Item 1.
Business.
General
We are a diversified mortgage and real estate services business. We provide mortgage insurance and products and services to the real estate and mortgage finance industries through our two business segments-Mortgage Insurance and Services. Our Mortgage Insurance segment provides credit-related insurance coverage, principally through private mortgage insurance, as well as other credit risk management solutions to mortgage lending institutions and mortgage credit investors. Our Services segment is primarily a fee-for-service business that offers a broad array of real estate, title and mortgage services to market participants across the mortgage and real estate value chain. We offer these services primarily to mortgage lenders, financial institutions, investors and government entities. In addition, we provide title insurance and settlement services to mortgage lenders as well as directly to consumers. Prior to our January 2020 sale of Clayton, our mortgage services included transaction management services such as loan review, RMBS securitization and distressed asset reviews as well as servicer and loan surveillance. See Note 7 of Notes to Consolidated Financial Statements for additional information on the sale of Clayton.
Radian Group serves as the holding company for our insurance and other subsidiaries, through which we offer our products and services, and does not have any operations of its own.
2019 Highlights. Below are highlights of our key accomplishments that furthered our strategic objectives and contributed to our financial and operating results during 2019.
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Wrote $71.3 billion of NIW on a Flow Basis, the highest flow volume in Radian’s 40+ year history
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Represents a 26% increase over 2018
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Grew primary IIF by 9%, from $221.4 billion at December 31, 2018 to $240.6 billion at December 31, 2019
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Earned pretax income of $849.0 million in 2019, an increase of 24% compared to $684.2 million in 2018
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Grew adjusted pretax operating income to $854.6 million, an increase of 15% compared to $745.5 million for 2018 (1)
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Improved composition of mortgage insurance portfolio
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95% of our primary RIF consists of business written after 2008, including loans refinanced under HARP
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Fully implemented RADAR Rates, our black box pricing framework and digital delivery platform, which expands our risk-based pricing granularity and allows us to more dynamically shape and manage our mortgage insurance portfolio
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Took steps to optimize our capital and liquidity position
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Repurchased over 13 million shares of Radian Group’s common stock
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Added $375 million to Radian Group liquidity as a result of Radian Guaranty’s return of capital to Radian Group in April 2019
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Reduced our total debt outstanding and improved our debt maturity profile through a series of transactions, which also helped to reduce our debt-to-capital ratio from 22.8% at December 31, 2018 to 18.0% at December 31, 2019
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Expanded our risk distribution strategy to optimize the amounts and types of capital and risk distribution deployed against insured risk and reduce future loss volatility
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Radian Guaranty executed the Eagle Re 2019-1 mortgage insurance-linked notes transaction, which provides for up to $562.0 million aggregate excess-of-loss reinsurance coverage for mortgage insurance losses
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Increased the excess of Available Assets over Minimum Required Assets under PMIERs to $804 million, or 28% more than the Minimum Required Assets under PMIERs
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(1)
Adjusted pretax operating income is a non-GAAP measure. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Results of Operations-Consolidated-Use of Non-GAAP Financial Measures” for the definition and reconciliation of this measure to the most comparable GAAP measure, pretax income.
For additional information regarding these items as well as other factors impacting our business and financial results in 2019, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
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Business Strategy. We are strategically focused on supporting the American dream of homeownership by delivering new levels of service and innovation to our customers across the residential mortgage and real estate spectrum through the combination of our mortgage insurance and risk services business and our comprehensive suite of real estate, title and mortgage services. Our objectives include driving strong growth, increasing value creation and providing attractive stockholder returns. Consistent with these objectives, our business strategy, as highlighted below, is focused on growing our businesses and diversifying our revenue sources, while at the same time leveraging our operational excellence and the strength of our “One Radian” brand.
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Maximize the long-term economic value of our insured portfolio to drive future earnings by writing profitable NIW and effectively maintaining the portfolio’s health, balance and profitability, including by using risk distribution strategies to manage our retained exposure
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Leverage the strength of our One Radian brand and core competencies and increase our competitive differentiation in order to:
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Grow our mortgage insurance business in innovative ways
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Expand our presence in the mortgage and real estate value chain beyond mortgage insurance
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Maintain strong comprehensive enterprise risk management and risk/return discipline based on sound data and analytics
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Enhance the quality and performance of our operations and delivery of products and services
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Manage our capital to build strategic financial flexibility and increase stockholder value
We utilize various tools to assess the long-term economic value of our insured portfolio in order to identify opportunities to create stockholder value. For our mortgage insurance business, we evaluate the long-term economic value of our existing and future insured portfolio by using a measure that incorporates expected lifetime returns for our insurance policies, taking into consideration projected premiums, credit losses, investment income, operating expenses, taxes and an assumed cost of capital. This projected economic value is present-valued to arrive at an estimated long-term economic value of our portfolio. We use this economic value to assist us in evaluating various portfolio strategies.
A key element of our business strategy is to build competitive differentiation across our mortgage insurance business and use our Services segment to diversify our business and revenue streams by increasing our participation in multiple facets of the residential real estate and mortgage finance markets. Beginning in 2017, we initiated a review of the strategic direction of our Services business and made several decisions with respect to the business strategy that are designed to reposition this business to drive future growth and profitability. As a further step in repositioning the Services business, we initiated a process in 2019 to evaluate a potential sale of Clayton, through which we provided mortgage services related to loan acquisition, RMBS securitization and distressed asset reviews and servicer and loan surveillance. This sale was completed in January 2020, and we currently are focused on growing our real estate, title and remaining mortgage services, including our title insurance and settlement services, valuation and asset management services that support our REO and single family rental businesses, as well as our other digital real estate services. See “Services-Services Business Overview.”
Corporate Background. Radian Group has been incorporated as a business corporation under the laws of the State of Delaware since 1991. Our principal executive offices are located at 1500 Market Street, Philadelphia, Pennsylvania 19102, and our telephone number is (215) 231-1000.
Additional Information. Our website address is www.radian.biz. Copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, as well as any amendments to those reports, are available free of charge through our website as soon as reasonably practicable after they are electronically filed with, or furnished to, the SEC. In addition, our guidelines of corporate governance, code of business conduct and ethics (which includes the code of ethics applicable to our chief executive officer, principal financial officer and principal accounting officer) and the governing charters for each standing committee of Radian Group’s board of directors are available free of charge on our website, as well as in print, to any stockholder upon request.
The public may read materials we file with the SEC, including reports, proxy and information statements, and other information, on the Internet site maintained by the SEC. The address of that site is www.sec.gov.
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The above references to our website and the SEC’s website do not constitute incorporation by reference of the information contained on the websites and such information should not be considered part of this document.
Operating Environment
As a seller of mortgage credit protection and other credit risk management solutions, as well as a provider of real estate, title and mortgage services, the demand for our products and services is largely driven by the macroeconomic environment generally, and more specifically by the health of the housing, mortgage finance and related real estate markets.
Mortgage Insurance. Our mortgage insurance business is impacted by specific macroeconomic conditions and events that impact the mortgage origination environment and the credit performance of our portfolio of insured loans. The improvement in macroeconomic conditions since the financial crisis of 2007-2008, together with tighter credit requirements on new loans and an improvement in loan servicing, has contributed to the positive credit trends in our mortgage insurance portfolio, including a lower level of new defaults and a higher level of defaulted loans becoming current, or “curing.”
Among other factors, private mortgage insurance industry volumes are impacted by total mortgage origination volumes and the mix between mortgage originations that are for home purchases versus refinancings of existing mortgages, with the penetration rate for private mortgage insurance being generally three to five times higher for purchase transactions than for refinancings. In 2019, the total mortgage origination market was larger than anticipated, driven by an increase in purchase transactions as well as stronger than anticipated refinancings due to low mortgage interest rates. As a result of the larger overall mortgage origination market, and in particular the strong purchase market, the private mortgage insurance market increased in 2019 as compared to 2018. The most recently available industry reports currently project the mortgage origination market to be lower in 2020 in comparison to 2019, with purchase loan volume expected to increase, but to be more than offset by a significant decrease in refinancings. Based on these industry projections and our expected mortgage insurance penetration rates, we are projecting that the private mortgage insurance market in 2020 will be lower in comparison to 2019, and we currently expect our NIW for 2020 to be approximately $60 billion.
The environment for private mortgage insurers is highly competitive, with private mortgage insurers competing primarily on the basis of price, underwriting guidelines, overall service, customer relationships, perceived financial strength and reputation. In addition to other private mortgage insurers, we compete with governmental agencies, principally the FHA and the VA. See “Mortgage Insurance-Competition.”
In 2019, the mortgage insurance industry migrated away from a predominantly rate-card-based pricing model, and various pricing methodologies are now being deployed with differing degrees of risk-based granularity, including the increased use of “black box” pricing frameworks. The shift away from a predominantly rate-card-based pricing model and the increase in “black box” pricing frameworks provides a more dynamic pricing capability that has led to an increase in the frequency of pricing changes throughout the mortgage insurance industry and a reduction in pricing transparency. See “Mortgage Insurance-Mortgage Insurance Business Overview-Premium Rates.”
In addition to the transformation of pricing frameworks, in recent years, participants in the private mortgage insurance industry have engaged in a range of risk distribution strategies. In our mortgage insurance business, Radian uses reinsurance as a capital and risk management tool to lower the risk profile and financial volatility of our mortgage insurance portfolio through economic cycles. Among other benefits, risk distribution reduces our required capital, lowers our overall cost of capital and enhances our projected return on capital. As the industry continues to evolve from a model where private mortgage insurers “originate and hold” risk to an “aggregate, manage and distribute” risk model, we expect to continue to utilize multiple forms of risk distribution, subject to cost, availability and other factors. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Overview-Risk Distribution.”
Services. The macroeconomic conditions and other events that impact the housing, mortgage finance and related real estate markets also affect the demand for the services we offer through our Services business segment. Sales volume in our Services business varies based on the overall activity in the housing and mortgage finance markets and the health of related industries. We believe that the combination of our mortgage insurance business with the unique set of diversified services provided through our Services segment provides us with an opportunity to become increasingly more relevant to our customers and that this combination serves as a competitive differentiator for us compared to other private mortgage insurance companies.
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Mortgage Insurance
Mortgage Insurance Business Overview
Overview
Our Mortgage Insurance segment provides credit-related insurance coverage, principally through private mortgage insurance, as well as other credit risk management solutions, to mortgage lending institutions and mortgage credit investors. Private mortgage insurance plays an important role in the U.S. housing finance system because it promotes affordable home ownership and helps protect mortgage lenders, investors and other beneficiaries by mitigating default-related losses on residential mortgage loans. Generally, these loans are made to home buyers who make down payments of less than 20% of the purchase price for their home or, in the case of refinancings, have less than 20% equity in their home. Private mortgage insurance also facilitates the sale of these loans in the secondary mortgage market, most of which are currently sold to the GSEs.
See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Key Factors Affecting Our Results-Mortgage Insurance.”
Mortgage Insurance Products
Primary Mortgage Insurance. Primary mortgage insurance provides protection against mortgage defaults at a specified coverage percentage. When there is a valid claim under primary mortgage insurance, the maximum liability is determined by multiplying the claim amount, which consists of the unpaid loan principal, plus past due interest and certain expenses associated with the default, by the coverage percentage. Claims may be settled for the maximum liability or for other amounts. See “-Claims Management” below.
We mainly provide primary mortgage insurance on an individual loan basis as each mortgage is originated, but we also can provide primary mortgage insurance on individual loans in an aggregate group of mortgages after they have been originated. We primarily write insurance in a “first loss” position, where we are responsible for the first losses incurred on an insured loan subject to a policy limit. See “-Mortgage Insurance Portfolio-Mortgage Loan Characteristics.”
The terms of our primary mortgage insurance coverage are set forth in a Master Policy that we enter into with each of our customers. Among other things our Master Policies set forth the applicable terms and conditions of our mortgage insurance coverage, including: loan eligibility requirements; premium payment requirements; coverage term; provisions for policy administration, servicing standards and requirements; exclusions or reductions in coverage; claims payment and settlement procedures; and dispute resolution procedures. We file our Master Policies in each of the jurisdictions in which we conduct business.
Radian Guaranty and the other private mortgage insurers have prepared new master policy forms based on updated requirements issued by the FHFA and the GSEs. See “-Claims Management-Rescissions.” Radian Guaranty’s new master policy, the 2020 Master Policy, will be effective for applications received on or after March 1, 2020 and is approved for use by the GSEs and in all 50 states and the District of Columbia. Applications received through February 29, 2020 will continue to be administered under Radian Guaranty’s 2014 Master Policy.
Although the primary mortgage insurance we write protects lenders from a portion of losses resulting from mortgage defaults, it generally does not provide protection against property loss or physical damage, including damage caused by hurricanes or other severe weather events or natural disasters.
We wrote $71.3 billion and $56.5 billion of first-lien primary mortgage insurance in 2019 and 2018, respectively. Substantially all of our primary mortgage insurance written during 2019 and 2018 was written on a Flow Basis. Our 2019 NIW, partially offset by cancellations and amortization within our existing portfolio, resulted in an increase in IIF to $240.6 billion at December 31, 2019, compared to $221.4 billion at December 31, 2018. Our total direct primary mortgage insurance RIF was $60.9 billion at December 31, 2019, compared to $56.7 billion at December 31, 2018.
Other Mortgage Insurance Products. We also have other mortgage insurance products that had RIF of $0.6 billion at December 31, 2019, as described below:
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GSE Credit Risk Transfer. Part of our business strategy includes leveraging our core expertise in credit risk management and expanding our presence in the mortgage finance industry. We participate in credit risk transfer programs developed by Fannie Mae and Freddie Mac as part of their initiative to distribute mortgage credit risk and increase the role of private capital in the mortgage market. Our total RIF under the credit risk transfer transactions was $275.2 million as of December 31, 2019, compared to $196.8 million as of December 31, 2018.
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We will only experience claims under these credit risk transfer transactions if the borrower’s equity, any existing primary mortgage insurance (if applicable) and the GSEs’ retained risk are depleted. In participating in these GSE transactions, we assume incremental risk (beyond that which we typically cover in our traditional mortgage insurance business) associated with the risk of defaults caused by physical damage, including natural disasters such as hurricanes and wildfires, which is not covered by the underlying primary mortgage insurance. We regularly evaluate this risk, including the geographic diversity of the loans included in these transactions and our remote risk position, in assessing our participation in these transactions.
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Pool Insurance. Prior to 2008, we wrote Pool Insurance on a limited basis. At December 31, 2019, Pool Insurance made up only $313.5 million of our total direct first-lien insurance RIF, as compared to $324.6 million at December 31, 2018. With respect to our Pool Insurance, an aggregate exposure limit, or “stop loss” (usually between 1% and 10%), is generally applied to the initial aggregate loan balance on a group or “pool” of mortgages. In addition, an insured pool of mortgages may contain mortgages that are already covered by primary mortgage insurance. In these transactions, Pool Insurance is secondary to any primary mortgage insurance that exists on mortgages within the pool. Our Pool Insurance policies are privately negotiated and are separate from the Master Policies that we use for our primary mortgage insurance.
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Non-Traditional Risk. In the past, we provided non-traditional products that included mortgage insurance on second-lien residential mortgage loans and mortgage insurance on an international basis. Our total amount of non-traditional risk was $10.4 million at December 31, 2019, which consisted entirely of second-lien RIF, as compared to $15.2 million at December 31, 2018.
Premium Rates
Primary Mortgage Insurance. A premium rate is determined when insurance coverage is requested on a mortgage, which is generally near the time of loan origination. Premiums for our mortgage insurance products are established based on performance models that consider a broad range of borrower, loan and property characteristics as well as current and projected market and economic conditions. Our premium rates are subject to regulation, and in most states where our insurance subsidiaries are licensed, our premiums must be filed, and in some cases approved, before their use. See “Regulation-State Regulation.”
Our pricing strategy is to set our premium levels to manage the risk/return profile and long-term economic value of our insured portfolio. Our premium levels are designed to maximize the long-term economic value of our mortgage insurance portfolio by balancing credit risk, profitability and volume considerations, and achieve an overall risk-adjusted rate of return on capital given our modeled performance expectations. Our actual returns may differ from our expectations based on changing market conditions and other factors. Among other factors, we set our premium rates based on competitive and economic conditions, as well as assumptions about policy performance, including, without limitation, our expectations and assumptions about: (i) the likelihood of default; (ii) how long the policy will remain in place; (iii) the costs of acquiring and maintaining the insurance; (iv) taxes; and (v) the capital that is required to support the insurance.
Premiums on our mortgage insurance products generally are written on either: (i) a recurring basis, either as monthly or annual premiums, pursuant to our Monthly and Other Recurring Premium Policies or (ii) on a multi-year basis as a single premium generally paid at the time of loan origination pursuant to our Single Premium Policies. There are also alternative products where premiums may be paid on an annual installment basis or as a combination of up-front premium at origination plus a monthly installment. In addition, premiums may be paid after loan origination or may include a refundable component. Some programs, subject to certain conditions, provide coverage for the life of the loan while others terminate when certain criteria are met. There are many factors that influence the types of premiums we receive, including: (i) the percentage of mortgage originations derived from refinancing transactions versus new home purchases; (ii) the customers with whom we do business (e.g., mix of Single Premium Policies and Monthly and Other Recurring Premium Policies varies by customer); and (iii) the relative premium levels we and our competitors set for the various forms of premiums offered.
Mortgage insurance premiums can be funded through a number of methods, and while the coverage remains for the benefit of the insured or third-party beneficiary, the premiums may be paid by the borrower or by the lender. Borrower-paid Monthly and Other Recurring Premiums are generally paid as part of the borrower’s monthly mortgage payment, while borrower-paid Single Premiums are paid at the time of closing either as part of the settlement charges or financed as a component of the mortgage loan amount. Lender-paid mortgage insurance premiums are paid by the lender and are typically passed through to the borrower in the form of additional origination fees or a higher interest rate on the mortgage note. The majority of our Monthly and Other Recurring Premiums are established as a fixed percentage of the initial loan balance for a set period of time (typically 10 years), after which the premium declines to a lower fixed percentage for the remaining life of the
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policy. Our remaining Monthly and Other Recurring Premiums are established as a fixed percentage of the loan’s amortizing balance over the life of the policy.
The impact of market conditions on our returns will vary based on, among other factors, whether the insurance is borrower-paid or lender-paid, and whether the payments are made monthly or on another recurring basis, or in a single premium payment at the time of origination. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Key Factors Affecting Our Results-Mortgage Insurance-Premiums.” A change in capital requirements on insured loans can also affect our returns. See “Regulation-GSE Requirements-PMIERs-Private Mortgage Insurer Eligibility Requirements.”
In 2019, the mortgage insurance industry migrated away from a predominantly rate-card-based pricing model, and various pricing methodologies are being deployed with differing degrees of risk-based granularity. Although the current pricing frameworks are based upon the same general risk attributes as have been considered in mortgage insurance pricing historically; more granular risk-based pricing factors are now being incorporated into pricing tools. The shift away from a predominantly rate-card-based pricing model and the increase in “black box” pricing frameworks provides a more dynamic pricing capability that has led to an increase in the frequency of pricing changes throughout the mortgage insurance industry and a reduction in pricing transparency. Further, this shift in risk-based, granular pricing methodologies, as well as the development of enhanced digital technologies for delivering and receiving price quotes, has led to an increasing number of customers making their choice of mortgage insurance providers based on the lowest price available for any particular loan, without consideration of other factors.
Overall, our approach to pricing is customer-centric and flexible, as we offer a spectrum of risk-based pricing solutions for our customers with varying degrees of granularity and transparency. This approach represents a continuation of our strategy to pursue multiple pricing delivery options that can be customized to a lender’s loan origination process and balanced with our own objectives for managing our volume of NIW and the risk/return profile of our mortgage insurance portfolio. These solutions range from more traditional pricing forms (i.e., standard rate card) to RADAR Rates, our “black box” pricing framework and digital delivery platform that utilizes Radian’s proprietary RADAR risk model and analyzes credit risk inputs to customize a rate quote to a borrower’s individual risk profile, loan attributes and property characteristics. See “Item 1A.
Item 1A. Risk Factors.
Radian Guaranty may fail to maintain its eligibility status with the GSEs.
In order to be eligible to insure loans purchased by the GSEs, mortgage insurers such as Radian Guaranty must meet the GSEs’ eligibility requirements, or PMIERs. The PMIERs are comprehensive, covering virtually all aspects of the business of a private mortgage insurer, including internal risk management and quality controls, the relationship between the GSEs and the approved insurer and the approved insurer’s financial condition, as well as extensive requirements related to the conduct and operations of a mortgage insurer’s business. If Radian Guaranty is unable to satisfy the requirements set forth in the PMIERs, Freddie Mac and/or Fannie Mae could restrict it from conducting certain types of business with them or take actions that may include not purchasing loans insured by Radian Guaranty.
The PMIERs financial requirements currently require that a mortgage insurer’s Available Assets meet or exceed its Minimum Required Assets. At December 31, 2019, Radian Guaranty was in compliance with the PMIERs financial requirements and had Available Assets of $3.6 billion, which resulted in an excess or “cushion” of $804 million over its Minimum Required Assets of $2.8 billion. Radian Guaranty’s ability to continue to comply with the PMIERs financial requirements could be impacted by, among other factors: (i) the product mix of our NIW and factors affecting the performance of our mortgage insurance portfolio, including our level of new defaults, prepayments, the losses we incur on new or existing defaults and the credit characteristics of our mortgage insurance; (ii) the amount of credit that we receive under the PMIERs financial requirements for our third-party reinsurance transactions (which is subject to initial and ongoing review by the GSEs); and (iii) potential updates to the PMIERs, including an increase in the capital requirements under the PMIERs financial requirements.
Under the PMIERs financial requirements there are increased financial requirements for loans with a higher likelihood of default and/or certain credit characteristics, such as higher LTVs and lower FICO scores, as well as for loans originated after January 1, 2016 that are insured under lender-paid mortgage insurance policies not subject to automatic termination under the HPA. Therefore, if our mix of business includes more loans that are subject to these increased financial requirements, it increases the amount of Available Assets that Radian Guaranty is required to hold. Depending on the circumstances, we may limit the type and volume of business we are willing to write for certain of our products based on the increased financial requirements associated with certain loans. This could reduce the amount of NIW we write, which could reduce our revenues. Additionally, as we have experienced in the past, our insured loans may experience increased defaults in the future. Increases in defaults, including as a result of natural disasters, would subject Radian Guaranty to an increase in Minimum Required Assets under the PMIERs, and therefore, could impact our compliance with the PMIERs or negatively impact our results of operations.
The GSEs may amend the PMIERs at any time, although the GSEs have communicated that for material changes, including material changes affecting Minimum Required Assets, they will generally provide written notice 180 days prior to the effective date. The GSEs also have broad discretion to interpret the PMIERs, which could impact the calculation of Radian Guaranty’s Available Assets and/or Minimum Required Assets. The most recent revisions to PMIERs, or PMIERs 2.0, became
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effective on March 31, 2019. We expect the GSEs to continue to update the PMIERs periodically in the future, including if and when there are changes to the GSEs’ capital requirements, such as if and when the CCF is finalized.
Compliance with the PMIERs financial requirements could impact our holding company liquidity. If additional capital is required to support Radian Guaranty’s compliance with the PMIERs financial requirements, it may make it more difficult for Radian Guaranty to return capital to Radian Group in the form of dividends or otherwise, and depending on the circumstances, could require Radian Group to contribute capital through capital contributions or surplus notes to Radian Guaranty, which would leave less liquidity to satisfy Radian Group’s other obligations. Depending on the amount of liquidity that is utilized from Radian Group, we may be required (or may decide) to seek additional capital by incurring additional debt, issuing additional equity, or selling assets, which we may not be able to do on favorable terms, if at all.
In addition to the PMIERs financial requirements, the PMIERs contain requirements related to the operations of our mortgage insurance business, including extensive operational requirements in areas such as claim processing, loss mitigation, document retention, underwriting, quality control, reporting and monitoring, among others. These increased operational requirements have resulted in additional expenses and have required substantial time and effort from management and our employees, which we expect will continue.
The PMIERs prohibit Radian Guaranty from engaging in certain activities such as insuring loans originated or serviced by an affiliate (except under certain circumstances) and require Radian Guaranty to obtain the prior consent of the GSEs before taking many actions, which may include entering into various intercompany agreements, settling loss mitigation disputes with customers and commuting risk, among others. These restrictions could prohibit or delay Radian Guaranty from taking certain actions that would be advantageous to it or its affiliates.
Although we expect Radian Guaranty to retain its eligibility status with the GSEs and to continue to comply with the PMIERs financial requirements, including as potentially updated in the future, we cannot provide assurance that this will occur. Loss of Radian Guaranty’s eligibility status with the GSEs would have an immediate and material adverse impact on the franchise value of our mortgage insurance business and our future prospects, as well as a material negative impact on our future results of operations and financial condition.
Our insurance subsidiaries are subject to comprehensive state insurance regulations and other requirements, which we may fail to satisfy.
We and our insurance subsidiaries are subject to comprehensive, detailed regulation by the insurance regulators in the states where they are domiciled or licensed to transact business. These regulations are principally designed for the protection of our insurance policyholders rather than for the benefit of our investors. Insurance laws vary from state to state, but generally grant broad supervisory powers to examine insurance companies and enforce rules or exercise discretion affecting almost every significant aspect of the insurance business, including the power to revoke or restrict an insurance company’s ability to write new business. Among other matters, the state insurance regulators impose various capital requirements on our insurance subsidiaries.
State insurance capital requirements for our mortgage insurance subsidiaries include Risk-to-capital ratios, other risk-based capital measures and surplus requirements that may limit the amount of insurance that our mortgage insurance subsidiaries write or the ability of our insurance subsidiaries to distribute capital to Radian Group. Similarly, our title insurance subsidiary is required to maintain statutory premium reserves that vary by state and subject to periodic reviews of certain financial performance ratios, and the results of those ratios could result in additional capital requirements in states where it is licensed. Our failure to maintain adequate levels of capital in our mortgage insurance and title insurance subsidiaries, among other things, could lead to intervention by the various insurance regulatory authorities, which could materially and adversely affect our business, business prospects and financial condition.
With respect to our mortgage insurance subsidiaries, there are 16 states that currently impose a Statutory RBC Requirement. If Radian Guaranty is not in compliance with a state’s applicable Statutory RBC Requirement, it may be prohibited from writing new business in that state until it is back in compliance or it receives a waiver of, or similar relief from, the requirement. As of December 31, 2019, Radian Guaranty was in compliance with all applicable Statutory RBC Requirements. In states that do not have a Statutory RBC Requirement, it is not clear what actions the applicable state regulators would take if a mortgage insurer fails to meet the Statutory RBC Requirement established by another state. If Radian Guaranty were to fail to meet the Statutory RBC Requirement in one or more states, it could be required to suspend writing business in some or all of the states in which it does business. In addition, the GSEs and our mortgage lending customers may decide not to conduct new business with Radian Guaranty (or may reduce current business levels) or impose restrictions on Radian Guaranty while it was not in compliance. The franchise value of our mortgage insurance business likely would be
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significantly diminished if we were prohibited from writing new business or restricted in the amount of new business we could write in one or more states.
Radian Group also may be required to provide capital support for Radian Guaranty and its affiliated insurers if additional capital is required by those subsidiaries pursuant to future changes to insurance laws and regulations. The NAIC is in the process of reviewing the minimum capital and surplus requirements for mortgage insurers and considering changes to the Model Act. The NAIC working group overseeing this initiative has released an exposure draft of a revised Model Act, including new proposed mortgage guaranty insurance capital requirements. As proposed, the capital requirements set forth in the current exposure draft are impacted, among other things, by changes in the economic and housing environment, including changes in home prices and incomes. Although the outcome of this process remains uncertain, given the current economic and housing environment, if the exposure draft of the new Model Act was adopted and in effect today, we do not believe that the capital requirements imposed by the new Model Act would exceed those of the current PMIERs financial requirements.
The mortgage insurance industry has always been highly competitive with respect to pricing. Our mortgage insurance subsidiaries’ premium rates and policy forms are generally subject to regulation in every state in which they are licensed to transact business. These regulations are intended to protect policyholders against the adverse effects of excessive, inadequate or unfairly discriminatory rates and to encourage fair competition in the insurance marketplace. In most states where our insurance subsidiaries are licensed, premium rates and policy forms must be filed with the state insurance regulatory authority and, in some states, must be approved, before their use. We may be subject to regulatory inquiries or examinations with respect to our mortgage insurance premium rates and policy forms.
Our title insurance business is subject to extensive rate regulation by the applicable state agencies in the states in which it operates. Title insurance rates are regulated differently in various states, with some states requiring the subsidiaries to file and receive approval of rates before such rates become effective and some states promulgating the rates that can be charged. In general, premium rates are determined on the basis of historical data for claim frequency and severity as well as related production costs and other expenses.
Given that the premium rates for our insurance subsidiaries are highly regulated, we could lose business opportunities and fail to successfully implement our business strategies if we are unable to respond to competitor pricing actions and our customers’ demands in a timely and compliant manner.
The credit performance of our mortgage insurance portfolio is impacted by macroeconomic conditions and specific events that affect the ability of borrowers to pay their mortgages.
As a seller of mortgage credit protection, our results are subject to macroeconomic conditions and specific events that impact the housing finance and real estate markets, including events that impact mortgage originations and the credit performance of our mortgage insurance portfolio. Many of these conditions are beyond our control, including housing prices, unemployment levels, interest rate changes, the availability of credit and other factors that may be derived from national and regional economic conditions. In general, a deterioration in economic conditions increases the likelihood that borrowers will be unable to satisfy their mortgage obligations. A deteriorating economy can adversely affect housing values, which in turn can influence the willingness of borrowers to continue to make mortgage payments despite having the financial resources to do so.
Mortgage defaults can occur due to a variety of specific events affecting borrowers, including death or illness, divorce or other family problems, unemployment, or other events. In addition, factors impacting regional economic conditions, acts of terrorism, war or other severe conflicts, event-specific economic depressions or other catastrophic events such as natural disasters and pandemics could result in increased defaults due to the impact of such events on the ability of borrowers to satisfy their mortgage obligations and the value of affected homes.
Unfavorable macroeconomic developments and the other factors cited above could have a material negative impact on our results of operations and financial condition.
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The length of time that our mortgage insurance policies remain in force could decline and result in a decrease in our future revenues.
As of December 31, 2019, 72% of our total primary IIF consists of policies for which we expect to receive premiums in the future, typically through Monthly Premium Policies. As a result, most of our earned premiums are derived from insurance that was written in prior years. The length of time that this insurance remains in force, which we refer to as the Persistency Rate, is a significant driver of our future revenues, with a lower overall Persistency Rate generally reducing our future revenues. The factors affecting the length of time that our insurance remains in force include:
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prevailing mortgage interest rates compared to the mortgage rates on our IIF, which affects the incentive for borrowers to refinance (i.e., lower current interest rates make it more attractive for borrowers to refinance and receive a lower interest rate);
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applicable policies for mortgage insurance cancellation, along with the current value of the homes underlying the mortgages in our IIF;
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the credit policies of lenders, which may make it more difficult for homeowners to refinance loans; and
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economic conditions that can affect a borrower’s decision to pay off a mortgage earlier than required, including the strength of the housing market, which impacts a borrower’s prospects for selling their existing home and finding a suitable and affordable new home.
If these or other factors cause a decrease in the length of time that our Monthly Premium Policies (or other policies for which we expect to receive premiums in the future) remain in force, our future revenues could be negatively impacted, which could negatively impact our results of operations and financial condition.
Our Loss Mitigation Activity is not expected to mitigate mortgage insurance losses to the same extent as in prior years; Loss Mitigation Activity could continue to negatively impact our customer relationships.
As part of our claims management process we pursue opportunities to mitigate losses both before and after we receive claims, including processes to ensure claims are valid. Following the financial crisis, our Loss Mitigation Activities, such as Rescissions, Claim Denials and Claim Curtailments, increased significantly in response to the poor underwriting, servicer negligence and general non-compliance with our insurance policies that was prevalent in the period leading up to the financial crisis. These Loss Mitigation Activities materially mitigated our paid losses for loans originated and serviced during this period and resulted in a significant reduction in our loss reserves. Following the financial crisis, mortgage underwriting and servicing have generally improved, and the amount of Loss Mitigation Activity required with respect to the claims on loans originated and serviced in more recent periods has significantly decreased. As a result, our future Loss Mitigation Activity is not expected to mitigate our paid losses to the same extent as it did in the years following the financial crisis.
In addition, under our 2014 Master Policy, for NIW after October 1, 2014, our rights to conduct Loss Mitigation Activity generally are more limited than under our prior master insurance policies. Radian Guaranty offers 12-month and 36-month rescission relief programs in accordance with the specified terms and conditions set forth in our 2014 Master Policy. Further, in December 2017, the FHFA and the GSEs proposed revised GSE Rescission Relief Principles to further clarify the circumstances under which mortgage insurers may rescind coverage, and required private mortgage insurers to implement these principles into their master policies for loans insured going forward. Our 2020 Master Policy incorporates these principles. Among other things, the 2020 Master Policy includes a new 60-month rescission relief program that provides that a loan may be eligible to qualify for rescission relief even if the loan failed to meet the conditions required to receive 36-month rescission relief. The 2020 Master Policy will apply to applications received on or after March 1, 2020. The reduction in the Loss Mitigation rights available under our 2014 Master Policy and 2020 Master Policy could result in higher losses than would have been the case under our Prior Master Policy.
Our Loss Mitigation Activities and claims paying practices have resulted in disputes with certain of our customers and in some cases, damaged our relationships with customers, resulting in a loss of business. While we have resolved many of these disputes, a risk remains that our Loss Mitigation Activities or claims paying practices could continue to have a negative impact on our relationships with customers or potential customers. Further, disputes with our customers that are not resolved could result in additional arbitration or judicial proceedings, requiring significant legal expenses, beyond those we are currently facing. See “Item 3. Legal Proceedings.” To the extent that past or future Loss Mitigation Activities or claims paying practices impact our customer relationships, our competitive position could be adversely affected, resulting in the potential loss of business and impacting our results of operations.
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Changes in the charters, business practices, or role of the GSEs in the U.S. housing market generally, could significantly impact our mortgage insurance business.
Our current business model is highly dependent on the GSEs as the GSEs are the primary beneficiaries of most of our mortgage insurance policies. The GSEs’ federal charters generally require credit enhancement for low down payment mortgage loans (i.e., a loan amount that exceeds 80% of a home’s value) in order for such loans to be eligible for purchase by them. Lenders generally have used private mortgage insurance to satisfy this credit enhancement requirement. As a result, low down payment mortgages purchased by the GSEs generally are insured with private mortgage insurance. In order to be eligible to insure loans purchased by the GSEs, mortgage insurers such as Radian Guaranty must meet the GSEs’ eligibility requirements, or PMIERs.
The GSEs’ business practices may be impacted by their results of operations, by administrative policy decisions (such as a desire to increase the competitiveness of private capital executions in the secondary mortgage market) as well as by legislative or regulatory changes. Since September 2008, the GSEs have been operating under the conservatorship of the FHFA. With respect to loans purchased by the GSEs, changes in the business practices of the GSEs, which can be implemented by the GSEs acting independently or through their conservator, the FHFA, could negatively impact our mortgage insurance business and financial performance, including changes to:
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eligibility requirements for a mortgage insurer to become and remain an approved eligible insurer for the GSEs;
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underwriting standards on mortgages they purchase, including as a result of the FHFA’s current focus on reducing the GSEs’ risk profile with respect to loans with multiple higher risk characteristics;
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policies or requirements that may result in a reduction in the number of mortgages they acquire;
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the national conforming loan limit for mortgages they acquire;
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the level of mortgage insurance required, including expanding the loans that are eligible for reduced insurance coverage;
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the terms on which mortgage insurance coverage may be canceled before reaching the cancellation thresholds established by law;
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the terms required to be included in master policies for the mortgage insurance policies they acquire, including limitations on our ability to mitigate losses on insured mortgages that are in default;
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the amount of loan level price adjustments (based on risk) or guarantee fees (which may result in a higher cost to borrowers) that the GSEs charge on loans that require mortgage insurance; and
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the degree of influence that the GSEs have over a mortgage lender’s selection of the mortgage insurer providing coverage.
The FHFA has called for the GSEs to transfer a meaningful portion of credit risk, known as a “credit risk transfer,” to the private sector. This mandate builds upon the goals set in each of the last four years for the GSEs to increase the role of private capital by experimenting with different forms of transactions and structures. We continue to participate in these credit risk transfer programs developed by Fannie Mae and Freddie Mac. Additional information about these programs may be found in Item 1. Business, see “Regulation-Federal Regulation-Housing Finance Reform” and “Mortgage Insurance-Mortgage Insurance Business Overview-Mortgage Insurance Products-Other Mortgage Insurance Products-GSE Credit Risk Transfer.”
It is difficult to predict what other types of credit risk transfer transactions and structures may be used in the future. If any of the credit risk transfer transactions and structures were to displace primary loan level or standard levels of mortgage insurance, the amount of insurance we write may be reduced, which could negatively impact our franchise value, results of operations and financial condition. As a result, the impact of any credit risk transfer products and transactions or other structures implemented by the GSEs is uncertain and hard to predict. For example, in 2018 Freddie Mac and Fannie Mae announced the launch of pilot programs, IMAGIN and EPMI, respectively, as alternative ways for lenders to obtain credit enhancement and sell loans with LTVs greater than 80% to the GSEs. These investor-paid mortgage insurance programs, in which insurance is acquired directly by each GSE, have many of the same features as private mortgage insurance and represent an alternative to traditional private mortgage insurance products that are provided to individual lenders. Participants in IMAGIN and EPMI are not subject to compliance with the PMIERs which may create a competitive disadvantage for private mortgage insurers if these pilot programs are expanded. See “Item 1. Business-Regulation-Federal Regulation-Housing Finance Reform.”
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Since the FHFA was appointed as conservator of the GSEs, there has been a wide range of legislative proposals to reform the U.S. housing finance market, including proposals for GSE reform ranging from some that advocate nearly complete privatization and elimination of the role of the GSEs to others that support a system that combines a federal role with private capital. In September 2019, the U.S. Department of the Treasury and HUD released the Treasury Plan and the HUD Plan to reform the housing finance market, and with respect to the Treasury Plan, to release the GSEs from conservatorship after certain conditions were met. Leadership at the FHFA and HUD have stated that they plan to use the Plans to guide the direction and activities of the GSEs and FHA. With the Plans serving as a roadmap, we expect HUD and FHFA will continue to take actions to shape the role of the FHA and GSEs in the housing finance market and to prepare the GSEs to exit conservatorship. In particular, the FHFA has stated a desire to reduce the GSEs’ exposure to loans with multiple higher risk characteristics in light of the fact that the GSEs currently maintain limited capital positions to support such risk. It is difficult to predict whether or how the Treasury Plan and HUD Plan may be implemented and what impact actions taken in furtherance of these plans could have on our business, financial condition and results of operations. See “Item 1. Business-Regulation-Federal Regulation-Housing Finance Reform.”
The future structure of the residential housing finance system remains uncertain, including whether comprehensive housing reform legislation will be adopted and, if so, what form it may ultimately take. It is difficult to predict the impact of any changes on our business. See “Item 1. Business-Regulation-Federal Regulation-Housing Finance Reform.” Although we believe that traditional private mortgage insurance will continue to play an important role in any future housing finance structure, developments in the practices of the GSEs, including potentially new federal legislation that reduces the level of private mortgage insurance coverage used by the GSEs as credit enhancement, or even eliminates the requirement, may diminish the franchise value of our mortgage insurance business and materially and adversely affect our business prospects, results of operations and financial condition.
A decrease in the volume of mortgage originations could result in fewer opportunities for us to write new mortgage insurance business.
The amount of new business we write depends, among other things, on a steady flow of low down payment mortgages that benefit from our mortgage insurance. The volume of low down payment mortgage originations is impacted by a number of factors, including:
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restrictions on mortgage credit due to changes in lender underwriting standards, capital requirements affecting lenders, regulatory requirements such as the QM designation for mortgage loans, and the health of the private securitization market;
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mortgage interest rates;
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the health of the domestic economy generally, as well as specific conditions in regional and local economies;
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housing affordability;
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tax laws and policies and their impact on, among other things, deductions for mortgage insurance premiums, mortgage interest payments and real estate taxes;
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demographic trends, including the rate of household formation;
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the rate of home price appreciation;
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government housing policy encouraging loans to first-time homebuyers; and
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the practices of the GSEs, including the extent to which the guaranty fees, loan level price adjustments (based on risk), credit underwriting guidelines and other business terms provided by the GSEs affect the cost of mortgages and lenders’ willingness to extend credit for low down payment mortgages.
If the overall volume of new mortgage originations declines, we could experience a reduced opportunity to write new insurance business and likely will be subject to increased competition, which could negatively affect our business prospects, results of operations and financial condition.
Our NIW and franchise value could decline if we lose business from significant customers.
Our mortgage insurance business depends on our relationships with our customers. Our customers place insurance with us directly on loans they originate and they also do business with us indirectly through purchases of loans that already have our mortgage insurance coverage. Our relationships with our customers may influence both the amount of business they conduct with us directly and also their willingness to continue to approve us as a mortgage insurance provider for loans that they
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purchase. The loss of business from significant customers could have an adverse effect on the amount of new business we are able to write, and consequently, our franchise value.
During 2019, our top 10 mortgage insurance customers (measured by NIW) were responsible for 34.3% of our primary NIW, as compared to 29.1% in 2018. If we were to lose a significant customer, it is unlikely that the loss could be completely offset by other customers in the near-term, if at all. Some of our lending customers may decide to write business only with a limited number of mortgage insurers or only with certain mortgage insurers, based on their views with respect to an insurer’s pricing, service levels, underwriting guidelines, loss mitigation practices, financial strength or other factors. Alternatively, certain other lending customers have chosen for risk management purposes to diversify the mortgage insurers with which they do business, which may negatively affect our level of NIW and market share with those customers. Given that many of our customers currently give us a significant portion of their total mortgage insurance business, it is possible that further diversification could have a negative impact on our NIW if we are unable to mitigate the market share loss through new customers or increases in business with other customers. Further, we actively engage with our customers to ensure that we are receiving an appropriate mix of business from such customers at acceptable projected returns, and depending on the circumstances, we could take action with respect to customers (e.g., limiting the type of business we accept from them or instituting pricing changes that impact them) that could result in customers reducing the amount of business they do with us or deciding not to do business with us altogether. Any significant loss in our market share could negatively impact our mortgage insurance franchise, results of operations and financial condition.
Our mortgage insurance business faces intense competition.
The U.S. mortgage insurance industry is highly competitive. Our competitors primarily include other private mortgage insurers and governmental agencies, principally the FHA and VA.
We currently compete with other private mortgage insurers that are eligible to write business for the GSEs primarily on the basis of price, underwriting guidelines, overall service, customer relationships, perceived financial strength (including comparative credit ratings) and reputation. Overall service competition is based on, among other things, effective and timely delivery of products, timeliness of claims payments, customer service, timely and accurate servicing of policies, training, loss mitigation efforts and management and field service expertise. We also believe that service includes our ability to offer services to customers through our Services business that complement our mortgage insurance products. For more information about our competitive environment, including pricing competition, see “Item 1. Business-Mortgage Insurance-Competition.”
In developing our pricing and origination strategies, we monitor various competitive and economic factors while seeking to enhance the long-term value of our portfolio by balancing credit risk, profitability and volume and capital considerations. Pricing strategies continue to evolve in the mortgage insurance industry and mortgage insurers generally have migrated to offering various pricing methodologies with differing degrees of risk-based granularity. The shift away from a predominantly rate-card-based pricing model and the increase in “black box” pricing frameworks provides a more dynamic pricing environment that has led to an increase in the frequency of pricing changes throughout the mortgage insurance industry and a reduction in pricing transparency. As a result, we may not be aware of rate changes in the industry until we observe that our volume of NIW has changed. Further, this shift in risk-based, granular pricing methodologies, as well as the development of enhanced digital technologies for delivering and receiving price quotes, has led to an increasing number of customers making their choice of mortgage insurance providers based on the lowest price available for any particular loan, without consideration of other factors.
The evolution of pricing changes in the mortgage insurance industry has heightened overall competition and generally reduced pricing for our mortgage insurance. This reduction in our premium rates is expected to decrease the premium yield of our insured portfolio over time as older vintage insured loans with higher premium rates run-off and are replaced with insured loans with lower premium rates.
Overall, our approach to pricing is customer-centric and flexible, as we offer a spectrum of risk-based pricing solutions for our customers that are designed to be balanced with our objectives for managing our volume of NIW and the risk/return profile of our insured portfolio. Although we believe we are well-positioned to compete effectively, our pricing strategy may not be successful. Despite our pricing actions, we may experience returns below our targeted returns and we may lose business to other competitors. There can be no assurance that pricing competition will not intensify further, which could result in a decrease in our projected returns.
Certain of our private mortgage insurance competitors are subsidiaries of larger corporations, may have access to greater amounts of capital and financial resources than we do at a lower cost of capital (including off-shore reinsurance vehicles) and currently have better financial strength ratings than we have. As a result, they may be better positioned to compete outside of traditional mortgage insurance, including in the private label securitization market or if the GSEs expand their use of, or pursue
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alternative forms of, credit enhancement outside of private mortgage insurance in its traditional form. In addition, because of tax advantages associated with being off-shore, certain of our competitors have been able to reinsure to their offshore affiliates and achieve higher after-tax rates of return on the NIW they write compared to mortgage insurers such as Radian Guaranty that do not have access to offshore affiliates, which could allow these off-shore competitors to leverage reduced pricing to gain market share, while continuing to achieve acceptable returns on NIW.
We also compete with governmental entities, such as the FHA and VA, primarily on the basis of loan limits, pricing, credit guidelines, terms of our insurance policies and loss mitigation practices. These governmental entities typically do not have the same capital requirements or business objectives that we and other private mortgage insurance companies have, and therefore, may have greater financial flexibility in their pricing guidelines and capacity that could put us at a competitive disadvantage. If these entities lower their pricing or alter the terms and conditions of their mortgage insurance or other credit enhancement products in furtherance of political, social or other goals rather than a profit motive, we may be unable to compete in that market effectively, which could have an adverse effect on our business, financial condition and operating results.
Beginning in 2008, the FHA, which historically had not been a significant competitor, substantially increased its share of the mortgage insurance market, including by insuring a number of loans that would meet our current underwriting guidelines, sometimes at a lower monthly cost to the borrower than a loan that carries our mortgage insurance. The FHA may continue to maintain a significant market position and could increase its market position. Factors that could cause the FHA to maintain or enhance its competitive position include:
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governmental policy, including decreases in the pricing of FHA insurance or changes in the terms of FHA insurance such as the current life-of-loan coverage requirement;
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a coordinated effort by the FHFA and FHA to increase the FHA’s share of certain high LTV loans currently purchased by the GSEs;
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changes to the legal requirements (e.g., compliance certifications) for conducting business with the FHA, including those recently implemented, to reduce the perceived risk that lenders will be subject to liability in connection with loans insured by the FHA;
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changes to the CFPB definition of QM that results in a broader definition of qualified mortgage for FHA eligible loans than GSE eligible loans;
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capital requirements imposed on the private mortgage insurance industry;
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the tightening by private mortgage insurers of underwriting guidelines based on credit risk concerns;
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business changes by the GSEs, including underwriting changes, a reduction in loan limits or increases in the loan level price adjustments (based on risk) charged by the GSEs on loans that require mortgage insurance and changes in the amount of guarantee fees for the loans that they acquire (which may result in higher cost to borrowers); and
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the perceived operational ease of using FHA insurance compared to the products of private mortgage insurers.
Other private mortgage insurers may seek to compete for market share from the FHA or other mortgage insurers by reducing pricing, which could, in turn, improve their competitive position in the industry and negatively impact our level of NIW.
We have faced increasing competition from the VA. Based on publicly available information, the VA accounted for 26% of the insurable mortgage market in 2019. We believe that the VA’s market share has generally been increasing because the VA offers 100% LTV loans and charges a one-time funding fee that can be included in the loan amount with no additional monthly expense, and because of an increase in the number of borrowers that are eligible for the VA’s program.
In addition, as market conditions change, alternatives to private mortgage insurance may become more prevalent, which could reduce the demand for private mortgage insurance in its traditional form, including:
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structures, such as the IMAGIN and EPMI pilot programs launched in 2018 by Freddie Mac and Fannie Mae, respectively, that are commonly referred to as “investor paid mortgage insurance” in which affiliates of traditional mortgage insurers directly insure the GSEs against loss;
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lenders and other investors holding mortgages in their portfolio and self-insuring;
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lenders using pass-through vehicles that take on the risk of loss for loans ultimately sold to the GSEs;
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structured risk transfer transactions in the capital markets;
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risk sharing, risk transfer or using other risk mitigation techniques in conjunction with reduced levels of private mortgage insurance coverage;
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lenders originating mortgages using “piggyback” structures to avoid private mortgage insurance, such as a first-lien mortgage with an 80% LTV and a second mortgage with a 10%, 15% or 20% LTV; and
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other potential forms of credit enhancement that do not involve private mortgage insurance.
See “-Changes in the charters, business practices, or role of the GSEs in the U.S. housing market generally, could significantly impact our mortgage insurance business.”
The competitive environment is extremely challenging given the multitude of factors discussed above. This environment, as well as potential further changes to this evolving environment, could negatively impact our franchise value, business prospects, results of operations and financial condition.
Our business depends, in part, on effective and reliable loan servicing.
We depend on third-party servicing of the loans that we insure. Dependable servicing is necessary for timely billing and effective loss mitigation opportunities for delinquent or near-delinquent loans. Changes in the servicing industry, challenging economic and market conditions or periods of economic stress and high mortgage defaults could negatively affect the ability of servicers to effectively service the loans that we insure. Further, servicers are required to comply with a multitude of legal and regulatory requirements, procedures and standards for servicing residential mortgages such as the CFPB’s mortgage servicing rules. While these requirements are intended to ensure a high level of servicing performance, they also impose a high cost of compliance on servicers that may impact their financial condition and their operating effectiveness. If we experience a disruption in the servicing of mortgage loans covered by our insurance policies, this, in turn, could contribute to a rise in defaults and/or claims among those loans, which could have a material adverse effect on our business, financial condition and operating results.
An extension in the period of time that a loan remains in our defaulted loan inventory may increase the severity of claims that we ultimately are required to pay.
High levels of defaults and corresponding delays in foreclosures could delay our receipt of claims, resulting in an increase in the period of time that a loan remains in our defaulted loan inventory, and as a result, the Claim Severity. Following the financial crisis, the average time that it took for us to receive a claim increased. This was, in part, due to loss mitigation protocols that were established by servicers and also to a significant backlog of foreclosure proceedings in many states, and especially in those states that impose a judicial process for foreclosures. Generally, foreclosure delays do not stop the accrual of interest or affect other expenses on a loan, and unless a loan is cured during such delay, once title to the property ultimately is obtained and a claim is filed, our paid claim amount may include additional interest and expenses, increasing the Claim Severity. While foreclosure timelines have improved in recent years, a portion of our portfolio originated in the years prior to and including 2008 consists of severely delinquent loans. Further, another period of significant economic stress and a high level of defaults could once again delay claims and result in higher levels of Claim Severity. Higher levels of Claim Severity would increase our incurred losses and could negatively impact our results of operations and financial condition.
Our success depends on our ability to assess and manage our underwriting risks; the premiums we charge may not be adequate to compensate us for our liability for losses and the amount of capital we are required to hold against our insured risks. We expect to incur future provisions for losses beyond what we have reserved for in our financial statements.
The estimates and expectations we use to establish premium rates are based on assumptions made at the time our insurance is written. Our mortgage insurance premiums are based on, among other items, the amount of capital we are required to hold against our insured risks and our estimates of the long-term risk of claims on insured loans. Our premium rates are established based on performance models that consider a broad range of borrower, loan and property characteristics, as well as capital requirements and market and economic conditions. Our assumptions may ultimately prove to be inaccurate.
If the risk underlying a mortgage loan we have insured develops more adversely than we anticipated, we generally cannot increase the premium rates on this in-force business, or cancel coverage or elect not to renew coverage, to mitigate the effects of such adverse developments. Similarly, we cannot adjust our premiums if the amount of capital we are required to hold against our insured risks increases from the amount we were required to hold at the time a policy was written. As a result, if we are unable to compensate for or offset the increased capital requirements in other ways, the returns on our business may be lower than we assumed or expected. Our premiums earned and the associated investment income on those premiums may ultimately prove to be inadequate to compensate for the losses that we may incur and may not provide an adequate return on increased capital that may be required. As a result, our results of operations and financial condition could be negatively impacted.
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Additionally, in accordance with industry practice, we do not establish reserves in our mortgage insurance business until we are notified that a borrower has failed to make at least two monthly payments when due. Because our mortgage insurance reserving does not account for the impact of future losses that we expect to incur with respect to performing (non-defaulted) loans, our obligation for ultimate losses that we expect to incur at any period end is not reflected in our financial statements, except to the extent that a premium deficiency exists. As a result, our losses can be more severe in periods of high defaults given that we generally are not permitted to establish reserves in anticipation of such defaults.
If the estimates we use in establishing loss reserves are incorrect, we may be required to take unexpected charges to income, which could adversely affect our results of operations.
We establish loss reserves in our mortgage insurance business to provide for the estimated cost of future claims on defaulted loans. Setting our loss reserves requires significant judgment by management with respect to the likelihood, magnitude and timing of each potential loss, including an estimate of the impact of our Loss Mitigation Activities with respect to defaulted loans. The models, assumptions and estimates we use to establish loss reserves may not prove to be accurate, especially in the event of an extended economic downturn or a period of extreme market volatility and uncertainty. Because of this, claims paid may be substantially different than our loss reserves and these reserves may be insufficient to satisfy the full amount of claims that we ultimately have to pay. Changes to our estimates could adversely impact our results of operations and financial condition.
A portion of the defaulted loans in our portfolio originated in the years prior to and including 2008 have been in default for an extended period of time. While these loans are generally assigned a higher loss reserve based on our belief that they are more likely to result in a claim, we also assume, based on historical trends, that a significant portion of these loans will cure or otherwise not result in a claim. Given the significant period of time that these loans have been in default, it is possible that the ultimate cure rate for these defaulted loans will be less than our current estimates of Cures for this inventory of defaults.
If our estimates are inadequate, we may be required to increase our reserves, which could have a material adverse effect on our results of operations and financial condition.
Our delegated underwriting program may subject our mortgage insurance business to unanticipated claims.
In our mortgage insurance business, we permit lenders to obtain mortgage insurance for residential mortgage loans originated and underwritten by them using Radian’s pre-established underwriting guidelines. Once we accept a lender into our delegated underwriting program, we generally insure a mortgage loan originated by that lender based on our expectation that the lender has followed our specified underwriting guidelines in accordance with the endorsement. Under this program, a lender could commit us to insure a material number of loans with unacceptable risk profiles before we discover the problem and terminate that lender’s delegated underwriting authority or pursue other rights that may be available to us, such as our rights to rescind coverage or deny claims.
We face risks associated with our contract underwriting business.
We provide third-party contract underwriting services for our customers. We provide these customers with limited indemnification rights with respect to those loans that we simultaneously underwrite for both secondary market compliance and for potential mortgage insurance eligibility. In addition, in certain circumstances, we may also offer limited indemnification when we underwrite a loan only for secondary market compliance. In addition to indemnification, we typically have limited loss mitigation defenses available to us for loans that we have underwritten through our contract underwriting services. As a consequence, our results of operations could be negatively impacted if we are required to indemnify our customers for material underwriting errors in our contract underwriting services.
Reinsurance may not be available, affordable or adequate to protect us against losses.
In our mortgage insurance business, we use reinsurance as a capital and risk management tool. We have distributed risk through third-party quota share and excess-of-loss reinsurance arrangements, as well as through the capital markets using mortgage insurance-linked notes transactions.
The availability and cost of reinsurance are subject to market conditions beyond our control. No assurance can be given that reinsurance will remain available to us in amounts that we consider sufficient and at rates that we consider acceptable. Accordingly, we may be forced to incur additional expenses for reinsurance or may not be able to obtain sufficient reinsurance on acceptable terms, which could cause us to increase the amount of risk we retain, negatively affect the returns we are able to achieve on the business we write and adversely affect our ability to write future business. Further, reinsurance does not relieve us of our direct liability to policyholders, therefore, if the reinsurer is unable or unwilling to meet its obligations to us, we remain liable to make claims payments to our policyholders. As a result, our reinsurance arrangements do not fully eliminate
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our obligation to pay claims, and we have assumed credit risk with respect to our inability to recover amounts due from reinsurers. If we are unable to obtain sufficient reinsurance on acceptable terms or to collect amounts due from our reinsurers, it could have a material adverse effect on our business, financial condition and results of operations.
Uncertainty relating to the potential discontinuance of LIBOR after 2021 may adversely affect us.
In 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, announced that after 2021 it would no longer compel banks to submit rate quotations required to calculate LIBOR. As a result, it is uncertain whether LIBOR will continue to be quoted after 2021. Efforts are underway to identify and transition to a set of alternative reference rates. The set of alternative rates includes the Secured Overnight Financing Rate (“SOFR”), which the Federal Reserve Bank of New York began publishing in 2018. In addition, central banks in several other jurisdictions have also announced plans for alternative reference rates for other currencies. There is considerable uncertainty as to how the financial services industry will address the expected discontinuance of LIBOR in financial instruments that are indexed to LIBOR. Financial instruments indexed to LIBOR could experience disparate outcomes based on their contractual terms, ability to amend those terms, market or product type, legal or regulatory jurisdiction, and other factors. Alternative reference rates that replace LIBOR may not yield the same or similar economic results over the lives of the financial instruments, which could adversely affect the value of and return on these instruments.
Any changes to or discontinuation of LIBOR may have an adverse effect on the premium rates we are required to pay in connection with our existing insurance-linked notes transactions, which are tied to LIBOR, or other assets or liabilities whose value is tied to LIBOR or to a LIBOR alternative, including floating rate bonds we hold in our investment portfolio and borrowings under our credit facility which currently uses LIBOR as a benchmark for establishing the interest rate. Furthermore, changes to or the discontinuation of LIBOR may impact our investment portfolio and our cost of debt, as well as other aspects of our business, such as our insurance products, the pricing we charge and the models we use to support our business decisions. It is possible that the discontinuance or replacement of LIBOR, including the implementation of alternative benchmark rates to LIBOR, could have an adverse effect on our business, results of operations or financial condition.
The current financial strength ratings assigned to our mortgage insurance subsidiaries could weaken our competitive position.
Radian Guaranty has been assigned a rating of Baa1 by Moody’s and a rating of BBB+ by S&P. While Radian Guaranty’s financial strength ratings currently are investment grade, these ratings are below the ratings assigned to certain other private mortgage insurers. We do not believe our ratings have had a material adverse effect on our relationships with existing customers. However, if financial strength ratings become a more prominent consideration for lenders, we may be competitively disadvantaged by customers choosing to do business with private mortgage insurers that have higher financial strength ratings. In addition, the current PMIERs do not include a specific ratings requirement with respect to eligibility, but if this were to change in the future, we may become subject to a ratings requirement in order to retain our eligibility status under the PMIERs.
The GSEs currently consider financial strength ratings, among other items, to determine the amount of collateral that an insurer must post when participating in the credit risk transfer transactions currently being conducted by the GSEs. As a result, the returns that we are able to achieve when participating in these transactions are dependent, in part, on our financial strength ratings. We currently use Radian Reinsurance to participate in the GSEs’ credit risk transfer transactions. Radian Reinsurance has been assigned a rating of BBB+ by S&P. Market participants with higher ratings than us are assigned lower collateral requirements by the GSEs for these transactions and generally have a lower cost of capital, which may give them a competitive advantage, including the ability to price more aggressively for these transactions.
We believe that financial strength ratings remain a significant consideration for participants seeking to secure credit enhancement in the non-GSE mortgage market, which includes most non-qualified mortgage loans. While this market has remained limited since the financial crisis, we view this market as an area of potential future growth, which could be further accelerated by changes to the QM Rule currently under consideration by the CFPB, and our ability to successfully participate in this market could depend on our ability to secure higher ratings for our mortgage insurance subsidiaries. In addition, if legislative or regulatory changes were to alter the current state of the housing finance industry such that the GSEs no longer operate in their current capacity, we may be forced to compete in a new marketplace in which financial strength ratings may play a greater role. If we are unable to compete effectively in the current or any future markets as a result of the financial strength ratings assigned to our mortgage insurance subsidiaries, the franchise value and future prospects for our mortgage insurance business could be negatively affected.
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Our success depends, in part, on our ability to manage risks in our investment portfolio.
Our investment portfolio is an important source of revenue and is our primary source of claims paying resources. Although our investment portfolio consists mostly of highly-rated fixed income investments, our investment strategy is affected by general economic conditions, which may adversely affect the markets for credit and interest-rate-sensitive securities, including the extent and timing of investor participation in these markets, the level and volatility of interest rates and credit spreads and, consequently, the value of our fixed income securities, and as such, we may not achieve our investment objectives. Volatility or lack of liquidity in the markets in which we hold positions has at times reduced the market value of some of our investments, and if this worsens substantially it could have a material adverse effect on our liquidity, financial condition and results of operations.
Interest rates and investment yields on our investments continue to be low compared to historical averages, which has reduced the investment income we generate. Although in recent years our portfolio yield has been increasing, continued low interest rates could negatively affect our portfolio yield. For the significant portion of our investment portfolio held by our insurance subsidiaries, to receive full capital credit under insurance regulatory requirements and under the PMIERs, we generally are limited to investing in highly-rated investments that are unlikely to increase our investment returns. Because we depend on our investments as a source of revenue, a prolonged period of lower than expected investment yields would have an adverse impact on our revenues and could potentially adversely affect our results of operations. Further, future updates to the NAIC Model Act or PMIERs could impact our investment choices, which could negatively impact our investment strategy.
In addition, we structure our investment portfolio to satisfy our expected liabilities, including claim payments in our mortgage insurance business. If we underestimate our liabilities or improperly structure our investments to meet these liabilities, we could have unexpected losses resulting from the forced liquidation of investments before their maturity, which could adversely affect our results of operations.
Radian Group’s sources of liquidity may be insufficient to fund its obligations.
Radian Group serves as the holding company for our operating subsidiaries and does not have any operations of its own. As of December 31, 2019, Radian Group had available, either directly or through unregulated subsidiaries, unrestricted cash and liquid investments of $652.6 million. This amount excludes certain additional cash and liquid investments that have been advanced to Radian Group from our subsidiaries for corporate expenses and interest payments. Total liquidity, which includes our undrawn $267.5 million unsecured revolving credit facility entered into in October 2017, was $920.1 million as of December 31, 2019.
We expect Radian Group’s principal liquidity demands for the next 12 months to be: (i) the payment of corporate expenses, including taxes; (ii) interest payments on our outstanding debt obligations; (iii) the payment of dividends on our common stock, which we recently increased to $0.125 per share; and (iv) the repurchases of Radian Group common stock pursuant to our authorized share repurchase program.
In addition to our ongoing short-term liquidity needs discussed above, our most significant need for liquidity beyond the next 12 months is the repayment of $900 million aggregate principal amount of our senior debt due in future years. Radian Group’s liquidity demands for the next 12 months or in future periods could also include: (i) early repurchases or redemptions of portions of our debt obligations and (ii) potential investments to support our business strategy, including potential additional capital contributions to our subsidiaries and possible acquisitions or investments in new businesses.
In addition to available cash and marketable securities, Radian Group’s principal sources of cash to fund future liquidity needs include: (i) payments made to Radian Group by its subsidiaries under expense- and tax-sharing arrangements; (ii) net investment income earned on its cash and marketable securities; (iii) to the extent available, dividends or other distributions from our subsidiaries; and (iv) amounts that Radian Guaranty is able to repay under the Surplus Notes. Radian Group also has in place a $267.5 million unsecured revolving credit facility with a syndicate of bank lenders. At December 31, 2019, the full $267.5 million remains undrawn and available under the facility. Radian Group’s expense-sharing arrangements with its principal operating subsidiaries require those subsidiaries to pay their allocated share of certain holding-company-level expenses, including interest payments on our outstanding senior notes. The expense-sharing arrangements between Radian Group and our mortgage insurance subsidiaries, as amended, have been approved by the Pennsylvania Insurance Department, but such approval may be modified or revoked at any time.
In light of Radian Guaranty’s negative unassigned surplus related to operating losses in prior periods and the ongoing need to set aside contingency reserves, we do not anticipate that Radian Guaranty will be permitted under applicable insurance laws to pay ordinary dividends to Radian Group for the foreseeable future. Based on the typical 10-year holding requirement, Radian Guaranty is scheduled to release contingency reserves to unassigned surplus in material amounts beginning in 2024,
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which should accelerate the reduction of its negative unassigned surplus. See Note 18 of Notes to Consolidated Financial Statements for additional information on contingency reserve requirements.
Further, the Services segment has not generated sufficient cash flows to pay dividends to Radian Group. In the event the cash flow from operations of the Services segment is not adequate to fund all of its needs, Radian Group may provide additional funds to the Services segment in the form of a capital contribution or an intercompany note.
As of December 31, 2019, certain of our subsidiaries have incurred federal NOLs that could not be carried-back and utilized on a separate company tax return basis. As a result, we are not currently obligated under our tax-sharing agreement to reimburse these subsidiaries for their separate company federal NOL carryforward. However, if in a future period, one of these subsidiaries utilizes its share of federal NOL carryforwards on a separate entity basis, then Radian Group may be obligated to fund such subsidiary’s share of our consolidated tax liability to the IRS. Certain subsidiaries currently have federal NOLs on a separate entity basis that are available for future utilization. However, we do not expect to fund material obligations related to these subsidiary NOLs.
In light of Radian Group’s short- and long-term needs, it is possible that our sources of liquidity could be insufficient to fund our obligations and could exceed available holding company funds. If this were to occur, we may need or otherwise may decide to increase our available liquidity, including by reducing our quarterly dividend or terminating our stock repurchase authorizations, incurring additional debt, by issuing additional equity or by selling assets, any of which we may be unable to do on favorable terms, if at all.
Our revolving credit facility contains restrictive covenants that could limit our operating flexibility. A default under our credit facility could trigger an event of default under the terms of our senior notes. We may not have access to funding under our credit facility when we require it.
Radian Group is a party to a $267.5 million unsecured revolving credit facility with a syndicate of bank lenders. As of December 31, 2019, no borrowings were outstanding under the credit facility.
The credit facility contains certain restrictive covenants that, among other things, provide certain limitations on our ability to incur additional indebtedness, make investments, create liens, transfer or dispose of assets, merge with or acquire other companies and pay dividends. The credit facility also requires us to comply with certain financial covenants and further provides that: (i) Radian Group must be rated by S&P or Moody’s and (ii) Radian Guaranty must remain eligible under the PMIERs to insure loans purchased by the GSEs. A failure to comply with these covenants or the other terms of the credit facility could result in an event of default, which could: (a) result in the termination of the commitments by the lenders to make loans to Radian Group under the credit facility and (b) enable the lenders to declare, subject to the terms and conditions of the credit facility, any outstanding obligations under the credit facility to be immediately due and payable.
Further, the occurrence of an event of default under the terms of our credit facility may trigger an event of default under the terms of our senior notes. An event of default would occur under the terms of our senior notes if a default: (i) in any scheduled payment of principal of other indebtedness by Radian Group or its subsidiaries of more than $100 million principal amount occurs, after giving effect to any applicable grace period or (ii) in the performance of any term or provision of any indebtedness of Radian Group or its subsidiaries in excess of $100 million principal amount occurs that results in the acceleration of the date such indebtedness is due and payable, subject to certain limited exceptions. See Note 12 of Notes to Consolidated Financial Statements for more information on the carrying value of our senior notes.
If the commitments of the lenders under the credit facility are terminated or we are unable to satisfy certain covenants or representations, we may not have access to funding in a timely manner, or at all, when we require it. If funding is not available under the credit facility when we require it, our ability to continue our business practices or pursue our current strategy could be limited. If the indebtedness under the credit facility or our senior notes is accelerated, we may not be able to repay our debt or borrow sufficient funds to refinance it.
Our credit facility terminates on October 16, 2020 and we may be unable to renew or replace this facility on acceptable terms. If we are unable to obtain new financing or funding when needed, or if there were to be an event of default under our credit facility or senior notes for any reason, our cash flows, financial results or financial condition could be materially and adversely affected.
We may not continue to pay dividends at the same rate we are currently paying them, or at all, and any decrease in or suspension of payment of a dividend could cause our stock price to decline.
Effective February 13, 2020, Radian Group’s board of directors authorized an increase to the Company’s quarterly cash dividend to $0.125 per share effective for the quarterly dividend payable in March 2020. The payment of future cash dividends
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is subject to the determination each quarter by our board of directors that the dividend remains in the best interests of the Company and our stockholders, which determination will be based on a number of factors, including, among others, economic conditions, our earnings, financial condition, actual and forecasted cash flows, capital resources, capital requirements and alternative uses of capital, including potential investments to support our business strategy and possible acquisitions or investments in new businesses. Any decrease in the amount of the dividend, or suspension or discontinuance of payment of a dividend, could cause our stock price to decline.
Our reported earnings are subject to fluctuations based on changes in our trading securities, equity securities and short-term investments that require us to adjust their fair market value.
We have significant holdings of trading securities, equity securities and short-term investments that we carry at fair value. Because the changes in fair value of these financial instruments are reflected on our statements of operations each period, they affect our reported earnings and can create earnings volatility. Among other factors, interest rate changes, market volatility and declines in the value of underlying collateral will impact the value of our investments, potentially resulting in unrealized losses that could negatively impact our results of operations.
Our information technology systems may fail or become outmoded, be temporarily interrupted or otherwise cause us to be unable to meet our customers’ demands.
Our business is highly dependent on the effective operation of our information technology systems, which are vulnerable to damage or interruption from power outages, computer and telecommunications failures, computer viruses, cyber-attacks, security breaches, catastrophic events and errors in usage. Although we have disaster recovery and business continuity plans in place, we may not be able to adequately execute these plans in a timely fashion.
Additionally, our ability to meet the needs of our customers depends on our ability to keep pace with technological advances and to invest in new technology as it becomes available or otherwise upgrade our technological capabilities. We rely on e-commerce and other technologies to provide our products and services to our customers, and they generally require that we provide an increasing number of our products and services electronically. Accordingly, we may not satisfy our customers’ requirements if we fail to invest sufficient resources or are otherwise unable to maintain and upgrade our technological capabilities. Further, customers may choose to do business only with business partners with which they are technologically compatible and may choose to retain existing relationships with mortgage insurance or mortgage and real estate services providers rather than invest the time and resources to on-board new providers. As a result, technology can represent a potential barrier to signing new customers.
Because we rely on our information technology systems for many critical functions, including connecting with our customers, if such systems were to fail, experience a prolonged interruption, or become outmoded, we may experience a significant disruption in our operations and in the business we receive, which could have a material adverse effect on our business, financial condition and operating results.
In addition, we are in the process of implementing a major technology project to improve our operating systems, including a new platform for our mortgage insurance underwriting, policy administration, claims management and billing processes. The implementation of these technological improvements is complex, expensive, time consuming and, in certain respects, depends on the ability of third parties to perform their obligations in a timely manner. If we fail to timely and successfully implement the new technology systems and business processes, or if the systems do not operate as expected, it could have an adverse impact on our business, business prospects and results of operations.
We could incur significant liability or reputational harm if the security of our information technology systems is breached, including as result of a cyberattack, or we otherwise fail to protect confidential information, including non-public personal information that we maintain.
Our information technology systems may be vulnerable to physical or electronic intrusions, computer viruses or other attacks, including cyberattacks. In recent years, cyberattacks such as distributed denial of service attacks, computer viruses, hacking, malware, ransomware, phishing or other forms of social engineering and insider threats designed to obtain confidential information, destroy data, disrupt or degrade service, sabotage systems or to cause other damage have grown in volume and level of sophistication. Further, the risks of cyberattacks and information security breaches continue to increase in businesses such as ours due to, among other things, the proliferation of new technologies and the use of digital channels to conduct our business, including connectivity with customer devices that are beyond our security control systems.
As part of our business, we, and certain of our subsidiaries and affiliates, maintain large amounts of confidential information, including non-public personal information on borrowers, consumers and our employees. If the security of our
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Part I Item 1A. Risk Factors
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information technology is breached, including as a result of a cyberattack, it could result in the loss or misuse of this information, which could, in turn, result in potential regulatory actions or litigation, including material claims for damages, as well as interruption to our operations and damage to our customer relationships and reputation. While we have information security policies, controls and systems in place in order to attempt to prevent, detect and respond to unauthorized use or disclosure of confidential information, including non-public personal information, there can be no assurance that such use or disclosure will not occur. Any cybersecurity event or other compromise of the security of our information technology systems, or unauthorized use or disclosure of confidential information, could subject us to liability, regulatory scrutiny and action, damage our reputation and negatively affect our ability to attract and maintain customers, and could have a material adverse effect on our business prospects, financial condition and results of operations.
We are subject to litigation and regulatory proceedings.
We operate in highly regulated industries that are subject to a heightened risk of litigation and regulatory proceedings. We often are a party to material litigation and also are subject to legal and regulatory claims, assertions, actions, reviews, audits, inquiries and investigations. Additional lawsuits, legal and regulatory proceedings and inquiries and other matters may arise in the future. The outcome of existing and future legal and regulatory proceedings and inquiries and other matters could result in adverse judgments, settlements, fines, injunctions, restitutions or other relief which could require significant expenditures or have a material adverse effect on our business prospects, results of operations and financial condition. See “Item 3. Legal Proceedings.”
Legislation and administrative and regulatory changes and interpretations could impact our businesses.
Our businesses are subject to and may be impacted by many federal and state lending, insurance and consumer laws and regulations and may be affected by changes in these laws and regulations or the way they are interpreted or applied. In particular, our businesses may be significantly impacted by the following:
•
legislation, administrative or regulatory action impacting the charters or business practices of the GSEs;
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reform of the U.S. housing finance system;
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legislation and regulation impacting the FHA and its competitive position versus private mortgage insurers;
•
state insurance laws and regulations that address, among other items, licensing of companies to transact business, claims handling, reinsurance requirements, premium rates, policy forms offered to customers and requirements for Risk-to-capital, minimum policyholder positions, reserves (including contingency reserves), surplus, reinsurance and payment of dividends;
•
the application of state, federal or private sector programs aimed at supporting borrowers and the housing market;
•
the application of RESPA, the FCRA and other laws to our businesses;
•
new federal standards and oversight for mortgage insurers, including as a result of the recommendation of the Federal Insurance Office of the U.S. Department of the Treasury that federal standards and oversight for mortgage insurers be developed and implemented;
•
the implementation of new regulations under, or the potential repeal or amendment of provisions of, the Dodd-Frank Act, including future changes in the QM Rule and QM loan requirements as are currently being contemplated by the CFPB; and
•
the implementation in the U.S. of the Basel III capital adequacy guidelines.
See “Item 1. Business-Regulation.”
Any of the items discussed above could adversely affect our results of operations, financial condition and business prospects. In addition, our businesses could be impacted by new legislation or regulations, as well as changes to existing legislation or regulations or the way they are interpreted or applied, including changes that are not currently contemplated and which could occur at any time.
We rely on our management team and our business could be harmed if we are unable to retain qualified personnel or successfully develop and/or recruit their replacements.
Our success depends, in part, on the skills, working relationships and continued services of our management team and other key personnel, any of whom could terminate his or her relationship with us at any time. The unexpected departure of key personnel could adversely affect the conduct of our business. In such event, we would be required to obtain other personnel to
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manage and operate our business. In addition, we will be required to replace the knowledge and expertise of our workforce as our workers retire. In either case, there can be no assurance that we would be able to develop or recruit suitable replacements for the departing individuals, that replacements could be hired, if necessary, on terms that are favorable to us, or that we can successfully transition such replacements in a timely manner. Failure to effectively implement our succession planning efforts and to ensure effective transfers of knowledge and smooth transitions involving members of our management team and other key personnel could adversely affect our business and results of operations. Without a properly skilled and experienced workforce, our costs, including costs associated with a loss of productivity and costs to replace employees, may increase, and this could negatively impact our earnings.
We may make investments to grow our existing businesses, pursue new lines of business or new business initiatives, acquire other companies or engage in other strategic initiatives, each of which may result in additional risks and uncertainties.
In support of our growth strategy, we may make strategic investments, acquisitions or pursue other strategic initiatives that expose us to additional risks and uncertainties that include, without limitation:
•
the use of capital and potential diversion of other resources, such as the diversion of management’s attention from our core businesses and potential disruption of those businesses;
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the assumption of liabilities in connection with any strategic investment, including any acquired business;
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our ability to comply with additional regulatory requirements associated with new products, services, lines of business, or other business or strategic initiatives;
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our ability to successfully integrate or develop the operations of any new business initiative or acquisition;
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the possibility that any new business initiatives may be disruptive to our existing customer relationships;
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the possibility that we may fail to realize the anticipated benefits of an acquisition or other strategic investment or initiative, including expected synergies, cost savings, or sales or growth opportunities, within the anticipated timeframe or at all; and
•
the possibility that we may fail to achieve forecasted results for a strategic investment, acquisition or other initiative that could result in lower or negative earnings contribution and/or impairment charges associated with intangible assets acquired.
We face risks associated with our Services business.
Our Services business exposes us to certain risks that may negatively affect our results of operations and financial condition, including, among others, the following:
•
Our Services revenue is dependent on a limited number of large customers that represent a significant proportion of our Services total revenues. The loss or reduction of business from one or more of these significant customers could adversely affect our revenues and results of operations. In addition, Radian Guaranty does business with many of these significant customers. In the event of a dispute between a significant customer and either of our business segments, the overall customer relationship for Radian could be negatively impacted.
•
Due to the transactional nature of our business, our Services segment revenues are subject to fluctuation from period to period and are difficult to predict.
•
The services we offer through our Services business are influenced by the level of overall activity in the mortgage, real estate and mortgage finance markets generally. If real estate transaction volumes decline, we could experience less demand for our real estate and title services.
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Red Bell is a licensed real estate brokerage and provides real estate brokerage services in all 50 states and the District of Columbia. As a licensed real estate brokerage, Red Bell receives residential real estate information from various multiple listing services (“MLS”). Red Bell receives this information, which it uses in its business to broker real estate transactions and provide valuation products and services, pursuant to the terms of agreements with the MLS providers. If these agreements were to terminate or Red Bell otherwise were to lose access to this information, it could negatively impact Red Bell’s ability to conduct its business and our future real estate strategies.
•
By their nature, title claims are often complex, vary greatly in dollar amounts and are affected by economic and market conditions and the legal environment existing at the time of settlement of the claims. Estimating future title loss payments is difficult because of the complex nature of title claims, the long periods of time over which claims
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are paid, significantly varying dollar amounts of individual claims and other factors. From time to time, we could experience large losses or an overall worsening of our loss payment experience in regard to the frequency or severity of claims that require us to record additional charges to our claims loss reserve. These loss events are unpredictable and could adversely affect the financial performance of our Services business.
Item 1B.
Item 1B.
Unresolved Staff Comments.
None.
Item 2.
Item 2.
Properties.
In addition to leases of other properties and facilities to support our business operations, the Company currently leases approximately 174,000 square feet of office and storage space at our corporate headquarters, located at 1500 Market Street, West Tower, in Philadelphia, Pennsylvania.
We believe our existing properties are well utilized, suitable and adequate for our present circumstances.
Item 3.
Item 3.
Legal Proceedings.
We are routinely involved in a number of legal actions and proceedings, including reviews, audits and inquiries by various regulatory entities, as well as litigation and other disputes arising in the ordinary course of our business. These proceedings could result in adverse judgments, settlements, fines, injunctions, restitutions or other relief that could require significant expenditures or have other effects on our business. Management believes, based on current knowledge and after consultation with counsel, that the outcome of such actions will not have a material adverse effect on our consolidated financial condition. The outcome of litigation and other legal and regulatory matters and proceedings is inherently uncertain, and it is possible that one or more of the matters currently pending or threatened could have an adverse effect on our liquidity, financial condition or results of operations for any particular period. In accordance with applicable accounting standards and guidance, we establish accruals only when we determine both that it is probable that a loss has been incurred and the amount of the loss is reasonably estimable. We accrue the amount that represents our best estimate of the probable loss; however, if we can only determine a range of estimated losses, we accrue an amount within the range that, in our judgment, reflects the most likely outcome, and if none of the estimates within the range is more likely, we accrue the minimum amount of the range.
In the course of our regular review of pending legal and regulatory matters, we determine whether it is reasonably possible that a potential loss may have a material impact on our liquidity, results of operations or financial condition. If we determine such a loss is reasonably possible, we disclose information relating to such potential loss, including an estimate or range of loss or a statement that such an estimate cannot be made. On a quarterly basis, we review relevant information with respect to loss contingencies and update our accruals, disclosures and estimates of reasonably possible losses or range of losses based on such reviews. We are often unable to estimate the possible loss or range of loss until developments in such matters have provided sufficient information to support an assessment of the range of possible loss, such as quantification of a damage demand from plaintiffs, discovery from other parties and investigation of factual allegations, rulings by the court on motions or appeals, analysis by experts, and the progress of settlement negotiations. In addition, we generally make no disclosures for loss contingencies that are determined to be remote. For matters for which we disclose an estimated loss, the disclosed estimate reflects the reasonably possible loss or range of loss in excess of the amount accrued, if any.
Loss estimates are inherently subjective, based on currently available information, and are subject to management’s judgment and various assumptions. Due to the inherently subjective nature of these estimates and the uncertainty and unpredictability surrounding the outcome of legal and other proceedings, actual results may differ materially from any amounts that have been accrued.
On December 22, 2016, Ocwen Loan Servicing, LLC and Homeward Residential, Inc. (collectively, “Ocwen”) filed a complaint in the U.S. District Court for the Eastern District of Pennsylvania against Radian Guaranty alleging breach of contract and bad faith claims and seeking monetary damages and declaratory relief. Ocwen has also initiated similar legal proceedings against several other mortgage insurers. On December 17, 2016, Ocwen separately filed a parallel arbitration petition against Radian Guaranty before the American Arbitration Association (“AAA”) asserting substantially the same allegations (the “Arbitration”). Ocwen’s filings together listed 9,420 mortgage insurance certificates issued under multiple insurance policies, including Pool Insurance policies, as subject to the dispute. On June 5, 2017, Ocwen filed an amended complaint and an amended petition (collectively, the “Amended Filings”) with both the court and the AAA, respectively, together listing 8,870 certificates as subject to the dispute. On April 11, 2018, the parties entered into a confidential agreement with respect to all certificates subject to the dispute. The confidential agreement resolved certain categories of claims involved
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in the dispute and, on April 12, 2018, the parties filed a stipulation of voluntary dismissal of the federal court proceeding and the trial judge issued an order dismissing all claims and counterclaims subject to the parties’ agreement. Radian Guaranty was not required to make any payment in connection with this confidential agreement. Pursuant to the confidential agreement, the parties: (1) dismissed the federal court proceeding; (2) narrowed the scope of the dispute to Ocwen’s breach of contract claims seeking payment of insurance benefits on approximately 2,500 certificates that Ocwen was previously pursuing through the Amended Filings; and (3) agreed to resolve the remaining dispute through the Arbitration. The Arbitration is proceeding, and Radian continues to defend against Ocwen’s claims vigorously.
On August 31, 2018, Nationstar Mortgage LLC d/b/a Mr. Cooper (“Nationstar”) filed a complaint in the U.S. District Court for the Eastern District of Pennsylvania against Radian Guaranty (the “Complaint”) alleging breach of contract, bad faith, equitable indemnification, unjust enrichment, and conversion claims and seeking monetary damages and declaratory relief. Exhibit 1 to the Complaint lists 3,014 mortgage insurance certificates issued under multiple insurance policies as subject to disputes involving insurance coverage decisions (the “Coverage Disputed Loans”). Exhibit 2 to the Complaint further lists 2,231 mortgage insurance certificates issued under multiple insurance policies as subject to disputes involving premium refund requests. In December 2018, Radian Guaranty filed a motion to dismiss the Complaint. In March 2019, the trial judge issued an order granting in part, and denying in part, our motion to dismiss, and dismissed Nationstar’s unjust enrichment and conversion claims. In May 2019, Radian Guaranty filed an answer, with affirmative defenses and counterclaims, in response to the Complaint. On September 23, 2019, the trial judge entered as an order a joint stipulation submitted by Nationstar and Radian Guaranty that narrowed the scope of the dispute involving Coverage Disputed Loans to claims relating to 1,704 mortgage insurance certificates. Radian Guaranty believes that Nationstar’s allegations and claims in the legal proceedings described above are without merit and legally deficient, and continues to defend against these claims vigorously.
In 2019, the Company increased its IBNR reserve estimate by $30.5 million related to our best estimate of our probable loss in connection with the above legal proceedings. While Radian believes it has substantial defenses in these matters and intends to continue to defend against these claims vigorously, it is not feasible to predict the ultimate outcome of these disputes, and the Company could in the future be required to pay amounts as a result of settlements or decisions in these matters, potentially in excess of accruals.
We also are periodically subject to reviews and audits, as well as inquiries, information-gathering requests and investigations. In connection with these matters, from time to time we receive requests and subpoenas seeking information and documents related to aspects of our business.
Our Master Policies establish the timeline within which any suit or action arising from any right of an insured under the
policy generally must be commenced. In general, any suit or action arising from any right of an insured under the policy must be commenced within two years after such right first arose for primary insurance and within three years for certain other policies, including certain Pool Insurance policies. Although we believe that our Loss Mitigation Activities are justified under our policies, we continue to face challenges from certain lender and servicer customers regarding our Loss Mitigation Activities, which may result in some reversals of our decisions regarding Rescissions, Claim Denials or Claim Curtailments. To the extent we are unable to resolve challenges from our customers regarding Loss Mitigation Activities and our claim payment practices, it could result in arbitration or judicial proceedings and we may need to reassume the risk on, and increase
loss reserves for, those policies or pay additional claims.
The legal and regulatory matters discussed above could result in adverse judgments, settlements, fines, injunctions, restitutions or other relief that could require significant expenditures or have other effects on our business. Management believes, based on current knowledge and after consultation with counsel, that the outcome of such actions will not have a material adverse effect on our consolidated financial condition. The outcome of litigation and other legal and regulatory matters and proceedings is inherently uncertain, and it is possible that one or more of the matters currently pending or threatened could have an adverse effect on our liquidity, financial condition or results of operations for any particular period.
Item 4.
Item 4.
Mine Safety Disclosures.
Not applicable.
Glossary
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PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock is listed on the New York Stock Exchange (“NYSE”) under the symbol “RDN.” At February 25, 2020, there were 198,640,237 shares of our common stock outstanding and 54 holders of record.
In 2019 and 2018, we declared quarterly cash dividends on our common stock equal to $0.0025 per share. We presently expect to continue to declare a regular quarterly dividend on our common stock. On February 13, 2020, Radian Group’s board of directors authorized an increase to the Company’s quarterly cash dividend from $0.0025 to $0.125 per share. For information on Radian Group’s ability to pay dividends, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.”
Reference is made to the information in Item 12 of this report under the caption “Equity Compensation Plans,” which is incorporated herein by reference.
Issuance of Unregistered Securities
During the last three years, no equity securities of the Company were sold that were not registered under the Securities Act.
Issuer Purchases of Equity Securities
The following table provides information about purchases of Radian Group common stock by us (and our affiliated purchasers) during the three months ended December 31, 2019.
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(1)
Includes 4,029 shares tendered by employees as payment of taxes withheld on the vesting of certain restricted stock awards granted under the Company’s equity compensation plans.
(2)
On August 14, 2019, Radian Group’s board of directors approved a share repurchase program authorizing the Company to spend up to $200 million to repurchase Radian Group common stock. Pursuant to this authorization, during the three months ended December 31, 2019, the Company purchased 1,090,875 shares at an average price of $22.93 per share, including commissions. On February 13, 2020, Radian Group’s board of directors authorized a $275 million increase in this program, bringing the total authorization to repurchase shares up to $475 million, excluding commissions. This share repurchase program expires on August 31, 2021. As of February 25, 2020, purchase authority of up to $359.2 million remained available under this program. See Note 14 of Notes to Consolidated Financial Statements for additional information.
Glossary
Part II Item 6.
Item 6.
Selected Financial Data.
The information in the following table should be read in conjunction with our Consolidated Financial Statements and Notes thereto included in Item 8 and the information included in Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following analysis of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and Notes thereto included in Item 8. Certain terms and acronyms used throughout this report are defined in the Glossary of Abbreviations and Acronyms included as part of this report. Some of the information in this discussion and analysis or included elsewhere in this report, including information with respect to our projections, plans and strategy for our business, are forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and the timing of events could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under “Cautionary Note Regarding Forward-Looking Statements-Safe Harbor Provisions” and in the Risk Factors detailed in Item 1A of this Annual Report on Form 10-K.
This section of our Annual Report on Form 10-K generally discusses our financial results for the years ended December 31, 2019 and 2018 and a year-over-year comparison between 2019 and 2018. Detailed discussions of our financial results for the year ended December 31, 2017, including the year-over-year comparisons between 2018 and 2017, that are not included in this Annual Report on Form 10-K can be found in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2018 filed with the SEC on February 28, 2019.
Overview
We are a diversified mortgage and real estate services business with two business segments-Mortgage Insurance and Services. Our Mortgage Insurance segment provides credit-related insurance coverage, principally through private mortgage insurance, as well as other credit risk management solutions, to mortgage lending institutions and mortgage credit investors. Our Services segment is primarily a fee-for-service business that offers a broad array of real estate, title and mortgage services to market participants across the mortgage and real estate value chain.
Operating Environment
As a seller of mortgage credit protection and other mortgage and credit risk management solutions, our results are subject to macroeconomic conditions and other events that impact the housing finance and real estate markets, including seasonal fluctuations, that specifically impact the mortgage origination environment, the credit performance of our underlying insured assets and our future business opportunities. The macroeconomic conditions, seasonality and other events that impact the housing, mortgage finance and related real estate markets also affect the demand for our real estate, title and mortgage services offered through our Services segment.
Our mortgage insurance business continues to benefit from the improvement in market conditions since the financial crisis of 2007-2008, and from the current strength of the U.S. economy and housing finance industry. In addition, our mortgage insurance business has benefited from strong demand for home purchases by first-time home buyers and other purchasers requiring low down payment loans. The positive growth in home prices and historically low levels of unemployment are reflected in the performance and favorable results of our existing portfolio of IIF, as evidenced by, among other things, the improvement in our levels of new defaults, incurred losses, paid claims and cure rates.
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Loans originated for the private mortgage insurance market since 2008 have consisted primarily of high credit quality loans and mortgage underwriting quality remained strong throughout 2019. These high credit quality loans have significantly better credit performance than the loans originated during 2008 and prior periods. Significant contributors to the improved loan quality include the greater risk discipline of loan originators and the private mortgage insurance providers, the Qualified Mortgage (QM) loan requirements under the Dodd Frank Act (including the QM Patch, which is scheduled to expire in January 2021) and the loan-level criteria of the PMIERs financial requirements.
Based on the most recently available industry reports, total mortgage origination volume was higher for 2019 as compared to 2018, due to an increase in both purchase and refinance originations. Mortgage originations for home purchases increased 7% in 2019 as compared to 2018, while refinancing activity increased 74% due to declining interest rates. Mortgage insurance penetration in the private mortgage insurance market has gradually increased over the past few years and is generally three to five times higher for purchase originations than for refinancings. In 2019 and 2018, our results were favorably impacted by: (i) the strong mortgage origination market, including the elevated volume of refinance originations in 2019, and (ii) increased private mortgage insurance penetration rates for both purchase and refinance originations. These trends resulted in a larger private mortgage insurance market in 2019 as compared to 2018.
Although it is difficult to predict future volumes, the most recently available industry reports currently project the mortgage origination market for 2020 to be lower in comparison to 2019, with purchase loan volume expected to increase, but to be more than offset by a significant decrease in refinancings. We also currently expect the private mortgage insurance market for 2020 to decrease in comparison to 2019, driven by a decrease in refinance originations. Based on current industry forecasts and our projections, we expect our NIW in 2020 to be approximately $60 billion.
Our Services business, comprising real estate, title and mortgage services, is largely a transactional business that depends on the level of customer activity and may be sensitive to changes in macro-level home sales, home prices, interest rates, home default rates and GSE guidelines. In addition, demand for our title services may be impacted by general marketplace competition in the real estate title industry, coupled with housing and mortgage banking related conditions such as new home sales, the sizes of the real estate purchase and refinance markets and interest rate fluctuations. See “Item 1. Business-Services-Services Business Overview” and Notes 4 and 7 of Notes to Consolidated Financial Statements for additional information regarding the Services segment.
PMIERs. In order to be eligible to insure loans purchased by the GSEs, mortgage insurers such as Radian Guaranty must meet the GSEs’ eligibility requirements, or PMIERs. The GSEs have significant discretion under the PMIERs and may amend the PMIERs at any time. The most recent revisions to PMIERs, or PMIERs 2.0, became effective on March 31, 2019. Radian Guaranty currently is an approved mortgage insurer under the PMIERs. See “Item 1. Business-Regulation-GSE Requirements,” “Liquidity and Capital Resources-Mortgage Insurance” and Note 18 of Notes to Consolidated Financial Statements for additional information.
Competition
In our mortgage insurance business, our primary competitors include other private mortgage insurers and governmental agencies, principally the FHA and the VA. We compete with other private mortgage insurers on the basis of price, underwriting guidelines, overall service, customer relationships, perceived financial strength (including based on comparative financial strength credit ratings) and reputation, as well as the breadth and quality of the services offered through our Services business that complement our mortgage insurance products. We compete with the FHA and VA primarily on the basis of loan limits, pricing, credit guidelines, terms of our insurance policies and loss mitigation practices. For additional information, see “Item 1. Business-Mortgage Insurance-Competition.”
Pricing is highly competitive in the mortgage insurance industry. During 2019, the mortgage insurance industry has continued to shift to a pricing environment where a variety of pricing methodologies and pricing levels are being deployed with differing degrees of risk-based granularity. The shift away from a predominately rate card-based pricing model and the increase in “black box” and other pricing frameworks provides a more dynamic pricing capability that allows for more frequent pricing changes throughout the mortgage insurance industry.
Risk Distribution
In recent years, participants in the private mortgage insurance industry have engaged in a range of risk distribution strategies. In our mortgage insurance business, we use reinsurance as a capital and risk management tool to lower the risk profile and financial volatility of our mortgage insurance portfolio through economic cycles. We have distributed risk through third-party quota share and excess-of-loss reinsurance arrangements, as well as through the capital markets by using mortgage insurance-linked notes transactions. Among other benefits, risk distribution reduces our required capital, lowers our overall
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cost of capital and enhances our projected return on capital. Risk distribution may also provide additional claims paying resources and increase our strength as a counterparty. As the industry continues to evolve from a model where private mortgage insurers “originate and hold” risk to an “aggregate, manage and distribute” risk model, we expect to continue to leverage multiple forms of risk distribution. After consideration of the Eagle Re 2020-1 insurance-linked notes transaction that was completed in early 2020, 72% of our primary RIF as of December 31, 2019 is subject to a form of risk distribution.
Key Factors Affecting Our Results
Mortgage Insurance
Our Mortgage Insurance segment provides credit-related insurance coverage, principally through private mortgage insurance, as well as other credit risk management solutions, to mortgage lending institutions and mortgage credit investors nationwide. The following sections discuss certain key drivers affecting our Mortgage Insurance revenue, as well as other key factors affecting our results.
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IIF; Persistency Rate; Mix of Business. Our IIF is one of the primary drivers of our future premiums that we expect to earn over time. Although not reflected in the current period financial statements, nor in our reported book value, we expect our IIF to generate substantial earnings in future periods, due to the high credit quality of our current mortgage insurance portfolio and expected Persistency Rate over multiple years.
Based on the composition of our mortgage insurance portfolio, with Monthly Premium Policies comprising a larger proportion of our total portfolio than Single Premium Policies, an increase or decrease in IIF generally has a corresponding impact on premiums earned. Cancellations of our insurance policies as a result of prepayments and other reductions of IIF, such as Rescissions of coverage and claims paid, generally have a negative effect on premiums earned. See “Results of Operations-Mortgage Insurance-NIW, IIF, RIF” for more information about the levels and characteristics of our NIW, IIF and RIF.
The ultimate profitability of our mortgage insurance business is affected by the impact of mortgage prepayment speeds based on the mix of business we write. The measure for assessing the impact of policy cancellations on our IIF is our Persistency Rate, defined as the percentage of IIF that remains in force over a period of time. Assuming all other factors remain constant, over the life of the policies, prepayment speeds have an inverse impact on IIF and the expected revenue from our Monthly Premium Policies. Slower loan prepayment speeds, demonstrated by a higher Persistency Rate, result in more IIF remaining in place, providing increased revenue from Monthly Premium Policies over time as premium payments continue. Earlier than anticipated loan prepayments, demonstrated by a lower Persistency Rate, reduce IIF and the revenue from our Monthly Premium Policies. Among other factors, prepayment speeds may be affected by changes in interest rates and other macroeconomic factors. A rising interest rate environment generally will reduce refinancing activity and result in lower prepayments, whereas a declining interest rate environment generally will increase the level of refinancing activity and therefore increase prepayments.
In contrast to Monthly Premium Policies, when Single Premium Policies are cancelled by the insured because the loan has been paid off or otherwise, we accelerate the recognition of any remaining unearned premiums, net of any refunds that may be owed to the borrower. Although these cancellations reduce IIF, assuming all other factors remain constant, the profitability of our Single Premium business increases when Persistency Rates are lower. As a result, we believe that writing a mix of Single Premium Policies and Monthly Premium Policies has the potential to moderate the overall impact on our results if actual prepayment speeds are significantly different from expectations. However, the impact of this moderating effect may be affected by the amount of reinsurance we obtain on portions of our portfolio, with the Single Premium QSR Program currently reducing the proportion of retained Single Premium Policies in our portfolio.
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NIW; Origination Market; Penetration Rate. NIW increases our IIF and our premiums written and earned. NIW is affected by the overall size of the mortgage origination market, the penetration percentage of private mortgage insurance into the overall mortgage origination market and our market share of the private mortgage insurance market. The overall mortgage origination market is influenced by macroeconomic factors such as household formation, household composition, home affordability, interest rates, housing markets in general, credit availability and the impact of various legislative and regulatory actions that may influence the housing and mortgage finance industries. The penetration percentage of private mortgage insurance is mainly influenced by: (i) the competitiveness of private mortgage insurance for GSE conforming loans compared to FHA and VA insured loans and (ii) the relative percentage of mortgage originations that are for purchased homes versus refinances. We
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believe, for example, that better execution for borrowers with higher FICO scores, lender preference and the inability to cancel FHA insurance for certain loans are factors that continue to provide a competitive advantage for private mortgage insurers. See “Results of Operations-Mortgage Insurance-NIW, IIF, RIF.”
Private mortgage insurance penetration in the insurable market has generally been significantly higher on new mortgages for purchased homes than on the refinance of existing mortgages, because average LTVs are typically higher on home purchases and therefore these low down payment loans are more likely to require mortgage insurance. Radian Guaranty’s share of the private mortgage insurance market is influenced by competition in that market. See “Item 1. Business-Mortgage Insurance-Competition” and “Results of Operations-Mortgage Insurance-NIW, IIF, RIF.”
The following charts provide a historical perspective on certain key market drivers, including:
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the mortgage origination volume from home purchases and refinancings;
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private mortgage insurance penetration as a percentage of the mortgage origination market; and
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the composition of the insured mortgage market between private mortgage insurance and FHA insurance.
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(1)
Based on actual dollars generated in the credit enhanced market, as reported by the U.S. Department of Housing and Urban Development and industry publicly reported information. Mortgage originations are based upon the average of originations reported by the Mortgage Bankers Association, Freddie Mac and Fannie Mae in their most recent published industry reports.
(2)
Excluding originations under HARP.
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Premiums. The premium rates we charge for our insurance are based on a number of borrower, loan and property characteristics. The mortgage insurance industry is highly competitive and private mortgage insurers compete with each other and with the FHA and VA with respect to price and other factors. We expect price competition to
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continue throughout the mortgage insurance industry and future price changes from private mortgage insurers or the FHA could impact our future premium rates or our ability to compete.
Our pricing is risk-based and is intended to generally align with the capital requirements under the PMIERs, while considering pricing trends within the private mortgage insurance industry. As a result, our pricing is expected to generate relatively consistent returns across the credit spectrum and to provide relatively stable expected loss ratios regardless of further credit expansion or contraction. In developing our strategies, we monitor various competitive and economic factors while seeking to enhance the long-term value of our portfolio by balancing credit risk, profitability and volume considerations, and aim to achieve an overall risk-adjusted rate of return on capital given our modeled performance expectations. We continued to generate strong NIW in 2019, and believe we remain well positioned to compete for the NIW being originated today, while at the same time maintaining projected returns on NIW within our targeted ranges.
Our pricing actions gradually affect our results over time, as existing IIF cancels and is replaced with NIW at current pricing. See “Liquidity and Capital Resources-Mortgage Insurance” and “Results of Operations-Mortgage Insurance-NIW, IIF, RIF” for additional information.
Premiums on our mortgage insurance products are generally paid either on an installment basis or in a single payment at the time of loan origination. See “Item 1. Business-Mortgage Insurance-Mortgage Insurance Business Overview-Premium Rates-Primary Mortgage Insurance.” Our expected premium yield on our Single Premium Policies is lower than on our Monthly Premium Policies because our premium rates are generally lower for our Single Premium Policies. However, as discussed above, the ultimate profitability of Single Premium Policies may be higher or lower than expected due to the level of prepayments. See “-IIF; Persistency Rate; Mix of Business” above.
Our actual portfolio returns will depend on a number of factors, including economic conditions, the mix of NIW that we are able to write, our pricing, the amount of reinsurance we use and the level of capital required under the PMIERs financial requirements.
Approximately 69% of the loans in our total primary mortgage insurance portfolio at December 31, 2019 are Monthly Premium Policies that provide a level monthly premium for the first 10 years of the policy, followed by a reduced level monthly premium thereafter. For loans that have been refinanced under HARP or HARP Replacement Programs, the initial 10-year period is reset. Due to the borrower’s ability to cancel the policy generally when the LTV reaches 80% of the original value, and the automatic cancellation of the policy on the date the LTV is scheduled to reach 78% of the original value, the volume of loans that remain insured after 10 years and would be subject to the premium reset is generally not material in relation to the total loans originated. However, to the extent the volume of loans resetting from year to year varies significantly, the trend in earned premiums may also vary.
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Losses. Incurred losses represent the estimated future claim payments on newly defaulted insured loans as well as any change in our claim estimates for existing defaults, including changes in the estimates we use to determine our expected losses, and estimates with respect to the frequency, magnitude and timing of anticipated losses on defaulted loans. Other factors influencing incurred losses include:
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The mix of credit characteristics in our total direct RIF (e.g., loans with higher risk characteristics, or loans with layered risk that combine multiple higher-risk attributes within the same loan, generally result in more delinquencies and claims). See “Results of Operations-Mortgage Insurance-NIW, IIF, RIF.”
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The average loan size (relatively higher priced properties with larger average loan amounts may result in higher incurred losses).
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The percentage of coverage on insured loans (higher percentages of insurance coverage generally correlate with higher incurred losses) and the presence of structural mitigants such as deductibles or stop losses.
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Changes in housing values (declines in housing values generally make it more difficult for borrowers to sell a home to avoid default or for the property to be sold to mitigate a claim, and also may negatively affect a borrower’s willingness to continue to make mortgage payments when the home value is less than the mortgage balance; conversely, increases in housing values tend to reduce the level of defaults as well as make it more likely that foreclosures will result in the loan being satisfied).
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The distribution of claims over the life cycle of a portfolio (historically, claims are relatively low during the first two years after a loan is originated and then increase over a period of several years before declining; however, several factors can impact and change this cycle, including the economic environment, the quality of the underwriting of the loan, characteristics of the mortgage loan, the credit profile of the borrower, housing prices and unemployment rates).
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Our ability to mitigate potential losses through Rescissions, Claim Denials, cancellations and Claim Curtailments on claims submitted to us. These actions all reduce our incurred losses. However, if these Loss Mitigation Activities are successfully challenged at rates that are higher than expected or we agree to settle disputes related to our Loss Mitigation Activities, our incurred losses will increase. We may enter into specific agreements that govern activities such as claims decisions, claim payments, Loss Mitigation Activities and insurance coverage. As our portfolio originated prior to and including 2008 has become a smaller percentage of our overall insured portfolio, there has been a decrease in the amount of Loss Mitigation Activity with respect to the claims we receive, and we expect this trend to continue, particularly given the limitations on our Loss Mitigation Activities imposed in the 2014 Master Policy and the additional clarifications that will be effective under our new 2020 Master Policy. See Note 2 of Notes to Consolidated Financial Statements for additional information on Loss Mitigation Activities and “Item 1A. Risk Factors-Our Loss Mitigation Activity is not expected to mitigate mortgage insurance losses to the same extent as in prior years; Loss Mitigation Activity could continue to negatively impact our customer relationships.”
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Other Operating Expenses. Our other operating expenses are affected by the amount of our NIW, as well as the amount of IIF. Our other operating expenses may also be affected by the impact of performance on our incentive compensation programs, as a result of our pay-for-performance approach to compensation that is based on the level of achievement of both short-term and long-term goals.
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Risk Distribution. We use third-party reinsurance in our mortgage insurance business to manage capital and risk in an effort to optimize the amounts and types of capital and risk distribution deployed against insured risk. See “-IIF; Persistency Rate; Mix of Business” above. Currently, we distribute risk in our mortgage insurance portfolio through quota share and excess-of-loss reinsurance programs. When we enter into a quota share reinsurance agreement, the reinsurer receives a premium and, in exchange, agrees to insure an agreed upon portion of incurred losses. These arrangements reduce our earned premiums but also reduce our net RIF, which provides capital relief, including under the PMIERs financial requirements. Our incurred losses are reduced by any incurred losses ceded in accordance with the reinsurance agreement, and we often receive ceding commissions from the reinsurer as part of the transaction, which, in turn, reduce our reported operating expenses and policy acquisition costs. Our Excess-of-Loss Program accesses the capital markets (through a VIE funded by mortgage insurance-linked notes), as well as the reinsurance markets directly (through separate excess-of-loss reinsurance with a third-party reinsurer). Our Excess-of-Loss Program reduces our net RIF and our incurred losses are reduced by any incurred losses allocated in accordance with the structure of the transaction. While these reinsurance arrangements have the impact of reducing our earned premiums, they also provide capital relief, including under the PMIERs financial requirements. See Note 8 of Notes to Consolidated Financial Statements for more information about our reinsurance arrangements.
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Investment Income. Investment income is determined primarily by the investment balances held and the average yield on our overall investment portfolio.
Services
Our Services segment offers a broad array of real estate, title and mortgage services to market participants across the mortgage and real estate value chain. See “Item 1. Business-Services-Services Business Overview” and Note 1 of Notes to Consolidated Financial Statements for additional information regarding the Services segment and the January 2020 sale of Clayton.
In contrast to our mortgage insurance business, the Services segment is primarily a fee-for-service business without significant balance sheet risk. Key factors impacting results for our Services business include:
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Services Revenue. Our Services segment is dependent upon overall activity in the mortgage, real estate and mortgage finance markets, as well as the overall health of the related industries. Due, in part, to the transactional nature of the business, revenues for our Services segment are subject to fluctuations from period to period, including seasonal fluctuations that reflect the activities in these markets. Sales volume is also affected by the number of competing companies and alternative products offered in the market. We believe the diversity of
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services we offer has the potential to produce fee income from the Services segment throughout various mortgage finance environments, although market conditions can significantly impact the mix and amount of fee income we generate in any particular period. In addition, see Note 2 of Notes to Consolidated Financial Statements for information on revenue recognition policies for our Services segment.
The Services segment is dependent on a limited number of large customers that represent a significant portion of its revenues. An unexpected loss of a major customer could significantly impact the level of Services revenue. Generally, our contracts do not contain volume commitments and may be terminated by clients at any time. Access to Radian Guaranty’s mortgage insurance customer base provides additional opportunities to expand the Services segment’s existing customers.
Revenue for the Services segment also includes inter-segment revenues from services performed for our Mortgage Insurance segment. See Note 4 of Notes to Consolidated Financial Statements for additional information.
Our Services revenue is primarily generated under fixed-price contracts. Under fixed-price contracts, we agree to perform the specified services and deliverables for a pre-determined per-unit or per-file price or day rate. To the extent our actual direct and allocated indirect costs decrease or increase from the estimates upon which the price was negotiated, we will generate more or less profit, respectively, or could incur a loss. See “Item 1. Business-Services-Services Business Overview” for more information on our Services revenue.
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Cost of Services. Our cost of services is primarily affected by our level of services revenue. Our cost of services primarily consists of employee compensation and related payroll benefits and to a lesser extent, other costs of providing services such as travel and related expenses incurred in providing client services, costs paid to outside vendors, data acquisition costs and other compensation-related expenses to maintain software application platforms that directly support our businesses. The level of these costs may fluctuate if market rates of compensation change, or if there is decreased availability or a loss of qualified employees.
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Premiums. We earn net premiums on title insurance, effective with our acquisition of Radian Title Insurance in the first quarter of 2018. By adding the capabilities of this subsidiary to the title and settlement services that we already were offering through our existing title agency, Radian Settlement Services, we expanded the geographic reach of our title services and are positioned to provide title insurance and settlement services to our customers across the country.
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Operating Expenses. Our operating expenses primarily consist of salaries and benefits not classified as cost of services because they are related to employees, such as sales and corporate employees, who are not directly involved in providing client services. Operating expenses also include other selling, general and administrative expenses, depreciation, and allocations of corporate general and administrative expenses.
Other Factors Affecting Consolidated Results
The following items also may impact our consolidated results in the ordinary course. The items listed are not representative of all potential items impacting our consolidated results. See “Item 1A. Risk Factors” for additional information on the risks affecting our business.
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Net Gains (Losses) on Investments and Other Financial Instruments. The recognition of realized investment gains or losses can vary significantly across periods as the activity is highly discretionary based on the timing of individual securities sales due to such factors as market opportunities, our tax and capital profile and overall market cycles. Unrealized gains and losses arise primarily from changes in the market value of our investments that are classified as trading or, effective with our implementation of the update to the standard for the accounting of financial instruments effective January 1, 2018, equity securities. These valuation adjustments may not necessarily result in realized economic gains or losses.
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Loss on Extinguishment of Debt. Gains or losses on early extinguishment of debt and losses incurred to purchase our debt prior to maturity are discretionary activities that are undertaken in order to take advantage of market opportunities to strengthen our financial and capital positions.
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Impairment of Goodwill or Other Acquired Intangible Assets. The periodic review of goodwill and other acquired intangible assets for potential impairment may impact consolidated results. Our goodwill and other acquired intangible assets is based on management’s assumptions, which are inherently subject to risks and uncertainties. See Note 7 of Notes to Consolidated Financial Statements for additional information.
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Results of Operations-Consolidated
Radian Group serves as the holding company for our operating subsidiaries and does not have any operations of its own. Our consolidated operating results for 2019 primarily reflect the financial results and performance of our two business segments-Mortgage Insurance and Services. See Note 4 of Notes to Consolidated Financial Statements for information regarding the basis of our segment reporting, including the related allocations. See “Results of Operations-Mortgage Insurance,” and “Results of Operations-Services” for the operating results of these business segments.
In addition to the results of our operating segments, pretax income (loss) is also affected by other factors. See “Key Factors Affecting Our Results-Other Factors Affecting Consolidated Results.” See “-Use of Non-GAAP Financial Measures” below for more information regarding items that are excluded from the operating results of our operating segments.
The following table highlights selected information related to our consolidated results of operations for the years ended December 31, 2019, 2018 and 2017:
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(1)
Relates primarily to the Mortgage Insurance segment. See “Results of Operations-Mortgage Insurance” for more information.
(2)
Relates to our Services segment. See “Results of Operations-Services” for more information.
(3)
See “-Use of Non-GAAP Financial Measures” below.
Net Income. As discussed in more detail below, our net income increased for 2019 compared to 2018 primarily reflecting: (i) an increase in net premiums earned; (ii) an increase in net gains on investments and other financial instruments; and (iii) an increase in net investment income. Partially offsetting these items are increases in: (i) provision for losses; (ii) other operating
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expenses; and (iii) loss on extinguishment of debt. In addition, the overall increase in net income was partially offset by an increase in the income tax provision, due primarily to a $73.6 million tax benefit in 2018 related to the impact of the settlement of the IRS Matter. See “-Income Tax Provision” below.
Diluted Net Income Per Share. The increase in diluted net income per share for 2019 compared to 2018 is primarily due to the change in net income, as discussed above, and by the decrease in average diluted shares from 218.6 million shares in 2018 to 210.3 million shares for 2019.
Adjusted Diluted Net Operating Income Per Share. The increase in adjusted diluted net operating income per share for 2019 compared to 2018 is primarily due to the increase in our Mortgage Insurance segment’s adjusted pretax operating income, which increased to $868.9 million in 2019, from $772.6 million in 2018.
Book Value Per Share. The increase in book value per share from $16.34 at December 31, 2018, to $20.13 at December 31, 2019, is primarily due to: (i) our net income for the year ended December 31, 2019 and (ii) an increase of $0.80 per share due to net unrealized gains in our available for sale securities, recorded in accumulated other comprehensive income. These increases were partially offset by a decrease of $0.25 per share from the net impact of our share repurchases for the year ended December 31, 2019, inclusive of the cost of these repurchases.
Return on Equity. The changes in return on equity across all periods presented are primarily due to the changes in net income and, to a lesser extent, increases in stockholders’ equity. See “-Net Income” above for more information on the changes in net income.
Adjusted Net Operating Return on Equity. The changes in adjusted net operating return on equity across all periods presented are primarily due to the increases in our adjusted pretax operating income, partially offset by increases in stockholders’ equity. The increases in our adjusted pretax operating income primarily reflect the increases in our Mortgage Insurance segment’s adjusted pretax operating income. See “Results of Operations-Mortgage Insurance-Adjusted Pretax Operating Income” for more information on our Mortgage Insurance segment’s results.
Net Gains (Losses) on Investments and Other Financial Instruments. The net gains on investments and other financial instruments for 2019, as compared to net losses in 2018, are primarily due to: (i) the increase in unrealized gains in our trading portfolio related to changes in fair value resulting from lower interest rates and (ii) net realized gains on our fixed-maturities available for sale. See Note 6 of Notes to Consolidated Financial Statements for additional information on net gains (losses) on investments.
Other Operating Expenses. Other operating expenses for 2019 increased as compared to 2018, primarily due to: (i) higher compensation expense in 2019, including variable and incentive-based compensation and (ii) ongoing investments in our technology systems. Additionally, operating expenses increased due to: (i) the inclusion of operating expenses of businesses acquired in 2018 and (ii) an increase in non-operating items, primarily related to impairment of other long-lived assets. Partially offsetting these items is an increase in ceding commissions, related to higher earned premiums on policies covered under our Single Premium QSR Program.
Restructuring and Other Exit Costs. In 2019, we did not recognize any restructuring or other exit costs. For 2018, we recognized $3.6 million of other exit costs associated with impairment of internal-use software. Restructuring and other exit costs for 2018 also include the remaining charges associated with our 2017 plan to restructure the Services business.
Interest Expense. Interest expense for 2019 decreased compared to 2018. This decrease was primarily due to reductions in interest expense from our: (i) repayment at maturity of $158.6 million aggregate principal amount of our Senior Notes due 2019 and (ii) tender offers and the subsequent redemptions that together resulted in the repayment of the remaining aggregate principal amounts of $234.1 million and $197.7 million of our Senior Notes due 2020 and 2021, respectively. Partially offsetting these decreases was higher interest expense from the issuance of $450 million aggregate principal amount of Senior Notes due 2027.
Loss on Extinguishment of Debt. During 2019, the redemption of our remaining Senior Notes due 2020 and 2021 resulted in a loss on extinguishment of debt of $22.7 million. See Note 12 of Notes to Consolidated Financial Statements for additional information. During 2018, we had no loss on extinguishment of debt.
Amortization and Impairment of Other Acquired Intangible Assets and Impairment of Goodwill. During the fourth quarter of 2019, in connection with the reclassification of Clayton to held for sale, we recorded a goodwill impairment of $4.8 million, as well as an impairment charge for other acquired intangible assets of $13.7 million. See Note 7 of Notes to Consolidated Financial Statements for additional information.
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The amortization of intangible assets primarily reflects the amortization of intangible assets acquired as part of the Clayton acquisition in 2014.
Income Tax Provision. Our 2019 effective tax rate was 20.8%, which approximates the 21% federal statutory tax rate. Our 2018 effective tax rate of 11.4% was lower than the federal statutory tax rate primarily as a result of the tax benefit recorded related to the settlement of our IRS Matter.
Use of Non-GAAP Financial Measures. In addition to the traditional GAAP financial measures, we have presented “adjusted pretax operating income,” “adjusted diluted net operating income per share” and “adjusted net operating return on equity,” which are non-GAAP financial measures for the consolidated company, among our key performance indicators to evaluate our fundamental financial performance. These non-GAAP financial measures align with the way our business performance is evaluated by both management and by our board of directors. These measures have been established in order to increase transparency for the purposes of evaluating our operating trends and enabling more meaningful comparisons with our peers. Although on a consolidated basis “adjusted pretax operating income,” “adjusted diluted net operating income per share” and “adjusted net operating return on equity” are non-GAAP financial measures, for the reasons discussed above we believe these measures aid in understanding the underlying performance of our operations. Our senior management, including our Chief Executive Officer (Radian’s chief operating decision maker), uses adjusted pretax operating income (loss) as our primary measure to evaluate the fundamental financial performance of the Company’s business segments and to allocate resources to the segments.
Adjusted pretax operating income is defined as GAAP consolidated pretax income (loss), excluding the effects of: (i) net gains (losses) on investments and other financial instruments; (ii) loss on extinguishment of debt; (iii) amortization and impairment of goodwill and other acquired intangible assets; and (iv) impairment of other long-lived assets and other non-operating items, such as losses from the sale of lines of business and acquisition-related expenses. Adjusted diluted net operating income per share is calculated by dividing (i) adjusted pretax operating income attributable to common stockholders, net of taxes computed using the Company’s statutory tax rate, by (ii) the sum of the weighted average number of common shares outstanding and all dilutive potential common shares outstanding. Adjusted net operating return on equity is calculated by dividing annualized adjusted pretax operating income, net of taxes computed using the Company’s statutory tax rate, by average stockholders’ equity, based on the average of the beginning and ending balances for each period presented.
Although adjusted pretax operating income excludes certain items that have occurred in the past and are expected to occur in the future, the excluded items represent those that are: (i) not viewed as part of the operating performance of our primary activities or (ii) not expected to result in an economic impact equal to the amount reflected in pretax income. These adjustments, along with the reasons for their treatment, are described below.
(1)
Net gains (losses) on investments and other financial instruments. The recognition of realized investment gains or losses can vary significantly across periods as the activity is highly discretionary based on the timing of individual securities sales due to such factors as market opportunities, our tax and capital profile and overall market cycles. Unrealized gains and losses arise primarily from changes in the market value of our investments that are classified as trading or equity securities. These valuation adjustments may not necessarily result in realized economic gains or losses.
Trends in the profitability of our fundamental operating activities can be more clearly identified without the fluctuations of these realized and unrealized gains or losses and changes in fair value of other financial instruments. We do not view them to be indicative of our fundamental operating activities.
(2)
Loss on extinguishment of debt. Gains or losses on early extinguishment of debt and losses incurred to purchase our debt prior to maturity are discretionary activities that are undertaken in order to take advantage of market opportunities to strengthen our financial and capital positions; therefore, we do not view these activities as part of our operating performance. Such transactions do not reflect expected future operations and do not provide meaningful insight regarding our current or past operating trends.
(3)
Amortization and impairment of goodwill and other acquired intangible assets. Amortization of acquired intangible assets represents the periodic expense required to amortize the cost of acquired intangible assets over their estimated useful lives. Acquired intangible assets are also periodically reviewed for potential impairment, and impairment adjustments are made whenever appropriate. We do not view these charges as part of the operating performance of our primary activities.
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Part II Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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(4)
Impairment of other long-lived assets and other non-operating items. Includes activities that we do not view to be indicative of our fundamental operating activities, such as: (i) gains (losses) from the sale of lines of business and (ii) acquisition-related expenses.
Total adjusted pretax operating income, adjusted diluted net operating income per share, and adjusted net operating return on equity are not measures of overall profitability, and therefore should not be considered in isolation or viewed as substitutes for GAAP pretax income, diluted net income per share, or return on equity. Our definitions of adjusted pretax operating income, adjusted diluted net operating income per share, and adjusted net operating return on equity may not be comparable to similarly-named measures reported by other companies.
The following tables provide reconciliations of the most comparable GAAP measures of consolidated pretax income, diluted net income per share and return on equity, to our non-GAAP financial measures for the consolidated Company of adjusted pretax operating income, adjusted diluted net income per share and adjusted net operating return on equity, respectively:
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(1)
The amount for the year ended December 31, 2019 primarily relates to impairments of other long-lived assets and is included in other operating expenses on the consolidated statement of operations. The amounts for the years ended December 31, 2018 and December 31, 2017 are included within restructuring and other exit costs on the consolidated statements of operations, except for $1.6 million in 2018 related to the impairment of other long-lived assets, included in other operating expenses.
(2)
Total adjusted pretax operating income on a consolidated basis consists of adjusted pretax operating income (loss) for our
Mortgage Insurance segment and our Services segment, as further detailed in Note 4 of Notes to Consolidated Financial Statements.
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Part II Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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(1)
Calculated using the Company’s federal statutory tax rates of 21% for 2019 and 2018 and 35% for 2017. Any permanent tax adjustments and state income taxes on these items have been deemed immaterial and are not included.
(2)
For 2018, includes $0.34 of tax benefit related to the settlement of the IRS Matter, which includes both the impact of the settlement with the IRS as well as the reversal of certain related previously accrued state and local tax liabilities. All of the 2017 amount represents additional tax expense related to the remeasurement of our net deferred tax assets as a result of the TCJA enacted in December 2017.
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(1)
Calculated by dividing net income by average stockholders’ equity.
(2)
As a percentage of average stockholders’ equity.
(3)
Calculated using the Company’s federal statutory tax rates of 21% for 2019 and 2018 and 35% for 2017. Any permanent tax adjustments and state income taxes on these items have been deemed immaterial and are not included.
(4)
The difference in 2018 includes the tax benefit related to the settlement of the IRS Matter, which includes both the impact of the settlement with the IRS as well as the reversal of certain related previously accrued state and local tax liabilities. All of the 2017 amount represents additional tax expense related to the remeasurement of our net deferred tax assets as a result of the TCJA enacted in December 2017.
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Part II Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Results of Operations-Mortgage Insurance
During 2019, we continued our strategy of growing our mortgage insurance portfolio, executing our risk distribution strategy and effectively managing our capital and liquidity positions.
The following table summarizes our Mortgage Insurance segment’s results of operations for the years ended December 31, 2019, 2018 and 2017:
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(1)
Our senior management uses adjusted pretax operating income as our primary measure to evaluate the fundamental financial performance of our business segments. See Note 4 of Notes to Consolidated Financial Statements for more information.
(2)
Includes allocation of corporate operating expenses of $104.1 million, $80.1 million and $55.4 million for 2019, 2018 and 2017, respectively.
Adjusted Pretax Operating Income. The increase in our Mortgage Insurance segment’s adjusted pretax operating income for 2019, compared to 2018, primarily reflects: (i) an increase in net premiums earned and (ii) an increase in net investment income. See “-NIW, IIF, RIF-Net Premiums Written and Earned” for more information about our net premiums earned. Partially offsetting these items are increases in: (i) provision for losses; (ii) other operating expenses; and (iii) interest expense as a result of the Clayton Intercompany Note repayment. See “Results of Operations-Services-Interest Expense” for additional information.
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Part II Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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NIW, IIF, RIF
A key component of our current business strategy is to write profitable NIW while effectively maintaining the portfolio’s health, balance and profitability. Consistent with this objective, we wrote $71.3 billion of primary new mortgage insurance in 2019, compared to $56.5 billion of NIW in 2018. The NIW written on a Flow Basis in 2019 was Radian’s highest volume in its history. Our 2019 NIW, partially offset by cancellations and amortization within our existing portfolio, resulted in an increase in IIF to $240.6 billion at December 31, 2019, from $221.4 billion at December 31, 2018, as shown in the chart below.
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(1)
Policy years represent the original policy years, and have not been adjusted to reflect subsequent refinancing activity under HARP.
(2)
Adjusted to reflect subsequent refinancing activity under HARP, this percentage would decrease to 4.7%, 6.0%, and 8.4% as of December 31, 2019, December 31, 2018 and December 31, 2017, respectively.
Our IIF is the primary driver of the future premiums that we expect to earn over time. Although not reflected in the current period financial statements, nor in our reported book value, we expect our IIF to generate substantial earnings in future periods, due to the high credit quality of our current mortgage insurance portfolio and its expected persistency over multiple years. See “Key Factors Affecting Our Results-Mortgage Insurance-IIF; Persistency Rate; Mix of Business” for more information.
We target a blended return on required capital on new business on an unlevered basis (i.e., after-tax underwriting returns
plus projected investment income) within the mid-teens range. This projected targeted return incorporates the impact of the PMIERs 2.0 financial requirements and the risk distribution programs we have in place to cover NIW at the time it is originated, such as our Single Premium QSR Program, but does not include the impact of leverage or risk distribution transactions that are executed after the NIW has been originated, such as our Excess-of-Loss Program. Actions we take with respect to pricing and risk on NIW we are writing today are expected to gradually affect our results over time, due to the natural turnover of the mortgage insurance portfolio as existing IIF cancels.
Our NIW increased by 26.1% in 2019 as compared to 2018, aided by a strong mortgage origination market and increased private mortgage insurance penetration rates. See “Overview-Operating Environment” for additional information about the mortgage origination market. Our NIW for 2019 also reflects the successful implementation of our spectrum of innovative pricing structures, including RADAR Rates, our “black box” pricing strategy. Currently, a majority of the NIW we are writing is being priced through RADAR Rates.
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Part II Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Historical loan performance data indicates that credit scores and underwriting quality are key drivers of credit performance. As of December 31, 2019, our portfolio of business written subsequent to 2008, including refinancings under HARP, represented approximately 95% of our total primary RIF. Loan originations after 2008 have consisted primarily of high credit quality loans with significantly better credit performance than loans originated during 2008 and prior periods. The volume of insurance that we have written on high credit quality loans after 2008 has significantly improved our mortgage insurance portfolio mix. Our actual and expected future losses on our portfolio written after 2008, together with refinancings under HARP, are significantly lower than those experienced on our NIW prior to and including 2008. The following charts illustrate the trends of our cumulative incurred loss ratios by year of origination and development year.
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(1)
Represents inception-to-date losses incurred as a percentage of net premiums earned.
(2)
Radian’s stochastic modeling, used for pricing, indicates an approximate 20% through-the-cycle loss ratio on newly originated mortgage insurance business.
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Part II Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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The following tables provide selected information as of and for the periods indicated related to mortgage insurance NIW, RIF and IIF. Policy years represent the original policy years and have not been adjusted to reflect subsequent refinancing activity under HARP. Throughout this report, unless otherwise noted, RIF is presented on a gross basis and includes the amount ceded under reinsurance. NIW, RIF and IIF for direct Single Premiums include policies written on an individual basis (as each loan is originated) and on an aggregated basis (in which each individual loan in a group of loans is insured in a single transaction, typically after the loans have been originated).
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(1)
Lender-paid Single Premium Policies have higher Minimum Required Assets under the PMIERs as compared to borrower-paid Single Premium Policies. See “Item 1. Business-Regulation-GSE Requirements-PMIERs-Private Mortgage Insurer Eligibility Requirements” for additional information.
(2)
For loans with multiple borrowers, the percentage of primary NIW by FICO score represents the lowest of the borrowers’ FICO scores. Data for 2018 and 2017 had previously been presented based on the FICO score of the primary borrower and have been restated to reflect the lowest of the borrowers’ FICO scores.
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Part II Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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(1)
The Persistency Rate on a quarterly, annualized basis is calculated based on loan-level detail for the quarter ending as of the date shown. It may be impacted by seasonality or other factors, including the level of refinance activity during the applicable periods, and may not be indicative of full-year trends.
(2)
Calculated by dividing net premiums earned by average primary IIF. For 2019, includes a 1.4 basis point increase resulting from the impact of the cumulative adjustments in 2019 related to an update to the amortization rates used to
Glossary
Part II Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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recognize revenue for Single Premium Policies. See Note 2 of Notes to Consolidated Financial Statements for additional information.
(3)
Lender-paid Single Premium Policies have higher Minimum Required Assets under the PMIERs as compared to borrower-paid Single Premium Policies.
(4)
For loans with multiple borrowers, the percentage of primary RIF by FICO score represents the lowest of the borrowers’ FICO scores. Data for 2018 and 2017 had previously been presented based on the FICO score of the primary borrower and have been restated to reflect the lowest of the borrowers’ FICO scores.
Net Premiums Written and Earned. Net premiums written and earned for 2019 increased compared to 2018, reflecting an increase in our IIF primarily related to an increase in our Monthly Premium Policies. Net premiums earned for 2019 also includes a $32.9 million cumulative adjustment related to an update to the amortization rates used to recognize revenue for Single Premium Policies. See Note 2 of Notes to Consolidated Financial Statements for further information.
The table below provides additional information about the components of mortgage insurance net premiums earned for the periods indicated, including the effects of our reinsurance programs.
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(1)
Includes premiums earned from our participation in certain credit risk transfer programs.
(2)
Includes the impact of related profit commissions.
(3)
The amounts represent the profit commission on the Single Premium QSR Program, excluding the impact of Single Premium Policy cancellations.
The impact of the level of mortgage prepayments based on the mix of business we write affects the revenue ultimately produced by our mortgage insurance business. We believe that writing a mix of Single Premium Policies and Monthly Premium Policies has the potential to moderate the overall impact on our results if actual prepayments are significantly different from expectations. However, the impact of this moderating effect is affected by the amount of reinsurance we obtain on portions of our portfolio, with the Single Premium QSR Program currently reducing the proportion of retained Single Premium Policies in our portfolio. See “Overview-Operating Environment” as well as “Key Factors Affecting Our Results-Mortgage Insurance-IIF; Persistency Rate; Mix of Business” above for more information.
We experienced a decrease in our total mix of Single Premium Policies to 16.5% of our NIW for 2019, compared to 21.2% for 2018. Borrower-paid Single Premium Policies were 86.1% of our total direct Single Premium NIW for 2019 compared to 56.1% for 2018. We expect our production level for Single Premium Policies to fluctuate over time based on various factors, which include risk/return considerations and market conditions.
Net Premiums Written and Earned-Ceded. We use third-party reinsurance in our mortgage insurance business as part of our risk distribution strategy, including to manage our capital position and risk profile. When we enter into a reinsurance agreement, the reinsurer receives a premium and, in exchange, agrees to insure an agreed upon portion of incurred losses. While these arrangements have the impact of reducing our earned premiums, they reduce our required capital and are expected to
Glossary
Part II Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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increase our return on required capital for the related policies. The impact of these programs on our financial results will vary depending on the level of ceded RIF, as well as the levels of prepayments and incurred losses on the reinsured portfolios, among other factors. See “Key Factors Affecting Our Results-Mortgage Insurance-Risk Distribution” and Note 8 of Notes to Consolidated Financial Statements for more information about our reinsurance transactions.
The following table provides information related to the premium impact of our reinsurance transactions. See Note 8 of Notes to Consolidated Financial Statements for more information about our reinsurance programs.
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(1)
Does not include ceded premiums earned related to our captive reinsurance arrangements or the benefit from ceding commissions on our Single Premium QSR Programs, which are included in other operating expenses on the consolidated statement of operations. See Note 8 of Notes to Consolidated Financial Statements for additional information.
The table below provides information about the PMIERs impact of our reinsurance programs on our Minimum Required Assets as of the dates indicated.
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(1)
Excludes the impact of intercompany reinsurance and captive reinsurance arrangements.
Net Investment Income. Higher average investment balances, combined with higher investment yields, resulted in increases in investment income for 2019, compared to 2018. Our higher investment balances were primarily a result of investing our positive cash flow from operations. All periods include full allocation to the Mortgage Insurance segment of net investment income from investments held at Radian Group.
Glossary
Part II Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Provision for Losses. The following table details the financial impact of the significant components of our provision for losses for the periods indicated:
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(1)
Related to defaulted loans with a most recent default notice dated in the year indicated. For example, if a loan had defaulted in a prior year, but then subsequently cured and later re-defaulted in the current year, that default would be considered a current year default.
(2)
Related to defaulted loans with a default notice dated in a year earlier than the year indicated, which have been continuously in default since that time.
(3)
Provision for losses as a percentage of net premiums earned.
Our mortgage insurance provision for losses for 2019 increased by $27.0 million as compared to 2018. Reserves established for new default notices were the primary driver of our total incurred losses for 2019 and 2018. Current period new primary defaults increased by 0.8% in 2019, compared to 2018. Our gross Default to Claim Rate assumption for new primary defaults was 7.5% at December 31, 2019, compared to 8.0% as of December 31, 2018. This reduction in the estimated gross Default to Claim Rate assumption, which was based on observed trends, partially mitigated the increase in our provision for losses related to the increased number of new defaults in 2019, compared to 2018.
Our provision for losses during 2019 was positively impacted by favorable reserve development on prior year defaults. This favorable development was primarily driven by a reduction during the period in certain Default to Claim Rate assumptions for prior year defaults, based on observed trends of higher Cures than were previously estimated on those prior year defaults, partially offset by an increase in our IBNR reserve estimate related to certain legal proceedings. See Note 13 of Notes to Consolidated Financial Statements for additional information.
Our primary default rate at December 31, 2019 was 2.0% compared to 2.1% at December 31, 2018. The following table shows a rollforward of the number of our primary loans in default, including new defaults from our insurance written in years: (i) prior to and including 2008 and (ii) after 2008:
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(1)
Includes those charged to a deductible or captive reinsurance arrangements, as well as commutations.
(2)
Net of any previous Rescission and Claim Denials that were reinstated during the period. Such reinstated Rescissions and Claim Denials may ultimately result in a paid claim.
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Part II Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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We develop our Default to Claim Rate estimates on defaulted loans based on models that use a variety of loan characteristics to determine the likelihood that a default will reach claim status. Our gross Default to Claim Rate estimates on defaulted loans are mainly developed based on the Stage of Default and Time in Default of the underlying defaulted loans, as measured by the progress toward foreclosure sale and the number of months in default. See Note 11 of Notes to Consolidated Financial Statements for the table detailing our Default to Claim Rate assumptions.
The following tables show additional information about our primary loans in default as of the dates indicated:
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N/A - Not applicable
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Part II Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Our aggregate weighted-average net Default to Claim Rate assumption for our primary loans used in estimating our reserve for losses, which is net of estimated Claim Denials and Rescissions, was approximately 30% and 33%, at December 31, 2019 and 2018, respectively. Our net Default to Claim Rate and loss reserve estimate incorporates our expectations with respect to future Rescissions, Claim Denials and Claim Curtailments. Our estimate of such net future Loss Mitigation Activities, inclusive of claim withdrawals, reduced our loss reserve as of December 31, 2019 and 2018 by $19 million and $32 million, respectively. These expectations are based primarily on recent claim withdrawal activity and our recent experience with respect to the number of claims that have been denied due to the policyholder’s failure to submit sufficient documentation to perfect a claim within the time period permitted under our Master Policies and also our recent experience with respect to the number of insurance certificates that have been rescinded due to fraud, underwriter negligence or other factors.
Our reported Rescission, Claim Denial and Claim Curtailments activity in any given period is subject to challenge by our lender and servicer customers through our claims rebuttal process. In addition, we are at times engaged in discussions with our lender and servicer customers regarding our Loss Mitigation Activities. Unless a liability associated with such activities or discussions becomes probable and can be reasonably estimated, we consider our claim payments and our Rescissions, Claim Denials and Claim Curtailments to be resolved for financial reporting purposes. In accordance with the accounting standard regarding contingencies, we accrue for an estimated loss when we determine that the loss is probable and can be reasonably estimated.
We expect that a portion of previously rescinded policies will be reinstated and previously denied claims will be resubmitted with the required documentation and ultimately paid; therefore, we have incorporated this expectation into our IBNR reserve estimate. Our IBNR reserve estimate was $41.0 million and $11.3 million at December 31, 2019 and 2018, respectively. See Note 11 of Notes to Consolidated Financial Statements for additional information.
Factors that impact the severity of a claim include, but are not limited to: (i) the size of the loan; (ii) the amount of mortgage insurance coverage placed on the loan; (iii) the amount of time between default and claim during which we are expected to cover interest (capped at two years under our Prior Master Policy and capped at three years under our 2014 Master Policy) and certain expenses; and (iv) the impact of certain loss management activities with respect to the loan. The average Claim Severity experienced for loans covered by our primary insurance was 101.8% for 2019, compared to 104.9% in 2018.
Our mortgage insurance total loss reserve as a percentage of our mortgage insurance total RIF was 0.7% at both December 31, 2019 and December 31, 2018. See Note 11 of Notes to Consolidated Financial Statements for information regarding our reserves for losses and a reconciliation of our Mortgage Insurance segment’s beginning and ending reserves for losses and LAE.
Total mortgage insurance claims paid in 2019 of $132.2 million have decreased from claims paid of $215.9 million in 2018. The decrease in claims paid is consistent with the ongoing decline in the outstanding default inventory. Claims paid in both periods also include the impact of commutations. Although expected claims are included in our reserve for losses, the timing of claims paid is subject to fluctuation from quarter to quarter, based on the rate that defaults cure and other factors (as described in “Item 1. Business-Mortgage Insurance-Defaults and Claims”) that make the timing of paid claims difficult to predict.
The following table shows net claims paid by product and the average claim paid by product for the periods indicated:
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(1)
Net of reinsurance recoveries.
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Part II Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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(2)
Includes payments to commute mortgage insurance coverage on certain performing and non-performing loans. For 2019 and 2017, includes payments that, as expected, were made in connection with the settlement of the Freddie Mac Agreement, as well as payments to commute mortgage insurance coverage on certain performing and non-performing loans on which we had Pool Insurance risk.
(3)
Calculated without giving effect to the impact of captive reinsurance terminations and other commutations.
(4)
Before reinsurance recoveries.
Other Operating Expenses. The increase in other operating expenses for 2019, as compared to 2018, is primarily due to higher allocated corporate operating expenses. This increase was partially offset by an increase in ceding commissions related to higher earned premiums on policies covered under our Single Premium QSR Program.
Our expense ratio on a net premiums earned basis represents our Mortgage Insurance segment’s operating expenses (which include policy acquisition costs and other operating expenses, as well as allocated corporate operating expenses), expressed as a percentage of net premiums earned. Our expense ratio was 22.2% for 2019, compared to 23.9% for 2018. The increase in net premiums earned during 2019 was the primary driver of the decrease in the expense ratio as compared to 2018.
Results of Operations-Services
The following table summarizes our Services segment’s results of operations for the years ended December 31, 2019, 2018 and 2017:
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(1)
Our senior management uses adjusted pretax operating income (loss) as our primary measure to evaluate the fundamental financial performance of each of our business segments. See Note 4 of Notes to Consolidated Financial Statements.
(2)
Includes allocation of corporate operating expenses of $16.9 million, $12.0 million and $14.3 million for 2019, 2018 and 2017, respectively.
Our Services segment offers a broad array of real estate, title and mortgage services to market participants across the mortgage and real estate value chain. These services are primarily provided to mortgage lenders, financial institutions, investors and government entities. In addition, we provide title insurance and settlement services to mortgage lenders as well as directly to consumers. Prior to our January 2020 sale of Clayton, our mortgage services included transaction management services such as loan review, RMBS securitization and distressed asset reviews, as well as servicer and loan surveillance. See “Item 1. Business-Services-Services Business Overview-Services Offered” and Note 1 of Notes to Consolidated Financial Statements for additional information regarding the Services segment and the January 2020 sale of Clayton.
Adjusted Pretax Operating Income (Loss). Our Services segment’s adjusted pretax operating loss for 2019 was $14.3 million, compared to an adjusted pretax operating loss of $27.1 million in 2018. The decrease in our adjusted pretax operating loss for 2019, as compared to 2018, was driven by a decrease in interest expense, as discussed below, partially offset by an increase in operating expense.
Net Premiums Earned-Insurance. Net premiums earned for 2019 increased compared to 2018, as a result of the acquisition of the title insurance business in March 2018 and the inclusion of its operations.
Services Revenue. Services revenue increased for 2019, as compared to 2018, primarily due to the inclusion of revenue from businesses acquired in 2018 since their respective dates of acquisition.
Glossary
Part II Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Cost of Services. Our cost of services is primarily affected by our level of services revenue and the mix of services provided. The level of these costs may also fluctuate if market rates of compensation change, or if there is decreased availability or a loss of qualified employees.
Other Operating Expenses. Other operating expenses for 2019 were impacted by businesses acquired in 2018 and the resulting inclusion of other operating expenses for these businesses from their respective dates of acquisition. Other operating expenses also include other selling, general and administrative expenses, depreciation, and allocations of corporate general and administrative expenses. See “Results of Operations-Consolidated-Other Operating Expenses.”
Interest Expense. Effective January 1, 2019, the Clayton Intercompany Note was repaid using proceeds from an additional capital contribution from Radian Group. As a result of the intercompany note repayment, the Services segment no longer incurs interest expense on the intercompany note.
Contractual Obligations and Commitments
We have various contractual obligations that are recorded as liabilities in our consolidated financial statements.
The following table summarizes certain of our contractual obligations and commitments, including our expected claim payments on insurance policies and interest payments on debt obligations, as of December 31, 2019, and the future periods in which such obligations are expected to be settled in cash. Additional details regarding these obligations are provided in the narrative following the table and in the Notes to Consolidated Financial Statements that are referenced in the table.
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(1)
Includes contractual principal and related interest for $450 million of Senior Notes due 2024 and $450 million of Senior Notes due 2027, both of which may be redeemed in whole or in part at any time prior to maturity.
(2)
Includes $3.8 million for operating leases that were divested as part of the sale of Clayton.
(3)
Includes our reserve for losses and LAE which reflects the application of accounting policies described below in “Critical Accounting Policies-Reserve for Losses and LAE.” The payments due by period are based on management’s estimates and assume that all of the loss reserves included in the table will result in claim payments, net of expected recoveries.
(4)
Excludes approximately $38.5 million in potential additional liabilities associated with uncertain tax positions as of December 31, 2019. The timing or magnitude of any potential payments is unknown.
Other Contractual Obligations and Commitments
In the ordinary course of business, Radian enters into agreements pursuant to which we may be obligated under specified circumstances or upon the occurrence of certain events to indemnify the counterparties with respect to certain matters. The terms and amount of indemnification are negotiated on a transaction by transaction basis, but generally the circumstances of the transaction and/or the contract provisions are such that we believe the exposure to material liability is remote.
Off-Balance Sheet Arrangements
As of December 31, 2019, we had not entered into any material off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K, other than those below:
Securities Lending Agreements
We participate in securities lending agreements for the purpose of increasing the yield on our investment securities portfolio with minimal incremental risk. Pursuant to these agreements, we loan to third-party borrowers certain securities that are held as part of our investment portfolio. For a complete discussion of our securities lending agreements, including the effect of these agreements on our liquidity and risks related to these agreements, see Note 6 of Notes to Consolidated Financial Statements and “Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Market risk represents the potential for loss due to adverse changes in the value of financial instruments as a result of changes in market conditions. Examples of market risk include changes in interest rates, credit spreads, foreign currency exchange rates and equity prices. We perform sensitivity analyses to determine the effects of market risk exposures on our investment securities by determining the potential loss in future earnings, fair values or cash flows of market-risk-sensitive instruments resulting from one or more selected hypothetical changes in the above mentioned market risks.
Interest-Rate Risk and Credit-Spread Risk
The primary market risks in our investment portfolio are interest-rate risk and credit-spread risk, namely the fair value sensitivity of our fixed income securities to changes in interest rates and credit spreads, respectively. We regularly analyze our exposure to interest-rate risk and credit-spread risk and have determined that the fair value of our investments is materially exposed to changes in both interest rates and credit spreads. As of December 31, 2019, we held $317.2 million of investment securities for trading purposes, representing less than 6% of our total investment portfolio. Accordingly, in presenting this discussion, we have not distinguished between trading and non-trading instruments.
We calculate the duration of our fixed income securities, expressed in years, in order to estimate the interest-rate sensitivity of these securities. The average duration of our total fixed income portfolio was 4.0 years at December 31, 2019 and at December 31, 2018. To assist us in setting duration targets for the investment portfolio, we analyze: (i) the interest-rate sensitivities of our liabilities, including prepayment risk associated with premium cash flows and credit losses; (ii) entity specific cash flows under various economic scenarios; (iii) return, volatility and correlation of specific asset classes and the interconnection with our liabilities; and (iv) our current risk appetite.
Our sensitivity analysis for interest rates is based on the change in fair value of our fixed income securities, assuming a hypothetical instantaneous and parallel 100-basis point increase or decrease in the U.S. Treasury yield curve, with all other factors remaining constant. The carrying value of our fixed income securities has a balance of $5.6 billion and $5.1 billion. If interest rates experienced an increase of 100 basis points, our fixed income portfolio would decrease by $220.4 million and $198.4 million of the market value of the related fixed income portfolio for 2019 and 2018, respectively. A decrease of 100 basis points to interest rates would increase our fixed income portfolio by $228.1 million and $212.1 million for 2019 and 2018, respectively.
Credit spread represents the additional yield on a fixed income security, above the risk-free rate, that is paid by an issuer to compensate investors for assuming the credit risk of the issuer and market liquidity of the fixed income security. We manage credit-spread risk on both an entity and group level, across issuer, maturity, sector and asset class. Our sensitivity analysis for credit-spread risk is based on the change in fair value of our fixed income securities, assuming a hypothetical 100-basis point increase or decrease in all credit spreads, with the exception of U.S. Treasury and agency obligations for which we have assumed no change in credit spreads, and assuming all other factors remain constant. If credit-spread experienced an increase of 100 basis points, our fixed income portfolio would decrease by $211.3 million and $210.3 million of the market value of the related fixed income portfolio for 2019 and 2018, respectively. A decrease of 100 basis points to credit spread would increase our fixed income portfolio by $172.1 million and $195.7 million for 2019 and 2018, respectively.
Actual shifts in credit spreads generally vary by issuer and security, based on issuer-specific and security-specific factors such as credit quality, maturity, sector and asset class. Within a given asset class, investment grade securities generally exhibit less credit-spread volatility than securities with lower credit ratings. Our investment securities portfolio primarily consists of investment grade securities.
Our sensitivity analyses for interest-rate risk and credit-spread risk provide an indication of our investment portfolio’s sensitivity to shifts in interest rates and credit spreads. However, the timing and magnitude of actual market changes may differ from the hypothetical assumptions used in our sensitivity calculations.
See “Item 1. Business-Investment Policy and Portfolio” for a discussion of portfolio strategy and risk exposure.
Glossary
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
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Securities Lending Agreements. Radian Group, Radian Guaranty and Radian Reinsurance from time to time enter into short-term securities lending agreements with third-party borrowers for the purpose of increasing the yield on our investment securities portfolio with minimal incremental risk. Market factors, including changes in interest rates, credit spreads and equity prices, may impact the timing or magnitude of cash outflows for the return of cash collateral. As of December 31, 2019 and 2018, the carrying value of these securities included in the sensitivity analyses above was $39.0 million and $17.8 million, respectively.
We also have the right to request the return of the loaned securities at any time. For additional information on our securities lending agreements, see Note 6 of Notes to Consolidated Financial Statements.
Glossary
Item 8.
Item 8.
Financial Statements and Supplementary Data.
Glossary
REPORT ON MANAGEMENT’S RESPONSIBILITY
Management is responsible for the preparation, integrity and objectivity of the Consolidated Financial Statements and other financial information presented in this annual report. The accompanying Consolidated Financial Statements were prepared in accordance with accounting principles generally accepted in the United States of America, applying certain estimations and judgments as required.
Our board of directors exercises its responsibility for the financial statements through its Audit Committee, which consists entirely of independent non-management board members. The Audit Committee meets periodically with management and with PricewaterhouseCoopers LLP, the independent registered public accounting firm retained to audit our Consolidated Financial Statements, both privately and with management present, to review accounting, auditing, internal control and financial reporting matters.
The accompanying report of PricewaterhouseCoopers LLP is based on its audit, which it is required to conduct in accordance with the standards of the Public Company Accounting Oversight Board (U.S.), and which includes the consideration of our internal control over financial reporting to establish a basis for reliance thereon in determining the nature, timing and extent of audit tests to be applied.
Richard G. Thornberry
Chief Executive Officer
J. Franklin Hall
Senior Executive Vice President and Chief Financial Officer
Glossary
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Radian Group Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Radian Group Inc. and its subsidiaries (the “Company”) as of December 31, 2019 and 2018, and the related consolidated statements of operations, comprehensive income, changes in common stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2019, including the related notes and financial statement schedules listed in the index appearing under Item 15(a)(3) (collectively referred to as the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Glossary
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Valuation of First-Lien Primary Case Reserves for Mortgage Insurance Policies
As described in Notes 2 and 11 to the consolidated financial statements, the Company establishes case reserves for losses on mortgage insurance policies for loans that are considered to be in default, as well as reserves for loss adjustment expenses, IBNR and other reserves. As of December 31, 2019, first-lien primary case reserves were $339.8 million of the total $401.3 million of mortgage insurance loss reserves. Management’s estimate of the case reserves involves significant reliance upon assumptions and estimates with regard to the likelihood, magnitude and timing of each potential loss. Management uses an actuarial projection methodology referred to as a “roll rate” analysis that uses historical claim frequency information to determine the projected ultimate default to claim rates based on the stage of default and time in default as well as the date that a loan goes into default. After estimating the default to claim rate, management estimates claim severity based on the average of recently observed severity rates within product type, type of insurance, and time in default cohorts.
The principal considerations for our determination that performing procedures relating to the valuation of first-lien primary case reserves for mortgage insurance policies is a critical audit matter are (i) there was significant judgment by management when developing their estimates of the default to claim rates and claim severity, which in turn led to a high degree of auditor subjectivity and judgment in performing procedures relating to such estimates, (ii) there was significant audit effort and subjectivity in evaluating the audit evidence relating to the default to claim rates, management’s assessment of the relevance of historical claim frequency information and claim severity, and (iii) the audit effort included the involvement of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the audit evidence obtained.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to management’s valuation of first-lien primary case reserves for mortgage insurance policies, including controls over the development of the default to claim rates and claim severity. These procedures also included, among others, the involvement of professionals with specialized skill and knowledge to assist in developing an independent estimate of the case reserves for first-lien primary mortgage insurance policies using actual historical data, comparing this independent estimate to management’s determined case reserves, and evaluating the reasonableness of management’s assumptions related to the default to claim rates and claim severity. Performing these procedures involved testing the completeness and accuracy of data provided by management.
/s/ PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
February 28, 2020
We have served as the Company’s auditor since 2007.
Glossary
See Notes to Consolidated Financial Statements.
Glossary
See Notes to Consolidated Financial Statements.
Glossary
See Notes to Consolidated Financial Statements.
Glossary
See Notes to Consolidated Financial Statements.
Glossary
Glossary
See Notes to Consolidated Financial Statements.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements
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1. Description of Business
We are a diversified mortgage and real estate services business, providing both credit-related insurance coverage and other credit risk management solutions, as well as a broad array of real estate, title and mortgage services. We have two reportable business segments-Mortgage Insurance and Services.
Mortgage Insurance
Our Mortgage Insurance segment provides credit-related insurance coverage, principally through private mortgage insurance on residential first-lien mortgage loans, as well as other credit risk management solutions, to mortgage lending institutions and mortgage credit investors. We provide our mortgage insurance products and services mainly through our wholly-owned subsidiary, Radian Guaranty. Private mortgage insurance plays an important role in the U.S. housing finance system because it promotes affordable home ownership and helps protect mortgage lenders, investors and other beneficiaries by mitigating default-related losses on residential mortgage loans. Generally, these loans are made to home buyers who make down payments of less than 20% of the purchase price for their home or, in the case of refinancings, have less than 20% equity in their home. Private mortgage insurance also facilitates the sale of these low down payment loans in the secondary mortgage market, most of which are currently sold to the GSEs. Our total direct primary mortgage IIF and RIF were $240.6 billion and $60.9 billion, respectively, as of December 31, 2019.
The GSEs and state insurance regulators impose various capital and financial requirements on our insurance subsidiaries. These include Risk-to-capital, other risk-based capital measures and surplus requirements, as well as the PMIERs financial requirements. Failure to comply with these capital and financial requirements may limit the amount of insurance that our mortgage insurance subsidiaries may write or prohibit our mortgage insurance subsidiaries from writing insurance altogether. The GSEs and state insurance regulators also possess significant discretion with respect to our mortgage insurance subsidiaries and all aspects of their business. See Note 18 for additional information on PMIERs and other regulatory information.
Services
Our Services segment is primarily a fee-for-service business that offers a broad array of real estate, title and mortgage services to market participants across the mortgage and real estate value chain. We offer these services primarily to mortgage lenders, financial institutions, investors and government entities. In addition, we provide title insurance and settlement services to mortgage lenders as well as directly to consumers. Our real estate services help lenders, investors and real estate agents evaluate, manage, monitor and sell properties. These real estate services include software as a service solutions and platforms, as well as managed services, such as REO asset management, real estate valuation services and real estate brokerage services. Our title services provide a comprehensive suite of insurance and non-insurance title, closing and settlement services for residential mortgage loans. Our mortgage services include a full range of services to support the single family rental business and asset class and contract underwriting to support our mortgage insurance customers.
Prior to our January 2020 sale of Clayton, our mortgage services also included transaction management services, such as loan review, RMBS securitization and distressed asset reviews and servicer and loan surveillance services. See Note 7 for additional information on the sale of Clayton.
2. Significant Accounting Policies
Basis of Presentation
Our consolidated financial statements are prepared in accordance with GAAP and include the accounts of Radian Group Inc. and its subsidiaries. All intercompany accounts and transactions, and intercompany profits and losses, have been eliminated. Certain prior period amounts have been reclassified to conform to current period presentation.
We refer to Radian Group Inc. together with its consolidated subsidiaries as “Radian,” the “Company,” “we,” “us” or “our,” unless the context requires otherwise. We generally refer to Radian Group Inc. alone, without its consolidated subsidiaries, as “Radian Group.” Unless otherwise defined in this report, certain terms and acronyms used throughout this report are defined in the Glossary of Abbreviations and Acronyms included as part of this report.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of our contingent assets and liabilities at the dates of the
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. While the amounts included in our consolidated financial statements include our best estimates and assumptions, actual results may vary materially.
Investments
We group fixed-maturity securities in our investment portfolio into one of three main categories: held to maturity, available for sale or trading securities. Fixed-maturity securities for which we have the positive intent and ability to hold to maturity, if any, are classified as held to maturity and are reported at amortized cost. Trading securities are reported at fair value, with unrealized gains and losses reported as a separate component of income. Investments in fixed-maturity securities not classified as held to maturity or trading securities are classified as available for sale and are reported at fair value, with unrealized gains and losses (net of tax) reported as a separate component of stockholders’ equity as accumulated other comprehensive income (loss). Equity securities consist of holdings in common stock, preferred stock and exchange traded funds, which, effective January 1, 2018, are all recorded at fair value with unrealized gains and losses reported in income. Prior to the implementation of the update to the standard for the accounting of financial instruments effective January 1, 2018, the unrealized gains (losses) associated with equity securities that were available for sale were classified in accumulated other comprehensive income. Short-term investments consist of money market instruments, certificates of deposit and highly liquid, interest-bearing instruments with an original maturity of 12 months or less at the time of purchase. Amortization of premium and accretion of discount are calculated principally using the interest method over the term of the investment. Realized gains and losses on investments are recognized using the specific identification method. See Notes 5 and 6 for further discussion on investments.
We record an other-than-temporary impairment adjustment on a security with an unrealized loss if we intend to sell the impaired security, if it is more likely than not that we will be required to sell the impaired security prior to recovery of its amortized cost basis, or if the present value of cash flows we expect to collect is less than the amortized cost basis of the security. If a sale is likely, the security is classified as other-than-temporarily impaired and the full amount of the impairment is recognized as a loss in the statement of operations. Otherwise, losses on securities that are other-than-temporarily impaired are separated into: (i) the portion of loss that represents the credit loss and (ii) the portion that is due to other factors. The credit loss portion is recognized as a loss in the statement of operations, while the loss due to other factors is recognized in accumulated other comprehensive income (loss), net of taxes. A credit loss is determined to exist if the present value of discounted cash flows expected to be collected from the security is less than the amortized cost basis of the security. The present value of discounted cash flows is determined using the original yield of the security. In evaluating whether a decline in value is other-than-temporary, we consider several factors in addition to the above, including, but not limited to, the following:
•
the extent and the duration of the decline in value;
•
the reasons for the decline in value (e.g., credit event, interest-related or market fluctuations); and
•
the financial position, access to capital and near term prospects of the issuer, including the current and future impact of any specific events.
Fair Value of Financial Instruments
Our estimated fair value measurements are intended to reflect the assumptions market participants would use in pricing an asset or liability based on the best information available. Assumptions include the risks inherent in a particular valuation technique (such as a pricing model) and the risks inherent in the inputs to the model. Changes in economic conditions and capital market conditions, including but not limited to, credit spread changes, benchmark interest rate changes, market volatility and changes in the value of underlying collateral, could cause actual results to differ materially from our estimated fair value measurements. We define fair value as the current amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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In accordance with GAAP, we established a three-level valuation hierarchy for disclosure of fair value measurements based on the transparency of inputs to the valuation of an asset or liability as of the measurement date. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level I measurements) and the lowest priority to unobservable inputs (Level III measurements). The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is significant to the measurement in its entirety. The three levels of the fair value hierarchy are defined below:
Level I
- Unadjusted quoted prices for identical assets or liabilities in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level II
- Prices or valuations based on observable inputs other than quoted prices in active markets for identical assets and liabilities; and
Level III
- Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable. Level III inputs are used to measure fair value only to the extent that observable inputs are not available.
For markets in which inputs are not observable or are limited, we use significant judgment and assumptions that a typical market participant would use to evaluate the market price of an asset or liability. Given the level of judgment necessary, another market participant may derive a materially different estimate of fair value. These assets and liabilities are classified in Level III of our fair value hierarchy.
Available for sale securities, trading securities, equity securities and certain other assets are recorded at fair value as described in Note 5. All changes in fair value of trading securities, equity securities (effective January 1, 2018) and certain other assets are included in our consolidated statements of operations.
Restricted Cash
Included in our restricted cash balances as of December 31, 2019 were cash funds held in trusts for the benefit of: a mortgage insurance reserve policy held in escrow for any future duties, rights and liabilities; certain policyholders; servicer liabilities; and title services obligations.
Accounts and Notes Receivable
Accounts and notes receivable primarily consist of accrued premiums receivable due from our Mortgage Insurance customers, amounts billed and due from our Services customers for services our Services segment has performed, and profit commission receivable, if any, related to our reinsurance transactions. See Note 8 for details. Accounts and notes receivable are carried at their estimated collectible amounts, net of any allowance for doubtful accounts, and are periodically evaluated for collectability based on past payment history and current economic conditions. Accounts and notes receivable exclude unbilled receivables totaling $13.8 million, which represent receivables for services performed that are not yet billed. Unbilled receivables are presented in other assets.
Income Taxes
We provide for income taxes in accordance with the provisions of the accounting standard regarding accounting for income taxes. As required under this standard, our deferred tax assets and deferred tax liabilities are recognized under the balance sheet method, which recognizes the future tax effect of temporary differences between the amounts recorded in our consolidated financial statements and the tax bases of these amounts. Deferred tax assets and deferred tax liabilities are measured using the enacted tax rates that are expected to apply to taxable income in the periods in which the deferred tax asset or deferred tax liability is expected to be realized or settled. In regards to accumulated other comprehensive income, the Company’s policy for releasing disproportionate income tax effects is to release the effects as individual items are sold.
We are required to establish a valuation allowance against our deferred tax assets when it is more likely than not that all or some portion of our deferred tax assets will not be realized. At each balance sheet date, we assess our need for a valuation allowance. Our assessment is based on all available evidence, both positive and negative. This requires management to exercise judgment and make assumptions regarding whether our deferred tax assets will be realized in future periods.
Our provision for income taxes for interim financial periods is based on an estimate of our annual effective tax rate for the full year. When estimating our full year effective tax rates, we adjust our forecasted pre-tax income for gains and losses on our investments, changes in the accounting for uncertainty in income taxes, changes in our beginning of year valuation allowance, and other adjustments. The impact of these items is accounted for as Discrete Items at the applicable federal tax rate.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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Reserve for Losses and LAE
We establish reserves to provide for losses and LAE, which include the estimated costs of settling claims in our Mortgage Insurance segment, in accordance with the accounting standard regarding accounting and reporting by insurance enterprises (ASC 944). Although this standard specifically excludes mortgage insurance from its guidance relating to the reserve for losses, because there is no specific guidance for mortgage insurance, we establish reserves for mortgage insurance as described below, using the guidance contained in this standard supplemented with other accounting guidance.
In our mortgage insurance business, the default and claim cycle begins with the receipt of a default notice from the loan servicer. Case reserves for losses are established upon receipt of notification from servicers that a borrower has missed two monthly payments, which is when we consider a loan to be in default for financial statement and internal tracking purposes. We also establish reserves for associated LAE, consisting of the estimated cost of the claims administration process, including legal and other fees and expenses associated with administering the claims process.
With respect to loans that are in default, considerable judgment is exercised as to the adequacy of reserve levels. We use an actuarial projection methodology referred to as a “roll rate” analysis that uses historical claim frequency information to determine the projected ultimate Default to Claim Rates based on the Stage of Default and Time in Default as well as the date that a loan goes into default. The Default to Claim Rate also includes our estimates with respect to expected Rescissions and Claim Denials, which have the effect of reducing our Default to Claim Rates.
After estimating the Default to Claim Rate, we estimate Claim Severity based on the average of recently observed severity rates within product type, type of insurance, and Time in Default cohorts. These average severity estimates are then applied to individual loan coverage amounts to determine reserves.
Estimating our case reserve for losses involves significant reliance upon assumptions and estimates with regard to the likelihood, magnitude and timing of each potential loss, including an estimate of the impact of our Loss Mitigation Activities. The models, assumptions and estimates we use to establish loss reserves may prove to be inaccurate, especially during an extended economic downturn or a period of extreme market volatility and uncertainty. As such, we cannot be certain that our reserve estimate will be adequate to cover ultimate losses on incurred defaults. This uncertainty requires management to use considerable judgment in estimating the rate at which these loans will result in claims.
We also establish reserves for defaults that we estimate have been incurred but have not been reported (“IBNR”) to us on a timely basis by the servicer, as well as for previous Rescissions, Claim Denials, and Claim Curtailments that we estimate will be reinstated and subsequently paid. We generally give the policyholder up to 30 days to challenge our decision to rescind coverage before we consider a policy to be rescinded and remove it from our defaulted inventory. We currently expect a significant percentage of claims that were denied to be resubmitted as a perfected claim and ultimately paid. All estimates are periodically reviewed and adjustments are made as they become necessary.
The impact to our reserve due to estimated future Loss Mitigation Activities incorporates our expectations regarding the number of policies that we expect to be reinstated as a result of our claims rebuttal process. Rescissions, Claim Denials and Claim Curtailments may occur for various reasons, including, without limitation, underwriting negligence, fraudulent applications and appraisals, breach of representations and warranties and inadequate documentation, primarily related to our insurance written in years prior to and including 2008.
We do not establish reserves for loans that are in default if we believe that we will not be liable for the payment of a claim with respect to that default. We generally do not establish loss reserves for expected future claims on insured mortgages that are not in default. See “-Reserve for Premium Deficiency” below for an exception to these general principles.
Unless a liability associated with such activities or discussions becomes probable and can be reasonably estimated, we consider our claim payments and our Rescissions, Claim Denials and Claim Curtailments to be resolved for financial reporting purposes. Under the accounting standard regarding contingencies, an estimated loss is accrued only if we determine that the loss is probable and can be reasonably estimated. For populations of disputed Rescissions, Claim Denials and Claim Curtailments where we determine that a settlement is probable and that a loss can be reasonably estimated, we reflect our best estimate of the expected loss related to the populations under discussion in our financial statements, primarily as a component of our IBNR reserve. While our reserves include our best estimate of such losses, the outcome of the discussions or potential legal proceedings that could ensue is uncertain, and it is reasonably possible that a loss exists in excess of the amount accrued.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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Reserve for Premium Deficiency
Insurance enterprises are required to establish a PDR if the net present value of the expected future losses and expenses for a particular product line exceeds the net present value of expected future premiums and existing reserves for that product line. We reassess our expectations for premiums, losses and expenses for our mortgage insurance business at least quarterly and update our premium deficiency analyses accordingly. For our mortgage insurance business, we group our mortgage insurance products into two categories: first-lien and second-lien mortgage loans. As of December 31, 2019 and 2018, the combination of the net present value of our expected future premiums and existing reserves (net of reinsurance recoverables) significantly exceeded the net present value of our future expected losses and expenses associated with our first lien mortgage insurance portfolio. Our second-lien PDR, which was $0.2 million and $0.9 million as of December 31, 2019 and 2018,
respectively, is recorded as a component of other liabilities.
Revenue Recognition-Insurance Premiums
Mortgage Insurance
Premiums on mortgage insurance products are written on a recurring basis, either as monthly or annual premiums, or on a multi-year basis as a single premium. Monthly premiums written are earned as coverage is provided each month. For certain monthly policies where the billing is deferred for the first month’s coverage period, currently to the end of the policy, we record a net premium receivable representing the present value of such deferred premiums that we estimate will be collected at that future date. As of December 31, 2019, this net premium receivable was $17.4 million, representing the present value of $78.4 million in contractual deferred monthly premiums, after adjustments for the estimated collectability and timing of future billing. We recognize changes in this receivable based on changes in the estimated amount and timing of such collections, including as a result of changes in observed trends as well as our periodic review of our operations and collections practices. Annual premiums written are initially recorded as unearned premiums and amortized on a monthly, straight-line basis.
Single premiums written are initially recorded as unearned premiums and earned over time based on the anticipated claim payment pattern, which includes historical industry experience and is updated periodically. During 2019, we updated the amortization rates due to the continuing increase in the significance of borrower-paid Single Premium Policies in our portfolio following our rate reductions on borrower-paid Single Premium Policies in 2018. Under HPA, most borrower-paid policies must be canceled automatically on the date the LTV is scheduled to reach 78% of the original value (or, if the loan is not current on that date, on the subsequent date that the loan becomes current). As a result, given the shift in our mix of Single Premium Policies toward more borrower-paid Single Premium Policies than lender-paid, the average anticipated term of our Single Premium IIF is declining compared to historical levels. We updated our analysis to reflect not only this anticipated effect of HPA cancellations on borrower-paid policies, but also changes in observed and projected loss patterns for both borrower-paid and lender-paid policies. Our results for 2019 include a $32.9 million increase in net premiums earned and a $0.12 increase in net income per share, resulting from a cumulative adjustment related to the updated amortization rates used to recognize revenue for Single Premium Policies.
When we rescind insurance coverage on a loan, we refund all premiums received in connection with such coverage. When insurance coverage on a loan is canceled due to claim payment, we refund all premiums received since the date of delinquency. When insurance coverage is cancelled for a reason other than Rescission or claim payment, all premium that is nonrefundable is immediately earned. Premium revenue is recognized net of our accrual for estimated premium refunds due to Rescissions or other factors, which accrual is presented in other liabilities.
With respect to our reinsurance transactions, ceded premiums written on an annual or multi-year basis are initially set up as prepaid reinsurance and are amortized in a manner consistent with the recognition of income on direct premiums.
Title Insurance
Title insurance premiums are typically due and earned in full when the real estate transaction is closed. Premiums generally are calculated with reference to the policy amount. The premium charged by a title insurer or an agent is subject to regulation in most areas. Such regulations vary from state to state.
Revenue Recognition-Services
The FASB issued an update to the accounting standard regarding revenue recognition, Revenue from Contracts with Customers, which establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from our contracts with customers to provide services. We adopted this update effective January 1, 2018,
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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using the modified retrospective approach. The principle of this update requires an entity to recognize revenue representing the transfer of services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those services, recognized as the performance obligations are satisfied.
This update is primarily applicable to revenues from our Services segment. This update did not change revenue recognition principles related to our investments and insurance products, which together represented the majority of our total revenue for 2018 and are subject to other GAAP guidance discussed elsewhere within our disclosures. See Note 1 “-Services” for information about the services we offer.
Revenue expected to be recognized in any future period related to remaining performance obligations, such as contracts where revenue is recognized as invoiced and contracts with variable consideration related to undelivered performance obligations, is not material.
Fee-for-Service Contracts
Generally, our contracts with our Services clients do not include minimum volume commitments and can be terminated at any time by our clients. Although some of our contracts and assignments are recurring in nature, and include repetitive monthly assignments, a portion of our engagements are transactional in nature. Due to the transactional nature of our business, our Services segment revenues may fluctuate from period to period as transactions are commenced or completed. We do not recognize revenue or expense related to amounts advanced by us and subsequently reimbursed by clients for maintenance or repairs, because we do not take control of the service prior to the client taking control. We record an expense if an advance is made by us that is not in accordance with a client contract, and the client is not obligated to reimburse us.
Due to the nature of the services provided, our Services arrangements with customers may include fixed price contracts, and to a lesser extent, percentage-of-sale contracts.
Fixed-Price Contracts. Following the Clayton sale, we use fixed-price contracts in our real estate valuation and asset management business activities, our title and closing services, as well as our services related to single family rental services and contract underwriting. Prior to the Clayton sale, we also used fixed-price contracts in our surveillance business for our servicer oversight services and RMBS surveillance services. Under fixed-price contracts we agree to perform the specified services and deliverables for a pre-determined per-unit or per-file price or day rate. Each service qualifies as a separate performance obligation and revenue is recognized as the service performed is made available to the client.
Percentage-of-Sale Contracts. Under percentage-of-sale contracts, we are paid a contractual percentage of the sale proceeds upon the sale of each property. These contracts are only used for a portion of our REO management services and our real estate brokerage services. In addition, through the use of our proprietary technology, property leads are sent to select clients. Revenue attributable to services provided under a percentage-of-sale contract is recognized over time and measured based on the progress to date and typically coincides with the client’s successful closing on the property. The revenue recognized for these transactions is based on a percentage of the sale.
In certain instances, fees are received at the time that an asset is assigned to Radian for management. These fees are recorded as deferred revenue and are recognized over time based on progress to date and the availability to customers.
Cost of Services
Cost of services consists primarily of costs paid to outside vendors, including real estate agents that provide valuation and related services, as well as data acquisition costs and other compensation-related expenses to maintain software application platforms that directly support our businesses. Cost of services also includes employee compensation and related payroll benefits, as well as corresponding travel and related expenses incurred in providing such services to clients in our Services segment. Cost of services does not include an allocation of overhead costs.
Leases
We determine if an arrangement includes a lease at inception, and if it does, we recognize a right-of-use asset and lease liability in other assets and other liabilities, respectively, in our consolidated balance sheet. Right-of-use assets represent our right to use an underlying asset for the lease term and are recognized net of any payments made or received from the lessor. Lease liabilities represent our obligation to make lease payments arising from the lease and are based on the present value of lease payments over the lease term. In determining the net present value of lease payments, we use our incremental borrowing rate based on the information available at the lease commencement date or as of our date of adoption, January 1, 2019.
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Lease expense is recognized on a straight-line basis over the expected lease term. For lease agreements entered into after the adoption of a new accounting standard in 2019, lease and non-lease components are generally not accounted for separately. For more information regarding this new accounting standard, see “-Recent Accounting Pronouncements-Accounting Standards Adopted During 2019” below. We have elected the short-term exemption for contracts with lease terms of 12 months or less.
Our lease agreements primarily relate to operating leases for office space we use in our operations. Certain of our leases include renewal options and/or termination options that we did not consider in the determination of the right-of-use asset or the lease liability as we did not believe it was reasonably certain that we would exercise such options. Our lease agreements do not contain any variable lease payments, material residual value guarantees or material restrictive covenants.
Reinsurance
We cede insurance risk through the use of reinsurance contracts and follow reinsurance accounting for those transactions where significant risk is transferred. Loss reserves and unearned premiums are established before consideration is given to amounts related to our reinsurance agreements.
In accordance with the terms of the Single Premium QSR Program, rather than making a cash payment or transferring investments for ceded premiums written, Radian Guaranty holds the related amounts to collateralize the reinsurers’ obligations and has established a corresponding funds withheld liability. Any loss recoveries and any potential profit commission to Radian Guaranty will be realized from this account. The reinsurers’ share of earned premiums is paid from this account on a quarterly basis. This liability also includes an interest credit on funds withheld, which is recorded as ceded premiums at a rate specified in the agreement and, depending on experience under the contract, may be paid to either Radian Guaranty or the reinsurers. The ceding commission earned for premiums ceded pursuant to this transaction is attributable to other underwriting costs (including any related deferred policy acquisition costs). The unamortized portion of the ceding commission in excess of our related acquisition cost is reflected in other liabilities. Ceded premiums written are recorded on the balance sheet as prepaid reinsurance premiums and amortized to ceded premiums earned in a manner consistent with the recognition of income on direct premiums. See Note 8 for further discussion of our reinsurance transactions.
Variable Interest Entity
In connection with our reinsurance programs for our mortgage insurance business, we may enter into contracts with variable interest entities (“VIEs”). VIEs include corporations, trusts or partnerships in which: (i) the entity has insufficient equity at risk to allow it to finance its activities without additional subordinated financial support or (ii) at-risk equity holders, as a group, do not have the characteristics of a controlling financial interest.
We perform an evaluation to determine whether we are required to consolidate the VIE’s assets and liabilities in our consolidated financial statements, based on whether we are deemed to be the primary beneficiary. The primary beneficiary of a VIE is the variable interest holder that is determined to have the controlling financial interest as a result of having both: (i) the power to direct the activities of a VIE that most significantly impact the economic performance of the VIE and (ii) the obligation to absorb losses or right to receive benefits from the VIE that potentially could be significant to the VIE. See Note 8 for additional information.
Goodwill and Other Acquired Intangible Assets, Net
Goodwill and other acquired intangible assets were established in connection with acquisitions. Goodwill is an asset representing the estimated future economic benefits arising from the assets we have acquired that were not individually identified and separately recognized, and includes the value of discounted expected future cash flows of the entities acquired, the workforce, and expected synergies with our other affiliates and other unidentifiable intangible assets. Goodwill is deemed to have an indefinite useful life and is subject to review for impairment annually, or more frequently, whenever circumstances indicate potential impairment at the reporting unit level. A reporting unit represents a business for which discrete financial information is available; more than one reporting unit may be aggregated into a single reporting unit if they have similar economic characteristics. We have concluded that we have one reporting unit, the Services segment, for purposes of our goodwill impairment assessment. Events that could result in an interim assessment of goodwill impairment and/or a potential impairment charge include, but are not limited to: (i) a more-likely-than-not expectation of selling or disposing of all, or a portion, of a reporting unit; (ii) significant under-performance relative to historical or projected future operating results; (iii) significant changes in the strategy for the Services segment; (iv) significant negative industry or economic trends; and (v) a decline in Radian’s market capitalization below book value if such decline is attributable to the Services segment. Management
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regularly updates certain assumptions related to our projections, including the likelihood of achieving the assumed potential revenues from new initiatives and business strategies, and if these or other items have a significant negative impact on the reporting unit’s projections we may perform additional analysis to determine whether an impairment charge is needed. Lower earnings over sustained periods also can lead to impairment of goodwill, which could result in a charge to earnings. The value of goodwill is primarily supported by revenue projections, which are mostly driven by projected transaction volume and margins.
Acquired intangible assets, other than goodwill, primarily consist of customer relationships and represents the value of the specifically acquired customer relationships and are valued using the excess earnings approach using estimated client revenues, attrition rates, implied royalty rates and discount rates. The excess earnings approach estimates the present value of expected earnings in excess of a traditional return on business assets. For financial reporting purposes, intangible assets with finite lives are amortized over their applicable estimated useful lives in a manner that approximates the pattern of expected economic benefit from each intangible asset.
The calculation of the estimated fair value of goodwill and other acquired intangibles is performed primarily using an income approach and requires the use of significant estimates and assumptions that are highly subjective in nature, such as attrition rates, discount rates, future expected cash flows and market conditions. The most significant assumptions relate to the valuation of customer relationships. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. For more information on our accounting for goodwill and other acquired intangibles, including our impairment analysis policy, see Note 7.
Internal-use software, Property and Equipment
We capitalize certain costs associated with the development of internal-use software and the purchase of property and equipment. Software, property and equipment are carried at cost, net of accumulated depreciation and amortization. Amortization and depreciation commence during the month of our placement of the assets into use. Amortization and depreciation are calculated on a straight-line basis over the estimated useful life of the respective assets, typically from three to seven years, unless factors indicate a shorter useful life. Leasehold improvements are depreciated over the lesser of the estimated useful life of the asset improved or the remaining term of the lease. See Note 9 for additional information.
Deferred Policy Acquisition Costs
Incremental, direct costs associated with the successful acquisition of mortgage insurance policies, consisting of compensation, premium tax, and other policy issuance and underwriting expenses, are initially deferred and reported as deferred policy acquisition costs. Consistent with industry accounting practice, amortization of these costs for each underwriting year book of business is recognized in proportion to estimated gross profits over the estimated life of the policies.
Estimated gross profits are composed of earned premium, interest income, losses and LAE. Estimates of expected gross profit, including the Persistency Rate and loss development assumptions for each underwriting year used as a basis for amortization, are evaluated quarterly and the total amortization recorded to date is adjusted by a charge or credit to our consolidated statements of operations if actual experience or other evidence suggests that previous estimates should be revised. Considerable judgment is used in evaluating these estimates and the assumptions on which they are based. The use of different assumptions may have a significant effect on the amortization of deferred policy acquisition costs. Ceding commissions received under our reinsurance arrangements related to these costs are also deferred and accounted for using similar assumptions. See Notes 8 and 9 for additional information.
Earnings per Share
Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding, while diluted net income per share is computed by dividing net income attributable to common stockholders by the sum of the weighted-average number of common shares outstanding and the weighted-average number of dilutive potential common shares. Dilutive potential common shares relate primarily to our share-based compensation arrangements. For all calculations, the determination of whether potential common shares are dilutive or anti-dilutive is based on net income.
Accounting for Share-Based Compensation
The stock-based compensation cost related to share-based equity instruments is measured based on the grant-date fair value at the date of issuance. For share-based awards with performance conditions related to our own operations, the expense
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recognized is dependent on the probability of the performance measure being achieved. Compensation cost is generally recognized over the periods that an employee provides service in exchange for the award. See Note 15 for further information.
Recent Accounting Pronouncements
Accounting Standards Adopted During 2019
We adopted ASU 2016-02, Leases, on January 1, 2019. Most significantly, this update requires a lessee to recognize, as of the lease commencement date, a liability to make lease payments and an asset with respect to its right to use the underlying asset for the lease term. Upon adoption for contracts in effect as of January 1, 2019, we recorded a lease liability of $73.5 million within other liabilities, and a right-of-use asset of $49.4 million within other assets, corresponding to the lease liability as adjusted for deferred rent and unamortized allowances and incentives of $24.1 million. We elected the optional transition method and the practical expedients for transitioning existing leases to the new standard as of the effective date. As a result of applying the practical expedients: (i) we did not reassess expired or existing contracts to determine if they contain additional leases; (ii) we did not reassess the lease classification for expired and existing leases; and (iii) we did not reassess initial direct costs for existing leases. Prior period amounts continue to be reported in accordance with our historic accounting under previous lease guidance. We do not have material sublease agreements. As of December 31, 2019, there were no leases that had not yet commenced but that created significant rights and obligations for us. See Note 13 for more information about our lease agreements.
We adopted ASU 2017-08, Receivables-Nonrefundable Fees and Other Costs, on January 1, 2019. The new standard requires certain premiums on purchased callable debt securities to be amortized to the earliest call date. The amortization period for callable debt securities purchased at a discount will not be impacted. The adoption of this update did not have a material effect on our financial statements and disclosures.
In August 2018, the FASB issued ASU 2018-15, Intangibles-Goodwill and Other-Internal-Use Software. This ASU requires the capitalization of implementation costs for activities performed in a cloud computing arrangement that is a service contract. The new standard aligns the accounting for implementation costs of hosting arrangements that are service contracts with the accounting for capitalizing internal-use software. This update is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. We elected to early adopt this update effective December 31, 2019. The adoption of this update did not have a material effect on our financial statements and disclosures.
Accounting Standards Not Yet Adopted
In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses, and issued subsequent amendments to the initial guidance. This ASU and the associated subsequent amendments require that financial assets measured at their amortized cost basis be presented at the net amount expected to be collected. Credit losses relating to our available-for-sale debt securities are to be recorded through an allowance for credit losses, rather than a write-down of the asset, with the amount of the allowance limited to the amount by which fair value is less than amortized cost. This allowance method will allow reversals of credit losses if the estimate of credit losses declines. This ASU will also affect certain of our accounts and notes receivable, including premiums receivable, and certain of our other assets, including reinsurance recoverables. However, this ASU is not applicable to the accounting for insurance losses and loss adjustment expenses. Due to the nature of our assets affected by this update, we do not expect it to have a material effect on our financial statements and disclosures. This update is effective for public companies for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. We will adopt this standard effective January 1, 2020 using the modified retrospective adoption approach. The adoption of this ASU is not expected to have a material effect on the Company’s consolidated financial statements.
In August 2018, the FASB issued ASU 2018-12, Financial Services-Insurance. The new standard: (i) requires that assumptions used to measure the liability for future policy benefits be reviewed at least annually; (ii) defines and simplifies the measurement of market risk benefits; (iii) simplifies the amortization of deferred acquisition costs; and (iv) enhances the required disclosures about long-duration contracts. This update is effective for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the impact on our financial statements and future disclosures as a result of this update.
In April 2019, the FASB issued ASU 2019-04, Codification Improvements related to Financial Instruments-Credit Losses, Derivatives and Hedging, and Financial Instruments. This update to the accounting standards regarding financial instruments and derivatives and hedging clarifies the accounting treatment for the measurement of credit losses and provides further clarification on previously issued updates. This update is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15,
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2018, including interim periods within those fiscal years. We will adopt this standard effective January 1, 2020 using the modified retrospective adoption approach. The adoption of this ASU is not expected to have a material effect on the Company’s consolidated financial statements.
3. Net Income Per Share
The calculation of basic and diluted net income per share is as follows:
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(1)
The following number of shares of our common stock equivalents issued under our share-based compensation arrangements were not included in the calculation of diluted net income per share because they were anti-dilutive:
4. Segment Reporting
We have two strategic business segments that we manage separately-Mortgage Insurance and Services. Adjusted pretax operating income (loss) for each segment represents segment results on a standalone basis; therefore, inter-segment eliminations and reclassifications required for consolidated GAAP presentation have not been reflected. Inter-segment activities are recorded at market rates for segment reporting and eliminated in consolidation.
We allocate to our Mortgage Insurance segment: (i) corporate expenses based on the segment’s forecasted annual percentage of total revenue, which approximates the estimated percentage of time spent on the segment; (ii) except as described below for periods prior to January 1, 2019, all interest expense; and (iii) all net investment income from corporate cash and investments. Effective January 1, 2019, Radian Group recapitalized the Services segment with a capital contribution that enabled the Services segment to repay the Clayton Intercompany Note and its accumulated allocated interest expense associated with the note, and thereafter, all interest expense is allocated to our Mortgage Insurance segment.
We allocate to our Services segment: (i) corporate expenses based on the segment’s forecasted annual percentage of total revenue, which approximates the estimated percentage of time spent on the segment and (ii) until January 1, 2019, the allocated interest expense related to the Clayton Intercompany Note as described above.
With the exception of goodwill and other acquired intangible assets that relate to our Services segment, which are reviewed as part of our annual goodwill impairment assessment, we do not manage assets by segment.
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Adjusted Pretax Operating Income (Loss)
Our senior management, including our Chief Executive Officer (Radian’s chief operating decision maker), uses adjusted pretax operating income (loss) as our primary measure to evaluate the fundamental financial performance of each of Radian’s business segments and to allocate resources to the segments. Adjusted pretax operating income (loss) is defined as pretax income (loss) from continuing operations excluding the effects of: (i) net gains (losses) on investments and other financial instruments; (ii) loss on extinguishment of debt; (iii) amortization and impairment of goodwill and other acquired intangible assets; and (iv) impairment of other long-lived assets and other non-operating items, such as gains (losses) from the sale of lines of business and acquisition-related expenses.
Although adjusted pretax operating income excludes certain items that have occurred in the past and are expected to occur in the future, the excluded items represent those that are: (i) not viewed as part of the operating performance of our primary activities or (ii) not expected to result in an economic impact equal to the amount reflected in pretax income. These adjustments, along with the reasons for their treatment, are described below.
(1)
Net gains (losses) on investments and other financial instruments. The recognition of realized investment gains or losses can vary significantly across periods as the activity is highly discretionary based on the timing of individual securities sales due to such factors as market opportunities, our tax and capital profile and overall market cycles. Unrealized gains and losses arise primarily from changes in the market value of our investments that are classified as trading or equity securities. These valuation adjustments may not necessarily result in realized economic gains or losses.
Trends in the profitability of our fundamental operating activities can be more clearly identified without the fluctuations of these realized and unrealized gains or losses and changes in fair value of other financial instruments. We do not view them to be indicative of our fundamental operating activities.
(2)
Loss on extinguishment of debt. Gains or losses on early extinguishment of debt and losses incurred to purchase our debt prior to maturity are discretionary activities that are undertaken in order to take advantage of market opportunities to strengthen our financial and capital positions; therefore, we do not view these activities as part of our operating performance. Such transactions do not reflect expected future operations and do not provide meaningful insight regarding our current or past operating trends.
(3)
Amortization and impairment of goodwill and other acquired intangible assets. Amortization of acquired intangible assets represents the periodic expense required to amortize the cost of acquired intangible assets over their estimated useful lives. Acquired intangible assets are also periodically reviewed for potential impairment, and impairment adjustments are made whenever appropriate. We do not view these charges as part of the operating performance of our primary activities.
(4)
Impairment of other long-lived assets and other non-operating items. Includes activities that we do not view to be indicative of our fundamental operating activities, such as: (i) gains (losses) from the sale of lines of business and (ii) acquisition-related expenses.
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The reconciliation of adjusted pretax operating income (loss) for our reportable segments to consolidated pretax income is as follows:
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(1)
Includes inter-segment revenues as reflected in the tables below.
Revenue and Other Segment Information
The following tables reconcile reportable segment revenues to consolidated revenues and summarize interest expense, depreciation expense, allocation of corporate operating expenses and adjusted pretax operating income for our reportable segments as follows:
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(1)
Includes additional depreciation expense of $1.6 million, $0.2 million and $1.8 million allocated to Mortgage Insurance, Services and Reportable Segment Total, respectively.
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(1)
Includes additional depreciation expense of $0.5 million, $0.1 million and $0.6 million allocated to Mortgage Insurance, Services and Reportable Segment Total, respectively.
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(1)
Includes additional depreciation expense of $0.2 million, $0.1 million and $0.3 million allocated to Mortgage Insurance, Services and Reportable Segment Total, respectively.
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The table below represents the disaggregation of services revenues by revenue type:
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(1)
Includes $48.4 million, $50.8 million and $46.1 million for the years ended December 31, 2019, 2018 and 2017, respectively, related to Clayton, which was sold in January 2020.
Our Services segment revenues are recognized over time and measured each period based on the progress to date as services are performed and made available to customers. Our contracts with customers, including payment terms, are generally short-term in nature; therefore, any impact related to timing is immaterial. Revenue recognized related to services made available to customers and billed is reflected in accounts and notes receivable. Revenue recognized related to services performed and not yet billed is recorded in unbilled receivables and reflected in other assets. We have no material bad-debt expense. The following represents balances related to service revenue contracts as of the dates indicated:
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(1)
Excludes $10.5 million and $3.9 million of accounts receivable and unbilled receivables, respectively, that are related to Clayton and classified as held-for-sale.
There was no single customer that accounted for more than 10% of NIW or more than 10% of our consolidated revenues (excluding net gains (losses) on investments and other financial instruments) in 2019, 2018 or 2017.
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5. Fair Value of Financial Instruments
The following is a list of assets that are measured at fair value by hierarchy level as of December 31, 2019:
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(1)
Comprising short-term certificates of deposit and commercial paper.
(2)
Does not include other invested assets of $2.6 million that are primarily invested in limited partnership investments valued using the net asset value as a practical expedient and $1.5 million invested in a private convertible promissory note.
(3)
Securities loaned to third-party borrowers under securities lending agreements are classified as other assets in our consolidated balance sheets. See Note 6 for more information.
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The following is a list of assets that are measured at fair value by hierarchy level as of December 31, 2018:
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(1)
Comprising short-term certificates of deposit and commercial paper.
(2)
Does not include other invested assets of $3.4 million that are primarily invested in limited partnerships valued using the net asset value as a practical expedient.
(3)
Securities loaned to third-party borrowers under securities lending agreements are classified as other assets in our consolidated balance sheets. See Note 6 for more information.
At December 31, 2019 and 2018, there were no material Level III assets measured at fair value, and no Level III liabilities. There were no investment transfers to or from Level III for the years ended December 31, 2019 and 2018. Activity
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related to Level III assets and liabilities (including realized and unrealized gains and losses, purchases, sales, issuances, settlements and transfers) was immaterial for the years ended December 31, 2019 and 2018.
Valuation Methodologies for Assets Measured at Fair Value
The following are descriptions of our valuation methodologies for financial assets measured at fair value.
We are responsible for the determination of the value of all investments carried at fair value and the supporting methodologies and assumptions. To assist us in this responsibility, we utilize independent third-party valuation service providers to gather, analyze and interpret market information and estimate fair values based upon relevant methodologies and assumptions for various asset classes and individual securities. We perform monthly quantitative and qualitative analyses on the prices received from third parties to determine whether the prices are reasonable estimates of fair value. Our analysis includes: (i) a review of the methodology used by third-party pricing services; (ii) a comparison of pricing services’ valuations to other independent sources; (iii) a review of month-to-month price fluctuations; and (iv) a comparison of actual purchase and sale transactions with valuations received from third parties. These processes are designed to ensure that our investment values are accurately recorded, that the data inputs and valuation techniques utilized are appropriate and consistently applied and that the assumptions are reasonable and consistent with the objective of determining fair value.
U.S. Government and Agency Securities. The fair value of U.S. government and agency securities is estimated using observed market transactions, including broker-dealer quotes and actual trade activity as a basis for valuation. U.S. government and agency securities are categorized in either Level I or Level II of the fair value hierarchy.
State and Municipal Obligations. The fair value of state and municipal obligations is estimated using recent transaction activity, including market observations. Valuation models are used, which incorporate bond structure, yield curve, credit spreads and other factors. These securities are generally categorized in Level II of the fair value hierarchy or in Level III when market-based transaction activity is unavailable.
Money Market Instruments. The fair value of money market instruments is based on daily prices, which are published and available to all potential investors and market participants. As such, these securities are categorized in Level I of the fair value hierarchy.
Corporate Bonds and Notes. The fair value of corporate bonds and notes is estimated using recent transaction activity, including market observations. Spread models are used that incorporate issuer and structure characteristics, such as credit risk and early redemption features, where applicable. These securities are generally categorized in Level II of the fair value hierarchy or in Level III when market-based transaction activity is unavailable.
RMBS, CMBS, and Other ABS. The fair value of these instruments is estimated based on prices of comparable securities and spreads and observable prepayment speeds. These securities are generally categorized in Level II of the fair value hierarchy or in Level III when market-based transaction activity is unavailable. The fair value of any Level III securities is generally estimated by discounting estimated future cash flows.
Foreign Government and Agency Securities. The fair value of foreign government and agency securities is estimated using observed market yields used to create a maturity curve and observed credit spreads from market makers and broker-dealers. These securities are categorized in Level II of the fair value hierarchy.
Equity Securities. The fair value of these securities is generally estimated using observable market data in active markets or bid prices from market makers and broker-dealers. Generally, these securities are categorized in Level I or II of the fair value hierarchy, as observable market data are readily available. From time to time, certain equity securities may be categorized in Level III of the fair value hierarchy due to a lack of market-based transaction data or the use of model-based valuations.
Other Investments. These securities primarily consist of commercial paper and short-term certificates of deposit, which are categorized in Level II of the fair value hierarchy. The fair value of these investments is estimated using market data for comparable instruments of similar maturity and average yield.
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Other Fair Value Disclosure
The carrying value and estimated fair value of other selected liabilities not carried at fair value in our consolidated balance sheets were as follows as of the dates indicated:
The fair value of our senior notes is estimated based on the quoted market prices. The fair value of our FHLB advances is estimated based on expected cash flows for similar borrowings. These liabilities are categorized in Level II of the fair value hierarchy. See Note 12 for further information.
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6. Investments
Available for Sale Securities
Our available for sale securities within our investment portfolio consisted of the following as of the dates indicated:
Gross Unrealized Losses and Related Fair Values of Available for Sale Securities
For securities deemed “available for sale” and that are in an unrealized loss position, the following tables show the gross unrealized losses and fair values, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of the dates indicated. Included in the amounts as of December 31, 2019 and 2018, are loaned securities under securities lending agreements that are classified as other assets in our consolidated balance sheets, as further described below.
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Although we held available for sale securities in an unrealized loss position as of December 31, 2019, we did not consider those securities to be other-than-temporarily impaired as of such date. For all investment categories, the unrealized losses of 12 months or greater duration as of December 31, 2019 were generally caused by interest rate or credit spread movements since the purchase date, and as such, we expect to recover the amortized cost basis of these securities. As of December 31, 2019, we did not have the intent to sell any available for sale securities in an unrealized loss position, and we determined that it is more likely than not that we will not be required to sell the securities before recovery of their cost basis, which may be at maturity; therefore, we did not consider these investments to be other-than-temporarily impaired at December 31, 2019.
Other-Than-Temporary Impairment Activity. To the extent we determine that a security is deemed to have had an other-than-temporary impairment, an impairment loss is recognized. While there were no other-than-temporary impairment losses in earnings during the year ended December 31, 2019, we recognized such losses during the years ended December 31, 2018 and 2017. There were no other-than-temporary impairment losses recognized in accumulated other comprehensive income (loss) for any of those periods.
For the year ended December 31, 2018, we recorded other-than-temporary impairment losses in earnings of $1.7 million due to our intent to sell certain securities. For the year ended December 31, 2017, we recorded other-than-temporary impairment losses in earnings of $1.4 million, due primarily to credit deterioration in certain securities.
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Securities Lending Agreements
During the third quarter of 2017, we commenced participation in a securities lending program whereby we loan certain securities in our investment portfolio to third parties, generally large banks, for short periods of time. These securities lending agreements are collateralized financing arrangements whereby we transfer securities to third parties through an intermediary in exchange for cash or other securities. However, pursuant to the terms of these agreements, we maintain effective control over all loaned securities. Although we report such securities at fair value within other assets in our consolidated balance sheets, rather than in investments, the detailed information provided in this Note includes these securities. See Note 9 for additional information.
Under our securities lending agreements, the borrower is required to provide to us collateral, consisting of cash or securities, in amounts generally equal to or exceeding: (i) 102% of the value of the loaned securities (105% in the case of foreign securities) or (ii) another agreed-upon percentage not less than 100% of the market value of the loaned securities. Any cash collateral we receive may be invested in liquid assets. Cash collateral, which is reinvested for our benefit by the intermediary in accordance with the investment guidelines contained in the securities lending and collateral agreements, is reflected in short-term investments, with an offsetting liability recognized in other liabilities for the obligation to return the cash collateral. Securities collateral we receive is held on deposit for the borrower’s benefit and we may not transfer or loan such securities collateral unless the borrower is in default. Therefore, such securities collateral is not reflected in our consolidated financial statements given that the risks and rewards of ownership are not transferred to us from the borrowers.
Fees received and paid in connection with securities lending agreements are recorded in net investment income and interest expense, respectively, on the consolidated statements of operations.
All of our securities lending agreements are classified as overnight and revolving. Securities collateral on deposit with us from third-party borrowers totaling $42.4 million and $16.8 million as of December 31, 2019 and December 31, 2018, respectively, may not be transferred or re-pledged unless the third-party borrower is in default, and is therefore not reflected in our consolidated financial statements.
Net Investment Income
Net investment income consisted of:
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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Net Gains (Losses) on Investments
Net gains (losses) on investments consisted of:
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(1)Components of net realized gains (losses) on fixed-maturities available for sale include:
(2)
These amounts include unrealized gains (losses) on investment securities other than securities available for sale. For 2017, the unrealized gains (losses) on investments exclude the net change in unrealized gains and losses on equity securities. Prior to the implementation of the update to the standard for the accounting of financial instruments effective January 1, 2018, the unrealized gains (losses) associated with equity securities were classified in accumulated other comprehensive income.
The net changes in unrealized gains (losses) recognized in earnings on investments that were still held at each period-end were as follows:
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(1)
Prior to the implementation of the update to the standard for the accounting of financial instruments effective January 1, 2018, the unrealized gains (losses) associated with equity securities were classified in accumulated other comprehensive income.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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Change in Unrealized Gains (Losses) Recorded in Accumulated Other Comprehensive Income (Loss)
The change in unrealized gains (losses) recorded in accumulated other comprehensive income (loss) consisted of the following:
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(1)
Prior to our implementation of the update to the standard for the accounting of financial instruments effective January 1, 2018, the unrealized losses associated with equity securities were classified in accumulated other comprehensive income. Effective January 1, 2018, we measure our equity investments at fair value, with changes in fair value recognized in net income.
Contractual Maturities
The contractual maturities of fixed-maturities available for sale were as follows:
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(1)
Actual maturities may differ as a result of calls before scheduled maturity.
(2)
RMBS, CMBS, and Other ABS are shown separately, as they are not due at a single maturity date.
Other
For the years ended December 31, 2019, 2018 and 2017, we did not transfer any securities to or from the available for sale or trading categories.
Our fixed-maturities available for sale include securities totaling $16.8 million and $17.6 million at December 31, 2019 and 2018, respectively, on deposit and serving as collateral with various state regulatory authorities. Our fixed-maturities available for sale also include securities serving as collateral for our FHLB advances. See Note 12 for additional information about our FHLB advances.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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7. Goodwill and Other Acquired Intangible Assets, Net
All of our goodwill and other acquired intangible assets relate to our Services segment. The purchase price allocation for the acquisition of Five Bridges in December 2018 was finalized in the first quarter of 2019. In comparison to the preliminary fair value amounts recorded as of December 31, 2018, the final calculations resulted in an increase in goodwill of $0.5 million and a decrease in other acquired intangible assets of $0.5 million.
The following table shows the changes in the carrying amount of goodwill as of and for the years ended December 31, 2019 and 2018:
The following is a summary of the gross and net carrying amounts and accumulated amortization (including impairment) of our other acquired intangible assets as of the periods indicated:
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(1)
Excludes total gross carrying amount and accumulated amortization (including impairment) related to Clayton of $60.9 million and $57.2 million, respectively, which were reclassified to assets held-for-sale and included in other assets on our consolidated balance sheets at December 31, 2019.
(2)
Includes accumulated impairment charges of $15.8 million as of December 31, 2018, which were related entirely to Clayton.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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For the years ended December 31, 2019, 2018 and 2017, amortization expense was $8.6 million, $12.4 million and $11.8 million, respectively. The estimated aggregate expense for 2020 and thereafter is as follows:
Impairment Analysis
2019 Activity
As described below, in 2017, we undertook a strategic review of our Services business and made several decisions with respect to the business strategy that were designed to reposition this business to drive future growth and profitability. As a further step in this strategic repositioning, we initiated a process in 2019 to evaluate a potential sale of Clayton, through which we provided mortgage services related to loan acquisition, RMBS securitization and distressed asset reviews and servicer and loan surveillance services. This sale was completed in January 2020.
We report an asset group as held for sale when: (i) management is committed to a formal plan to sell the assets; (ii) the asset group is available for immediate sale; (iii) it is being actively marketed at a price that is reasonable in relation to its fair value; (iv) there is an active program to locate a buyer and other actions required to complete the plan to sell the asset have been initiated; (v) the sale is probable and expected to be completed within one year; and (vi) it is deemed unlikely that significant changes to the plan will be made or that the plan will be withdrawn. Based on developments in the fourth quarter of 2019, we determined that the asset group associated with the sale of Clayton met the criteria to be reclassified as held for sale as of December 31, 2019.
An asset group classified as held for sale is reflected at the lower of its carrying amount or estimated fair value less cost to sell. If the carrying amount of the business exceeds its estimated fair value, a loss is recognized. Due to the reclassification as held for sale of the asset group associated with the sale of Clayton, we recognized an impairment charge of $4.8 million for goodwill allocated to this asset group. The allocation was based on the estimated relative indicated fair value of the Clayton asset group and the remaining Services reporting unit. In addition, we recognized an impairment of other acquired intangible assets for $13.7 million and reclassified the remaining other acquired intangible assets balance associated with the asset group of $3.7 million as held for sale as of December 31, 2019.
Assets and liabilities related to Clayton classified as held for sale are presented in other assets and other liabilities, respectively, in the consolidated balance sheets in the period in which the business is classified as held for sale. See Notes 4 and 9 for additional detail on assets held for sale as of December 31, 2019.
We generally perform our annual goodwill impairment test during the fourth quarter of each year, using balances as of the prior quarter. Following the reclassification to held for sale of allocated goodwill and other acquired intangible assets and the related impairment recognized, we elected to perform a qualitative impairment analysis for the remaining goodwill and other acquired intangible assets in the fourth quarter of 2019. The qualitative analysis requires us to assess all relevant events and circumstances that could affect the significant inputs used to determine the fair value of the reporting unit. We considered factors such as: (i) our recent impairment of goodwill and other acquired intangible assets related to the sale of Clayton and (ii) the increase in and timing of revenues during the third and fourth quarters of 2019 for the remaining reporting unit (as compared to the forecasted amounts for the same periods), including the impact of higher margin business. Based on our qualitative assessment in the fourth quarter of 2019, we concluded that it is not “more likely than not” that the fair value of the remaining Services reporting unit is less than its carrying amount as of December 31, 2019. In addition, based on our analysis, there was no impairment indicated for the remaining other acquired intangible assets, as the carrying amounts were estimated to be recoverable from future cash flows.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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2018 Activity
As part of our annual goodwill impairment assessment in 2018, which was conducted in the fourth quarter of 2018, we estimated the fair value of the reporting unit using primarily an income approach and, to a lesser extent, a market approach. The key factor in our fair value analysis was forecasted future cash flows. We considered both positive and negative factors and concluded that, after considering all of the factors and evidence available, there was no impairment of goodwill as of December 31, 2018 because the estimated fair value of the reporting unit exceeded our carrying amount.
As of December 31, 2018, we also evaluated the recoverability of our other acquired intangible assets. Factors affecting the estimated fair value of our goodwill were also considered in estimating the recoverability of our other acquired intangible assets. Based on our analysis, there was no impairment indicated for other acquired intangible assets, as the carrying amounts were estimated to be recoverable from future cash flows.
2017 Activity
Our Chief Executive Officer joined Radian in March 2017 and initiated a review to evaluate the strategic direction of the Services segment. Based on this strategic review, in the second quarter of 2017, we made several decisions with respect to business strategy for the segment in order to reposition the Services business to drive future growth and profitability. We determined to: (i) discontinue certain initiatives and (ii) shift the strategy of the Services segment to focus on core products and services that were expected to have higher growth potential, to produce more predictable, recurring revenue streams over time and to better align with our market expertise and the needs of our customers.
During the second quarter of 2017, the Services segment performed below forecasted levels. The anticipated business and growth opportunities for certain business lines in our Services segment had been impacted by: (i) market demand, which was lower than anticipated; (ii) increased competition, including with respect to product alternatives and pricing; and (iii) delays in the realization of efficiencies and margin improvements associated with certain technology initiatives. The impact of the observed market trends, which we expected to continue, together with our strategic decisions in 2017 discussed above, resulted in changes to our expected product mix and the expected growth rates associated with various initiatives, which in turn generated material reductions to our forecasted net cash flows. As a result of the quantitative goodwill analysis, we recorded an impairment charge of $184.4 million for the three months ended June 30, 2017, to reduce the carrying amount of the Services segment to its estimated fair value. Prior to finalizing this amount, we also evaluated the recoverability of the segment’s other acquired intangible assets and recorded impairment charges of $15.8 million related to the Services segment’s other acquired intangible assets.
During the fourth quarter of 2017, we elected to perform a qualitative annual goodwill impairment analysis, which requires us to assess all relevant events and circumstances that could affect the significant inputs used to determine the fair value of the reporting unit. We considered factors such as: (i) the increase in and timing of revenues during the third and fourth quarters of 2017 (as compared to the forecasted amounts for the same periods); (ii) the impact to projected cash flows, a significant input used to determine the fair value of the reporting unit, associated with the TCJA enacted in the fourth quarter of 2017; (iii) our recent interim goodwill impairment test and recognition of impairment charges; and (iv) the January 2020 sale of a business line. Based on our qualitative assessment in the fourth quarter of 2017, we concluded that it was not “more likely than not” that the fair value of the Services reporting unit was less than its carrying amount as of December 31, 2017.
For additional information on our accounting policies for goodwill and other acquired intangible assets, see Note 2.
8. Reinsurance
In our mortgage insurance and title insurance businesses, we use reinsurance as part of our risk distribution strategy, including to manage our capital position and risk profile. The reinsurance arrangements for our mortgage insurance business include premiums ceded under the QSR Program, the Single Premium QSR Program, and the Excess-of-Loss Program. The Company’s related PMIERs credit under these programs are subject to GSE approval.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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The effect of all of our reinsurance programs on our net income is as follows:
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(1)
Includes premiums earned from our participation in certain credit risk transfer programs.
(2)
Net of profit commission.
(3)
Deferred ceding commissions of $74.8 million and $91.4 million are included in other liabilities on our consolidated balance sheets at December 31, 2019 and 2018, respectively.
QSR Program
In 2012, Radian Guaranty entered into the QSR Program with a third-party reinsurance provider. Radian Guaranty has ceded the maximum amount permitted under the QSR Program and is no longer ceding NIW under this program. RIF ceded under the QSR Program was $0.6 billion, $0.9 billion and $1.2 billion as of December 31, 2019, 2018 and 2017, respectively.
Single Premium QSR Program
2016 Single Premium QSR Agreement. In 2016, Radian Guaranty entered into the 2016 Single Premium QSR Agreement with a panel of third-party reinsurers. Under the 2016 Single Premium QSR Agreement, effective January 1, 2016, Radian Guaranty began ceding the following Single Premium IIF and NIW, subject to certain conditions:
•
20% of its existing performing Single Premium Policies written between January 1, 2012 and March 31, 2013;
•
35% of its existing performing Single Premium Policies written between April 1, 2013 and December 31, 2015; and
•
35% of its Single Premium NIW from January 1, 2016 to December 31, 2017.
Radian Guaranty received a 25% ceding commission for ceded premiums written pursuant to this transaction. Radian Guaranty also receives a profit commission, provided that the loss ratio on the loans covered under the agreement generally remains below 55%. Losses on the ceded risk above this level reduce Radian Guaranty’s profit commission on a dollar-for-dollar basis.
The agreement is scheduled to terminate on December 31, 2027. Radian Guaranty has the option, based on certain conditions and subject to a termination fee, to terminate the agreement at the end of any calendar quarter on or after January 1, 2020. If Radian Guaranty exercises this option in the future, it would result in Radian Guaranty reassuming the related RIF in exchange for a net payment to the reinsurer calculated in accordance with the terms of the agreement. Radian Guaranty also may terminate this agreement prior to the scheduled termination date under certain circumstances/conditions, including if one or both of the GSEs no longer grant full PMIERs credit for the reinsurance.
Effective December 31, 2017, we amended the 2016 Single Premium QSR Agreement to increase the amount of ceded risk on performing loans under the agreement from 35% to 65% for the 2015 through 2017 vintages. As of the effective date, the result of this amendment increased the amount of risk ceded on Single Premium Policies, including for the purposes of calculating any future ceding commissions and profit commissions that Radian Guaranty will earn. It also increased the future
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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amounts of our ceded premiums and ceded losses. RIF ceded under the 2016 Single Premium QSR Agreement was $5.4 billion as of December 31, 2019, compared to $6.3 billion and $6.9 billion as of December 31, 2018 and 2017, respectively. As of January 1, 2018, Radian Guaranty is no longer ceding NIW under this arrangement.
2018 Single Premium QSR Agreement. In October 2017, we entered into the 2018 Single Premium QSR Agreement with a panel of third-party reinsurers. Under the 2018 Single Premium QSR Agreement, we ceded 65% of our Single Premium NIW beginning with the business written in January 2018, subject to certain conditions.
Radian Guaranty received a 25% ceding commission for ceded premiums written pursuant to this transaction. Radian Guaranty also receives an annual profit commission based on the performance of the loans subject to the agreement, provided that the loss ratio on the subject loans is below 56% for that calendar year.
The agreement is scheduled to terminate on December 31, 2029. Radian Guaranty has the option, based on certain conditions and subject to a termination fee, to terminate the agreement as of January 1, 2022, or at the end of any calendar quarter thereafter, which would result in Radian Guaranty reassuming the related RIF in exchange for a net payment to the reinsurer calculated in accordance with the terms of the agreement. Radian Guaranty also may terminate this agreement prior to the scheduled termination date under certain circumstances/conditions, including if one or both of the GSEs no longer grant full PMIERs credit for the reinsurance. RIF ceded under the 2018 Single Premium QSR Agreement was $3.2 billion as of December 31, 2019, compared to $1.9 billion as of December 31, 2018. As of January 1, 2020, Radian Guaranty is no longer ceding NIW under this arrangement.
2020 Single Premium QSR Agreement. In January 2020, we entered into the 2020 Single Premium QSR Agreement with a panel of third-party reinsurers. Under the 2020 Single Premium QSR Agreement, beginning with the business written in January 2020, we expect to cede 65% of our Single Premium NIW, subject to certain conditions and a limitation on ceded premiums written equal to $250 million for policies issued between January 1, 2020 and December 31, 2021. The parties may mutually agree to increase the amount of ceded risk above this level.
Radian Guaranty will receive a 25% ceding commission for ceded premiums written pursuant to this transaction. Radian Guaranty will also receive an annual profit commission based on the performance of the loans subject to the agreement, provided that the loss ratio on the subject loans is below 56% for that calendar year. Radian Guaranty may discontinue ceding new policies under the agreement at the end of any calendar quarter.
The agreement is scheduled to terminate on December 31, 2031. Radian Guaranty has the option, based on certain conditions and subject to a termination fee, to terminate the agreement as of January 1, 2024, or at the end of any calendar quarter thereafter, which would result in Radian Guaranty reassuming the related RIF in exchange for a net payment to the reinsurer calculated in accordance with the terms of the agreement. Radian Guaranty also may terminate this agreement prior to the scheduled termination date under certain circumstances/conditions, including if one or both of the GSEs no longer grant full PMIERs credit for the reinsurance.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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Excess-of-Loss Program
Through December 31, 2019, Radian Guaranty entered into two fully collateralized reinsurance arrangements with the Eagle Re Issuers. For the respective coverage periods, Radian Guaranty will retain the first-loss layer of aggregate losses, as well as any losses in excess of the outstanding reinsurance coverage amounts. The Eagle Re Issuers will provide the second layer coverage up to the outstanding coverage amounts. The aggregate excess-of-loss reinsurance coverage for these transactions decreases over a ten-year period as the principal balances of the underlying covered mortgages decrease and as any claims are paid by the applicable Eagle Re Issuer or the mortgage insurance is canceled. The outstanding reinsurance coverage amount will begin amortizing after an initial period in which a target level of credit enhancement is obtained and will stop amortizing if certain thresholds are reached, such as if the reinsured mortgages were to experience an elevated level of delinquencies or certain credit enhancement tests were not maintained. Radian Guaranty has rights to terminate the reinsurance agreements upon the occurrence of certain events. The Eagle Re Issuers financed their coverage by issuing mortgage insurance-linked notes to eligible third-party capital markets investors in an unregistered private offering.
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(1)
Excludes a separate excess-of-loss reinsurance agreement entered into by Radian Guaranty that initially provided up to $21.4 million of coverage.
The Eagle Re Issuers are not subsidiaries or affiliates of Radian Guaranty. Based on the accounting guidance that addresses VIEs, we have not consolidated any of the Eagle Re Issuers in our consolidated financial statements, because Radian does not have: (i) the power to direct the activities that most significantly affect the Eagle Re Issuers’ economic performances or (ii) the obligation to absorb losses or the right to receive benefits from the Eagle Re Issuers that potentially could be significant to the Eagle Re Issuers.
The reinsurance premium due to the Eagle Re Issuers is calculated by multiplying the outstanding reinsurance coverage amount at the beginning of a period by a coupon rate, which is the sum of one-month LIBOR plus a contractual risk margin, and then subtracting actual investment income collected on the assets in the reinsurance trust during the preceding month. As a result, the premiums we pay will vary based on: (i) the spread between LIBOR and the rates on the investments held by the reinsurance trust and (ii) the outstanding amount of reinsurance coverage. As the reinsurance premium will vary based on changes in these rates, we concluded that the reinsurance agreements contain embedded derivatives, which we have accounted for separately as freestanding derivatives and recorded in other assets on our consolidated balance sheets. See Note 2 for more information on our accounting treatment of VIEs.
As of December 31, 2019 and 2018, our maximum exposure to loss associated with our Eagle Re Issuers was $0.4 million and $1.1 million, respectively, which represents the fair value of the embedded derivatives. In the event the VIE is unable to meet its future obligations to us, if any, our insurance subsidiaries would be liable to make claims payments to our policyholders. In the event that all of the assets in the reinsurance trust (consisting of U.S. government money market funds, cash or U.S. Treasury securities) have become worthless and the VIE is unable to make its payments to us, our maximum potential loss would be the amount of mortgage insurance claim payments for losses on the insured policies, net of the aggregate reinsurance payments already received, up to the full aggregate excess-of-loss reinsurance coverage amount. In the same scenario, the related embedded derivative would no longer have value.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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The Eagle Re Issuers represent our only VIEs as of December 31, 2019. The following table presents the total assets of the Eagle Re Issuers as of the dates indicated.
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(1)
Assets held by the Eagle Re Issuers are required to be invested in U.S. government money market funds, cash or U.S. Treasury securities. Liabilities of Eagle Re Issuers consist of their mortgage insurance-linked notes, as described above.
In February 2020, Radian Guaranty entered into a fully collateralized reinsurance agreement with Eagle Re 2020-1. Eagle Re 2020-1 is a VIE and is not a subsidiary or affiliate of Radian Guaranty. This reinsurance agreement provides for up to $488.4 million of aggregate excess-of-loss reinsurance coverage for the mortgage insurance losses on new defaults on an existing portfolio of eligible Recurring Premium Policies with RIF of $9.9 billion that were issued between January 1, 2019 and September 30, 2019. Eagle Re 2020-1 financed its coverage by issuing mortgage insurance-linked notes in an aggregate amount of $488.4 million to eligible third-party capital markets investors in an unregistered private offering.
Other Collateral
Although we use reinsurance as one of our risk management tools, reinsurance does not relieve us of our obligations to our policyholders. In the event the reinsurers are unable to meet their obligations to us, our insurance subsidiaries would be liable for any defaulted amounts. However, consistent with the PMIERs reinsurer counterparty collateral requirements, Radian Guaranty’s reinsurers have established trusts to help secure our potential cash recoveries. In addition to the total VIE assets of the Eagle Re Issuers discussed above, the amount held in reinsurance trusts was $203.2 million as of December 31, 2019, compared to $212.2 million as of December 31, 2018. In addition, for the Single Premium QSR Program, Radian Guaranty holds amounts received from ceded premiums written to collateralize the reinsurers’ obligations, which is reported in reinsurance funds withheld on our consolidated balance sheets. Any loss recoveries and profit commissions paid to Radian Guaranty related to the Single Premium QSR Program are expected to be realized from this account.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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9. Other Assets
The following table shows the components of other assets for the periods indicated:
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(1)
Internal-use software, at cost, has been reduced by accumulated amortization of $73.5 million and $60.3 million at December 31, 2019 and 2018, respectively, as well as $3.8 million of impairment charges in 2019 and $5.1 million of impairment charges in 2018. Amortization expense was $13.0 million, $11.4 million and $10.7 million for the years ended December 31, 2019, 2018 and 2017, respectively.
(2)
Represents right-of-use assets recognized as a result of our adoption, as of January 1, 2019, of the new accounting and
disclosure requirements for leases of property, plant and equipment. See Note 2 for additional information. Right-of-use assets are shown less accumulated amortization of $8.5 million at December 31, 2019.
(3)
Property and equipment at cost, less accumulated depreciation of $68.4 million and $62.9 million at December 31, 2019 and 2018, respectively. Depreciation expense was $7.8 million, $8.0 million and $6.9 million for the years ended December 31, 2019, 2018 and 2017, respectively.
(4)
Related to the sale of Clayton. See Notes 4 and 7 for additional information on assets held for sale. Liabilities held for sale at December 31, 2019 are included in other liabilities on our consolidated balance sheets.
(5)
During the year ended December 31, 2019, current federal income tax receivable was reduced by our receipt of the remaining $57.2 million refund from amounts on deposit with the IRS related to the settlement of the IRS Matter.
10. Income Taxes
Income Tax Provision
The components of our consolidated income tax provision from continuing operations are as follows:
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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The reconciliation of taxes computed at the statutory tax rate of 21% in 2019 and 2018 and 35% in 2017 to the provision for income taxes is as follows:
Deferred Tax Assets and Liabilities
The significant components of our net deferred tax assets and liabilities from continuing operations are summarized as follows:
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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Current and Deferred Taxes
As of December 31, 2019, we recorded a net current income tax payable of $39.1 million, which primarily relates to applying the standards of accounting for uncertainty in income taxes. Certain entities within our consolidated group have generated net deferred tax assets of approximately $65.8 million, relating primarily to state and local NOL carryforwards which, if unutilized, will expire during various future tax periods.
As a mortgage guaranty insurer, we are eligible for a tax deduction, subject to certain limitations, under Internal Revenue Code Section 832(e) for amounts required by state law or regulation to be set aside in statutory contingency reserves. The deduction is allowed only to the extent that we purchase non-interest bearing U.S. Mortgage Guaranty Tax and Loss Bonds issued by the U.S. Department of the Treasury in an amount equal to the tax benefit derived from deducting any portion of our statutory contingency reserves. As of December 31, 2019, we held $134.8 million of these bonds, which are included as prepaid income taxes within other assets in our consolidated balance sheets. The corresponding deduction of our statutory contingency reserves resulted in the recognition of a net deferred tax liability, which is included in other liabilities in our consolidated balance sheets.
Valuation Allowances
We are required to establish a valuation allowance against our deferred tax assets when it is more likely than not that all or some portion of our deferred tax assets will not be realized. At each balance sheet date, we assess our need for a valuation allowance. Our assessment is based on all available evidence, both positive and negative. This requires management to exercise judgment and make assumptions regarding whether our deferred tax assets will be realized in future periods. We have determined that certain non-insurance entities within Radian may continue to generate taxable losses on a separate company basis in the near term and may not be able to fully utilize certain state and local NOLs on their state and local tax returns. Therefore, with respect to deferred tax assets relating to these state and local NOLs and other state timing adjustments, we retained a valuation allowance of $66.4 million at December 31, 2019 and $64.5 million at December 31, 2018.
IRS Matter
In July 2018, we finalized a settlement with the IRS related to adjustments we had been contesting that resulted from the examination by the IRS of our 2000 through 2007 consolidated federal income tax returns. This settlement with the IRS resolved the issues and concluded all disputes related to the IRS Matter. During 2018, we recorded tax benefits of $73.6 million, which includes both the impact of the settlement with the IRS as well as the reversal of certain previously accrued state and local tax liabilities. In 2018, under the terms of the settlement, Radian utilized its “qualified deposits” with the U.S. Department of the Treasury to settle its $31 million obligation to the IRS, and during the first quarter of 2019, the IRS refunded to Radian the remaining $57.2 million that was previously on deposit. See Note 9 for additional information about these qualified deposits.
Unrecognized Tax Benefits
As of December 31, 2019, we have $17.8 million of unrecognized tax benefits, including $1.3 million of interest and penalties, that would affect the effective tax rate, if recognized. Our policy for the recognition of interest and penalties associated with uncertain tax positions is to record such items as a component of our income tax provision, of which $1.3 million and $2.2 million were recorded for the years ended December 31, 2019 and 2017, respectively. In 2018, we recorded an income tax benefit of $61.6 million for interest and penalties primarily related to our IRS settlement.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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A reconciliation of the beginning and ending unrecognized tax benefits is as follows:
Our total net unrecognized tax benefits increased by $3.7 million from December 31, 2018 to December 31, 2019, primarily due to the impact of unrecognized tax benefits associated with our recognition of certain premium income. Over the next 12 months, our unrecognized tax benefits may decrease by approximately $7.5 million due to the expiration of the applicable statute of limitations relating to the 2015 and 2016 tax years. The statute of limitations related to our federal consolidated income tax return remains open for tax years 2015-2018. Additionally, among the entities within our consolidated group, various tax years remain open to potential examination by state and local taxing authorities.
11. Losses and Loss Adjustment Expenses
Our reserve for losses and LAE, at the end of each period indicated, consisted of:
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(1)
Primarily comprises first lien primary case reserves of $339.8 million and $361.7 million at December 31, 2019 and 2018, respectively.
(2)
A majority of this amount is subject to reinsurance, with the related reinsurance recoverables reported in other assets in our consolidated balance sheet, and relates to Radian Title Insurance. For all periods presented, total incurred losses and paid claims for Radian Title Insurance were not material.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
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For the periods indicated, the following table presents information relating to our mortgage insurance reserve for losses, including our IBNR reserve and LAE, but excluding our second-lien mortgage loan PDR:
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(1)
Related to ceded losses recoverable, if any, on reinsurance transactions. See Note 8 for additional information.
(2)
Related to underlying defaulted loans with a most recent default notice dated in the year indicated. For example, if a loan had defaulted in a prior year, but then subsequently cured and later re-defaulted in the current year, that default would be considered a current year default. For 2017, includes payments made on pool commutations, in some cases for loans not previously in default.
(3)
Includes the payment of $54.8 million made in connection with the scheduled final settlement of the Freddie Mac Agreement in the third quarter of 2017.
Reserve Activity
Incurred Losses
For all periods presented, our case reserves established for new first-lien primary default notices were the primary driver of our total incurred losses, and they were primarily impacted by the number of new primary default notices received in the period and our related gross Default to Claim Rate assumption applied to those new defaults, as reflected in the Default to Claim Rate table below. Additionally, our provision for losses was positively impacted by favorable reserve development on prior year defaults. This favorable development in all periods was primarily driven by a reduction during the period in certain Default to Claim Rate assumptions for these prior year defaults based on observed trends. For 2019, this favorable development was partially offset by a $30.5 million increase in our IBNR reserve estimate. The increase in our IBNR reserve estimate is related to certain legal proceedings involving challenges from certain servicers regarding our Loss Mitigation Activities, which challenges may result in the reversal of certain decisions regarding prior Rescissions, Claim Denials or Claim Curtailments. See Note 13 for additional information.
Hurricane Impact 2018/2017. During the third quarter of 2017, Hurricanes Harvey and Irma caused extensive property damage to areas of Texas, Florida and Georgia, as well as other general disruptions including power outages and flooding. Following Hurricanes Harvey and Irma, we observed an increase in new primary defaults from FEMA Designated Areas associated with these hurricanes. As expected, most of these hurricane-related defaults cured by the end of 2018, and at higher cure rates than the rates for our general population of defaults. These incremental defaults did not have a material impact on our provision for losses in 2017 or 2018.
Default to Claim Rate. Our Default to Claim Rate estimates on defaulted loans are mainly developed based on the Stage of Default and Time in Default of the underlying defaulted loans grouped according to the period in which the default occurred,
Glossary
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as measured by the progress toward foreclosure sale and the number of months in default. Our estimate of expected Rescissions and Claim Denials (net of expected Reinstatements) embedded in our estimated Default to Claim Rate is generally based on our recent experience. Consideration is also given to differences in characteristics between those rescinded policies and denied claims and the loans remaining in our defaulted inventory. The following table shows our gross Default to Claim Rates on our primary portfolio based on the Time in Default and as of the dates indicated:
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(1)
A 3% Default to Claim Rate assumption was assigned to the new primary defaults from FEMA Designated Areas associated with Hurricanes Harvey and Irma that were reported subsequent to those two natural disasters in 2017 and through February 2018.
(2)
Represents the weighted average Default to Claim Rate for all defaults not in foreclosure stage that have been in default for up to five years, including new defaults. The estimated Default to Claim Rates applied to defaults within this population vary by Time in Default, and range from the Default to Claim Rates on new defaults shown above, up to 55.6%, 57.4% and 62.0% for more aged defaults in this category as of December 31, 2019, 2018, and 2017, respectively.
Claims Paid
Total claims paid continue to decrease consistent with the ongoing decline in the outstanding default inventory. Claims paid for 2017 were higher because they included payments that were made in connection with the scheduled final settlement of the Freddie Mac Agreement in the third quarter of 2017.
Concentration of Risk
As of December 31, 2019, California is the only state that accounted for more than 10% of our mortgage insurance business measured by primary RIF. California accounted for 11.2% of our Mortgage Insurance segment’s primary RIF at December 31, 2019, compared to 12.3% at December 31, 2018. California accounted for 10.6% of our Mortgage Insurance segment’s direct primary NIW for the year ended December 31, 2019, compared to 11.9% and 14.1% for the years ended December 31, 2018 and 2017, respectively.
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Notes to Consolidated Financial Statements (Continued)
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Additional Disclosures
The following tables provide information as of and for the periods indicated about: (i) incurred losses, net of reinsurance; (ii) the total of IBNR liabilities plus expected development on reported claims, included within the net incurred loss amounts; (iii) the cumulative number of reported defaults; and (iv) cumulative paid claims, net of reinsurance. The default year represents the period that a new default notice is first reported to us by loan servicers, related to borrowers that missed two monthly payments.
The information about net incurred losses and paid claims development for the years ended prior to 2019 is presented as supplementary information.
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(1)
Represents reserves as of December 31, 2019 related to IBNR liabilities.
(2)
Represents total number of new default notices received in each calendar year as compiled monthly based on reports received from loan servicers. As reflected in our Default to Claim Rate assumptions, a significant portion of reported defaults generally do not result in a claim. In certain instances, a defaulted loan may cure, and then re-default in a later period. Consistent with our reserving practice, each new event of default is treated as a unique occurrence and therefore certain loans that cure and re-default may be included as a reported default in multiple periods.
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Notes to Consolidated Financial Statements (Continued)
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(1)
Calculated as follows:
The following table provides a reconciliation of the net incurred losses and paid claims development tables above to the Mortgage Insurance reserve for losses and LAE at December 31, 2019:
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(1)
Excludes Services reserve for losses and LAE of $3.5 million.
The following is supplementary information about average historical claims duration as of December 31, 2019, representing the average distribution of when claims are paid relative to the year of default:
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12. Borrowings and Financing Activities
The carrying value of our debt at December 31, 2019 and 2018 was as follows:
Extinguishment of Debt
2019 Activity
Repayment of Senior Notes due 2019. In accordance with the terms of the notes under the related indenture, we retired the remaining aggregate principal amount of $158.6 million of outstanding Senior Notes due 2019 upon their maturity in June 2019.
Repurchases of Senior Notes due 2020 and 2021. During the second quarter of 2019, pursuant to cash tender offers to purchase any and all of our outstanding Senior Notes due 2020 and 2021, we purchased aggregate principal amounts of $207.2 million and $127.3 million of our Senior Notes due 2020 and 2021, respectively. We funded the purchases with $351.8 million in cash (which includes accrued and unpaid interest due on the purchased notes). These purchases resulted in a loss on extinguishment of debt of $16.8 million.
During the third quarter of 2019, we redeemed the remaining $27.0 million and $70.4 million aggregate principal amount of Senior Notes due 2020 and 2021, respectively, in accordance with the terms of the related indentures. The aggregate redemption amount paid was $103.1 million, which includes accrued interest through the applicable redemption dates. These purchases resulted in a loss on extinguishment of debt of $5.9 million.
Following these purchases and redemptions, there were no remaining principal amounts outstanding on the Senior Notes due 2020 and 2021 at December 31, 2019.
2017 Activity
Repurchases of Senior Notes due 2019, 2020 and 2021. During the third quarter of 2017, pursuant to cash tender offers, we purchased aggregate principal amounts of $141.4 million, $115.9 million and $152.3 million of our Senior Notes due 2019, 2020 and 2021, respectively. We funded the purchases with $450.8 million in cash (plus accrued and unpaid interest due on the purchased notes). These purchases resulted in a loss on extinguishment of debt of $45.8 million. At December 31, 2017, the remaining principal amounts of our outstanding Senior Notes due 2019, 2020 and 2021 were $158.6 million, $234.1 million and $197.7 million, respectively.
Repurchases of Convertible Senior Notes due 2017 and 2019. During the second quarter of 2017, we purchased an aggregate principal amount of $21.6 million of our outstanding Convertible Senior Notes due 2017. We funded the purchases
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with $31.6 million in cash (plus accrued and unpaid interest due on the purchased notes). These purchases of Convertible Senior Notes due 2017 resulted in a loss on extinguishment of debt of $1.2 million.
In connection with our purchases of Convertible Senior Notes due 2017, we terminated a corresponding portion of the capped call transactions we entered into in 2010 related to the initial issuance of the Convertible Senior Notes due 2017. We received proceeds of $4.1 million for this termination.
In November 2016, we announced our intent to exercise our redemption option for the remaining $68.0 million aggregate principal amount of our Convertible Senior Notes due 2019. As a result of the average closing price of our common stock exceeding the conversion price of $10.60 prior to the redemption date, all of the holders of these notes elected to exercise their conversion rights. Radian elected to settle all of the notes surrendered for conversion with cash. We settled our obligations with respect to these conversions on January 27, 2017, with a cash payment of $110.1 million. At the time of settlement, this transaction resulted in a pretax charge of $4.5 million, representing the difference between the fair value and the carrying value, net of unamortized issuance costs, of the liability component of the Convertible Senior Notes due 2019. This transaction also resulted in an aggregate decrease as of the settlement date of 6.4 million diluted shares for the purposes of determining diluted net income per share.
As of December 31, 2017, there were no Convertible Senior Notes due 2017 or Convertible Senior Notes due 2019 outstanding.
Senior Notes
Senior Notes due 2024. In September 2017, we issued $450 million aggregate principal amount of Senior Notes due 2024 and received net proceeds of $442.2 million. These notes mature on October 1, 2024 and bear interest at a rate of 4.500% per annum, payable semi-annually on April 1 and October 1 of each year, with interest payments commencing on April 1, 2018.
Senior Notes due 2027. In June 2019, we issued $450 million aggregate principal amount of Senior Notes due 2027 and received net proceeds of $442.2 million. These notes mature on March 15, 2027 and bear interest at a rate of 4.875% per annum, payable semi-annually on March 15 and September 15 of each year, with interest payments commencing on March 15, 2020.
Redemption Terms in Senior Notes. We have the option to redeem the Senior Notes due 2024 and 2027, in whole or in part, at any time, or from time to time, prior to July 1, 2024 (the date that is three months prior to the maturity date of the Senior notes due 2024) and September 15, 2026 (the date that is six months prior to the maturity date of the Senior notes due 2027) (the “Par Call Date”), respectively, at a redemption price equal to the greater of: (i) 100% of the aggregate principal amount of the notes to be redeemed and (ii) the make-whole amount, which is the sum of the present values of the remaining scheduled payments of principal and interest in respect of the notes to be redeemed from the redemption date to the Par Call Date discounted to the redemption date at the applicable treasury rate plus 50 basis points, plus, in each case, accrued and unpaid interest thereon to, but excluding, the redemption date. At any time on or after the Par Call Date, we may, at our option, redeem the notes in whole or in part, at a redemption price equal to 100% of the aggregate principal amount of the notes to be redeemed, plus accrued and unpaid interest thereon to, but excluding, the redemption date.
Covenants in Senior Notes. The indentures governing the Senior Notes due 2024 and 2027 contain covenants customary for securities of this nature, including covenants related to the payments of the notes, periodic reporting and certificates to be issued and covenants related to amendments to the indentures. Additionally, the indentures include covenants restricting us from encumbering the capital stock of a designated subsidiary (as defined in the indenture for the notes) or disposing of any capital stock of any designated subsidiary unless either all of the stock is disposed of or we retain more than 80% of the stock. We were in compliance with all covenants as of December 31, 2019.
FHLB Advances
In August 2016, Radian Guaranty and Radian Reinsurance became members of the FHLB. As members, they may borrow from the FHLB, subject to certain conditions, which include the need to post collateral and the requirement to maintain a minimum investment in FHLB stock, in part depending on the level of their outstanding FHLB advances.
As of December 31, 2019, we had $134.9 million of fixed-rate advances outstanding with a weighted average interest rate of 2.14%. Interest on the FHLB advances is payable quarterly, or at maturity if the term of the advance is less than 90 days. Principal is due at maturity. For obligations with maturities greater than or equal to 90 days, we may prepay the debt at any time, subject to a prepayment fee calculation.
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The FHLB advances are required to be collateralized by eligible assets with a market value that must be maintained at a minimum of approximately 103% to 105% of the principal balance of the FHLB advances. Our fixed-maturities available for sale include securities totaling $143.1 million and $88.4 million at December 31, 2019 and 2018, respectively, which serve as collateral for our FHLB advances to satisfy this requirement.
Revolving Credit Facility
Radian Group has in place a $267.5 million unsecured revolving credit facility with a syndicate of bank lenders, which is scheduled to expire on October 16, 2020. Terms of the credit facility include an accordion feature that allows Radian Group, at its option, to increase the total borrowing capacity during the term of the agreement, subject to our obtaining the necessary increased commitments from lenders (which may include then existing or other lenders), up to a total of $300 million.
Subject to certain limitations, borrowings under the credit facility may be used for working capital and general corporate purposes, including capital contributions to Radian Group’s insurance and reinsurance subsidiaries as well as growth initiatives. The credit facility contains customary representations, warranties, covenants, terms and conditions. Our ability to borrow under the credit facility is conditioned on the satisfaction of certain financial and other covenants, including covenants related to minimum net worth and statutory surplus, a maximum debt-to-capitalization level, limits on certain types of indebtedness and liens, minimum liquidity levels and Radian Guaranty’s eligibility as a private mortgage insurer with the GSEs. At December 31, 2019, Radian Group was in compliance with all the covenants and there were no amounts outstanding under this revolving credit facility.
13. Commitments and Contingencies
Legal Proceedings
We are routinely involved in a number of legal actions and proceedings, including reviews, audits and inquiries by various regulatory entities, as well as litigation and other disputes arising in the ordinary course of our business. These proceedings could result in adverse judgments, settlements, fines, injunctions, restitutions or other relief that could require significant expenditures or have other effects on our business. Management believes, based on current knowledge and after consultation with counsel, that the outcome of such actions will not have a material adverse effect on our consolidated financial condition. The outcome of litigation and other legal and regulatory matters and proceedings is inherently uncertain, and it is possible that one or more of the matters currently pending or threatened could have an adverse effect on our liquidity, financial condition or results of operations for any particular period. In accordance with applicable accounting standards and guidance, we establish accruals only when we determine both that it is probable that a loss has been incurred and the amount of the loss is reasonably estimable. We accrue the amount that represents our best estimate of the probable loss; however, if we can only determine a range of estimated losses, we accrue an amount within the range that, in our judgment, reflects the most likely outcome, and if none of the estimates within the range is more likely, we accrue the minimum amount of the range.
In the course of our regular review of pending legal and regulatory matters, we determine whether it is reasonably possible that a potential loss may have a material impact on our liquidity, results of operations or financial condition. If we determine such a loss is reasonably possible, we disclose information relating to such potential loss, including an estimate or range of loss or a statement that such an estimate cannot be made. On a quarterly basis, we review relevant information with respect to loss contingencies and update our accruals, disclosures and estimates of reasonably possible losses or range of losses based on such reviews. We are often unable to estimate the possible loss or range of loss until developments in such matters have provided sufficient information to support an assessment of the range of possible loss, such as quantification of a damage demand from plaintiffs, discovery from other parties and investigation of factual allegations, rulings by the court on motions or appeals, analysis by experts, and the progress of settlement negotiations. In addition, we generally make no disclosures for loss contingencies that are determined to be remote. For matters for which we disclose an estimated loss, the disclosed estimate reflects the reasonably possible loss or range of loss in excess of the amount accrued, if any.
Loss estimates are inherently subjective, based on currently available information, and are subject to management’s judgment and various assumptions. Due to the inherently subjective nature of these estimates and the uncertainty and unpredictability surrounding the outcome of legal and other proceedings, actual results may differ materially from any amounts that have been accrued.
On December 22, 2016, Ocwen Loan Servicing, LLC and Homeward Residential, Inc. (collectively, “Ocwen”) filed a complaint in the U.S. District Court for the Eastern District of Pennsylvania against Radian Guaranty alleging breach of contract and bad faith claims and seeking monetary damages and declaratory relief. Ocwen has also initiated similar legal
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proceedings against several other mortgage insurers. On December 17, 2016, Ocwen separately filed a parallel arbitration petition against Radian Guaranty before the American Arbitration Association (“AAA”) asserting substantially the same allegations (the “Arbitration”). Ocwen’s filings together listed 9,420 mortgage insurance certificates issued under multiple insurance policies, including Pool Insurance policies, as subject to the dispute. On June 5, 2017, Ocwen filed an amended complaint and an amended petition (collectively, the “Amended Filings”) with both the court and the AAA, respectively, together listing 8,870 certificates as subject to the dispute. On April 11, 2018, the parties entered into a confidential agreement with respect to all certificates subject to the dispute. The confidential agreement resolved certain categories of claims involved in the dispute and, on April 12, 2018, the parties filed a stipulation of voluntary dismissal of the federal court proceeding and the trial judge issued an order dismissing all claims and counterclaims subject to the parties’ agreement. Radian Guaranty was not required to make any payment in connection with this confidential agreement. Pursuant to the confidential agreement, the parties: (1) dismissed the federal court proceeding; (2) narrowed the scope of the dispute to Ocwen’s breach of contract claims seeking payment of insurance benefits on approximately 2,500 certificates that Ocwen was previously pursuing through the Amended Filings; and (3) agreed to resolve the remaining dispute through the Arbitration. The Arbitration is proceeding, and Radian continues to defend against Ocwen’s claims vigorously.
On August 31, 2018, Nationstar Mortgage LLC d/b/a Mr. Cooper (“Nationstar”) filed a complaint in the U.S. District Court for the Eastern District of Pennsylvania against Radian Guaranty (the “Complaint”) alleging breach of contract, bad faith, equitable indemnification, unjust enrichment, and conversion claims and seeking monetary damages and declaratory relief. Exhibit 1 to the Complaint lists 3,014 mortgage insurance certificates issued under multiple insurance policies as subject to disputes involving insurance coverage decisions (the “Coverage Disputed Loans”). Exhibit 2 to the Complaint further lists 2,231 mortgage insurance certificates issued under multiple insurance policies as subject to disputes involving premium refund requests. In December 2018, Radian Guaranty filed a motion to dismiss the Complaint. In March 2019, the trial judge issued an order granting in part, and denying in part, our motion to dismiss, and dismissed Nationstar’s unjust enrichment and conversion claims. In May 2019, Radian Guaranty filed an answer, with affirmative defenses and counterclaims, in response to the Complaint. On September 23, 2019, the trial judge entered as an order a joint stipulation submitted by Nationstar and Radian Guaranty that narrowed the scope of the dispute involving Coverage Disputed Loans to claims relating to 1,704 mortgage insurance certificates. Radian Guaranty believes that Nationstar’s allegations and claims in the legal proceedings described above are without merit and legally deficient, and continues to defend against these claims vigorously.
In 2019, the Company increased its IBNR reserve estimate by $30.5 million related to our best estimate of our probable loss in connection with the above legal proceedings. While Radian believes it has substantial defenses in these matters and intends to continue to defend against these claims vigorously, it is not feasible to predict the ultimate outcome of these disputes, and the Company could in the future be required to pay amounts as a result of settlements or decisions in these matters, potentially in excess of accruals.
We also are periodically subject to reviews and audits, as well as inquiries, information-gathering requests and investigations. In connection with these matters, from time to time we receive requests and subpoenas seeking information and documents related to aspects of our business.
Our Master Policies establish the timeline within which any suit or action arising from any right of an insured under the policy generally must be commenced. In general, any suit or action arising from any right of an insured under the policy must be commenced within two years after such right first arose for primary insurance and within three years for certain other policies, including certain Pool Insurance policies. Although we believe that our Loss Mitigation Activities are justified under our policies, from time to time we face challenges from certain lender and servicer customers regarding our Loss Mitigation Activities. These challenges could result in additional arbitration or judicial proceedings and we may need to reassume the risk on, and increase loss reserves for, the associated policies or pay additional claims.
The legal and regulatory matters discussed above could result in adverse judgments, settlements, fines, injunctions, restitutions or other relief that could require significant expenditures or have other effects on our business.
Other
We provide contract underwriting as an outsourced service to our customers. Under our current contract underwriting program the remedy we offer is limited indemnification to our contract underwriting customers only with respect to those loans that we simultaneously underwrite for both secondary market compliance and for potential mortgage insurance eligibility. In 2019, payments for losses related to contract underwriting remedies were de minimis. In 2019, our provision for contract underwriting expenses was de minimis. We monitor this risk and negotiate our underwriting fee structure and recourse agreements on a client-by-client basis. We also routinely audit the performance of our contract underwriters.
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Lease Liability
Our lease liability represents the present value of future lease payments over the lease term. Our leases do not provide a readily determinable implicit rate. Therefore, we must estimate our incremental borrowing rate, on a collateralized basis, to discount the lease payments based on information available at lease commencement. Our leases expire periodically through August 2032, and contain provisions for scheduled periodic rent increases. We estimate the incremental borrowing rate based on the yields of Radian Group corporate bonds, as adjusted to reflect a collateralized borrowing rate, results in discount rates ranging from 4.22% to 7.08%. While the majority of our lease population expires within one year of one of the Radian Group corporate bonds, our more significant leases do not. For those leases, we adjust the corporate bond rate for both U.S. Department of the Treasury rate yields and a corporate spread adjustment determined from recent market data.
The following tables provide additional information related to our leases, including: (i) the components of our total lease cost; (ii) the cash flows arising from our lease transactions; (iii) supplemental balance sheet information; (iv) the weighted-average remaining lease term; (v) the weighted-average discount rate used for our leases; and (vi) the remaining maturities of our lease liabilities, as of and for the periods indicated:
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(1)
Operating lease right-of-use assets and liabilities of $2.6 million and $3.8 million, respectively, are classified as held for sale and are excluded from the amounts in this disclosure.
(2)
Classified in other assets in our consolidated balance sheets. See Note 9.
(3)
Classified in other liabilities in our consolidated balance sheets.
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Pursuant to the previous lease accounting standard, rent expense for each of the years ended December 31, 2018 and 2017 was $9.7 million and $5.7 million, respectively. Our commitment for non-cancelable leases in future years as of December 31, 2018, as disclosed in our 2018 Form 10-K, was as follows (in thousands):
At December 31, 2019 and 2018, there were no future minimum receipts expected from sublease rental payments.
14. Capital Stock
2019 Activity
On August 16, 2018, Radian Group’s board of directors approved a share repurchase program that authorized the Company to repurchase up to $100 million of its common stock in the open market or in privately negotiated transactions, based on market and business conditions, stock price and other factors. On March 20, 2019, Radian Group’s board of directors approved a $150 million increase in authorization for this program, bringing the total authorization to repurchase shares up to $250 million, excluding commissions. Radian operated this program pursuant to a trading plan under Rule 10b5-1 of the Exchange Act, which permitted the Company to purchase shares, according to the parameters in the plan, when it may have otherwise been precluded from doing so. During 2019, the Company completed this program by purchasing 11,258,574 shares at an average price of $22.22 per share, including commissions, which represents 5.3% of the shares outstanding at the beginning of the program. As of December 31, 2019, no further purchase authority remains under this program.
On August 14, 2019, Radian Group’s board of directors approved a share repurchase program authorizing the Company to spend up to $200 million, excluding commissions, to repurchase Radian Group common stock in the open market or in privately negotiated transactions, based on market and business conditions, stock price and other factors. Radian operates this program pursuant to a trading plan under Rule 10b5-1 of the Exchange Act, which permits the Company to purchase shares, at pre-determined price targets, when it may otherwise be precluded from doing so. During 2019, the Company purchased 2,195,661 shares at an average price of $22.79 per share, including commissions. As of December 31, 2019, purchase authority of up to $150.0 million remained available under this program.
On February 13, 2020, Radian Group’s board of directors authorized a $275 million increase in this program, bringing the total authorization to repurchase shares up to $475 million, excluding commissions, and extended the expiration of this program extension from July 31, 2020 to August 31, 2021.
Subsequent to December 31, 2019, the Company purchased 2,738,462 shares of its common stock under its share repurchase program at an average price of $24.03 per share, including commissions. As of February 25, 2020, purchase authority of up to $359.2 million remained available under this program.
2018 Activity
On August 9, 2017, Radian Group’s board of directors authorized a share repurchase program to spend up to $50 million to repurchase Radian Group common stock in the open market or in privately negotiated transactions, based on market and business conditions, stock price and other factors. Radian established a trading plan under Rule 10b5-1 of the Exchange Act to implement the program. The Company completed this program during the first half of 2018 by purchasing 3,022,856 shares of Radian Group common stock at an average price of $16.56 per share, including commissions.
2017 Activity
On June 29, 2016, Radian Group’s board of directors authorized a share repurchase program to spend up to $125 million to repurchase Radian Group common stock. In order to implement the program, Radian adopted a trading plan under Rule 10b5-1 of the Exchange Act during the third quarter of 2016. During the second quarter of 2017, 380 shares were purchased at
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an average price of $15.59 per share, which represented the only purchases made under the plan. This share repurchase program expired on June 30, 2017.
Other Purchases
We may purchase shares on the open market to settle stock options exercised by employees and purchases under our Employee Stock Purchase Plan. Through December 31, 2019, from time to time we also purchased shares on the open market to fund certain 401(k) matches. In addition, upon the vesting of certain restricted stock awards under our equity compensation plans, we may withhold from such vested awards shares of our common stock to satisfy the tax liability of the award recipients.
Dividends Paid
In each of the quarters during 2019, 2018 and 2017, we declared quarterly cash dividends on our common stock equal to $0.0025 per share. On February 13, 2020, Radian Group’s board of directors authorized an increase to the Company’s quarterly cash dividend from $0.0025 to $0.125 per share.
15. Share-Based and Other Compensation Programs
On May 10, 2017, our stockholders approved the Amended and Restated Equity Compensation Plan, which amended and restated the 2014 Equity Plan. In addition to the Amended and Restated Equity Compensation Plan, we also have awards outstanding under our 2008 Equity Plan and 1995 Equity Plan. The last awards granted pursuant to the 2008 Equity Plan and 1995 Equity Plan were granted in 2014 and 2008, respectively. All awards granted under the Equity Plans have been performance-based or time-based awards in the form of non-qualified stock options, restricted stock, RSUs, phantom stock, or stock appreciation rights. The maximum contractual term for stock options and similar instruments under the Equity Plans is 10 years, although awards of these instruments may be granted with shorter terms.
The Amended and Restated Equity Compensation Plan authorizes the issuance of up to 8,954,109 shares, plus such number of shares of common stock that were subject to awards outstanding under the 2014 Equity Plan and the 2008 Equity Plan prior to the effective date of the Amended and Restated Equity Plan that subsequently terminate, expire or are cancelled and become available for issuance under the Amended and Restated Equity Compensation Plan (“Prior Plan Shares”). There were 6,266,017 shares available for grant under the Amended and Restated Equity Compensation Plan as of December 31, 2019 (the “share reserve”), which includes Prior Plan Shares. Each grant of restricted stock, RSUs, or performance share awards under the Amended and Restated Equity Compensation Plan (other than those settled in cash) reduces the share reserve available for grant under the Amended and Restated Equity Compensation Plan by 1.31 shares for every share subject to such grant. Absent this share reserve adjustment for outstanding restricted stock, RSUs, phantom stock or performance share awards, our shares remaining available for grant under the Amended and Restated Equity Compensation Plan would have been 9,678,723 shares as of December 31, 2019. Awards under the Amended and Restated Equity Compensation Plan that provide for settlement solely in cash (and not common shares) do not count against the share reserve.
Most awards vest at the end of the performance or service period and will vest earlier under certain circumstances. In the event of a grantee’s death or disability, awards generally vest immediately. Upon retirement, awards generally vest immediately or at the end of the performance period, if any. Certain time-based RSU awards granted to officers under our Amended and Restated Equity Compensation Plan will vest in whole or in part in the event the grantee’s employment is terminated by us without cause or for “good reason.” Awards granted under the Equity Plans to officers and our non-employee directors provide for “double trigger” vesting in the event of a change of control. As a result, awards granted to officers will vest in connection with a change of control only in the event the grantee’s employment is terminated by us without cause or the grantee terminates employment for “good reason,” in each case within 90 days before or one year after the change of control. Awards to our non-employee directors will vest in connection with a change of control only in the event the grantee fails to be appointed to the board of directors of the surviving entity or is not nominated for reelection, or fails to be reelected after nomination, to the board of directors of the Company or the surviving entity, in each case at any time beginning upon the change of control and ending 90 days following the first meeting of the stockholders of the Company or the surviving entity after the change in control. In the event of a hypothetical change of control as of December 31, 2019, we estimate that the vesting of awards, assuming for purposes of this hypothetical that “double trigger” vesting occurred, would have resulted in a pretax accounting charge to us of approximately $21.4 million, representing the acceleration of compensation expense.
We use the Monte Carlo valuation model to determine the fair value of all cash-settled awards where stock price is a factor in determining the vesting, as well as for cash- or equity-settled performance awards where there exists a similar stock price-based market condition. The Monte Carlo valuation model incorporates multiple input variables, including expected life,
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volatility, risk-free rate of return and dividend yield for each award to estimate the probability that a vesting condition will be achieved. In determining these assumptions for the Monte Carlo valuations, we consider historic and observable market data.
The following table summarizes the compensation cost recognized and additional information regarding all share-based awards for the years indicated:
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(1)
Compensation cost is generally recognized over the periods that an employee provides service in exchange for the award. For purposes of calculating compensation cost recognized, we generally consider awards effectively vested (and we recognize the full compensation costs) when grantees become retirement eligible.
As of December 31, 2019, unrecognized compensation expense related to the unvested portion of all of our share-based awards was $24.8 million. Absent a change of control under the Equity Plans, this expense is expected to be recognized over a weighted-average period of approximately 1.9 years.
RSUs
Information with regard to RSUs to be settled in stock for the periods indicated is as follows:
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(1)
The final amount of RSUs distributed depends on the level of performance achieved along with each employee’s continued service through the vest date, which could result in changes in vested RSUs.
(2)
For performance-based RSUs, amount represents the probable outcome at grant date.
(3)
Represents an adjustment to the number of unvested performance-based RSUs due to changes during the period in our estimated payouts, which can range from 0 to 200% of target depending on results over the applicable performance periods.
(4)
Represents amounts vested during the year, which can include both original shares granted and the impact of performance adjustments.
The weighted-average grant date fair value of RSUs granted during 2018 and 2017 was $15.43 and $16.60, respectively. The fair value as of the respective vesting dates of RSUs vested during 2019, 2018 and 2017 was $36.2 million, $3.3 million, and $1.4 million, respectively.
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Performance-Based RSUs. In 2019, 2018 and 2017, executive and non-executive officers were granted performance-based RSUs to be settled in common stock with target awards totaling 486,540, 595,320, and 456,510 RSUs, respectively. The maximum payout at the end of the three-year performance period is 200% of a grantee’s target number of RSUs. The maximum payout for awards based on the TSR Measures described below is generally subject to a maximum cap of six times the value of the grantee’s target award on the grant date. Performance-based RSUs granted to executive officers are subject to a one-year post vesting holding period.
In 2019 and 2018, the vesting of the performance-based RSUs granted to each executive officer and non-executive will be based upon the cumulative growth in Radian’s book value per share, adjusted for certain defined items, over a three-year performance period. In 2017, approximately 50% of the performance-based RSUs granted to each executive and non-executive officer will vest based on the cumulative growth in Radian book value per share, adjusted for certain defined items over a three-year period. The vesting of the remaining 50% of each performance-based RSU granted in 2017 is dependent upon: (i) Radian Group’s total stockholder return (“TSR”) compared to the median TSR of a designated peer group of companies as of the date of grant and (ii) Radian Group’s absolute TSR, in each case measured over a three-year performance period and subject to certain conditions.
The grant date fair value of the performance-based RSUs that are based on the cumulative growth in Radian’s book value per share is calculated based on the stock price as of the grant date, discounted for executives for the one-year post-vesting holding period. The compensation cost that is recognized over the remaining requisite service period is based on our expectations of the probable level of achievement of the performance condition.
Time-Vested RSUs. With the exception of certain time-vested RSUs granted in 2019 and 2018 to non-employee directors, the time-vested RSU awards granted in 2019, 2018 and 2017 are scheduled to vest in: (i) pro rata installments on each of the first three anniversaries of the grant date or (ii) generally at the end of three years. Certain time-vested RSU awards granted in 2019 and 2018 to non-employee directors generally are subject to one-year cliff vesting.
Non-Qualified Stock Options
Information with regard to stock options for the periods indicated is as follows:
______________________
(1)
Based on the market price of $25.16 at December 31, 2019.
The following table summarizes additional information concerning stock option activity for the periods indicated:
Upon the exercise of stock options, we generally issue shares from the authorized, unissued share reserves when the exercise price is less than the treasury stock repurchase price and from treasury stock when the exercise price is greater than the treasury stock repurchase price.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
______________________________________________________________________________________________________
The following table summarizes information concerning outstanding and exercisable options at December 31, 2019:
Generally, the stock option awards have a four-year vesting period, with 50% of the award vesting on or after the third anniversary of the grant date and the remaining 50% of the award vesting on or after the fourth anniversary of the grant date, provided the applicable stock price performance hurdle is met. The fair value of stock options vested during the year ended December 31, 2019 was $30 thousand, as compared to $1.3 million in 2018 and $3.3 million in 2017.
There were no stock options granted in 2017, 2018 and 2019.
Employee Stock Purchase Plan
On May 9, 2018, stockholders of Radian approved the Amended and Restated Radian Group Inc. ESPP, which amended and restated the Radian Group Inc. 2008 Employee Stock Purchase Plan. Under this plan, we issued 107,009; 103,668; and 105,476 shares to employees during the years ended December 31, 2019, 2018 and 2017, respectively, and when amended in 2018, an additional 1,250,000 shares of our authorized but unissued common stock were reserved for issuance. In January 2020, we issued 39,332 shares from the shares available for issuance under our Amended and Restated Radian Group Inc. ESPP. As a result, 1,902,459 shares currently remain available for issuance under the Amended and Restated Radian Group Inc. ESPP.
The Amended and Restated Radian Group Inc. ESPP is designed to allow eligible employees to purchase shares of our common stock at a discount of 15% off the lower of the fair market value of our common stock at the beginning or end of a six-month offering period (each period being the first and second six months in a calendar year).
The following assumptions were used in our calculation of Employee Stock Purchase Plan compensation expense during 2019:
16. Benefit Plans
The Radian Group Inc. Savings Incentive Plan (“Savings Plan”) covers substantially all of our full-time and our part-time employees. Participants can contribute up to 100% of their base earnings as pretax and/or after-tax (Roth IRA) contributions up to a maximum amount of $19,000 for 2019. The Savings Plan also includes a catch-up contribution provision whereby participants who are or will be age 50 and above during the Savings Plan year may contribute an additional contribution. The maximum catch-up contribution for the Savings Plan in 2019 was $6,000. We match up to 100% of the first 6.0% of base earnings contributed in any given year. Our expense for matching funds for the years ended December 31, 2019, 2018 and 2017 was $5.6 million, $6.1 million and $4.8 million, respectively.
Certain of the benefits of this plan are as follows:
•
allows for the immediate eligibility of new hire participation and provides for the automatic enrollment of eligible employees;
•
provides for the immediate vesting of matching contributions (including existing unvested matching contributions attributable to prior periods) and the elimination of all restrictions (other than Radian Group’s Insider Trading Policy) on a participant’s ability to diversify his/her position in matching contributions; and
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
______________________________________________________________________________________________________
•
permits Radian Group to make discretionary, pro rata (based on eligible pay) cash allocations to each eligible participant’s account, with vesting upon completion of three years of service with us.
17. Accumulated Other Comprehensive Income (Loss)
The following table shows the rollforward of accumulated other comprehensive income (loss) as of the periods indicated:
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
______________________________________________________________________________________________________
______________________
(1)
Included in net gains (losses) on investments and other financial instruments in our consolidated statements of operations.
(2)
Included in restructuring and other exit costs in our consolidated statements of operations.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
______________________________________________________________________________________________________
18. Statutory Information
Radian Group serves as the holding company for our insurance subsidiaries, through which we conduct our mortgage insurance and title insurance businesses. These insurance subsidiaries are subject to comprehensive, detailed regulation by the insurance departments in the various states where our insurance subsidiaries are domiciled or licensed to transact business. Insurance laws vary from state to state, but generally grant broad supervisory powers to state agencies or officials to examine insurance companies and enforce rules or exercise discretion affecting almost every significant aspect of the insurance business, including the power to revoke or restrict an insurance company’s ability to write new business. In addition, in order to be eligible to insure loans purchased by the GSEs, mortgage insurers such as Radian Guaranty must meet the GSEs’ eligibility requirements, or PMIERs. The PMIERs are comprehensive, covering virtually all aspects of the business and operations of a private mortgage insurer, including internal risk management and quality controls, the relationship between the GSEs and the approved insurer, as well as the approved insurer’s financial condition.
The PMIERs and state insurance regulations include various capital requirements and dividend restrictions based on our insurance subsidiaries’ statutory financial position and results of operations, as described below. Our failure to maintain adequate levels of capital could lead to intervention by the various insurance regulatory authorities, which could materially and adversely affect our business, business prospects and financial condition.
Statutory Financial Statements
We prepare our statutory financial statements in accordance with the accounting practices required or permitted, if applicable, by the insurance departments of the respective states of domicile of our insurance subsidiaries. Required SAP are established by the NAIC, as well as state laws, regulations and general administrative rules. In addition, insurance departments have the right to permit other specific practices that may deviate from prescribed practices. As of December 31, 2019, we did not have any prescribed or permitted SAP that resulted in reported statutory surplus or risk-based capital being different from what would have been reported had NAIC statutory accounting practices been followed.
Reflecting the principal differences between SAP and GAAP, statutory financial statements typically do not include unrealized gains or losses on fixed maturity securities, deferred policy acquisition costs, and certain net deferred tax assets and certain other less readily marketable assets that are designated as non-admitted assets. In addition to these general differences, SAP also requires that mortgage insurance companies establish a special contingency reserve equal to 50% of premiums earned in each year, generally to be maintained for 10 years, to protect policyholders against loss during adverse economic cycles. As a result of the requirement to establish and maintain this statutory liability, contingency reserves affect the ability of a mortgage insurer to pay dividends, as described below. With regulatory approval, a mortgage insurance company may make early withdrawals from this contingency reserve when incurred losses exceed 35% of net premiums in a calendar year. Neither Radian Guaranty nor any other of our other mortgage insurance subsidiaries released any amounts from their contingency reserves in 2019, 2018 or 2017. Based on the typical 10-year holding requirement, Radian Guaranty is scheduled to release contingency reserves to unassigned surplus in material amounts beginning in 2024.
As a mortgage guaranty insurer, we are eligible for a tax deduction, subject to certain limitations, related to amounts required to be set aside in statutory contingency reserves to the extent we purchase U.S. Mortgage Guaranty Tax and Loss Bonds issued by the U.S. Department of the Treasury. Under SAP, this deduction reduces the tax provision reflected in the statutory financial statements, which in turn increases statutory net income and surplus. See Note 10 for additional information.
All of our mortgage insurance subsidiaries are domiciled in Pennsylvania, and we currently write new business using two principal subsidiaries, Radian Guaranty and Radian Reinsurance.
Radian Guaranty, our only approved insurer under the PMIERs, is authorized as a monoline insurer to write mortgage guaranty insurance (or in states where there is no specific authorization for mortgage guaranty insurance, the applicable line of insurance under which mortgage guaranty insurance is regulated) in all 50 states, the District of Columbia and Guam. Radian Reinsurance is licensed only in Pennsylvania as a stock casualty insurance company authorized to carry on the business of credit insurance, which includes the authority to write direct mortgage guaranty insurance. We use Radian Reinsurance to participate in the credit risk transfer programs developed by Fannie Mae and Freddie Mac. Prior to the January 2020 actions described below, we also used Radian Reinsurance to provide reinsurance to Radian Guaranty. Our mortgage insurance subsidiaries also include Radian Insurance, Radian Mortgage Assurance, Radian Guaranty Reinsurance Inc., Radian Investor Surety Inc. and Radian Mortgage Guaranty Inc.; however, Radian Insurance is our only other mortgage insurance entity that had any remaining RIF as of December 31, 2019, totaling $10.2 million.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
______________________________________________________________________________________________________
Our mortgage insurance subsidiaries’ statutory net income, statutory policyholders’ surplus and contingency reserve as of and for the years ended December 31, 2019, 2018 and 2017 were as follows:
In January 2020, in connection with the termination of an intercompany reinsurance agreement between Radian Reinsurance and Radian Guaranty, Radian Reinsurance transferred $6.0 billion in RIF to Radian Guaranty and released substantially all of its contingency reserves to unassigned surplus. In turn, Radian Guaranty established equivalent contingency reserves with a corresponding decrease to its unassigned surplus. As part of these actions, the Pennsylvania Insurance Department approved a $465 million return of capital from Radian Reinsurance to Radian Group as well as the transfer of $200 million of cash and marketable securities from Radian Group to Radian Guaranty in exchange for a surplus note. This intercompany surplus note has a 3% interest rate and a stated maturity of January 31, 2030. The surplus note may be redeemed at any time upon 30 days prior notice, subject to a request by Radian Guaranty for the approval of the Pennsylvania Insurance Department.
Additionally, as part of our title services, we offer title insurance through Radian Title Insurance, an Ohio domiciled title insurance underwriter and settlement services company that is licensed to issue title insurance policies in 39 states and the District of Columbia. Radian Title Insurance’s statutory policyholders’ surplus and statutory net income were $27.0 million and $0.3 million, respectively, as of and for the year ended December 31, 2019.
Statutory Capital Requirements
Under state insurance regulations, Radian Guaranty is required to maintain minimum surplus levels and, in certain states, a minimum ratio of statutory capital relative to the level of net RIF, or Risk-to-capital. There are 16 RBC States that currently impose a Statutory RBC Requirement. The most common Statutory RBC Requirement is that a mortgage insurer’s Risk-to-capital may not exceed 25 to 1. In certain of the RBC States, a mortgage insurer must satisfy a MPP Requirement. Unless an RBC State grants a waiver or other form of relief, if a mortgage insurer, such as Radian Guaranty, is not in compliance with the Statutory RBC Requirement of that state, the mortgage insurer may be prohibited from writing new mortgage insurance business in that state. The statutory capital requirements for the non-RBC States are de minimis (ranging from $1 million to $5 million); however, the insurance laws of these states generally grant broad supervisory powers to state agencies or officials to enforce rules or exercise discretion affecting almost every significant aspect of the insurance business, including the power to revoke or restrict an insurance company’s ability to write new business. Radian Guaranty’s domiciliary state, Pennsylvania, is not one of the RBC States.
Radian Guaranty was in compliance with the Statutory RBC Requirements or MPP Requirements, as applicable, in each of the RBC States as of December 31, 2019. Radian Guaranty’s Risk-to-capital calculation appears in the table below. For purposes of the Risk-to-capital requirements imposed by certain states, statutory capital is defined as the sum of statutory policyholders’ surplus plus statutory contingency reserves.
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
______________________________________________________________________________________________________
______________________
(1)
Excludes risk ceded through all reinsurance programs (including with affiliates) and RIF on defaulted loans.
Our other mortgage insurance and title insurance subsidiaries were also in compliance with all statutory and counterparty capital requirements as of December 31, 2019 and 2018.
The NAIC is in the process of reviewing the minimum capital and surplus requirements for mortgage insurers and considering changes to the Model Act. In December 2019, a working group of state regulators released exposure drafts of a revised Model Act, including new proposed mortgage guaranty insurance capital requirements for mortgage insurers. The process for developing this framework is ongoing, and the outcome of this process remains uncertain. As proposed, the capital requirements set forth in the current exposure draft are impacted, among other things, by changes in the economic and housing environment, including changes in home prices and incomes. Given the current economic and housing environment, if the exposure draft of the new Model Act was adopted and in effect today, we do not believe that the capital requirements imposed by the new Model Act would exceed those of the current PMIERs financial requirements described below.
PMIERs. The PMIERs financial requirements require that a mortgage insurer’s Available Assets meet or exceed its Minimum Required Assets. At December 31, 2019, Radian Guaranty was in compliance with the PMIERs financial requirements.
The GSEs may amend the PMIERs at any time, and they have broad discretion to interpret the requirements, which could impact the calculation of Radian Guaranty’s Available Assets and/or Minimum Required Assets. In addition, the GSEs have a broad range of consent rights under the PMIERs and require private mortgage insurers to obtain the prior consent of the GSEs before taking certain actions. If Radian Guaranty is unable to satisfy the requirements set forth in the PMIERs, the GSEs could restrict it from conducting certain types of business with them or take actions that may include not purchasing loans insured by Radian Guaranty.
Statutory Dividend Restrictions
As of December 31, 2019, the amount of restricted net assets held by our consolidated insurance subsidiaries (which represents our equity investment in those insurance subsidiaries) totaled $4.2 billion of our consolidated net assets. Despite holding assets above the minimum statutory capital thresholds and PMIERs financial requirements, the ability of Radian’s mortgage insurance subsidiaries to pay dividends on their common stock is restricted by certain provisions of the insurance laws of Pennsylvania, their state of domicile. Under Pennsylvania’s insurance laws, ordinary dividends and distributions may only be paid out of an insurer’s positive unassigned surplus, measured as of the end of the prior fiscal year, unless the Pennsylvania Insurance Department approves the payment of extraordinary dividends or other distributions from another source.
As of December 31, 2019, Radian Guaranty and Radian Reinsurance had negative unassigned surplus of $503.3 million and $50.4 million, respectively. Therefore, no dividends or other ordinary distributions can be paid by these subsidiaries in 2020. In light of Radian Guaranty’s negative unassigned surplus related to operating losses in prior periods and the ongoing need to set aside contingency reserves, we do not anticipate that Radian Guaranty will be permitted under applicable insurance laws to pay ordinary dividends to Radian Group for the foreseeable future. As discussed above, Radian Guaranty is scheduled to release contingency reserves to unassigned surplus in material amounts beginning in 2024, which should accelerate the reduction of its negative unassigned surplus. Under Pennsylvania’s insurance laws, an insurer may request approval to pay an
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
______________________________________________________________________________________________________
Extraordinary Distribution, subject to the approval of the Pennsylvania Insurance Department. Radian Guaranty sought and received such approval to return capital by paying Extraordinary Distributions to Radian Group in 2019 and 2018. As described above, Radian Reinsurance sought and received approval to return capital by paying an Extraordinary Distribution to Radian Group in January 2020.
The surplus additions (distributions) between Radian Group and Radian Guaranty and our other insurance subsidiaries for the years ended December 31, 2019, 2018 and 2017 were as follows:
Glossary
Radian Group Inc.
Notes to Consolidated Financial Statements (Continued)
______________________________________________________________________________________________________
19. Quarterly Financial Data (Unaudited)
______________________
(1)
Diluted net income per share is computed independently for each period presented. Consequently, the sum of the quarters may not equal the total net income per share for the year.
Glossary
______________________________________________________________________________________________________
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A.
Controls and Procedures.
Disclosure Controls and Procedures
We maintain disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Our management, including our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of December 31, 2019 pursuant to Rule 15d-15(b) under the Exchange Act. Management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures, which by their nature, can provide only reasonable assurance regarding management’s control objectives. Management does not expect that our disclosure controls and procedures will prevent or detect all errors and fraud. A control system, irrespective of how well it is designed and operated, can only provide reasonable assurance and cannot guarantee that it will succeed in its stated objectives.
Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2019, our disclosure controls and procedures were effective to provide reasonable assurance that the information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Our internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP and that our receipts and expenditures are being made only in accordance with authorizations of our management and our directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting, as of December 31, 2019, using the criteria described in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation under the updated internal control framework in Internal Control-Integrated Framework (2013), management concluded that our internal control over financial reporting was effective as of December 31, 2019. The effectiveness of our internal control over financial reporting as of December 31, 2019 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report appearing in Item 8 of this Annual Report on Form 10-K.
Changes in Internal Control over Financial Reporting
There was no change in the internal control over financial reporting that occurred during the quarter ended December 31, 2019 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B.
Other Information.
None.
Glossary
______________________________________________________________________________________________________
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance.
The information required by this Item is incorporated by reference to, and will be contained in, our definitive proxy statement, which will be filed within 120 days after December 31, 2019. Accordingly, we have omitted the information from this Item pursuant to General Instruction G (3) of Form 10-K.
Item 11.
Item 11.
Executive Compensation.
The information required by this Item is incorporated by reference to, and will be contained in, our definitive proxy statement, which will be filed within 120 days after December 31, 2019. Accordingly, we have omitted the information from this Item pursuant to General Instruction G (3) of Form 10-K.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this Item is incorporated by reference to, and will be contained in, our definitive proxy statement, which will be filed within 120 days after December 31, 2019. Accordingly, we have omitted the information from this Item pursuant to General Instruction G (3) of Form 10-K.
Equity Compensation Plans
The following table sets forth certain information relating to the Company’s equity compensation plans as of December 31, 2019. Each number of securities reflected in the table is a reference to shares of our common stock.
__________________
(1)
The table does not include information for equity compensation plans assumed by us in mergers, under which we do not grant additional awards.
(2)
These plans consist of our 1995 Equity Plan, 2008 Equity Plan, the Amended and Restated Equity Compensation Plan and our Amended and Restated Radian Group Inc. ESPP.
(3)
Represents 175,791 shares of phantom stock issued under our 1995 Equity Plan, 496,152 non-qualified stock options and 760,426 RSUs issued under our 2008 Equity Plan, and 485,395 non-qualified stock options and 3,484,319 RSUs issued under our Amended and Restated Equity Compensation Plan. Of the RSUs included herein, 2,375,005 are performance-based stock-settled RSUs that could potentially pay out between 0% and 200% of this represented target.
(4)
The shares of phantom stock and RSUs were granted at full value, and therefore, have a weighted-average exercise price of $0. Excluding shares of phantom stock and RSUs from this calculation, the weighted-average exercise price of outstanding non-qualified stock options was $10.05 at December 31, 2019.
(5)
Includes 6,266,017 shares available for issuance under our Amended and Restated Equity Compensation Plan, and 1,941,791 shares available for issuance under our Amended and Restated Radian Group Inc. ESPP, in each case as of December 31, 2019. In January 2020, we issued 39,332 shares from the shares available for issuance under our Amended and Restated Radian Group Inc. ESPP. As a result, 1,902,459 shares currently remain available for issuance under the Amended and Restated Radian Group Inc. ESPP.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence.
The information required by this Item is incorporated by reference to, and will be contained in, our definitive proxy statement, which will be filed within 120 days after December 31, 2019. Accordingly, we have omitted the information from this Item pursuant to General Instruction G (3) of Form 10-K.
Item 14.
Item 14.
Principal Accountant Fees and Services.
The information required by this Item is incorporated by reference to, and will be contained in, our definitive proxy statement, which will be filed within 120 days after December 31, 2019. Accordingly, we have omitted the information from this Item pursuant to General Instruction G (3) of Form 10-K.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules.
(a)
1.
Financial Statements-See the “Index to Consolidated Financial Statements” included in Item 8 of this report for a list of the financial statements filed as part of this report.
2.Exhibits-See “Index to Exhibits” on page
of this report for a list of exhibits filed as part of this report.
3.Financial Statement Schedules-See the “Index to Financial Statement Schedules” on page
of this report for a list of the financial statement schedules filed as part of this report.
Schedule I-Summary of investments-other than investments in related parties (December 31, 2019)
Schedule II-Financial information of Radian Group, Inc., Parent Company Only (Registrant)
Condensed Balance Sheets as of December 31, 2019 and 2018
Condensed Statements of Operations for the Years Ended December 31, 2019, 2018 and 2017
Condensed Statements of Cash Flows for the Years Ended December 31, 2019, 2018 and 2017
Supplemental Notes to Condensed Financial Statements
Schedule IV-Reinsurance (December 31, 2019, 2018 and 2017)
Item 16.
Form 10-K Summary.
None.
Glossary
INDEX TO EXHIBITS
Glossary
Glossary
Glossary
Glossary
*
Filed herewith.
**
Furnished herewith.
+ Management contract, compensatory plan or arrangement
Glossary
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on February 28, 2020.
Radian Group Inc.
By:
/s/ Richard G. Thornberry
Richard G. Thornberry
Chief Executive Officer
Glossary
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on February 28, 2020, by the following persons on behalf of the registrant and in the capacities indicated.
Name
Title
/s/ RICHARD G. THORNBERRY
Chief Executive Officer (Principal Executive Officer) and Director
Richard G. Thornberry
/s/ J. FRANKLIN HALL
Senior Executive Vice President, Chief Financial Officer (Principal Financial Officer)
J. Franklin Hall
/s/ ROBERT J. QUIGLEY
Senior Vice President, Controller
(Principal Accounting Officer)
Robert J. Quigley
/s/ HERBERT WENDER
Non-Executive Chairman of the Board
Herbert Wender
/s/ DAVID C. CARNEY
Director
David C. Carney
/s/ BRAD L. CONNER
Director
Brad L. Conner
/s/ HOWARD B. CULANG
Director
Howard B. Culang
/s/ DEBRA HESS
Director
Debra Hess
/s/ LISA W. HESS
Director
Lisa W. Hess
/s/ LISA MUMFORD
Director
Lisa Mumford
/s/ GAETANO MUZIO
Director
Gaetano Muzio
/s/ GREGORY V. SERIO
Director
Gregory V. Serio
/s/ NOEL J. SPIEGEL
Director
Noel J. Spiegel
Glossary
All other schedules are omitted because the required information is not present or is not present in amounts sufficient to require submission of the schedules, or because the information required is included in our Consolidated Financial Statements and notes thereto.
Glossary
Radian Group Inc. and Its Consolidated Subsidiaries
Schedule I
Summary of Investments-Other Than Investments in Related Parties
December 31, 2019
______________________
(1)
Includes cash collateral held under securities lending agreements of $25.6 million that is reinvested in money market instruments.
(2)
Includes $24.0 million of fixed maturity securities available for sale, $27.5 million of equity securities and $14.9 million of short-term securities loaned under securities lending agreements that are classified as other assets in our consolidated balance sheets.
Glossary
Radian Group Inc.
Schedule II-Financial Information of Registrant
Condensed Balance Sheet
Parent Company Only
See Supplemental Notes.
Glossary
Radian Group Inc.
Schedule II-Financial Information of Registrant
Condensed Statements of Operations
Parent Company Only
See Supplemental Notes.
Glossary
Radian Group Inc.
Schedule II-Financial Information of Registrant
Condensed Statements of Cash Flows
Parent Company Only
______________________
(1)
Includes cash distributions received from subsidiaries of $26.6 million, $55.4 million and $24.3 million in 2019, 2018 and 2017, respectively. Excludes non-cash distributions received from subsidiaries of $362.4 million, $394.6 million and $197.3 million in 2019, 2018 and 2017, respectively.
See Supplemental Notes.
Glossary
Radian Group Inc.
Schedule II-Financial Information of Registrant
Parent Company Only
Supplemental Notes
Note A
The Radian Group Inc. (the “Parent Company”, “we” or “our”) financial statements represent the stand-alone financial statements of the Parent Company. These financial statements have been prepared on the same basis and using the same accounting policies as described in the consolidated financial statements included herein, except that the Parent Company uses the equity-method of accounting for its majority-owned subsidiaries. These financial statements should be read in conjunction with our consolidated financial statements and the accompanying notes thereto.
See Notes 12 and 14 of Notes to Consolidated Financial Statements for additional information on the Parent Company’s debt obligations and capital stock.
The Parent Company has entered into the following intercompany guarantees with certain of our subsidiaries:
•
Radian Group and Radian Mortgage Assurance are parties to a guaranty agreement, which provides that Radian Group will make sufficient funds available to Radian Mortgage Assurance to ensure that Radian Mortgage Assurance has a minimum of $5.0 million of statutory policyholders’ surplus every calendar quarter. Radian Mortgage Assurance had $8.8 million of statutory policyholders’ surplus and no RIF exposure as of December 31, 2019.
•
To allow our mortgage insurance customers to comply with applicable securities regulations for issuers of ABS (including mortgage-backed securities), Radian Group has guaranteed two structured transactions for Radian Guaranty with $79.3 million of aggregate remaining credit exposure as of December 31, 2019.
•
Radian Group and Radian Guaranty Reinsurance are parties to an Assumption and Indemnification Agreement with regard to obligations under our tax-sharing arrangements. Pursuant to this agreement, Radian Group is required to assume certain obligations that arise as a result of our tax-sharing arrangement.
As of December 31, 2019, Radian Group recorded a net deferred tax liability of $253.7 million. This balance includes liabilities related to certain of our subsidiaries which have incurred federal NOLs that could not be carried-back and utilized on a separate company tax return basis. As a result, we are not currently obligated under our tax-sharing agreement to reimburse these subsidiaries for their separate company federal NOL carryforward. However, if in a future period, one of these subsidiaries utilizes its share of federal NOL carryforwards on a separate entity basis, then Radian Group may be obligated to fund such subsidiary’s share of our consolidated tax liability to the IRS.
Note B
The Parent Company provides certain services to its subsidiaries. The Parent Company allocates to its subsidiaries expenses it incurs in the capacity of supporting those subsidiaries, including operating expenses, which are allocated based on the forecasted annual percentage of total revenue, which approximates the estimated percentage of time spent on certain subsidiaries, and interest expense, which is allocated based on relative capital. These expenses are presented net of allocations in the Statements of Operations. Substantially all operating expenses and interest expense, have been allocated to the subsidiaries for 2019, 2018 and 2017.
Amounts allocated to the subsidiaries for expenses are based on actual cost, without any mark-up. The Parent Company considers these charges fair and reasonable. The subsidiaries generally reimburse the Parent Company for these costs in a timely manner, which has the impact of temporarily improving the cash flows of the Parent Company, if accrued expenses are reimbursed prior to actual payment.
The following table shows the components of our Parent Company expenses that have been allocated to our subsidiaries for the periods indicated:
Glossary
Note C
During 2018, the Services segment had not generated sufficient cash flow to reimburse the Parent Company for its share of its direct and allocated operating expenses and interest expense, and therefore the Parent Company effectively contributed $66.1 million to Clayton Group Holdings Inc. to reflect the impairment of the interest receivable on the Clayton Intercompany Note of $17.8 million and the outstanding intercompany receivable balance of $48.3 million representing unreimbursed direct and allocated costs.
See Note 18 of Notes to Consolidated Financial Statements for additional information related to capital transactions between the Parent Company and its consolidated insurance subsidiaries.
Radian Group Inc.
Schedule IV-Reinsurance
Insurance Premiums Earned
Years Ended December 31, 2019, 2018 and 2017