Form 10-Q for the first quarter of 2020 and subsequent reports filed with the SEC. These are also available on our website. Now, I would like to turn the call over to Rick.

Thank you John and good morning. Thank you all for joining us today and for your interest in Radian. I am pleased to share with you the results of an excellent quarter for our company. These results are testament to the strength of our business model and the power of One Radian unified team. While the focus of today's call is on the first quarter of 2020, we recognize the primary interest is on how the COVID-19 pandemic environment will impact our business going forward, and I plan to share our latest thoughts and insights. Our goal is to provide you with the best information we have available. Before I begin, I want to take a minute to thank our team for the incredible resilience and commitments they have demonstrated throughout this time. Our business continuity plans were in place, our technology infrastructure was ready and our employees migrated to a work-from-home model in mid-March seamlessly without missing a beat. During this unexpected and unprecedented environment, our team has continued to operate effectively at a very high level with minimal disruption to our businesses or the services we provide to our customers. I'm very proud of how our entire team at Radian has responded to the challenge. Let's start with our first-quarter results. I'm pleased to report another excellent quarter for our company with a focus on several key highlights. We reported net income of $140.5 million or $0.70 per share. Adjusted pre-tax operating income was $204.6 million, and an adjusted diluted net operating income per share was $0.80. Return on equity was 14.2% and adjusted net operating return on equity was 16.3%. For our mortgage segment, we wrote $16.7 billion of NIW in the first quarter which helped grow our primary insurance in force to $241.6 billion. For our…

Thank you Rick and good morning everyone. As Rick mentioned, our first-quarter 2020 results were excellent, and I am pleased to share more details on those results shortly. I will also touch on some of the potential risks to our future operating performance expected as a result of the COVID-19 pandemic at the end of my remarks, but it is important to note that our results for the first quarter were relatively unaffected by the impact of COVID-19. As a reminder, given that the GAAP accounting standard for mortgage insurance establishes reserves only after a borrower has missed two loan payments, the financial impact from expected delinquencies associated with COVID-19 forbearance programs are likely to occur beginning in the second quarter. So turning now to our first-quarter results. I would like to highlight changes to our reporting segments as reflected in our release. These segment reporting changes align with the recent changes in personnel reporting lines, management oversight and branding following the sale of Clayton in January of this year. Reflecting these changes, we now have two reportable segments: mortgage and real estate. Among other changes, the historical results for Clayton have been removed and are now included in a separate all-other category to aid in the analysis of trends for our two reportable segments. The segment information included in press release Exhibit E has been recast to this new structure for all periods presented. Additional background on these changes can also be found in our press release. To recap our financial results issued yesterday evening, we reported GAAP net income of $140.5 million or $0.70 per diluted share for the first quarter of 2020 as compared to $0.79 per diluted share in the fourth quarter of 2019 and $0.78 per diluted share in the first quarter of 2019. Adjusted…

Before we take your questions, I'd like to remind you of a few items. The first quarter of 2020 was a very strong quarter for the company. We believe that we are well positioned to weather this negative economic environment resulting from the COVID-19 pandemic with strong PMIERs capital and Radian Group available liquidity plus the unrecognized future value in our insurance portfolio. While the market has changed dramatically, and our team is working currently remotely, we believe we have the resources and capabilities to continue to deliver our broad array of products and services to our customers and come out of this environment in a strong position. I also want to note that while we are managing our business in the new normal, we are also focused on making sure that we support our communities through thoughtful and high-impact charitable contribution programs, both as a company and in support of our employees. Operator, we are ready to take questions.

[Operator instructions] Our first question comes from Mihir Bhatia from BoA.

Good morning and thanks for taking my questions. Hope everyone is staying safe and healthy. Just wanted to start with -- on the forbearance loans and default-to-claim rate assumptions. I understand it's probably too early to give specific numbers, but could you maybe just contrast the range that you see between maybe what you saw in the crisis on your prime loans and the crisis in terms of default-to-claim versus what you see coming out of a natural disaster? Just to help us frame what a reasonable range of outcomes can be on that default to claim.

This is Derek. In terms of the crisis, it's a little hard to use that as a proxy, one, given the fact that that was a housing-led downturn. Also, fundamental home prices were significantly overvalued at that point. Also, the underwriting quality, and credit quality was much worse. So on those defaults, they roll at a much higher level. I think that a better proxy is if you look at hurricane propensities to roll the claim after default, those were significantly lower. And if you look at kind of our experience with Harvey and Irma, you would see kind of a roll to claim rate more in that 2% range. So the question, I don't think you would use the financial crisis as probably a good proxy for a roll to claim. What you would look at is just a bit of a combination of I would say a natural disaster induce. So you would see that as a bit of a proxy for a roll to claim. But as part of this, you also have real economic stress. But it's important to keep in mind that that economic stress is on much better quality loans with better underwriting and also much more temporary in nature in terms of its dislocation from an economic perspective which would also push down the probability that those loans would ultimately roll to claim. So that's why, I think you'd look at more of a run-of-the-mill recession and also more kind of our disaster experience. And it's kind of a combination of those things that you use to get your ultimate I would say roll to claim rate.

Understood. No that's helpful. Thank you. And then just another question. I was curious, do you -- are there any statistics that you can share around just borrower level industry exposure that you may have? Just clearly certain segments of the industry -- of the economy are more impacted. So I'm just trying to -- as we think about recovery rates and how quickly the default to claim can come down just from your borrower business, if there is any.

Yes. It's a little hard to I would say give you a statistic. I think what we can see, and I think we see some of this in the data, those who are applying for unemployment in the initial wave are probably more skewed toward income segments that would be less represented in terms of the mortgage borrower universe and less representative in our portfolio. So that makes it somewhat difficult to use traditional measures like unemployment and translate that into a default rate because it's skewed a bit away from our portfolio. Same thing from an industry perspective. It's more concentrated in kind of the sectors such as restaurants, leisure, and so things like that also are going to be less represented. And that's important because the other thing we do is we take that into account in terms of our pricing. So as we think about our pricing adjustments, what we're doing from a geographic perspective is increasing pricing more on a relative basis in those deals, where they have more concentration in those sectors. So I would say, compared to probably history, I would say that the unemployment forbearance is probably -- it's kind of pushed away from I would say our segment more so than has historically been the case.

And this is Rick. I might just add one comment to Derek's comments which he alluded to which is really just trying to understand the split between renters and homeowners in that unemployment number. And given Derek's characteristic of kind of that group, we really are watching the rent roll rates as much as we are kind of forbearance because from all the statistics, we can see is this is hitting renters potentially pretty hard as well. So again, more information to come, and we all need more data. But I think it's something that we're watching very carefully as well.

That is helpful. Thank you. And then just last question before I'll jump back in queue. But I had a question on the disaster relief on the 70% or the 30% multiplier, if you will, the disaster relief capital charge discount. There's a line in your 10-Q about the GSEs potentially interpreting that less favorably. I was just curious, what do you mean by that? Because I guess my understanding, like when you look at the PMIERs, it's there. So what is up for interpretation on that? Thank you.

Yeah. I think that in terms of the risk factors, some of it has to do with just the application of the haircut going forward. So to get a little bit technical here. The way it works is you essentially identify the loans that are given that initial haircut. And you look at the event and you go 30 days before and 90 days after and you -- that's your population. The one question is how long that multiplier continues to apply? And if you look at the PMIERs, what you look at are FEMA-declared disaster areas that are subject -- or eligible for individual assistance. Now this is less significant a risk for us because at this point, about 90% of our risk is actually in FEMA-declared disaster areas eligible for individual assistance. And why that matters is, to the extent it's, in one of those areas, and it's under a forbearance plan, then you get that haircut of 70% for as long, as it continues in forbearance. So one question is what happens with that remaining 9% that's not in areas that are eligible for individual assistance. So I would say that is probably I would say the risk around that right now. And you have some technical aspects such as, in this case, as opposed to a hurricane that has a point in time where you can give a date for the event, this is more of a rolling natural disaster. So where do you kind of peg the event? Again, more kind of technical nuances I think in terms of the particulars within PMIERs is what we're talking about at this point.

Just to clarify it, so there's not -- there isn't a risk that they would say, hey, no, no, this 70%, this isn't what we meant when we said natural disaster. Like that would actually be -- they'd have to make a change to PMIERs to say that. Like so base case, it is safe to assume that it does apply because it's PMIER designated and...

Right. Yes, it's pretty clear in the language. These are declared disaster. It's very clear which ones are subject or eligible for individual assistance. So it would have to be a fundamental change with respect to how they're approaching the PMIERs for that change to be made. Understood. Thank you. I'll jump back in queue. Thank you.

Our next question comes from Bose George from KBW.

Good morning. Just wanted to follow up again on capital. It looks like this year with the forbearance, the discount multiplier, you guys are very well positioned obviously for a very high forbearance rates. Going -- sort of moving forward into next year, once these forbearances are over, if there is an organic recession where delinquencies are very high, there could be a need for capital again. So I'm just curious, how are you thinking about that? Are there thoughts to look at ways to potentially sort of have capital available if it's necessary in the future?

Sure. Thanks Bob. This is Frank. Yeah, I think when it comes to the capital planning associated with this -- with the environment that we're in right now, we're going to continue to be flexible, and we're going to continue to position our capital in a way where we can be nimble and address the situation as it evolves. And so that could be further utilization of reinsurance, of ILNs. When you look at our available resources just as they sit today from a PMIER standpoint, we have technically excess available resources of $2 billion which is roughly 68% cushion for us right now. So as this continues to develop, we'll respond accordingly and make sure that we are positioned well. But yes I think fortunately, as Derek just went through, the haircut certainly helps. And I think we'll just have to see, even from a governmental policy standpoint, how things continue to evolve. I think there is just a general appreciation for the fact that they would like to have people stay in their homes. And so if it's a foreclosure holiday or something like that that continues. That of course helps us out from an ultimate claim perspective, and so we'll just see how all of these things align and operate on a go-forward basis. But the range of possibilities that we're looking at is vast, and we just want to make sure that we can look as far forward with the best information that we have available and make sure that we're well positioned again to maintain the strength and flexibility that we've demonstrated over time.

That makes sense. Thanks. And then actually, going back to the comments you said you made about price increases. Can you give us an idea of the magnitude of the increases? And also just in terms of the ROE, is it essentially still targeting the same ROE but the higher prices just incorporate the higher risk now in terms of returns?

Yes. This is Derek. That's a good question. So that is the right way to think about it. So as we think about it from a pricing perspective, we're adjusting the pricing factoring in kind of the new economic environment and the expectation that we're going to have an increase certainly in delinquencies and we're going through a stress period. So our attempt is to adjust pricing to kind of get back to that targeted return. So as a result, we adjusted prices significantly across the board. And then in certain segments -- and you can think about this from a credit dimension perspective, you can think about it from a geographic dimension perspective, we increased pricing relatively more or less based upon that view of our risk to kind of get back to that expected return we're looking to generate. And what we found in the industry is based on the data we have, we think that our competitors have also increased pricing. I think some of our competitors have perhaps done it more targeted, a more targeted basis. Like I said, we've targeted certain segments, but we've instituted pricing across -- increases across the board, I would say. So we continue to monitor that because again trying to get a sense as to where the competitive dynamics are. And again, we're always looking for opportunities where we can find spots to maximize the economic value we're generating on that new business. That's why it's very useful to have our new pricing tool, RADAR Rates which is very dynamic, flexible. We can make those pricing changes on a targeted basis, makes it much easier to manage the portfolio and make kind of quick changes when economic conditions change.

And actually just significant, is that sort of over 20% or you don't want to -- not want to be as precise about what that means?

Yeah. I think generally, you've been seeing price changes I would say just industrywide, ranging I would say anywhere from 10% to 50% increases depending upon again very dependent upon kind of the credit sectors that people are trying to target. So I would say, significant double-digit price increases we've been seeing.

Next question comes from Mackenzie Aron from Zelman.

Thanks. Good morning. Following up on the pricing changes. Can you also give us some insight into the underwriting changes that you've made? And I know there have been some product restrictions, and any way to quantify what percent of volume that was done in 2019 may no longer be eligible?

Yeah I think from a credit overlay perspective, we stopped underwriting investor loans, cash out refis. Those were pretty small percentages. I think in aggregate, those have been running at definitely less than 1% of the overall portfolio. I would say a lot of the underwriting changes again is trying to balance this new environment where there's certain difficulties posed such as verifying employment, income, assets. So a lot of it's been kind of around that. So documentation requirements around that, shortening the length of time in which documents can need to be updated and things like that. The other thing is just additional diligence around the underwriting side. Again, this new environment, there are certain things, underwriting activities you might traditionally do, for instance, on the appraisal side that make it more difficult. So a lot of the changes have to do with making sure we're appropriately dealing with from a risk perspective. And I would say we're working closely on this with the GSEs in terms of working with them. I think we've seen some changes in terms of their automated underwriting systems as well. I would say, overall though in terms of the portion of business we were doing that's no longer eligible, I don't think it's significant. But I think in terms of just the underwriting processes and taking out some of the tail risk, that's where we've seen a movement. The other thing I would point out is just from an overall risk perspective and a risk layering perspective. And if you look at that that's a continuation of a trend we've really seen over the last I would say year and a half. If you look at the percentage of our business coming in with below 680 FICO, greater than 95 LTV, greater than 45 DTI, that significantly increased over the last year. And perhaps even more importantly, layered risk, where we have -- the combination of those factors have dramatically decreased. So I would say a continuation, also important, is a very good position to be in, in terms of the more recent books of business that might have benefited from less significant home price appreciation, has been really among the highest credit quality books of businesses that we've ever underwritten.

That's helpful. Thank you. And then switching gears. On the Real Estate services segment, can you talk about expectations around that business this year, given the lower transaction environment? And how we should be thinking about the contribution?

Thanks Mackenzie. Yes, happy to comment on it. I think we've hit the year running from a business point of view with the sale of Clayton, and really kind of refocusing our business around a core set of real estate assets, as we think of it, focused on growing our title valuation, asset management and just other real estate services, but really largely focused around real estate transactions. And I think we appointed Eric and Brien as the co-heads of that business or that segment and integrated across each of these four product groups, our sales and operations and technology and marketing teams. So we're as focused on, I would call it, in some of those groups, the monoline players that are either valuation-focused or title-focused. Our teams are focused on winning and developing kind of a disruptive position in their respective marketplaces. So we -- we're not really -- given some of the uncertainty in the marketplace, we're not at a point where we would provide guidance today. But I would say the momentum in those businesses is really very strong in light of some of the refinance activity, valuation title. We're seeing those businesses grow, right? And we would -- hopefully, as we get a little bit further in the year and we see this environment settle down, we can give a little clearer guidance. But the momentum is strong. The team has done a remarkable job. We -- so I like to say, we throw them all out of the office in mid-March and so go do growing levels of volume across our title and valuation businesses and do it in a very new setting, and they've done remarkably well. But I'd say we're seeing a great deal of receptivity from our MI clients. We're increasing the penetration of our MI clients across multiple products and growing the number of new clients. So today, we think narrowing the focus on the highest value elements, as I said, the past quarter after we sold the Clayton business, really focusing on the high-value opportunities where we think we can be a next-generation player in these markets that are very closely connected to our MI partnerships. So it's -- right now, I'm actually very pleased with the progress we're making and hope to have good news, continuing good news to report in the future quarters.

That's all. Thank you Rick.

Thank you.

Our next question comes from Jack Micenko from SIG.

Hi. Good morning everyone. Hey Frank, I wanted to go back to your initial comments around the 25% DQ rate in PMIERs compliance. On that, are you -- does that number, one, assume the initial asset factor on the three-month delinquency or do you run that all the way out to the one year? And then second, where was that $2 billion available, not -- I'm talking about -- you've got the 68% cushion when you layer in all the debt and everything else that's untapped. How does that factor into that calculation as well?

Sure Jack. The 25% number really is derived from an estimate at June 30. So if you think about where we stand right now with the delinquencies associated with forbearance programs, by June 30, they're only in that missed two to three payment bucket, so -- for the most part. So that's probably the largest assumption in the calculation of that number. And so that's what we're contemplating there. And then so the resources that we're attributing to the absorption of that number would be the full resources which are shown on Slide 19, the estimated resources at June 30 as well. So it's important to remember that the June 30 number projected which would include the PMIERs cushion at the opco expected holding company available resources and the credit facility.

And then, Rick, I think you -- the $60 billion number, can you talk to us about what you're seeing in April on a volume basis, maybe either year over year or split between purchase and refi? Obviously, refi, it's going to be a much, much bigger number than what people thought three, four months ago to kind of give you that confidence into the $60 billion full-year number.

Yeah. Jack, thank you. We feel very good about the greater than -- I think we said more than $60 billion which is -- as we sit here today, seeing, as I mentioned in my script, a very strong new commitment pipeline. Obviously, refinances are playing a bigger role in the marketplace. And as you can see, just from purchases pulling back as listings are pulled out, we may see that bounce back through the year. But right now, we're assuming that there's going to be a growing percent of refinances and a reduced percentage of purchase loans in the overall market. So today, we are seeing increased activity across refinances. We have a strong committed pipeline. Part of the question, and I -- as we think about it, is what does the second half of the year look like? How does it develop? Does -- what happens as the government starts to have to fund all the stimulus? What happens to interest rates? What happens to the purchase market. So I think we're taking a kind of a cautious view of the future, if you will, in thinking through how it will evolve. And I would say, today, based upon what we see, we feel very comfortable about the more than $60 billion. And hopefully, at the second -- at the end of the second quarter, Derek, and I can give you a better view of how the year is shaping up and -- but we think it's a little too early to have a view of the second half of the year.

Got it. Hey Frank, just real quick, one more, if I could sneak one in on expenses and run rate. You had some volatility in the expense line. It came in better this quarter, and I think there were some incentive and some one-timers. But as we go into this and everybody sort of activates their transition plan, there's some tech spend that probably goes up, but then there's some offset. The sales force is now entertaining and that sort of a thing. How do we think about expense run rate through the balance of the year on a quarterly basis?

Sure. So Jack, last quarter, we were sort of calibrating to a $70 million quarterly number after the sale of Clayton. I would tell you, it's probably too soon to tell what the -- what I'd call them the permanent impacts associated with the change in the landscape. So to the extent life does get back to normal, whatever that is, I would say that number is probably a good number to go with. But it really is just too early to tell right now and make any type of permanent adjustments.

Okay. Fair enough. Thanks guys. Good luck.

Thank you.

Our next question comes from Mark DeVries from Barclays.

Yeah. Thanks. Just a follow-up question on the 25% default assumption. Frank, do you have a sense for how high the default rate can go without you having to distribute any of the excess resources at the holding company down to Radian Guaranty? Is it as simple as -- since it sounds like that's about half of the available excess assets, that it would be somewhere like a 12% to 15% range?

Yeah. That actually is a good estimate for what that range is.

And should we assume that you're just going to be hoarding cash at the holding company until you get a sense that those kind of defaults have peaked out?

Mark, what I would describe, our approach has historically been, is making sure that we have positioned our cash throughout our legal entities in a way to preserve maximum flexibility. So we're certainly going to be mindful of the requirements for the operating company, and we'll be responsive as we need to be there. But we're going to make sure -- again, we do have maximum flexibility at the holding company, but we are sensitive to that PMIERs cushion at the opco as well. So we'll see how that plays out over time as far as how that may get rebalanced in the context of new information and what the second-quarter starts to shape up and look like. But that's generally how we have managed our resources just throughout the organization.

And Mark, this is Rick. I might just add to Frank's comments. One, as we released our 10-Q last night, we did get -- provide great detail on the risk factors about kind of our views around the capital situation. So you can -- we have a chance, go back and take a peek at those. But I think the other part I would say is that we've intentionally held capital at holdco to remain from a capital planning point of view and to remain from -- have a financial flexibility, maybe different than others. And so we've always thought of capital at the holdco as being flexible, and obviously, through this type of environment. So how things develop, we'll kind of drive our actions as we go forward. So we're -- we do look at capital on a consolidated basis and think through it at that level continuously.

Got it. And my next question maybe for Derek. Are you able to discuss for us -- when you price in this environment to mid teens return, what you guys are assuming in terms of kind of -- as rate? And should we expect that that would be lower than you would expect to see on your existing book?

I'm sorry, you cut out slightly there. Are we assuming what would be lower?

The ultimate default rate in claims rate on new insurance that you'll be writing today would be lower than what you expect to see on your existing book.

Yeah. So the way to look at it, when we're kind of resetting price, so when we're writing the new business now, we're actually assuming in this scenario that you would have a bit higher default rate. So the way to think about it, when we're setting pricing, we're doing it on a simulation basis. Right? So we're looking at multiple scenarios. But as the economy -- and this is an unusual situation where we kind of have telegraphed in front of us a recession. So in that case, when you kind of think about the let's say expected or mean path in our simulation, that got relatively worse. So that's going to translate naturally into assumptions that you're going to have higher claim rates. And so you're adjusting pricing to essentially account for that. In addition, having just higher claim rates, you're also assuming you're going to have just an increase in default rates which also factors in, in increasing the amount of capital we have to hold against it. So you basically use those as inputs. And then your output, you basically kind of solve for an appropriate price to get back to that return that you're looking for.

Understood. And then any color you can provide on kind of what you would assume today on kind of those default rates and claim rates?

Yeah. I'm probably not going to go into a lot of details and the particular assumptions. They're also very dynamic. I think the other thing to keep in mind, we're still early on in this. So we're still gathering a lot of information, particularly as we have the May payment dates coming up. So I would say we're constantly calibrating that and our pricing. So we do that regularly. So kind of give you my base case, that's going to be I would say stale very quickly. And that's the best way to think about it when we dynamically price, we're constantly adjusting that. And it's -- we're adjusting it. Obviously, there's more volatility around those adjustments in terms of our scenarios, just given kind of the nature of where we are because they've been unprecedented. It's not your run-of-the-mill recession. So trying to figure out again we talked about this earlier. The unemployment rate, our modeling takes into account as big explanatory variables obviously home price paths, unemployment. But even interpreting kind of those unemployment paths, where it's much bigger percentage that are fine for unemployment on a temporary basis. So how quickly that snaps back is going to be important variable. And I would say we're constantly tweaking and updating our assumptions around that as well and then how that actually affects home prices as well. Again, from a fundamental perspective, we think home prices again, coming into this, fundamentally were fairly valued, the supply demand dynamics were very good. We didn't have a lot of speculative excess. So we think that to the extent that there's kind of pressure on home prices, we don't see a significant kind of drop in our base case scenarios. But again, at the margins, we're constantly adjusting that.

I think, Mark, I would add that Derek and team have done an amazing job with RADAR Rates of being able to take that -- those analytics real-time into our pricing very, very quickly which if you go back a year or so, two years ago, this industry would have labored over making pricing changes. Now we can make them really very, very quickly and reflect the risk environment almost at the time it's occurring. So what Derek's referring to gets applied real time in the marketplace, so.

Great. Appreciate all the color.

And our next question comes from Geoffrey Dunn from Dowling & Partners.

Thanks. Good morning.

Good morning.

Derek, I think you said earlier on, maybe one way to think about this is kind of a combination of hurricane considerations and a run-of-the-mill recession, so something like a Moody's S3? Did I catch that correctly?

I think that is the right way to think about it. And it's hard to I think bifurcate kind of those type of defaults, right? So you kind of have to think about it in total. But that's right. And the way we kind of see this playing out, at least the way I think of it, is in the short term, it's probably more of a disaster, especially kind of some of those early forbearances. And in a typical disaster, what happens is you have businesses turn off and they turn back on. This might be more elongated compared to kind of a hurricane disaster. So we think that's probably -- that's a very big force within it. But again, just because of the fact that not all businesses are going to turn on and not all jobs are going to turn back on as you might see in a natural disaster, they are going to have kind of that I would say more of a typical recessionary impact as well. The one thing though I would also keep in mind is the unprecedented government support because in a typical run-of-mill recession like an S3, you don't have things like expanded unemployment benefits in terms of those who are eligible, expanded unemployment benefits, checks being mailed out to people, PPP loans. So trying to factor that in. So even if you think about it as a run-of-the-mill recession, I think you also need to think about the government support which is going to end up putting downward pressure, not to mention the fact that if you look at these loss mitigation workout options that the GSEs are putting in place, I think the most likely scenario for borrowers who find themselves in real difficulty being able to make up payments that they've missed because of forbearance, the most likely scenarios that they can't make those, those are put on at the end of the mortgage. So especially in a situation like this where it's recognized that it's really driven by kind of health issues and policy decisions, there's a real effort to keep people in their homes which is important for us since we don't pay claims until it actually goes through the foreclosure process. So that's why it's like a combination of things, natural disaster, run-of-the-mill recession. But a run-of-the-mill recession that has a very significant government intervention that you -- probably on scales that you've never seen.

So what I wanted to get at is in the majority of the scenarios that Radian is running, do ILNs attach? They're typically -- I mean, just a couple of years ago, I think the normalized loss assumption in pricing was two, two and a half percent cumulative. I would just call it on average, ILNs attaching at two and a half. So given your thought process on this and the various scenarios you're running, in the majority of the cases, are you even attaching on ILNs?

Our expectation in most cases is we are not attaching on the ILNs. So -- and I think you have some common scenarios out there and just to help since people use it as a frame of reference, for instance, if you're running a Moody's S3, you're not going to see an attachment, Moody's S4, we do see some of the ILNs attach and some not attach, right? And that's going to matter obviously the newer ILNs because we are fortunate and issued one that covered our 2019, the first three quarters. In a scenario like that in S3, you would -- you could see that attach in potentially a scenario like that. But generally I would say no, those aren't attaching. Those are providing tail coverage. And in this scenario, we're seeing kind of it outside of kind of most reasonable scenarios.

So on a life-of-book basis, while near-term could be painful, if you're not attaching ILNs, you're not exceeding maybe two and a half cumulative, it doesn't sound like your targeted returns are likely all that disrupted. Is that the right conclusion?

Again, I would say that there's a lot of uncertainty around it in terms of that economic path. But I do think the way to think about it is kind of making a distinction which Frank talked a bit about which is kind of a short term I would say PMIERs capital increase issue we have because as you have these delinquencies, you have to stack increased capital because PMIERs is quite pro cyclical in that sense. But if you think about it over the long term and the probability that those go delinquent in curing, and again, that natural disaster kind of scenario I talked about, you do see kind of this I would say front-loaded increase in delinquencies. So you have an increase in PMIERs capital, and then you have incurred losses, but then that should be pretty front-loaded. And over the long term again I think that depending on the scenarios, that's why I think we feel pretty comfortable from an ultimate claim perspective and how this plays out over the long term. But again, I would just caution, there's obviously a lot of uncertainty around that because it's based upon the information we have at this point in time, and it's going to be heavily dependent upon what happens, not only from an economic perspective, but what's happening from a health perspective and how quickly states get back up online and how long they stay online.

Thanks. And then just a quick follow-up. I think the sense was at the end of last year that the penetration rate on refis was higher than we had been seeing previously as the speed of somebody originating and then refi was getting shorter. Is your sense that the refi activity we're seeing in 2020 is still seeing those more elevated refi penetration levels?

Yeah. I think that's safe to say because I think it's the same dynamic that we've talked about before, right? It's because again rates -- and as they continue to go lower, you're seeing some of those books of business that have -- recent books of business that have a significant refi incentive. So for instance, when we look at our books like the 2018 vintage, if you look at that, depending upon your assumption, whether it's 75 or 100 basis points of kind of benefit you need. The majority of that has that incentive. So yes, I think that phenomenon we talked about before continues, and it will continue, especially as you see these new historical low interest rates.

And our next question comes from Chris Gamaitoni from Compass Point.

Thanks for taking my call. I'm not sure if this is for Derek or Frank. Typically, in a normal downturn, your delinquencies occur slowly and increase over time. And at least historically, provisions have been very dependent on the age or the amount of payments that they've missed. This cycle, it seems like we're going to get a whole lot of delinquencies very quickly. I guess my question is, the way you're thinking about it is if we assumed 100% of delinquency of forbearances come in the second quarter, are you trying to book the lifetime reserve there or is there still some aging concept of delinquency in future periods?

Yeah. This is Frank. It's a great question. And that was part of what I was trying to address in the prepared remarks. The first part of that question about the timing of delinquencies, we're saying that it's likely to occur over the next couple of quarters. And it may take some time for borrowers to miss that second payment, so not sure on the timing of that. And the other factor -- and Derek touched on this as well which is the forbearance numbers themselves can be a little misleading potentially in that. You can participate in a forbearance program but still be current on your payment. So that's something else to keep in mind. But at the time of that second missed payment, yes, we do need to make an estimate of what the ultimate claim rate will be on those new defaults, so. And Derek spoke to that early in the presentation about just the -- as far as what that might look like. And given our experience with natural disasters, etc., we're not expecting a rate higher than our current default-to-claim rate on the default of seven and a half percent. But we'll have to wait and see what available information we have at the point in time when we do make those estimates which will likely see a fairly significant ramp-up in the second quarter. I don't know, Derek, if you'd add anything else.

No. I think you covered it, Frank.

This is Rick. I might just add one other comment which is I think, just you have to think about right now where we're at. We're very, very early in the cycle. And as Frank commented, there are people that are continuing to make their payment while they're in forbearance. We saw it on April 1. We'll see what May 1 and what June 1 do. So the timing of all this is still early, and -- but the interesting part is Frank covered the GAAP accounting is, as they present themselves, we reserve, right? And it's -- we don't have material IBNRs. So we -- really, those defaults have to present themselves and kind of qualify for our reserves from a GAAP accounting point of view. So the timing of this is still early to project. We would expect to see a dramatic increase in the second quarter, just from the numbers obviously but how that period extends and how it plays out. Still early, guys. But we're watching all the metrics in the numbers.

Sure. I'm not asking you for your expectation of even what DTC is or how many forbearances, I'm just talking about the accounting. So my point is once a loan becomes delinquent and forbearant, would there be an additional reserve as those delinquencies age? Meaning once you're in forbearance and you missed two payments -- they have up to six months, and I think it's an automatic extension up to 12 months. As those get older, would you assume that the ultimate default-to-claim rate on those specific loans changes or because they're in a forbearance program, stays the same as they get older until they -- until you see whether they cure or not?

Sure. So a couple of technical requirements on what you said. Whether or not they're in a forbearance program doesn't impact the missed payments and the requirement under GAAP to establish the estimate of ultimate loss. So -- but participating in a forbearance program and having missed two payments will impact our expectation of what the ultimate loss will be. And so that is a factor that comes into play. Now the longer it stays delinquent, we're going to evaluate -- are they still participating in a forbearance plan? What are the facts and circumstances around those delinquencies? What's the profile? What's the overall economic landscape, etc.? So it gets updated in each subsequent period, and we'll make those adjustments in each period based on the information at that time. But I think maybe what you're looking for unlike PMIERs which has a very prescriptive accurateness, it's fourth payment. It now steps up for something else. Our reserving is not as prescriptive, and it is based upon all available facts and circumstances at the time. And so we may adjust up or adjust down what we expect the ultimate loss may be, but that happens in each period. I hope that's helpful.

Frank, I was just going to add. Just to be clear, I think in answer to your -- the way to think about it, as the loans progress, we would kind of assign a higher default-to-claim rate for those that remain in default. Because the way to think about it, you set kind of initial percentage, and then a portion of them, they cure. The remaining ones, then you increase your default-to-claim rate as they age through time. That's the way to think of it.

Yes, that's the story.

If we -- if we got a right upfront, then that all works its way through as these things age, right? And we wouldn't necessarily have a plus or minus to reserve. Obviously, there's never that degree of perfection. But we start with an estimate and then we continue to refine it as we see what cures and what continues.

Sure. The question just because this is so unique as there's an incentive, but there's no call on someone to cure until six months. So whether there are three or four payments delinquent, if they can defer on the end, it's just a different economic incentive for a person that there typically is in the situation. It's why I am so curious as to how they kind of work.

That's a very interesting point, and we're watching the behavioral aspects of this very, very closely because, like we said, people are going in forbearance plans and still making payments. You've got to watch the industry statistics because they're a little bit confusing. But as we get through May, we'll have a much better feel. But I think the social aspect of this and how -- because ultimately, there's no -- this is not a payment forgiveness. This is a payment deferral. And how it comes back around -- and you guys have read all the same articles, does it have to be paid back at the end of forbearance? Can it be deferred? And all the different waterfall workout options. Which are still -- are well-defined today, but I think still evolving as to where they might be. The behavior of people that want -- don't want to get behind or have forbearance kind of as part of the future, I think you're going to start to see some of that separate. But again, we don't know. It's so early. And how people take advantage of this program over a month or two, six months, 12 months, still to be determined.

All right. Well thank you so much and thank you for dealing with my annoying mortgage accounting of questions. I appreciate it.

Well, they're very good questions. Thank you.

And we will take our final question from Phil Stefano from Deutsche Bank.

Yeah. I guess you guys have been on the call for so long. Hopefully, just a couple of far less nuanced questions than Chris before me. So Rick, in your prepared remarks, you talked about the post the sale of Clayton on the real estate side, the expectation to grow certain businesses such as title. Is that organic growth, inorganic growth or a mix of both? Strategically, over the long run, understanding the short run is much, much less clear, how should we think about what growth means?

Growth, we think of it as organic growth. Just -- we feel like we -- you think about the title business which many of you all know very well. It's an old legacy business driven by agency relationships. We're very, very focused on leveraging data and analytics and technology to drive our title business and leverage our MI relationships and our other market relationships to grow. So Brian and Eric and our sales team and operations team have been very focused on onboarding new clients, right? So we're growing that business through the addition of new clients and the expansion of existing relationships. And we have our sales force, our kind of -- our entire sales force focused on at an enterprise level, looking at how we deepen relationships and expand relationships with our clients. Title and valuation are naturals right now. We may see our REO kind of asset management business come back, given the cycle. SFR, where we have a dominant market share in that business. From a diligence perspective, we're -- I think we have a strong foothold. And we see broader opportunities across technology and real estate services. So where we sit today, it's organic, and we are head down, focused on our customers. And the feedback I personally get, and I share this often, feedback I personally get, Derek gets, Frank gets, we all get from our customers is they view us differently than just an MI. Does it make a difference on the MI decision? In some cases, yes, in some cases, it's neutral. But from a relationship point of view, it can make the MI relationship, combined with it will serve them in a broader way. I think it provides us opportunity to grow our businesses organically.

And Derek, in response to an earlier question, I got the impression -- and please correct me if I misheard you, but it felt like 9% of the business was outside of the potential haircut for the FEMA disaster area. What exactly is that 9%, if I understood that correctly? What -- in my mind, forbearance was kind of widespread in every state of the FEMA disaster area. So what falls out?

Yes. So what I was distinguishing, so 100% actually in those areas are given the haircut day 1. So what I was getting into is, as you progress through time, so the distinction being is once you're kind of beyond this initial 120 days under PMIERs after the initial date, the way it's drafted in order to continue to get that haircut, you have to be subject to a forbearance plan. And you have to be in a state or an area that's eligible for individual assistance. And right now, right, so that's all I meant. And that's kind of -- when we talked about that PMIERs amendment, that's one of the kind of those open points. I would say PMIERs didn't really contemplate this. It really should be 100% of all those kind of forbearance loans. So more of a kind of a technicality I think in the PMIERs that we're trying to address.

No. Perfect. That makes sense. Thanks for the clarification there and hope you guys continue to be well.

Thank you.

And I will turn it over to CEO, Rick Thornberry, for final remarks.

Thank you. And I want to thank everyone for participating in our first time ever virtual call. Derek, Frank and John and I are all sitting in very different places in this country right now. And our team pulled off I think a very successful kind of environment. I also want to -- I want to wish you all and your families, I hope everyone is staying healthy and stays well given these challenging times. And I want to compliment our employees on just a phenomenal job. As I mentioned earlier, we asked everybody to leave their offices very quickly and go work from home. Everything was ready. They've done an amazing job, our customers have commented often about it. So I think with that, we look forward to continuing to have discussions as this environment plays out, and we look forward to talking to you all soon. Thank you for joining the call today, and stay well.

Thank you ladies and gentlemen, this concludes today’s conference. Thank you for participating. You may now disconnect.