Radian Group Inc.
Q4 2013 Earnings Call Transcript

Published: 5 Feb 2014

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to Radian's Fourth Quarter 2013 Earnings Call. [Operator Instructions] And as a reminder, today's conference call is being recorded. I would now like to turn the conference over to Emily Riley, Senior Vice President of Investor Relations and Corporate Communications. Please go ahead.

[Emily Riley:]

Thank you, and welcome to Radian's fourth quarter 2013 conference call. Our press release, which contains Radian's financial results for the quarter, was issued earlier today and is posted to the Investors section of our website at www.radian.biz. This press release includes non-GAAP measures that will be discussed during today's call. The complete description of these measures and the reconciliation to GAAP may be found in press release Exhibit O and on the Investors section of our website. 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; and Derek Brummer, Executive Vice President and Chief Risk Officer of Radian Group. 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 2012 Form 10-K, as well as subsequent quarterly and other 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.

[Sanford A. Ibrahim:]

Thank you, Emily. Thank you, all, for joining us and for your interest in Radian. This morning, I will discuss our fourth quarter and full year financial results and review our major accomplishments for 2013. Following my remarks, Bob will cover the details of our financial position. Achieving MI operating profitability in 2013, particularly after the challenging business environment we've navigated through in the recent years, has to be our most important accomplishment last year as Radian moves closer to normalized earnings. This was the result of both the improvement in the quality and size of our MI insurance in force, as well as the significant reductions in our legacy MI exposure. Let me first address the improvement in both of these areas. Radian's large, high-quality MI portfolio is expected to create a strong foundation for future earnings, especially when combined with increasing persistency primarily in business written in 2012 and '13. We expect improved operating profitability in 2014 driven by the MI premium generated from the high-quality and profitable new business we wrote since 2008. Today, this business represents 71% of our total primary mortgage insurance risk in force or 60% excluding HARP volume. The combined impact of an improving economy and our continued focus on loss mitigation in our MI portfolio has resulted in year-over-year decline in Radian's total number of primary delinquent loans of 35%, as seen on Slide 14 of our webcast presentation, with the trend continuing in January 2014. We also saw a decline in our primary default rate in 2013, as you can see on Slide 21, and we ended the year at a rate of 7.3%. The performance of our remaining legacy book has also improved significantly, which will further contribute to our future results. Turning to the quarter's results. Earlier today, we reported net income for the fourth quarter of 2013 of $36 million, or $0.19 per diluted share, including $31 million of combined fair value and other financial instrument gains and net losses on investments. This compares favorably to a net loss for the quarter ended December 31, 2012, of $177 million or $1.34 per diluted share. Book value per share at December 31, 2013, was $5.43. In our press release this morning, we introduced new non-GAAP measures that we believe will help you better evaluate Radian's financial performance. Bob will discuss these measures in more detail and you will find the full description and reconciliations in our press release Exhibit O, as well as on our website. Using these measures, adjusted pretax operating income was $9.1 million for the fourth quarter, including $1.7 million from the MI segment, and adjusted net operating income per diluted share was $0.03. Now let's turn to a few important highlights from the fourth quarter and the full year 2013. First, in 2013, we continued to write a high volume of new mortgage insurance business in this extremely attractive market. While the fourth quarter and the beginning of 2014 have been impacted by the decline in refinance activity, as well as the effect of a return to more normal seasonal patterns, the volume of new business written in the second half of 2013 still was one of the highest in our company's history. And while it remains difficult to project future NIW, we anticipate that Radian will write more than $40 billion of new business in 2014. I'm also pleased to report that we ended 2013 ranking as the largest mortgage insurance company with $161 billion of insurance in force. Second, this high volume of new business written improved the credit profile of our portfolio. As I mentioned, the high-quality books of mortgage insurance business written after 2008, including loans competing a HARP refinance, represented 71% of our primary mortgage insurance portfolio at the end of 2013. And the most problematic 2006 and '07 books are now down to less than 14% of the total portfolio. As you can see on Slide 8, the impact of the legacy MI portfolio is shrinking, and we expect it to be a less important driver of our future financial results. Third, Slide 9 shows that for the year ended December 31, 2013, the earned premiums less incurred losses from our 2009 and later MI vintages of $337 million far exceeded the comparable negative sum from the 2008 and prior vintages. In fact, this amount was nearly equal to the $345 million in 2011 and '12 combined. It is also important to note that the highest premium level for any vintage is typically earned in its second year. Therefore, we expect our large 2013 book to produce substantial premiums in 2014 and beyond. Fourth, the MI incurred loss ratio was 72% in the quarter, representing another positive trend we saw toward 2013. This compares to a loss ratio of 171% in the fourth quarter of 2012. And finally, we successfully reduced the exposure in our Financial Guaranty business by 29% in 2013 alone and by 79% since 2008, including in many of the riskiest segments of our portfolio. Radian maintains strong holding company liquidity of approximately $615 million, and Radian Guaranty's risk-to-capital ratio was 19.4

[C. Robert Quint:]

Thanks, S.A. I'll be updating you on our P&L activity and trends for the fourth quarter of 2013; our capital and liquidity positions as of year end; and some updated expectations regarding 2014. We've introduced non-GAAP measures to our disclosures this quarter to more closely align with the way we currently evaluate our business performance. For our 2 business segments, we show adjusted pretax operating income and on a consolidated basis, we show adjusted net operating income and adjusted diluted net operating income per share. The complete description of these measures and the reconciliation to GAAP is presented in Exhibit O of our earnings release, which is also posted to our website. Our calculation essentially eliminates all gains and losses on investments and derivatives, which are contained on 4 separate lines in our income statement, and adds back the operating components of the fair value line, which are our premiums earned on Financial Guaranty derivative contracts and the change in the present value of losses expected to be paid on derivative contracts, which is akin to losses incurred. Please note that our EPS calculation for the fourth quarter includes the dilutive impact of our 2019 convertible debt, which adds 37.7 million shares to our share count and adds back $3.5 million of aftertax interest expense to income for EPS calculation purposes. In subsequent quarters, if our stock price exceeds $14.11, there would be potential additional EPS dilution related to our 2017 convertible debt, with the estimated calculation as follows

[Sanford A. Ibrahim:]

Thank you, Bob. Let me summarize 3 important takeaways for 2013. First, we achieved operating profitability in our Mortgage Insurance business and expect improved levels of operating profitability in 2014. Second, we wrote 27% more new MI business in 2013 than 2012, and grew insurance in force by 15% to an industry-leading $161 billion. The future benefits from which will be further enhanced by increased persistency. In January 2014, we wrote $2.4 billion in NIW. Third, our Financial Guaranty business serves as an important source of capital for Radian Guaranty. We have successfully reduced our Financial Guaranty exposure from a peak of $115 billion in June 2008 when Radian Asset stopped writing new business to $24 billion at the end of 2013. Over the same time period, statutory surplus increased from approximately $950 million to $1.2 billion. Radian Asset had additional claims-paying resources of $400 million, including $264 million of contingency reserves as of December 31, 2013. As we look ahead to 2014, our top priority is to continue to leverage our ability to expand our franchise and build on our accomplishments of 2013, as well as opportunities for new MI business from the FHA pullback in order to drive Radian's future earnings. Now I'd like to open the call to your questions. Operator?

[Operator:]

[Operator Instructions] And we'll go to the line of Jack Micenko with SIG.

[Jack Micenko:]

I wanted to look, first, at the claim rate assumptions. Obviously, peers have moved that number down. Your credit quality continues to get better. I think 63% of your defaults this quarter were defaulters 3 or more times. When can we think about that number moving down? Is it a 2014 event? Is it -- any color you can give there will be helpful.

[C. Robert Quint:]

Jack, I think we're -- when we see defaults coming from the newer vintages, I think our roll rates on those vintages will likely be lower. The existing defaults are still from the older vintages. So we really haven't changed our roll rate assumptions in quite some time. And although we're seeing the same signs that everyone else is in terms of the improvements, that really hasn't manifested itself in our roll rates because so many of our delinquencies are still older delinquencies at this point.

[Jack Micenko:]

Okay. And then looking on Page 19 at the denial reinstatement, Bob, we had spoken, I know, a few times about sort of the time frame of reinstatements kind of falling off in the back half of '13. It appears to have fallen off pretty steeply. Is that a more normal reinstatement percentage now we should think about going forward? You've come down from the 60s to the 40s, and now you're sort of at 15%. I mean, how do we think about that percentage going forward?

[C. Robert Quint:]

Yes, I mean, that's really artificial because that's only been outstanding for 1 quarter. So we would expect 60% or approximately 60% to be the accurate number. We've seen a number of quarters settle in at that level, and we would expect the last 2 quarters on this chart on 19 to eventually be in that same range.

[Jack Micenko:]

Okay. And then just real quick, do you have an indication if the states have yet received the draft proposal from the FHFA?

[Teresa A. Bryce Bazemore:]

At least as of a couple of weeks ago, they had not yet received it. Our understanding was that they had received kind of an agreement from the FHA regarding, I guess, the confidentiality around that proposal and they were starting to look at that. We haven't heard anything. That's an update from that point.

[Operator:]

Next we'll go to the line of Bose George from KBW.

[Bose T. George:]

Just given your comments about the capital that you expect to meet, the capital standards within the timeline for compliance, is it fair to say, a, that you're not considering any quota share agreements, but also, b, that with your discussions with FHFA, the capital -- the subsidiary capital levels you field will be within the framework that's set out?

[C. Robert Quint:]

Bose, we really don't know what they'll look like. I think our statement is strong in terms of our confidence in being able to comply for a variety of reasons. We have a lot of options available to us if necessary. We have our holding company cash, which is obviously available; the reinsurance market, which we've all seen examples of reinsurance transactions done in the MI space to help the capital levels. That's certainly an option. The implementation period is a big deal because as we start to earn money and generate internal capital, that could go a long way. We really don't know if there will be a haircut and, if there is one, what the size will be. Nonetheless, I think in any of the potential scenarios, we're confident in our ability to comply.

[Sanford A. Ibrahim:]

The other thing to keep in mind, Bose, is that with our improving business trends, there are even more alternatives available to us, so it puts us in a stronger position going forward.

[Bose T. George:]

Okay, great, makes sense. And then actually just switching to the premium this quarter, was there much of a change in the average premium in the fourth quarter versus the third quarter?

[C. Robert Quint:]

Not really. Sometimes, the -- if you calculate the quarter's average earned premium rate, it could be impacted by things like rescission changes that impact the accrual for premium refunds. So we've seen certain quarters that premiums earned are much higher because we've taken our rescission rate estimates down. And this quarter, there was a little bit less of that impact. So I would say look at the earned premium rate over a longer time period. There was a reduction of 5 basis points, which will start bleeding into the results over time, but you're not going to see that dramatically in any.

[Bose T. George:]

Okay, great. And then just on the Financial Guaranty segment, you guys took a reserve release. I was just curious if there's anything we can read into that in terms of what happens there going forward.

[Derek Brummer:]

This is Derek. The reserve releases really had to do with several credits where we reduced reserves, for instance, on Jefferson County. In light of the settlement, we've reduced reserves there. And then for the most part, we didn't see a lot of negative reserve development in the fourth quarter.

[Operator:]

Next we'll go to the line of Mark DeVries with Barclays.

[Mark C. DeVries:]

So are you seeing any signs that originators are starting to reduce overlays? As they're put back, risk abates. And if so, could you discuss any implications for outlook for your business?

[Teresa A. Bryce Bazemore:]

This is Teresa. I think we're just starting to see a bit of that. Lenders are still a bit concerned about that. And I think also with the advent of the QM, a lot of them have been focused on putting those changes in place. But they would indicate, at least initially, they haven't seen a big change in the amount of business that they're doing as a result of that. So I think as people get more comfortable with settling in, in terms of the new sort of compliance requirement, we may see some more of that, but I think it's too early.

[Mark C. DeVries:]

Okay, great. Have there been any changes to the business that you're doing with builders, which seem to be doing a lot more higher LTV, 95%-plus transactions in their sales?

[Teresa A. Bryce Bazemore:]

I mean, we've had some good relationships with builders and their mortgage companies for quite some time. So I think there's some lift, as you can see in the numbers for the building industry. They're starting to bring on more units, and they're expected to bring on more units. So we think that's going to be a growing segment of the purchase market, but we have been very focused on continuing to have strong relationships in that segment.

[Mark C. DeVries:]

Okay. But have there been any changes to the amount of risk you're willing to take from them or moving up a little bit into the higher LTVs?

[Teresa A. Bryce Bazemore:]

I mean, we're already at the high LTV, so I think we don't see that there is a need for that. And we certainly haven't yet gotten any indication from them that there is a need for that in order to support them.

[Mark C. DeVries:]

Okay. And then, finally, any updates you can provide on thoughts around risk of any kind of claims from your Puerto Rico exposure?

[Derek Brummer:]

Yes, this is Derek. In terms of risk of claims, I mean, we've been watching the situation closely. Generally, our view is the risk has been heightened recently, and that's been driven more by questions as to their market access and whether they can fund themselves at a reasonable cost. In terms of the fundamentals on Puerto Rico, they seem to be taking the right actions in terms of kind of their fiscal situation. The question is whether they're going to have enough time to let that play out. So one of the things we're watching closely is just their ability to fund themselves and what the rates are going to be when they try to fund themselves in the next couple of months. So again, we're watching that closely, and we think the risk is marginally increasing.

[Mark C. DeVries:]

Okay. And is that exposure still in the $450 million range?

[Derek Brummer:]

It is. It's $452 million as of 12/31.

[Operator:]

And next we'll go to the line of Geoffrey Dunn with Dowling & Partners.

[Geoffrey M. Dunn:]

Bob, first, I just wanted to clarify your expense guidance. When you say 10% to 15% improvement off of this quarter, what's the starting rate? Are you excluding the performance base comp?

[C. Robert Quint:]

No, I'm just taking the numbers.

[Geoffrey M. Dunn:]

So if we held that static, you're thinking 10% to 15% improvement?

[C. Robert Quint:]

Yes. And, of course, Geoff, we don't contemplate further stock price changes. So that would be incremental benefit or it could go either way, but we don't typically forecast that.

[Geoffrey M. Dunn:]

And then second, I appreciate the comments about new business opportunities, but this quarter, it looks like -- and we don't know the denominator yet, but it looks like your share eroded further in the quarter. Was that mostly just the single premium business coming down or was there any kind of notable shift in your client base that might have helped that number?

[Teresa A. Bryce Bazemore:]

Yes, I think, Geoff, we think the market shares continue to be strong, particularly given the competitive environment, and we still have very strong customer relationships. We saw, as we sort of always do, some reallocation of share, particularly with some customers that we had very high shares with. But that's also the reason why we continue to do new business development. So as you heard, we brought on 2 top-20 customers actually in the fourth quarter. And we started seeing NIW related to those relationships in December, 214 new customers in 2013 and a lot of significant prospects that we're still working with. The other thing that is worth noting is that for our new customers, we actually see a higher share of -- a higher market share with those new customers. So we continue to be very positive and optimistic about our ability to continue writing a lot of good of this high profitable business.

[Sanford A. Ibrahim:]

Also, Geoff, this is not the first time we've seen some fluctuations in the customer allocations. We experienced that, I guess, about 3 years ago when we -- in that case, we actually stopped doing business with 2 of our top-10 customers. In a couple of quarters with the new business we added in from new customers, we replaced that. And since then, one of those customers that we -- had then stopped doing business with us is back doing business with us and I believe we're the #1 partner for that customer.

[Teresa A. Bryce Bazemore:]

That's right.

[Geoffrey M. Dunn:]

So when you evaluate the 2 new lenders that came on December, do you think that their addition on a full quarter basis offsets the loss of the other national lender reductions in the 4Q?

[Teresa A. Bryce Bazemore:]

And I think that's difficult to say because, obviously, a lot of that depends on how much business they write and what allocations we get. But I think it's that combined with the ramp-up of business for the customers that we brought on which came across the year and the pipeline of customers that we also have.

[Sanford A. Ibrahim:]

That's a dynamic thing, Geoff. The biggest thing we have going for us is the ability to keep bringing on new customers. And you have to remember that customers can change their allocations in the opposite direction in the future. So we -- at least I continue to feel very positive about the strong franchise position we have achieved. And I think if anything else, that franchise position will get even stronger in time and that will give us the resilience and the strength to deal with fluctuations in allocations, as we've already demonstrated.

[Geoffrey M. Dunn:]

Okay. And last question, I appreciate there's a lot of options that you have on the capital front, but when you think about your various plans, how much waiting do you give, kind of an extreme scenario, where there's a significant subsidiary haircut and/or a very short implementation period? How do you -- as you approach managing this whole issue, how much waiting do you give to kind of an off-the-wall extreme adjustment by the GSEs?

[C. Robert Quint:]

I mean, I think you have to consider that, that could happen, Geoff, and we have. Although we believe the implementation period will be reasonable, and that's a lot of the feedback we've gotten, we don't know for certain. So I think if it is much sooner and much bigger hit in terms of subsidiary capital or legacy exposure, we will have opportunities via reinsurance to deal with that.

[Operator:]

Our next question comes from the line of Douglas Harter with Crédit Suisse.

[Douglas Harter:]

Can you give us an update as to how much risk you expect to run off with the financial guarantor in 2014 and any plans for dividends up to the MI?

[Derek Brummer:]

Financial Guaranty will -- about half of the portfolio, I know, runs off over the next 4 years approximately. Over the next year, I would say, it's probably going to be in excess of 10% that will run off kind of as scheduled next year.

[C. Robert Quint:]

Yes, there's a big corporate CDO runoff in 2017. That's when the majority of that goes, but some of it runs off in '14. We've been paying ordinary dividends consistently from Financial Guaranty and continuing to improve the profile and the capital levels there. So certainly, that's something we will continue. And access to the capital in Financial Guaranty is very important to us, and we're focused on it.

[Douglas Harter:]

And, I guess, what sort of levels would you look towards -- or what would you -- what would trigger you guys looking for something other than kind of the ordinary course dividend?

[C. Robert Quint:]

Well I think if you look at the company by any measure, it's probably overcapitalized. So I think it's a case where the capital today counts for risk-to-capital purposes. We don't know what GSE eligibility will do to that. However, regardless of what GSE eligibility says, access to the capital in Financial Guaranty is very important. So as I said, we're focused on gaining that access as soon as we can.

[Operator:]

Our next question comes from the line of Jordon Hymowitz with Philadelphia Financial.

[Jordon Neil Hymowitz:]

You said you're going to do $40 billion as the goal in 2014?

[Sanford A. Ibrahim:]

Yes.

[Jordon Neil Hymowitz:]

So, I mean, it's like $1.1 billion MBA market, right? And you said it's 12% MI penetration. So are you targeting a 30% share this year? Is that back into the numbers the right way?

[Teresa A. Bryce Bazemore:]

No, I think that is about $1.2 billion, but we also believe that the penetration is going to go up, which has a bigger impact on what the NIW actually is at the end of the day.

[Sanford A. Ibrahim:]

And what that means is given the -- if you just eyeball the MBA forecast for the year, roughly 20% -- the forecast, roughly 20% of the origination for the year, will happen in the first quarter and, typically, January and February. February, given the smaller funding days in a normal purchase market, tends to be smaller with business picking up in March, but really manifesting itself in the second and third quarters. So based on that, we'd have to do around $8 billion in the first quarter to achieve $40 billion.

[Teresa A. Bryce Bazemore:]

Yes, and I think what we said was that it would be at least $40 billion. So we certainly are targeting for more, but we believe that based on the numbers that we're seeing that, that's reasonable.

[Jordon Neil Hymowitz:]

So let me ask the question a different way because who knows where the market's going to be if it's $1 billion or more. But what type of share are you targeting this year? Are you targeting 30%? Are you targeting the same 25% in the fourth quarter?

[Teresa A. Bryce Bazemore:]

We don't really target a particular share. We look more in terms of NIW and what we think the reasonable NIW is based on the customers that we have, what we think the penetration levels in the market size are going to be and that's how we came to that number that we were comfortable sharing.

[C. Robert Quint:]

Right. And in order -- Jordon, in order to get to that number, we don't need to gain share to get that.

[Jordon Neil Hymowitz:]

That's actually what I'm trying to get. Do you need to gain share to get to that number?

[Teresa A. Bryce Bazemore:]

No.

[Sanford A. Ibrahim:]

No.

[Jordon Neil Hymowitz:]

Okay. And then what percent of the industry, if it was 12% last year, do you think will be this year that has MI?

[Teresa A. Bryce Bazemore:]

We think that, that's going to increase and probably by a few percentage points.

[Operator:]

Our next question comes from the line of Eric Beardsley with Goldman Sachs.

[Eric Beardsley:]

I was wondering if you could just update us on your thoughts of capital contributions down to Radian Guaranty from the parent. I think last quarter, you'd expected to do $200 million over the next 12 months and you're already at $100 million of that.

[C. Robert Quint:]

Yes, I mean, it really -- it's going to depend on the GSE eligibility and what that does. In order to stable a 20

[Operator:]

We'll go to the line of Sean Dargan with Macquarie.

[Sean Dargan:]

A question about the competitive environment. Yes, the forecasts for purchase mortgage origination are up year-over-year, but they seem to be coming down every time they're revised. And with new entrants coming on board, I guess, investors want some kind of confidence that we won't see continued rate cuts. And I was just wondering what your position is on that.

[Sanford A. Ibrahim:]

Well, in terms of pricing, we believe that actions taken in the market recently demonstrate that rate cuts do not translate into permanent market share and while -- therefore, they are not the best way to gain market share. So if, however, given the new competitive environment, somebody initiates those as we will think carefully about how we want to respond, it is a competitive market, but we believe, since it has proven to be an instrument that doesn't work, there'll be less incentive for anybody to use it.

[Sean Dargan:]

Okay. And just a quick follow-up to Puerto Rico, S&P downgraded the GOs to junk last night, and I think S&P quantified for other financial guarantors with the capital charge would be when that happens. Do have a number?

[Derek Brummer:]

Not a capital charge number. I mean, the downgrade was pretty well anticipated by often, I think, the market, but I don't have any S&P capital charge number at hand.

[Operator:]

And we will take our final question from the line of Geoffrey Dunn with Dowling & Partners.

[Geoffrey M. Dunn:]

I just had a follow-up on -- was there any reallocation in the investment portfolio? It looked like your -- at least your MI yield might have jumped sequentially. I'm curious if you've changed the duration or any asset allocation?

[C. Robert Quint:]

Not materially, Geoff. We always sort of reposition in small ways, but there's nothing that jumps out.

[Operator:]

And with that, I'd like to turn it back over to Mr. Ibrahim for any final comments.

[Sanford A. Ibrahim:]

I'd like to thank all the participants on this call. And again, as we said earlier, we're looking forward to this year in continuing to build on our momentum and strength. Thank you.

[Operator:]

Thank you. And ladies and gentlemen, that does conclude your conference call for today. Thank you for your participation and for using AT&T Executive TeleConference Service. You may now disconnect.