Vertigo3d
Radian Group (NYSE:RDN) is a high quality mortgage insurance company, which I last wrote about in June of 2020, during the Covid-19 lockdowns, which created enormous pressure on the economy, leading to a massive surge in defaults for mortgage insurance companies. Any loan that misses two payments technically constitutes a default in the mortgage insurance portfolio, even if those payments are missed due to forbearance programs, which was a lynchpin of the government’s response to the economic crisis. Despite that pressure, which led to a substantial increase in loss provisioning, Radian remained solidly profitable, going back into strong growth in 2021. Better mortgage underwriting, a strong housing market, and a fundamental change in risk mitigation strategies such as insurance linked notes, have made the mortgage insurance industry much stronger than when it wilted during the Great Recession. Radian offers the opportunity to own a company capable of producing a nearly 20% ROE, right around book value per share.
Single family housing vacancy rates are the lowest in 60 years, so there is a fundamental supply shortage when compared to household creation. The unemployment rate is 3.6%, although we might see some pressure there as the economy is likely already in a recession. Mortgage lending standards are dramatically more conservative than they were during the Financial Crisis, and many homeowners have substantial equity in their homes, allowing them the option to sell instead of defaulting if they were unable to make payments. With these positives in mind, higher mortgage rates are definitely causing a slowdown in housing. Sellers are having to reduce prices more often and bidding wars are less common. The price increases we have seen over the last few years are not healthy, as affordability has never been lower, for both rents and home ownership. Over the last few weeks, the 10-year Treasury yield has plummeted to about 2.54%, as I write this. Spreads between mortgages and Treasuries are higher than normal and could revert lower, providing a little breathing room from the highs in mortgage rates. In my opinion, we have seen the worst of inflation, as the recession will pressure demand. Some of the data might lag with how they account for housing prices in the government data, but I don’t believe we are heading into a housing crisis by any means. This is a good environment for mortgage insurance companies to operate in and should lead to sustainable profitability.
Over the last four years, Radian has averaged net income of $568MM, versus a current market capitalization of less than $4 billion. Its growing insurance in force portfolio produces stable and recurring revenues, particularly with less refinancing occurring, which increases the persistency of the portfolio. Pricing pressure has been an issue for the industry over the last year, but the macroeconomic uncertainty could see that trend start to reverse a little bit. Ending default inventory has been declining since the pandemic/lockdown peak, and as of the end of Q2, there are only 21,861, down from 40,464 at the same time last year, and down from 25,510 in Q1. The default rate has dropped to 2.2% from 4% last year, and 2.6% from last quarter. 31% of defaults have missed three payments or fewer, 31.3% have missed 4-11 payments, and 36.3% have missed 12 payments or more. The company has substantial reserves to cover these and is generating strong profits, leaving plenty of margin for credit degradation before it would create any major problem. Pretax income was $764.8MM last year and $479.4MM in 2020 when the world shut down, so it would take a pretty epic housing recession to actually generate losses given the company’s strong and consistent revenues.
On August 1st, Radian reported a very strong second quarter, resulting in net income of $201.2MM, up from $181.1MM and $155.2MM, in Q1 and Q2 of 2021, respectively. Adjusted diluted net operating income per share was $1.36, up from $1.17 in Q2, and $0.75 at the same time last year. Radian’s adjusted net operating return on average equity grew to 23.6%, from 19.9% in Q1, and 13.6% in Q2 of 2021. While most financial stocks reported material declines in book value per share due to AOCI losses stemming from higher rates, Radian’s book value per share was quite steady ending the quarter at $23.63, down slightly from $23.75 in Q1, and up from $23.02 in Q2 of 2021. AOCI actually declined by $1.98 sequentially, but accretive stock buybacks at a discount to book value per share protected book value per share figures. The company ended the quarter with $772.5MM of holding company liquidity and an investment portfolio of $5.9B.
Primary insurance in force grew to $254.2B, up from $249B in Q1, and $237.3B in Q2 of 2021, reflecting a YoY increase of 12.6%. Higher mortgage rates have led to higher persistency in the mortgage rates, as there are fewer refinancing opportunities available. Net insurance written was $18.9B, up from $18.7B in Q1, but down from $21.7B at the same time last year. Net mortgage premiums earned were $246.9MM, up slightly from $245.2MM in Q1, and down slightly YoY from $247.1MM. Radian got a big boost from being able to decrease its provision for losses by $113.9MM, which was better than the decrease of $83.8MM in Q1, and a provision of $3.6MM in Q2 of 2021. This was a result of positive developments on prior period defaults. The company ended Q2 with a $594.8MM reserve losses and loss adjustment expense. PMIERS excess available assets were $1.4B, which is 38% of the required minimum assets. As of the end of Q2, 62% of Radian’s primary mortgage insurance risk in force is subject to some form of risk distribution, providing a $1.1B reduction to minimum required assets under PMIERs. Risk distribution is a big change in the industry since the Financial Crisis and provide substantial protection for a major downturn.
Radian’s homegenius segment provides title, real estate and technology products and services to consumers, mortgage lenders, mortgage, and real estate investors, GSEs, real estate brokers and agents. Total homegenius revenues in Q2 were $32.3MM, down from $33.9MM in Q1, and $33.5MM in Q2 of 2021. Adjusted pretax operating loss before allocated corporate operating expenses for the segment was $12MM, up from $8.2MM in Q1, and $4.5MM in Q2 of last year. Radian has a big presence in the real estate industry and is leveraging that to grow into new businesses. The unit clearly detracts from current profitability, but hopefully can be profitably monetized as the business is scaled up.
Radian’s management is making a smart capital allocation decision with its utilization of stock buybacks. During Q2, the company repurchased 9.1MM shares at a total cost of $183.8MM, including commissions. In addition, in July of 2022, Radian purchased an additional 4.8MM shares of common stock at a total cost of approximately $97.5MM, including commissions. From April through July, Radian repurchased a staggering 7.9% of its common shares at very attractive and accretive prices. There is still $97.6MM of purchase authority available after July, so I hope the buybacks continue while the stock is so cheap. Radian also pays a quarterly dividend of $0.20 per share, which is a very healthy 3.58% dividend yield at the recent price of $22.35. On July 21st, Moody’s Investors Service upgraded the insurance financial strength (IFS) rating of Radian Guaranty to A3 from Baa1. Moody’s also upgraded the senior unsecured debt rating of Radian Group Inc. to Baa3 from Baa1, and the outlook for the ratings is stable.
Clearly, there is uncertainty into the macroeconomic future. What isn’t uncertain is that Radian has substantial recurring revenues driven by its in-force insurance portfolio, which generates monthly premiums. Prices are starting to go up to account for the heightened risk that exists, as the recession and inflation takes its toll. Higher rates do allow insurance companies, including Radian, to invest their premiums at higher rates, generating higher net investment income. Radian’s prudent and timely stock buybacks bolstered its book value per share in spite of AOCI declines. These AOCI declines should reverse in the third quarter given the rather dramatic decline in 10-year Treasury rates, which along with the July buybacks and retained earnings, should provide for a nice book value per share bump. At a slight discount to book value, a nearly 20% ROE, 7x forward earnings, and a 3.58% dividend make Radian a buy. I believe the stock should trade for roughly $28 per share within the next 18-24 months as fears of a major housing downturn recede. To be clear, a housing slowdown is healthy, but there is a big difference between that and a crash like we saw in 2008, and Radian can still thrive with the pressures the economy is facing.
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