Summary
- Radian trades at 79% of book value and a little over 5 times earnings, which is crazy for a company that generates a mid-teens ROE.
- Radian could handle provisions for losses to increase by 6x from 2019 and still be about break-even on the year.
- Radian could handle up to 25% default rates while remaining in compliance with PMIERs.
- Radian's mortgage insurance portfolio is of dramatically higher quality than what it had in 2008 and this is not a housing-led recession.
Covid-19 and the lock-down have caused catastrophic economic devastation across the globe. It has created a sense of fear in many people, unlike anything I have lived through. While the glamorous tech stocks have glittered, economically-sensitive value stocks have struggled to get a firm footing. The only comparable period where value has been so out of favor was in the late 1990s, which set up an epic run for value in the following decade. I believe the common stock of Radian Group (RDN) offers an extremely compelling opportunity to buy an above-average business at a major discount. The stock could easily generate 50% plus returns over the next two to three years.
Source: RDN 2020 Investor Presentation
Increased unemployment and the mortgage relief opportunity provided by the CARES Act mortgage forbearance programs, assure the mortgage insurance industry will see increased defaults moving forward. The purpose of these programs is to support borrowers and help them to be able to remain in their homes, which ultimately is good for the borrower and the mortgage insurer. Despite the forbearance programs not impacting the borrower’s credit, any loan that has missed two payments technically constitutes a default in the MI portfolio, regardless of whether those payments are missed because of forbearance. These defaults will be the impetus for an increase in PMIERs capital, which must be held against those loans.
Fortunately, going into this crisis, the housing market was at a much more stable level than prior to the last recession. There is strong demand for housing and much more disciplined loan underwriting and servicing standards. Many people have built equity in their homes making them less likely to be willing to give up on their home if they can possibly avoid it. It is imperative to remember that private mortgage insurers do not pay a claim until title to the property is transferred primarily through foreclosure. Defaults resulting in claims will depend on a variety of factors such as employment, GDP growth, and the efficacy of the programs instituted by the government to keep people in their homes.
Radian had a strong 1st quarter of 2020, generating net income of $140.5MM, which was down 18% YoY, due primarily to a change in net gains on investments and other financial instruments. Diluted net income per share of $.70 was down 10% YoY. The return on equity was 14.2% and book value per share increased 16% YoY to $20.30. Adjusted net operating income per share was $.80, up from $.73, equating to an adjusted net operating return on equity of 16.3%.
Primary insurance in force increased by 8% YoY to $241.6 billion. Persistency will be worth watching, as the robust refinancing market could create some volatility there. The 12-month persistency rate of 75.4% decreased from 78.2% in the prior quarter, and 83.4% in the first quarter of 2019. Net mortgage premiums earned increased 5% to $275MM. New Insurance Written increased by 53% YoY to $16.7 billion. RDN boasts a $5.6 billion investment portfolio and has $1.1 billion in PMIERs excess capital, providing substantial room to handle increased delinquencies and continue writing new business.
Radian projected that the company could deal with a default rate up to approximately 25% of the mortgage insurance portfolio and remain in compliance with PMIERs. New business is being written at higher rates due to the uncertainty, as the industry has ramped up pricing by double digits. At the holding company, RDN has $648.2MM of capital. The company has no debt maturities prior to 2024 and ended the 1st quarter with debt to total capital of 18.7%. Radian still expects to write more than $60 billion in mortgage business for the year, despite the headwinds the economy faces.
