Sanford Ibrahim - Chief Executive Officer
Catherine Jackson - Senior Vice President and Corporate Controller
Radian Group, Inc. (RDN) Goldman Sachs Financial Services Conference December 11, 2013 9:20 AM ET
One of the topics in our [indiscernible] has significant earnings tailwinds [indiscernible] and is well-position for growth, as private mortgage insurance redeem market share from the FHA.
With that, I'll turn it over to S.A. for his prepared remarks and the presentation, and then we'll open up to audience questions.
Thank you, and good morning to all of you, and thanks for joining us today. This morning, I'm going to discuss Radian's strong financial and competitive position. And I believe that will help us take advantage of the opportunities that we see ahead. Finally, I'll provide a few quick insights into several regulatory and legislative issues before taking your questions.
With the most important part of the presentation, reminding you that some of the statements I'll make today will be forward-looking and these statements as well as Radian's prospects are subject to certain risks and uncertainties. You should read about these risks on the Slide 2 and 3. Now, that I have made my general council happy, we'll get into the presentation.
So as I mentioned, I'll cover a number of topics, which I believe are top of mind for you. And talk about the outstanding new business opportunity for industry and for Radian. This new business is transforming our portfolio and driving our return to sustain profitability.
So I see many familiar faces in the audience, but for those of you, who don't know us, Radian is a private mortgage insurance company that has been in business for more than 35 years. This is the only business in which we are active today and we are an industry with six other mortgage insurance players. We believe that for our industry as well as for our company, we are dealing with a bright future and we are very strongly positioned to participate in that future.
So very quickly, looking at the macro environment for our business, what you see here is household formations. And the two points I'd like to make is, they are on the rise again, after taking a dip in 2009. And you can see, while the statistic includes both renters and homeowners, there is other data to show that the interest in homeownership has remained undiminished and particularly is very strong among what is emerging as the potential target market for homeowners in the future, which is the Hispanic and Asian segments of the population.
Now, you would expect typically for us and homebuyers, who we see as the big piece of our future, typically are the ones who do not have the ability to put down 20%. So that's where we see our target opportunity for the mortgage insurance industry and for Radian. And you may have heard that at Radian, we just signed an agreement with the National Association of Hispanic Real Estate Professionals, which will help us access the Hispanic market.
The other thing to point out on this chart is, while the household formations are starting to go up, they are still far below, where they were at the historical levels, if you see during that period 2002 to 2006. In fact, they are like 47% of where they were, which shows you that should they rise to the same level, there's a significant opportunity.
The next slide shows the increasing availability of mortgage credit over the past year-and-a-half, which is also a positive for our business, as homebuyers now have access to more credit than they've had. And we'll be talking about also in addition to that, the outstanding credit quality of the business that we've been writing and we will continue to write. This is in many ways at least in my years of experience in the mortgage industry, both in the MI industry as well as from the lending perspective, one of the best environments to write high credit-quality business.
Now, there has been some talk about interest rates are raising again. But if you step back and look at interest rates, we see that while interest rate certainly have risen in the most recent time period, still relative to historical levels, they are very attractive for new homebuyers. So while this increase in interest rates is going to have a negative effect on the heavy reliance on refi business that we saw in the last few years, certainly the interest rates in spite of having risen or to level, where homes and home mortgages still remain very attractive to homebuyers.
So if you add to that the fact that home prices after the dip on the way back, you find three different factors that this story tells, before I move on to the next section, which is take the combination of the fact that home formations on the rise and homeownership interest remains high. Second, take into consideration of the fact that interest rates while they are moving up are still very attractive from the perspective of new homebuyers.
And third, look at this, which is one of the biggest fears that new homebuyers have is, falling home prices. When you're buying your first home, you are very scared of home prices falling, and just as the home prices rising, gives them an assurance that big financial activity they engage in is something worth doing.
Now, let's look at the business opportunity. So let's start with purchase originations, because as you see from this, the volume in the mortgage industry in recent times has come mainly from refinance activity. And as I mentioned earlier, the rise in interest rates is going to have a negative impact on refinance activity, yet, all industry forecast project that the purchase market is going to continue to increase.
And it's important to remember, that when you look at the mortgage insurance industry, our penetration into the refi market is only 4% to 5%, while our penetration into the purchase market is around 18% and may in fact be higher than that as time goes by. So as we look at the 2013 mix and we look beyond 2013 into 2014, we look at the reduction in the overall industry volume offset by the fact that purchase market is increasing and there is higher purchase penetration. So while it's very difficult to project future NIW, what we believe this represents for us and what we are anticipating at Radian is that we will write more than $40 billion of new business in 2014.
On the next chart, you see the other opportunity for us, which is the mix between private MI and FHA. And you can see from this chart that sometime in the 2008 period, there was a crossover from MI historically, representing a larger share of the market to the FHA taking over. And in the period immediately following that, the MI share of the market dropped to the lowest that has been around the 20% range with the FHA of the borrowers, who put down of the MI eligible population of the borrowers, who put down less than 20%; the FHA representing 80%. That trend has been changing back to where it's now roughly 50-50, which shows that there are still rooms to grow for us to recapture share from the FHA. And the FHA in fact continues to make statements about pulling back.
Now, keep in mind, that is not a straight line, because there is a lot of other factors that we have to take into consideration like GP increases and other fees. But if you look back, that trend in spite of the fact you see increase has continued to increase and we expect it to continue to increase. Looking at it another way, we believe today about 40% of the business that the FHA is a writing is attractive to us from an MI perspective.
This is another way of looking at the private MI versus the FHA share. And why so much time spent of FHA, because the biggest opportunity for us is the business we win back as an industry from the FHA. Each percentage point of that business won back is what a multiple of percentage increase in market share between the MI players. That's why we spent that much time on the FHA.
And you'll see here, again this is another way of looking at the fact that some of the business that the FHA is doing today meets our credit needs. And like I said about 40% or half of the volume is what meets our needs and if we can get it back, it represents a good opportunity for us. We also are in a situation, where it is cheaper for a borrower, in most instances, depending on their primary FICO score and LTV to get a GSE loan with MI rather than an FHA loan.
And that is one of the areas, where we at Radian have been taking the lead in educating those players, who influence the borrowers. And these are typically the loan officers, who interface with the borrowers. Because with the recent benefit that the FHA offered, we have to recalibrate their thinking to make them recommend the GSE loan with an MI, and we've been successful, as you can see from the previous chart.
The other perhaps one of the most important point to keep is, even as the industry volumes slows down, because of the interest rates, the rise in interest rates has a positive effect of that in terms of driving the persistency levels. And as persistency levels increase, so does our insurance in force as a combination of the business that we've written and the business that we retain.
And ultimately, profitability is just a function of insurance in force times premiums. That is what really drives our revenues. So that's what something to keep in mind. NIW is one of the drivers of that, but ultimately it's insurance in force times premiums that equals revenues. And here you see what's happening to the persistency levels in our business.
So if you look at persistency the way we calculate it is we look at each vintage strength and calculate persistency and then we sum it all up. So if you look at the individual strength, the persistencies range from anywhere 50% to 90%. Interestingly, some of the lowest persistency levels we've seen has been in the '09, '10 and '11 books and they have repaid very fast.
And more recent vintages we believe will be at the higher end of the range in terms of persistency. And when you add it all up, it translates to somewhere between 80% and 85% persistency levels going forward. So another way of looking at this is for every 1% of increase in persistency translates into $1.6 billion of insurance in force that's stays on our books.
Now, let's look at Radian's strong franchise and financial position. So first, on our financials, as you can see on the house in this slide below the mortgage insurance business is our financial guaranty business, Radian Asset Assurance. And that business today provides the most important capital support for our Radian Guaranty mortgage insurance business.
We'll talk more about the risk and opportunities in the financial guaranty business later in the presentation, but it's important to know, that Radian Asset has been providing capital support since 2008 as well as liquidity in the form of dividends to Radian Guaranty. Our financial guaranty business and this structure have served Radian very well as we've reduced the assets portfolio by 77%, including many of the riskier, and the financial guaranty company has been capital accretive, which has help support Radian Guaranty.
The next chart shows our financials highlights. Now there's a lot of information on this chart. So I'll just direct your attention to some of the points.
First, book value per share. So if you look at that we see the book value and I'll comment on what's going to happen to that. Second, the valuation allowance against our deferred tax assets, which is a larger number as of September 30, then our book value and the point to be made here is obviously that number is very meaningful in terms of our future book value.
And keep in mind that as we continue to expect that valuation allowance to be fully reversed in 2015, and the way it will work is that as we become profitable on a GAAP basis, the valuation allowance will naturally come down. And based on that trajectory of earnings and our internal projections, whatever is less, sometime in 2015 can be reversed and added back to our book value.
The other thing to keep in mind is we have significant holding company liquidity. Obviously, much of that is from our capital raise earlier this year and this liquidity is very important in terms of meeting potential GSE eligibility requirements that offers us overall financial flexibility. As of September 30, we have $700 million.
And the last point to this chart I'd make is the risk-to-capital ratio, which is also very important for us. In our case, we made a strategic decision to keep it at 20 to 1, which is below the current industry standards. And as the new industry standards come into line being at 20 to 1 already puts us in a strong position to meet those standards.
Second, let's look at the mix of our portfolio. We in fact, among the legacy players, perhaps have been ahead of the curve in shaping our legacy portfolio. So today, more than half or almost 60% of our portfolio is made up of book this profitable, high-quality business we've written since 2009. The legacy portfolio continues to shrink and get smaller each quarter. We expect that trend to continue in the future. And if you add to that, the HARP refinance business, 68% of our business has been underwritten since '09.
Next, what is my favorite chart, left side and right side, the left side shows basically how the impact of the new vintages is growing, while the 2008 and prior vintages are shrinking. And mind you, not all of those vintages 2008 and prior are unprofitable either. In our quarterly charts, you see how vintage-by-vintage that profit has breakdown.
The most important takeaway from this chart is on the right hand side, you see the positive impact of the performance of the new book far exceeds this declining negative impact of the old book. To the point where for the first nine months of this year, there's a dramatic difference between the two to the positive side.
Why has that happened and why have we been successful writing business, is because we have been successful in holding on to share from our legacy business customers, while adding a significant amount of new customers. You see from this chart that while our top-five customers accounted for over 50% of our business in 2009.
And by the way they accounted for lot more than 50% prior to '09, they now account for 20% of our business. The other thing to keep in mind is all of the five top customers we have right now only one of them was our top-five customer in 2009, that shows our capacity to bring on new customers, which has been one of our the most powerful drivers of our success story.
Looking at it another way, we also benefit from having a higher market share from our new customers that we've added on, since then from our legacy customers. So it shows not only our new customers importance, because they contribute to our success, but because they represent a larger part.
Couple of other things worth mentioning about our new customers. Recently there has been a lot of articles talking about the growth of the mortgage share of market coming from small customers. A lot of our franchise today, which is about 1,500 to 1,800 customers, it's a representative franchise across the entire industry, which includes a lot of small mortgage lenders, a lot of large independent mortgage lenders. There was another article talking about how some of the independent mortgage lenders, the large vendors are outgrowing some of the more traditional lenders.
Financial guarantee, you are very familiar because we keep talking about out derisking action. I'll jump through this slide very quickly to tell you where we are today. Keep in mind that we've reduced our exposure from a peak of $115 billion at its peak to when we start writing business in 2008 to something like $26 billion.
And we've done so while continuing to pay dividends to Radian Guaranty and while getting the New York Insurance Department to approve contingency capital reserve releases. On top of the reduction you've seen, our CDO portfolio is scheduled to run-off pretty much by '17, and you'll see the projected run-off schedule here.
And that brings me to the regulatory and legislative issues. I'll comment on a couple of key ones. One of them is that, QM, which you're familiar with, is going to be a big governor in terms of credit quality of the business written in the future. And while we will see January 14, what happens with the full impact of QM and how much business is written out of the QM, keep in mind most of the business we are writing today is within the QM box.
Second, QRM equals QM is something that we are clearly in favor of, and that's where we get the indication everybody is leaning. Third, on the GSE reform, we believe that while there is a lot of new views being expressed, all of them project a bigger role for private capital. Some of them specifically mentioned MI by name. Our view is if that reform doesn't happen in the first quarter and the first half of next year, it's not going to happen until after the new administration is in place as we get into an election year, next year.
And then, turning to the GSE eligibility, we expect to receive new guidelines for private mortgage insurers shortly. And at this point, we don't have a clear view of what that could entail, so we've been preparing ourselves in terms of dealing with different outcomes of that. And we believe that the strong position we have, the financial flexibility we have and the anticipated timeframe that we expect will be allowed to implement those guidelines, if the comfort that we should be able to in our opinion meet those guidelines.
And finally, the regulators, the NAIC is in the process of coming up with their own standard for the industry, and that is work in progress with all of us involved working with the regulators, and the outcome is going to be in the past -- I mean, well into the future.
To summarize key parts of the Radian story, our improved MI portfolio, which is the amount of new business we've written since 2008, which represents $125 billion, of what probably will go down in the history of the mortgage industry, as among the most profitable business written, and I'm glad to be standing here telling you, we wrote a pretty big share of that business. And that has improved the composition of our mortgage insurance portfolio and coupled with the declining legacy book and related losses, is going to be a driver of our future earnings.
Second, the FHA pullback and the improving housing market, and new customer and new business prospects, and congressional support for private capital represent significant growth opportunity for Radian. And then finally, as our financial performance improves driven by all those factors I talked about, which is the MI portfolio mix, increasing insurance and forth, and our declining losses, we expect this to present us with greater strength and market flexibility and profitability as we move towards the future.
And with that, I'll end my prepared remarks.
Great. So we'll just take a couple of questions up here first, then we'll turn over to the audience. So you mentioned that you have roughly $700 million of liquidity at the holding company. As you look out towards at FHFA capital requirements, what's the minimum amount that you'd be comfortable holding there?
What we've said is that the amount that we'd like to hold at the holding company to give us some level of flexibility at group level is maybe in the $100 million to $150 million range. We really don't have any pressing needs at the holdco level, the only need we have effectively is $55 million and $15 million, which is our debt due. Most of the expenses are allocated to the operating subsidiaries. The only thing that the group pays for directly is the modest amount of dividends we pay. Cathy, anything you'll add to that?
So as you look out and you try to plan for outcomes, in terms of not knowing what the rules are, but say hypothetically you have to put, but 15 to 1 on the legacy book, 18 to 1 on the new book, and you have one year to do that. And just forgetting about any haircuts on subsidiary capital for Radian asset, what type of actions might you take?
I'd like to point out that in addition to the liquidity we have at the holdco level, we have demonstrated in the last few years that we have the ability to use a lot of tools from our tool box. That includes opportunities to internally generate capital opportunities to externally generate capital through tools like reinsurance and other alternatives, but there is a fair amount of flexibility, and increasing flexibility with the strength that we have in writing the business we are writing today and the business we've already written, which just lays out the path to profitability. Anything more specific, Cathy, you want to add.
I don't think so. I mean I think just to expand in terms of reinsurance opportunities, we have shown that the market built in, and that's certainly something that we would consider as part of a capital plan in order to deal with increased requirements.
So if you look at liquidity at holdco timeframe to comply, currently you look at financial guaranty internally as a source of capital, that's been the source of capital in the past. If you look at reinsurance of MI book, whether it's past book, current books, new books, look at other alternatives available at the market, there is a fair number of tools in our toolkit.
I'll turn it over to the audience.
On that issue with regard to [indiscernible], can you definitively say that you will not need to raise equity in order to meet the new guidelines, I mean recognizing that you don't know what they are yet?
Even if we didn't had the GSE eligibility issue ahead of us, I would never definitively make a statement like that. All I can say to you is look at our past behavior and look at the fact that we have demonstrated the ability to use several tools. And we will make use of whatever tools appropriate, because remember we believe that future opportunity to write business is great, but even if we raise external capital, we would be able to use that to write more business in the future. So I would not rule that out even if we had nothing hanging, but doesn't mean we'll do that or not do that.
The convertible debentures that you have what are your plans? I know its few years down the road, what are your plans with that, just what are you going to do?
So you're talking about the '17?
Yes, I think '19 as well.
Like 900 in change, million.
So you're looking at, a long way off, given in the last three years how much we have been transformed and strengthened as a company. If you project forward to the next three years, hopefully we'll be in a completely different place with a lot more financial strength. And as we've been saying, we expect to recapture or to recognize our DTA back again in 2015. That will only happen by demonstrating sustained profitability.
And if you project that forward that means we could be in a position of accreting capital sometime in the future. First of all when you have earnings, you have access to a lot more alternatives including debt alternatives to deal with that, but I'll let Cathy talk about some of the base views, the base projections views behalf.
Just to make sure whether the '17 convert, the principal amount is settled in cash. So essentially that combined with the other debt that's due in '17, is about $615 million in debt, that's due in '17. And then the '19 convert is actually we have an early option to convert that in '16, if we chose to do so.
It's premature to say specifically what we'll do, but if you just predict from what we've been talking about we should have lot more flexible.
And just another question on, how you see your premium rates evolving over the next few years in terms of having your single-premium business, perhaps extend, had a recent rate cut across the industry. When can we see that settle out?
So I was talking about, our strategy has been to have a mix of single-premium as well as monthly-premium in our business. We've been in the most recent time period, the last year, we've been bringing our single-premium business down, not because we don't like it, we believe it was profitable business that it's inception. In fact some of the business we wrote in '10, '11, '12 time period has turned out to be more profitable than we expected when we wrote it, because the prepayments on those books have been higher, bringing the profitability of the single-premium business in line with the monthly business.
Now, we believe since we don't believe we don't have a crystal ball in predicting exactly what interest rates in the future are going to be and besides interest rate are not the only driver of prepayment behavior in the mortgage market, if you look at purchase activity, typically assume something like 70% of homes purchased in the U.S. are not new homes.
Somebody is selling that home, and chances that in most cases somebody who is selling that home is extinguishing a mortgage anyways. So the fact that the refis are going down doesn't tell the full story about the fact that there will continue to be some amount of extinguishing of existing mortgage debt. That aside we are very comfortable with the fact that the single-premium business we write is profitable. It is profitability that meets our requirements. And by keeping the mix we insulate ourselves and we hedge against movements in the mortgage industry.
I spent years as a lender prior to coming to Radian and one of the biggest things I saw across the many companies I worked with and the many companies I dealt with was that one of the biggest things that some of the brightest people in the industry got wrong was servicing hedging, because they always assumed that there would be extension in servicing and they didn't planned for anything on the other side, and some times they were surprised. That being said, if there is an extension, I'll let Cathy talk about, we are purposely comfortable with the resulting premium and the ROE.
Yes, I think that what we're looking at in terms of the future, we have reduced the percentage of mix of single business, and we do expect it to naturally decline in the future. So in looking at the blend, going forward, we don't think it will have a significant impact on our overall returns, no matter what the interest rates though.
And the onset of it, with the QM coming into effect, certain single-premium business will get affected because some of it may fall above the 3% limit on the closing cost associated with mortgages. So we see that coming down as a result of the QM coming into effect. And that may actually lead the industry to create more forms of products or push that business back to [ph] borrow of it.
Just a quick question on overall market share. I mean with the FHA potentially pulling back or hopefully pulling back and seeding more of the private market, where do you think the net impact of new entrance into the MI industry is going to be on, say, your overall share of admittedly, hopefully a growing pie?
You're right. I think the pie should keep growing. Now, when an industry goes from effectively four players to nine, 10 players or eight players, naturally, even if those new players drive only 1% or 2%, 3% of market share, it has to come from somewhere. So what we did was we went back and looked at the industry market share levels, when there were more players in the business or less players in the business. And we found that when there were more players in the industry than fewer players, nobody had been able to maintain a market share that exceeded 25%.
Now, it doesn't mean that's going to happen in the future or not. The point is, even if they give up a little market share on the margin, we're still starting from a very strong place. I'd rather start and be positioned when new players come into the industry, where we are positioned going into it, than where we were six years ago.
The good thing about our positioning in the past was we wrote less of the pre-2009 business, and we grew our market share, where we could write a lot of the good business. So no matter what happens to slight changes in markets in the future, the fact that we wrote all that good business stays with us and we start from a very strong position, as we face more newcomers coming into the industry.
So I guess just on your reserve methodology, you've disclosed in your supplement that roughly 50% of your default that have missed 12-plus payments will hopefully not go to claim. Just wondering if you could talk us through what the assumptions are behind that and what you've seen with those loans that make you comfortable that they won't go to claim eventually?
Cathy spends a lot of time on that, so I'll let her address it. But from a high level, how I draw comfort with our overall reserves is the fact that, overall, when we come up with our reserves we have two outside parties who will come up with independent views on our reserves. And we tend to be very much -- one of them is a very respected independent firm that our regulators require. The other is our outside auditor, the PWC. And we are very comfortable based on that that all three of us are in such a tight range that we have two other parties with high degree of objectivity and independents looking at the reserves and coming out separately.
Now, the other thing to keep in mind is we have territory in terms of aged defaults in our inventory, which nobody has any historical experience with. And one of the questions having been in this industry for long time I ask myself, is why have so many loan stayed in that late-stage bucket, without going into foreclosure. The services had every incentive to put them in foreclosure, because it costs them to service those loans.
So there has to be some reason, why they have not gone into foreclosure. And of course, each day they don't go into foreclosure, the world is getting better in terms of home prices. With that, I will turn it to Cathy. And by the way our incoming claims are going down at the same time. So try and think about this picture in terms of, we've got a lot of aged loans, but the claims seem to be going down.
There are several factors that we consider. Like S.A. mentioned, there are in that aged bucket, there are a lot of those aged delinquencies that are not proceeding towards foreclosure, until we're looking very closely at that bucket. But they're not proceeding towards foreclosure or claims and that the claims that are coming in or coming down.
There are cures from that bucket, we disclosed the cure rate, it's been running around 4%. Rescissions and denials are becoming less of a factor, but still we'll have some impact with respect to the aged, particularly the aged delinquencies, and curtailments, which will affect severity, not frequently, but will have an impact on the overall reserve estimate and we consider that as well.
Great. Well, thanks so much for your time.