Includes net premiums earned and services revenue on a segment basis, and excludes net investment income, net gain on investments and other financial instruments and other income.
Recently, mortgage originations for home purchases have increased and become a larger proportion of total mortgage originations, as refinancing activity has declined due to rising interest rates. During 2017 and 2018, we have benefited from this trend because mortgage insurance penetration in the insurable mortgage market is generally three to five times higher for purchase originations than for refinancings. Additionally, mortgage insurance penetration on purchase transactions has gradually increased over the past few years. The increase in home purchase transactions and the higher mortgage insurance penetration for purchase originations resulted in a larger mortgage insurance market in 2018 as compared to 2017.
For the PMIERs, in circumstances where there is more than one borrower, the lowest of the borrowers’ FICO scores is used.
Following the 2007-2008 financial crisis, the more restrictive credit environment resulted in an overall improvement in credit quality. More recently, with access to credit expanding and purchase volume becoming a larger proportion of total originations compared to refinancings, Radian Guaranty and the rest of the private mortgage insurance industry have been experiencing a shift in the mix of mortgage lending products toward higher LTVs and higher debt-to-income ratios. In part, this is because in general, borrowers who purchase a home with mortgage insurance tend to have higher LTVs than borrowers who refinance with mortgage insurance. Additional factors contributing to the increase in the industry’s NIW on mortgage loans with LTVs greater than 95% include: (i) GSE program enhancements and guideline changes, including Fannie Mae’s HomeReady program and Freddie Mac’s Home Possible and Home Possible Advantage programs, which are designed to make home ownership more affordable for low- to moderate-income borrowers and (ii) recent lender response to market demands, particularly in light of increasing demand from first-time home buyers. As a result of these factors, home purchases by first-time home buyers, who traditionally require mortgage loans with higher LTVs and may have higher debt-to-income ratios, continue to be an increasingly significant portion of the total market. Further, due in part to changes in GSE guidelines that increased acceptable debt-to-income limits, beginning in late 2017, the private mortgage industry observed a material increase in the volume of loans to borrowers with debt-to-income ratios greater than 45%, and Radian Guaranty imposed certain credit overlays and pricing changes to address this trend. These higher levels have continued during 2018. We believe that these trends toward higher LTVs and debt-to-income ratios have not materially impacted the overall credit quality of our portfolio. See “Results of Operations-Mortgage Insurance-NIW, IIF, RIF” for additional information regarding our portfolio mix and the mortgage industry.
to property damage. However, the future reserve impact of incremental defaults from these or other natural disasters may differ from our previous experience due to overall economic conditions, the pace of economic recovery in the affected areas or other factors. See Note 11 of Notes to Consolidated Financial Statements. See “Results of Operations-Mortgage Insurance-NIW, IIF, RIF-Provision for Losses” for more information on defaults. See “Liquidity and Capital Resources-Radian Group-Short-Term Liquidity Needs-Capital Support for Subsidiaries” for additional information on the impact of increased defaults on our PMIERs Minimum Required Assets.
Tax Cuts and Jobs Act. On December 22, 2017, the TCJA was signed into law, significantly changing the U.S. tax system. It included, among other items, the following provisions that impacted Radian:
Reduction of net deferred tax assets of $102.6 million at December 31, 2017, due to the lower statutory tax rate resulting in an increased tax provision;
A material reduction in cash tax payments in 2018 due to the repeal of the corporate alternative minimum tax;
Potential impacts of state tax changes that could be prompted in response to the TCJA.
For periods beginning January 1, 2018, the TCJA had a significant favorable impact on our net income, diluted earnings per share and cash flows, primarily due to the reduction in the federal corporate tax rate. The TCJA also significantly increased the economic value of our existing mortgage insurance portfolio as of December 31, 2017, due to the increase in expected future net cash flows from our IIF.
Services. The macroeconomic conditions and other events that impact the housing, mortgage finance and related real estate markets also affect the demand for our mortgage, real estate and title services offered through our Services business segment. As described in “-Key Factors Affecting our Results-Services,” revenues for our Services segment are subject to fluctuations from period to period, in part due to the combination of the transactional nature of our business and the overall activity in the housing and mortgage finance markets.
Our mortgage services business is dependent on customer activity and general secondary market dynamics including volume, types of transactions, and scopes of review. For example, while non-GSE or “private label” securitization activity remains limited compared to the pre-financial crisis market, this market continued to expand in 2018 due to larger institutions re-entering the market, suggesting increased potential growth in 2019. Similarly, the single family rental market continued to experience strong demand in 2018, driven in part by early refinance activity in the rising interest rate environment, as well as a GSE program that drove volume, but was later suspended at the end of 2018. While regulatory demands on mortgage market participants continue to be significant following the financial crisis, regulatory enforcement actions on mortgage industry participants have been less frequent, reducing the demand for our servicing quality control services as target customers form alternative strategies on how best to manage risk in the current and projected environment.
Radian’s real estate services consist primarily of home property valuation services, which include appraisals, broker price opinions and automated valuations, and REO services that include property preservation and software as a service (“SaaS”) technology products. These products and services are fundamentally volume driven and therefore sensitive to variances in macro level home sales, home price appreciation, interest rates, home default rates and GSE guidelines. Since the financial crisis, REO inventory levels continue to decline due to lower delinquencies and foreclosure activity, reducing demand for our REO asset management services. Further, as alternatives for managing costs have become more critical to the overall value proposition for market participants, we have observed increasing market trends toward the use of non-appraisal valuation alternatives, which we expect will continue to grow.
Radian’s title services comprise a suite of title, closing and settlement services for residential mortgage loans, including our recent entry into the title insurance business with the acquisition of Entitle Insurance in 2018. 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, could limit or create volatility in the timing and amount of potential revenue growth of this business.
Pricing is highly competitive in the mortgage insurance industry, with industry participants competing for market share and customer relationships. As a result of this competitive environment, recent industry pricing trends have included: (i) increases in the use of a spectrum of filed rates to allow for pricing based on more granular loan, borrower and property attributes, including granular pricing through the use of a “Black Box” framework, as further discussed below; (ii) the use of customized rates (often discounted from our published rate cards), including in response to requests for pricing bids by certain lenders; and (iii) other pricing changes that include, among other things, reductions in published rates.
increasing risk-based granularity of our pricing across most products, including the use of rate adjustors related to multi-borrower loans and loans with a debt-to-income ratio greater than 45%; and
introducing our proprietary RADAR Rates, which became available to customers beginning in January 2019, subject to regulatory approval.
We currently employ proprietary risk and customer analytics, as well as a digital pricing delivery platform, to deliver loan level pricing electronically to our customers. In January 2019, we broadly introduced RADAR Rates as our newest pricing option that is powered by 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. The granularity of our pricing is tailored to the business needs of our customers and their risk profiles. This framework represents a continuation of our strategy to consistently apply an approach to pricing that is customer-centric, flexible and customizable based on a lender’s loan origination process, as well as balanced with our own objectives for managing the risk and return profile of our mortgage insurance portfolio. We expect that RADAR Rates, which leverages our proprietary risk model, will enhance our ability to continue to build a high quality mortgage insurance portfolio.
Radian is focused on a number of strategic objectives, as described in “Radian’s Long-Term Strategic Objectives” in “Item 1. Business-General.” In developing our strategies for our mortgage insurance business, we monitor various competitive and economic factors while seeking to increase the long-term value of our portfolio by balancing both profitability and volume considerations in developing our pricing and origination strategies. We take a strategic, risk-based approach to establishing our premium rates and writing a mix of business that we expect to grow the economic value of our mortgage insurance portfolio and produce our targeted level of returns on a blended basis, while providing an acceptable level of NIW. See “-Competition and Pricing-Radian’s Pricing,” and “Results of Operations-Mortgage Insurance-NIW, IIF, RIF.”
Our growth strategy includes leveraging our core expertise in mortgage credit risk management and expanding our presence in the mortgage finance industry, including by participating in certain credit risk transfer programs developed by the GSEs. As part of their initiative to distribute mortgage risk and increase the role of private capital in the mortgage market, Fannie Mae and Freddie Mac have established Front-end credit risk transfer programs that provide the GSEs with credit risk coverage on a Flow Basis that is incremental to primary mortgage insurance, as well as Back-end programs that provide the GSEs with credit risk coverage on existing pools of loans. Since 2016, we have participated in the Front-end programs and Back-end programs through Radian Reinsurance. Our participation in these programs is subject to pre-established credit parameters. Our total RIF under the Front-end and Back-end credit risk transfer programs was $196.8 million at December 31, 2018 and $100.4 million at December 31, 2017. We expect to continue to participate in these and other similar programs in the
Radian Group’s liquidity increased as a result of Radian Guaranty’s return of $450 million in capital to Radian Group in December 2018, as approved by the Pennsylvania Insurance Department. This distribution of capital is part of our long-term capital plan, which is designed to improve our financial flexibility and capital position. A portion of the proceeds is expected to be used for the payment of $159 million principal amount of our outstanding Senior Notes due 2019. See Note 12 of Notes to Consolidated Financial Statements.
Services Acquisitions. During 2018, Radian made three acquisitions that, although the purchase prices were not material to Radian, were consistent with our strategic direction, including growth, diversification and enhancing the core product offerings of our Services business.
In December 2018, Radian acquired the assets of Five Bridges, a developer of proprietary software, data analytics and predictive models leveraging artificial intelligence, machine learning and traditional econometric techniques. With the assets acquired from Five Bridges, we expect to provide consumer and real estate analytics to customers, with a primary focus on valuation and risk management tools that span the entire loan life cycle, from underwriting and origination to servicing, secondary market purchase, and securitization.
Restructuring and Other Exit Costs. As a result of the Company’s continued implementation of its 2017 plan to restructure the Services business, restructuring charges were recognized in 2018. In the third quarter of 2018, as a result of our periodic review of long-lived assets for impairment, we also incurred other exit costs associated with impairment of internal-use software. See Notes 1 and 7 of Notes to Consolidated Financial Statements for additional details.
Size of mortgage origination market and market demand for low down payment loans
Penetration percentage of private mortgage insurance in overall mortgage market and legislative, regulatory and administrative changes impacting the demand for private mortgage insurance
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 over multiple years. Additionally, as a result of the TCJA, the economic value of our existing IIF increased significantly as of December 31, 2017, due to the increase in expected future net cash flows associated with the reduction in expected tax payments.
In contrast to Monthly Premium Policies, when Single Premium Policies are cancelled by the insured because the loan has been paid off or otherwise, after consideration of any refunds owed to the borrower, we accelerate the recognition of any remaining unearned premiums. 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, this moderating effect may depend on 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. The impact of all of our third-party quota share reinsurance programs reduced our retained RIF on Single Premium Policies as a percentage of total RIF from 29.7% to 17.2% at December 31, 2018. See “Overview-Business Strategy” for more information.
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 Mortgage Bankers Association, Freddie Mac and Fannie Mae January 2019 Financial Forecasts.
Based on actual dollars generated in the market based on industry publicly reported information and the most recent available reporting by the U.S. Department of Housing and Urban Development.
Approximately 66% of the loans in our total primary mortgage insurance portfolio at December 31, 2018 have 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. If a loan is refinanced under HARP, 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.
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.
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. See Note 11 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.”
compensation programs, as a result of our pay-for-performance and risk-based approach to compensation that is based on the level of achievement of both short-term and long-term goals.
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.
Time-and-Expense Contracts. Under a time-and-expense contract, we are paid a fixed hourly rate, and we are reimbursed for billable out-of-pocket expenses as work is performed. To the extent our actual direct labor costs decrease or increase in relation to the fixed hourly billing rates provided in the contract, we may generate more or less profit, respectively. However, because these contracts are generally short-term in nature, the risk is limited to the periods covered by the contracts. These contracts are used for our loan review, underwriting and due diligence services.
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. To the extent the sale of a property is delayed or not consummated, or the sales proceeds are significantly less than originally estimated, we may generate less profit than anticipated, or could incur a loss. See “Item 1. Business-Services-Services Business Overview” for more information on our Services revenue.
Premiums. We earn net premiums on title insurance, effective with our acquisition of EnTitle Direct in the first quarter of 2018. By adding the capabilities of its subsidiary, EnTitle Insurance, to the title and settlement services that we already were offering through our existing title agency, Radian Settlement Services, we have expanded the geographic reach of our title services and are positioned to provide title insurance and settlement services to our customers across the country.
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.
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 primarily relate to the acquisition of Clayton, and their valuation is based on management’s assumptions, which are inherently subject to risks and uncertainties. In 2017, we recorded total impairment charges of $200.2 million related to the goodwill and other acquired intangible assets of the Services segment. See Note 7 of Notes to Consolidated Financial Statements for additional information.
The TCJA, excluding the impact of Discrete Items, has had a significant favorable impact on the Company’s net income, diluted earnings per share and cash flows for 2018, as compared to the tax laws in effect in 2017, primarily due to the reduction in the federal corporate tax rate from 35% to 21%, which was effective on January 1, 2018. See “Results of Operations-Consolidated-Income Tax Provision” and Note 10 of Notes to Consolidated Financial Statements for additional information on the TCJA.
The following key metrics are used by management in evaluating our performance and measuring the overall growth in value generated for our stockholders. See “Results of Operations-Consolidated,” for additional information on our operating results.
The decrease in average diluted shares for 2017 compared to 2016 is primarily due to the full-year impact of the series of capital and liquidity actions completed in 2016, which included: (i) the purchases of portions of our Convertible Senior Notes due 2017 and 2019, and (ii) the purchase of 9.4 million shares of Radian Group common stock. In addition, in January 2017, we settled our obligations with respect to the remaining $68.0 million aggregate principal amount of our Convertible Senior Notes due 2019 which, as of the settlement date, resulted in a decrease of an additional 6.4 million diluted shares for purposes of determining diluted net income per share.
The increase in adjusted diluted net income per share for 2017, compared to 2016, is primarily due to the increase in our Mortgage Insurance segment’s adjusted pretax operating income, which increased to $651.0 million in 2017, from $561.9 million in 2016. The increase in adjusted diluted net operating income per share for 2017 as compared to 2016 was also impacted by the decrease in average diluted shares, as discussed above.
The amount of goodwill and other acquired intangible assets included in book value per share decreased significantly, from $1.29 per share at December 31, 2016 to $0.30 per share at December 31, 2017 and $0.28 per share at December 30, 2018, primarily due to the impairment of goodwill and other acquired intangible assets, in each case related to the Services segment, as shown in the chart below.
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 “Results of Operations-Consolidated-Net Income” for more information on the changes in net income.
Adjusted net operating return on equity. The increases 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. The increase in adjusted net operating return on equity for 2018 as compared to 2017 was also impacted by the reduction in the company’s federal statutory tax rate from 35% to 21%, which was effective on January 1, 2018.
For 2018, revenue increased compared to 2017, primarily driven by increases of 8% in mortgage insurance net premiums earned. Other operating expenses increased by 5% in 2018 compared to 2017. See “-Other Operating Expenses,” below.
As discussed in more detail below, our results for 2017 compared to 2016 primarily reflect: (i) the impairment of goodwill and other acquired intangible assets related to the Services segment; (ii) additional tax expense related to the remeasurement of our net deferred tax assets as a result of the TCJA; (iii) a decrease in net gains on investments and other financial instruments;
The decrease in net gains on investments and other financial instruments in 2017 as compared to 2016 is primarily due to: (i) the decrease in net realized gains attributable to sales and redemptions of fixed-maturities available for sale and trading securities and (ii) the decrease in unrealized gains on investments and other financial instruments in 2017, as compared to 2016, primarily related to the change in fair value of trading securities and other investments.
The components of the net gains (losses) on investments and other financial instruments for the periods indicated are as follows:
Other Operating Expenses. Other operating expenses for 2018 increased as compared to 2017, primarily as a result of: (i) higher compensation expense in 2018, including variable and incentive-based compensation and (ii) an increase due to the acquisition of EnTitle Direct on March 27, 2018, and the resulting inclusion of its operating expenses. These effects were partially offset by an increase in ceding commissions in 2018, primarily due to the 2018 Single Premium QSR Agreement and the increased cession percentage on the 2016 Single Premium QSR Agreement. In addition to these items, 2018, as compared to 2017, also included: (i) lower expenses associated with retirement and consulting agreements entered into in February 2017 with our former Chief Executive Officer and (ii) lower accrued legal expenses related to defending and resolving certain outstanding legal matters.
Other operating expenses for 2017 increased as compared to 2016, primarily due to: (i) $6.6 million of expenses associated with retirement and consulting agreements entered into in February 2017 with our former Chief Executive Officer; (ii) increases in technology expenses associated with a significant investment in upgrading our systems; (iii) expenses accrued to defend and resolve certain outstanding legal matters; and (iv) a decrease in ceding commissions. The increase in other operating expenses for 2017 was partially offset by lower compensation expense in 2017, including variable incentive-based compensation.
For 2017, restructuring and other exit costs represent charges associated with our plan to restructure the Services business. Charges are primarily due to severance and related benefit costs and impairment of long-lived assets and loss from the sale of a business line. See Note 7 of Notes to Consolidated Financial Statements for more information on our review of the strategic
Loss on induced conversion and debt extinguishment. During 2018, we had no induced conversion or debt extinguishment activities.
The amortization of intangible assets primarily reflects the amortization of intangible assets acquired as part of the Clayton acquisition. During the second quarter of 2017, we recorded a goodwill impairment charge of $184.4 million, as well as an impairment charge for other acquired intangible assets of $15.8 million, in each case related to our Services segment. These charges were primarily due to changes in expectations regarding the future growth of certain Services business lines, resulting from changes in our business strategy, combined with market trends observed during the second quarter of 2017 that we expected would persist. As a result, as of December 31, 2017, the remaining balances of goodwill and other acquired intangible assets reported in our consolidated balance sheet were $10.9 million and $53.3 million, respectively. See Note 7 of Notes to Consolidated Financial Statements for additional information.
Income Tax Provision. The TCJA significantly changed the U.S. tax system and, among other things, reduced the federal corporate tax rate from 35% to 21%, effective January 1, 2018. Our effective tax rate was 11.4% for 2018, compared to 65.1% for 2017 and 36.3% for 2016. The difference in our effective tax rates in comparison to the federal statutory rates were primarily the result of Discrete Items. Our 2018 effective tax rate was lower than the federal statutory tax rate of 21% primarily as a result of the tax benefit recorded related to the settlement of our IRS Matter. The increase in our effective tax rate for 2017 above the 35% federal statutory tax rate was primarily due to the impact of the TCJA, which resulted in a $102.6 million reduction of our net deferred tax assets, recorded as additional income tax provision. See “Overview-Operating Environment-Tax Cuts and Jobs Act” and Note 10 of Notes to Consolidated Financial Statements for additional information on the TCJA.
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 and are among our key performance indicators used in evaluating 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
Adjusted pretax operating income is defined as GAAP consolidated pretax income from continuing operations, excluding the effects of: (i) net gains (losses) on investments and other financial instruments; (ii) loss on induced conversion and debt extinguishment; (iii) acquisition-related expenses; (iv) amortization or impairment of goodwill and other acquired intangible assets; and (v) net impairment losses recognized in earnings and losses from the sale of lines of business. 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. Interest expense on convertible debt, share dilution from convertible debt and the impact of share-based compensation arrangements have been reflected in the per share calculations consistent with the accounting standard regarding earnings per share, whenever the impact is dilutive. 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.
Total adjusted pretax operating income, adjusted diluted net operating income per share, and adjusted net operating return on equity are not measures of total 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:
All amounts 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.
Total adjusted pretax operating income on a consolidated basis consists of adjusted pretax operating income (loss) for our
Calculated using the company’s federal statutory tax rates of 21% for 2018 and 35% for 2017 and 2016. Any permanent tax adjustments and state income taxes on these items have been deemed immaterial and are not included.
The following table summarizes our Mortgage Insurance segment’s results of operations for the years ended December 31, 2018, 2017 and 2016:
Net of ceded premiums written under the QSR Program, the Single Premium QSR Program and the Excess-of-Loss Program. See Note 8 of Notes to Consolidated Financial Statements for more information.
Adjusted Pretax Operating Income. Our Mortgage Insurance segment’s adjusted pretax operating income for 2018 was $772.6 million, compared to $651.0 million for 2017 and $561.9 million for 2016. The increase in our adjusted pretax operating income for 2018, compared to 2017, primarily reflects: (i) an increase in net premiums earned; (ii) a decrease in provision for losses; and (iii) an increase in net investment income. Our results for 2017 compared to 2016 primarily reflect a decrease in the provision for losses and to a lesser extent, a decrease in interest expense. These increases in adjusted pretax operating income were partially offset by higher other operating expenses.
If adjusted to reflect subsequent HARP refinancing activity, this percentage would decrease to 6.0%, 8.4%, and 12.1% as of December 31, 2018, December 31, 2017 and December 31, 2016, respectively.
We implemented pricing changes during the first half of 2018 that we estimate will result in an overall relative premium rate decrease on NIW. The changes are expected to gradually affect our results over time, as existing IIF is replaced with NIW at current pricing. These changes, however, do not affect the value or future returns on our IIF written prior to 2018; therefore, the impact of these pricing actions on near-term revenue is expected to be limited. As an example, assuming our current NIW levels, mix and persistency levels remain constant, we estimate that it would take approximately three years for approximately one-half of our IIF to reflect our current pricing structure. However, the ultimate results of the changes will be influenced by many other factors, including the amount of NIW, changes in the product and credit profile mix of both NIW and policy cancellations, the impact of interest rates and product mix on persistency, and the amount of reinsurance we use. See “Overview-Competition and Pricing-Radian’s Pricing” for additional information.
The 4.9% increase in NIW for 2018 compared to 2017 is primarily attributable to increases in mortgage insurance penetration and overall purchase mortgage originations, partially offset by decreases in refinance originations and our share of the mortgage insurance market.
Although it is difficult to project future volumes, industry sources expect the total mortgage origination market in 2019 to be comparable to the market in 2018, driven by a decline in refinance originations of approximately 11% as a result of higher anticipated interest rates, partially offset by an expected increase in purchase originations of approximately 4%. Given our expected penetration rates, we expect the private mortgage insurance market in 2019 to be comparable to 2018. Based on industry forecasts and our projections, we expect our NIW in 2019 to be in the range of $50 billion.
Our expected future losses on our portfolios written after 2008, together with HARP refinancings, 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.
Borrower-paid Single Premium Policies have lower Minimum Required Assets under PMIERs as compared to lender-paid Single Premium Policies. See “Overview-Competition and Pricing-Radian’s Pricing” for additional information.
Represents the percentage of direct Single Premium Policies written, after giving effect to the Single Premium NIW ceded under the Single Premium QSR Program (for NIW after the effective dates of the respective agreements). See Note 8 of Notes to Consolidated Financial Statements for additional information about these arrangements.
The Persistency Rate in the fourth quarter of 2017 was reduced by an increase in cancellations of Single Premium Policies due to increased cancellations identified through our ongoing servicer monitoring process for Single Premium Policies.
The Persistency Rate on a quarterly, annualized basis is calculated based on loan level detail for the fourth quarter of each year shown. It may be affected by seasonality or other factors, and may not be indicative of full-year trends.
Represents the dollar amount and percentage, respectively, of RIF on Single Premium Policies, after giving effect to all quota-share reinsurance ceded.
At December 31, 2018, 2017 and 2016, consists of 97.7%, 97.3% and 97.0%, respectively, of RIF related to fixed-rate mortgages.
The table below provides additional information about the components of mortgage insurance net premiums earned for the periods indicated.
We experienced a decrease in our total mix of Single Premium Policies to 21% of our NIW for 2018, compared to 23% for 2017 and 27% for 2016. 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 to manage capital and risk in an effort to optimize the amounts and types of capital and risk distribution deployed against insured risk. 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 are expected to increase Radian Guaranty’s 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-Third-Party Reinsurance” and Note 8 of Notes to Consolidated Financial Statements for more information about our reinsurance transactions.
Net Investment Income. Increasing yields from higher interest rates, combined with higher average investment balances, resulted in increases in investment income for 2018, compared to 2017. Our higher investment balances were primarily a result of investing our positive cash flow from operations. For 2017, net investment income increased compared to 2016, as we refined our investment liquidity targets and cash management strategies, consistent with rising short-term rates and an increased book yield in our portfolio. All periods include an allocation to the Mortgage Insurance segment of net investment income from investments held at Radian Group.
Provision for Losses. The following table details the financial impact of the significant components of our provision for losses for the periods indicated:
In addition to the positive trends in our provision for losses for current year defaults for 2018 and 2017, we experienced positive reserve development on prior year defaults, primarily due to reductions in certain Default to Claim Rate assumptions based on observed trends of higher Cures than were previously estimated on those prior year defaults.
Our mortgage insurance provision for losses for 2017 decreased by $68.0 million as compared to 2016. Reserves established for new default notices were the primary driver of our total incurred losses for 2017 and 2016. Current year primary defaults increased by 5.9% for 2017, compared to 2016, due to elevated new default notices in 2017 in the FEMA Designated Areas associated with Hurricanes Harvey and Irma received subsequent to those two natural disasters, which occurred during the third quarter of 2017. Due to exclusions in our Master Policies for physical damage, including damage caused by floods or other natural disasters, and based on our past experience with similar natural disasters, we assumed a 3% gross Default to Claim Rate for new primary defaults in FEMA Designated Areas associated with Hurricanes Harvey and Irma received subsequent to those two natural disasters. See “Overview-Operating Environment-Hurricanes” for additional information.
For all areas other than FEMA Designated Areas associated with Hurricanes Harvey and Irma, the number of total new primary mortgage insurance defaults in our insured portfolio decreased by 7.2%, as compared to 2016. Our gross Default to Claim Rate assumption for new primary defaults, excluding the new primary defaults in FEMA Designated Areas associated with Hurricanes Harvey and Irma received subsequent to those two natural disasters, was 10% as of December 31, 2017, compared to 12% as of December 31, 2016. This reduction in estimated gross Default to Claim Rate assumptions, which was based on observed trends, contributed to the reduction in the portion of our provision for losses related to new defaults in 2017, compared to 2016. In addition, the 2017 provision on current year defaults includes $14 million related to pool commutations.
Our primary default rate at December 31, 2018 was 2.1% compared to 2.9% at December 31, 2017. Our primary defaulted inventory comprised 21,093 loans at December 31, 2018, compared to 27,922 loans at December 31, 2017, representing a decrease of 24.5%. The reduction in our primary defaulted inventory is the result of the total number of defaulted loans: (i) that have cured or (ii) for which claim payments have been made, collectively, exceeding the total number of new defaults on insured loans. Consistent with typical default seasoning patterns, the shift in our portfolio composition toward more recent vintages is expected to result in slightly increased levels of new defaults in our total portfolio for 2019 as compared to 2018, because we do not expect that the reductions in new defaults from our portfolio of insurance written prior to and including 2008 will continue to outpace the anticipated increases from more recent vintages.
Included in this amount at December 31, 2018 and December 31, 2017 are the defaults in the FEMA Designated Areas associated with Hurricanes Harvey and Irma, which occurred during the third quarter of 2017. At December 31, 2018, 2017 and 2016, defaults in these areas were 2,627; 7,051; and 3,321, respectively.
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:
Included in this amount for the years ended December 31, 2018 and 2017 are the new defaults and Cures in the FEMA Designated Areas associated with Hurricanes Harvey and Irma, which occurred during the third quarter of 2017. For the years ended December 31, 2018, 2017 and 2016, new defaults and Cures in these areas were as follows:
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.
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 33%, 31% and 42%, at December 31, 2018, 2017 and 2016, respectively. The change in our Default to Claim Rate in 2017 resulted primarily from the lower Default to Claim Rate of 3% on new primary defaults in FEMA Designated Areas associated with Hurricanes Harvey and Irma subsequent to those two natural disasters and through February 2018. 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, 2018 and 2017 by $32 million and $31 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. See Note 11 of Notes to Consolidated Financial Statements.
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 $11.3 million, $10.4 million and $14.3 million at December 31, 2018, 2017 and 2016, respectively.
Our mortgage insurance total loss reserve as a percentage of our mortgage insurance total RIF was 0.7% at December 31, 2018, compared to 1.0% at December 31, 2017 and 1.6% at December 31, 2016. See Note 11 of Notes to Consolidated Financial Statements for information regarding our reserves for losses by category and a reconciliation of our Mortgage Insurance segment’s beginning and ending reserves for losses and LAE.
Our primary reserve per default (calculated as primary reserve excluding IBNR and other reserves divided by the number of primary defaults) was $17,634, $17,103 and $22,503 at December 31, 2018, 2017 and 2016, respectively. The $17,103 primary reserve per default at December 31, 2017, includes the impact of reserves and defaults related to the FEMA Designated Areas associated with Hurricanes Harvey and Irma. Excluding the impact from new defaults received subsequent to Hurricanes Harvey and Irma in these FEMA Designated Areas, this amount would be approximately $20,500 at December 31, 2017.
Notwithstanding historical trends, our portfolio originated prior to and including 2008 experienced default and claim activity sooner and to a significantly greater extent than had been the case historically for our books of business prior to the financial crisis. For the periods indicated, the following tables show: (i) cumulative direct claims paid by us on our primary insured book of business at the end of each successive year after origination, expressed as a percentage of the cumulative premiums written by us in each year of origination and (ii) direct claims paid by policy origination year. Direct claims paid represent first-lien claims paid prior to reinsurance recoveries and captive termination payments, and exclude LAE.
Other operating expenses for 2017, as compared to 2016, reflect an increase primarily due to: (i) increases in technology expenses associated with a significant investment in upgrading our systems; (ii) higher allocated corporate operating expenses, primarily due to expenses associated with the retirement and consulting agreements entered into with our former Chief Executive Officer; (iii) expenses accrued to defend and resolve certain outstanding legal matters; and (iv) a decrease in ceding
Interest Expense. These amounts reflect the portion of interest on Radian Group’s debt obligations allocated to our Mortgage Insurance segment, excluding the Senior Notes due 2019. The allocated interest decreased in 2018 and 2017 compared to 2016. These decreases were primarily due to the capital and liquidity actions taken in 2017 and 2016. See “Results of Operations-Consolidated-Interest Expense.”
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.
Includes allocation of corporate operating expenses of $12.0 million, $14.3 million and $8.5 million for 2018, 2017 and 2016, respectively.
loss for 2018, as compared to 2017, was driven by: (i) a decrease in compensation-related costs (exclusive of costs related to EnTitle Direct), primarily as a result of our restructuring activities in 2017 and (ii) a decrease in restructuring and other exit costs. These lower expenses were partially offset by the inclusion of the operating results of EnTitle Direct (acquired in March 2018).
Revenue decreased in 2017, as compared to 2016, primarily due to the decline in volume in: (i) mortgage services related primarily to our transaction management business and our surveillance business and (ii) real estate services primarily driven by our REO business. The decrease in transaction management was primarily due to a decline in loan review volume driven by a decline in demand for outsourcing. Our surveillance business is transactional and the decrease in surveillance services volume was primarily due to fewer transactions and pricing changes with one of our top 10 Services customers. The decline in REO asset management volume was primarily driven by a decline in REO asset inflow reflecting market conditions. These decreases were partially offset by an increase in title services transaction volumes related to a large contract.
Cost of Services. Our cost of services is primarily affected by our level of services revenue and the mix of services provided. Our cost of services primarily consists of employee compensation and related payroll benefits, including the cost of billable labor assigned to revenue-generating activities and, to a lesser extent, other costs of providing services such as travel and related expenses incurred in providing client services and 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.
Other Operating Expenses. Other operating expenses primarily consist of compensation costs 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. Compensation-related costs for 2018 represented 50% of the segment’s other operating expenses, compared to 50% and 55% for 2017 and 2016, respectively. Other operating expenses for 2018 were impacted by the acquisition of EnTitle Direct in March 2018 and the resulting inclusion of its other operating expenses from the date of acquisition. The inclusion of EnTitle Direct is the primary driver of the increase in compensation-related costs for 2018, compared to the same period in 2017, partially offset by decreases resulting from our restructuring actions taken in 2017.
the proportion of corporate expenses allocated to the Services segment combined with an increase in total corporate expenses. See “Results of Operations-Consolidated-Other Operating Expenses.”
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, 2018, 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.
Includes $158.6 million of Senior Notes due 2019 that may be redeemed, in whole or in part at any time prior to maturity.
Excludes IBNR reserves of $3.3 million relating to the Services business, as the timing or magnitude of any potential payments is unknown.
We have approximately $33.6 million in potential additional liabilities associated with uncertain tax positions as of December 31, 2018. The timing or magnitude of any potential payments is unknown.
To allow our mortgage insurance customers to comply with applicable securities regulations for issuers of ABS (including mortgage-backed securities), we have been required, depending on the amount of credit enhancement we were providing, to provide: (i) audited financial statements for the insurance subsidiary participating in these transactions or (ii) a full and unconditional holding-company level guarantee for our insurance subsidiaries’ obligations in such transactions. Radian Group has guaranteed two structured transactions for Radian Guaranty with approximately $87.8 million of aggregate remaining credit exposure as of December 31, 2018.
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 arrangements.
As of December 31, 2018, 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:
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 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 “
We have audited the accompanying consolidated balance sheets of Radian Group Inc. and its subsidiaries (the “Company”) as of December 31, 2018 and 2017, 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, 2018, 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, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
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 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 mortgage, real estate and title services. We have two reportable business segments-Mortgage Insurance and Services.
From time to time, we enter into reinsurance transactions as a component of our long-term risk distribution strategy to manage our capital position and risk profile, which includes managing Radian Guaranty’s capital position under the PMIERs financial requirements. The credit that we receive under the PMIERs financial requirements for these transactions is subject to initial and ongoing review by the GSEs.
Capital and Liquidity Actions. On August 9, 2017, Radian Group’s board of directors authorized the Company to repurchase up to $50 million of its common stock. The Company completed this program during the first half of 2018 by purchasing 3.0 million shares at an average price of $16.56 per share, including commissions.
On August 16, 2018, Radian Group’s board of directors approved a new share repurchase program that authorizes the Company to repurchase up to $100 million of its common stock in the open market or in privately negotiated transactions until expiration of the program on July 31, 2019. As of December 31, 2018, the full purchase authority of up to $100 million remained available under this program. See Note 15 for additional information.
IRS Matter. Radian finalized a settlement with the IRS which resolved the issues and concluded all disputes related to the IRS Matter. In the three-month period ended June 30, 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. Treasury to settle its $31 million obligation to the IRS, and in 2019, the Company expects the IRS to refund to Radian the remaining $58 million that was previously on deposit. See Note 10 for additional information.
Restructuring and Other Exit Costs. As a result of the Company’s continued implementation of its 2017 plan to restructure the Services business, for the year ended December 31, 2018, pretax restructuring charges of $2.5 million were recognized, which include $2.0 million in cash expenses. For the year ended December 31, 2017, pretax restructuring charges of $17.3 million were recognized, including $6.8 million of cash expenses. This initiative was completed during 2018 and, for the two-year period ending December 31, 2018, we recognized total restructuring charges of $19.8 million, consisting of: (i) asset impairment charges (including the loss recognized on the sale of our EuroRisk business) of $10.8 million; (ii) employee severance and benefit costs of $7.4 million; (iii) facility and lease termination costs of $1.3 million; and (iv) contract termination and other restructuring costs of $0.3 million. See Note 7 for additional information, including the events that led to the restructuring plan.
Estimating our loss reserves 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. For example, our mortgage insurance loss reserves generally increase as defaulted loans age, because historically, as defaulted loans age, they have been more likely to result in foreclosure, and therefore, have been more likely to result in a claim payment. While we believe this remains accurate, following the financial crisis, there are a significant number of loans in our defaulted portfolio that have been in default for an extended period of time, but which have not been subject to foreclosure, and therefore, have not resulted in claims. As a result, significant uncertainty remains with respect to the ultimate resolution of these aged defaults. This uncertainty requires management to use considerable judgment in estimating the rate at which these loans will result in claims.
With respect to loans that are in default, considerable judgment is exercised as to the adequacy of reserve levels. For purposes of reserve modeling, loans are aggregated into groups using a variety of factors. The attributes currently used to define the groups for purposes of developing various assumptions include, but are not limited to, the Stage of Default, the Time in Default and type of insurance (i.e., primary or pool). 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. With respect to new defaults in FEMA Designated Areas associated with Hurricanes Harvey and Irma received from September 2017 through February 2018, we assume a lower gross Default to Claim Rate than for new defaults with similar characteristics from other areas, due to our expectations based on past experience with other natural disasters, that a significant portion of these defaults will not result in claims. 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. We forecast the impact of our Loss Mitigation Activity in protecting us against fraud, underwriting negligence, breach of representation and warranties, inadequate documentation of submitted claims and other items that may give rise to Rescissions or cancellations and Claim Denials, to help determine the Default to Claim
Senior management regularly reviews the modeled frequency, Rescission, Claim Denial, Claim Curtailments and Claim Severity estimates, which are based on historical trends, as described above. If recent emerging or projected trends differ significantly from the historical trends used to develop the modeled estimates, management evaluates these trends and determines how they should be considered in its reserve estimates.
Mortgage insurance premiums written on an annual or multi-year basis are initially recorded as unearned premiums and earned over time. Annual premiums are amortized on a monthly, straight-line basis. Multi-year premiums are amortized over the terms of the contracts in relation to the anticipated claim payment pattern based on historical industry experience. Premium
s written on a monthly basis are earned over the period that coverage is provided. When we rescind insurance coverage on a loan, we refund all premiums received in connection with such coverage. Premium revenue is recognized net of our accrual for estimated premium refunds due to Rescissions or other factors. 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.
Incremental, direct costs associated with the successful acquisition of mortgage insurance business, consisting of compensation and other policy issuance and underwriting expenses, are initially deferred and reported as deferred policy acquisition costs. Amortization of these costs for each underwriting year book of business is expensed in proportion to estimated gross profits over the estimated life of the policies. 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 details.
The FASB has 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, 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.
The majority of our revenue-generating transactions are not subject to the new standard as 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. This update is primarily applicable to revenues from our Services segment. See Note 1 “-Services” for information about the services we offer.
The table below represents the disaggregation of Services revenues by revenue type:
Generally, our contracts with our 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 significant portion of our engagements are transactional in nature and may be performed in connection with securitizations, loan sales, loan purchases or other transactions. 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.
Fixed-Price Contracts. We use fixed-price contracts in our real estate valuation and component services, our loan review, underwriting and due diligence services as well as our title and closing services. We also use fixed-price contracts in our surveillance business for our servicer oversight services and RMBS surveillance services, and in our asset management business activities. 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.
Time-and-Expense Contracts. The Services segment also derives a portion of its revenue from professional service activities under time-and-expense contracts. In these types of contracts, we are paid a fixed hourly rate, and we are reimbursed for billable out-of-pocket expenses as work is performed. These contracts are used in our loan review, underwriting and due diligence services. Services revenue consisting of billed time fees and pass-through expenses is recorded over time and based on the progress to date as services are performed and made available to customers. Services revenue may also include expenses billed to clients, which includes travel and other out-of-pocket expenses, and other reimbursable expenses.
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.
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 does not include an allocation of overhead costs.
We provide for losses associated with title insurance policies, closing protection letters and other risk-based products based upon our historical experience and other factors by a charge to expense when the related premium revenue is recognized. The resulting reserve for IBNR claims, together with the reserve for known claims, reflects management’s best estimate of the total costs required to settle all incurred claims, and are considered to be adequate for such purpose.
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 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 securities that are purchased and held primarily for the purpose of selling them in the near term, and 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 the fair value of investments.
Property and equipment is carried at cost, net of depreciation. For financial statement reporting purposes, computer hardware and software is generally depreciated over three or five years, furniture and fixtures is depreciated over seven years, and office equipment is depreciated over five years. 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.
Intangible assets, other than goodwill, primarily consist of customer relationships, technology, trade name and trademarks, client backlog and non-competition agreements. Customer relationships represent 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. Technology represents proprietary software used for loan review, underwriting and due diligence, managing the REO disposition process, performing surveillance of mortgage loan servicers, real estate valuations and client workflow solutions. Trade name and trademarks primarily reflect the value inherent in the recognition of the “Clayton” name and its reputation. For purposes of our intangible assets, we use the term client backlog to refer to the estimated present value of fees to be earned for services performed on loans currently under surveillance or REO assets under management. The value of a non-competition agreement is an appraisal of potential lost revenues that would arise from an individual leaving to work for a competitor or initiating a competing enterprise. 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.
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.
Restructuring and other exit costs include items such as asset impairment charges (including loss from the sale of a business line), employee severance and benefit costs, facility and lease termination costs, contract terminations and other costs of restructuring or exiting activities. The timing of the future expense and associated cash payments for restructuring and other exit costs is dependent on the type of exit cost. We review assets for impairment in accordance with the accounting guidance for long-lived assets. The loss on sale of a business line is calculated by the excess of its carry amount over the sale price. Generally, our employee severance and benefit costs are part of the Company’s ongoing benefit arrangement and are recognized when probable and estimable. A liability for facility and lease contract termination costs is recognized at the date we cease the use of rights conveyed by the contract and is measured at its fair value, which is determined based on the remaining contractual lease rentals reduced by estimated sublease rentals. Other contract termination and exit costs include future costs that will be incurred, which are recognized in total when they no longer will benefit the Company. The liabilities for restructuring and other exit costs are recorded in other liabilities.
In January 2016, the FASB issued an update that makes certain changes to the standard for the accounting of financial instruments. Among other things, the update requires: (i) equity investments to be measured at fair value with changes in fair value recognized in net income; (ii) the use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (iii) separate presentation of financial assets and financial liabilities by measurement category and form of financial asset; and (iv) separate presentation in other comprehensive income of the portion of the total change in the fair value
In January 2017, the FASB issued an update to the accounting standard regarding business combinations. This update clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The guidance requires an entity to evaluate if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets; if so, the set of transferred assets and activities is not a business. The guidance also requires a business to include at least one substantive process and narrows the definition of outputs. The guidance is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years and should be applied prospectively as of the beginning of the period of adoption. We adopted this update effective January 1, 2018 and it did not have a material impact on our financial statements.
Accounting Standards Not Yet Adopted. In February 2016, the FASB issued an update that replaces the existing accounting and disclosure requirements for leases of property, plant and equipment. The update requires lessees to recognize, as of the lease commencement date, assets and liabilities for all leases with lease terms of more than 12 months, which is a change from the current GAAP requirement to recognize only capital leases on the balance sheet. Leases are required to be classified as either operating or finance, with expense on operating leases recorded as a single lease cost on a straight-line basis. For finance leases, interest expense on the lease liability is required to be recognized separately from the straight-line amortization of the right-of-use asset. Quantitative disclosures are required for certain items, including the cost of leases, the weighted-average remaining lease term, the weighted-average discount rate and a maturity analysis of lease liabilities. Additional qualitative disclosures are also required regarding the nature of the leases, such as basis, terms and conditions of: (i) variable interest payments; (ii) extension and termination options; and (iii) residual value guarantees. In July 2018 the FASB issued a further update containing certain targeted improvements to the accounting and disclosure requirements for leases, including an additional (and optional) transition method to recognize the cumulative-effect adjustment as of the beginning of the period of adoption, rather than recognizing the cumulative-effect adjustment as of the beginning of the earliest comparative period presented. We expect to elect the optional transition method to recognize the cumulative-effect adjustment as of the beginning $50 million, which represents a right of use asset, and a corresponding net increase in other liabilities for the same amount. The net increase of approximately $50 million in other liabilities represents a discounted lease liability of approximately $74 million from operating leases, primarily for our various facilities, which represents the present value of these future lease payments discounted at our incremental borrowing rate, partially offset by an adjustment for unamortized allowances and incentives. Additionally, upon adoption we expect to expand our financial statement disclosures as required by the amendments, as well as implement any necessary changes to our control environment and reporting processes to reflect the requirements of the amendments. See Note 14 for additional information about our leases. However, we do not expect the adoption of this standard to impact our stockholders’ equity, results of operations or liquidity. In addition, we expect to elect 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 are not required to reassess expired or existing contracts to determine if they contain additional leases; (ii) we are not required to reassess the lease classification for expired and existing leases; and (iii) we are not required to reassess initial direct costs for existing leases. The update is effective for us on January 1, 2019 and upon our adoption, we expect to record an increase in other assets of approximately $50 million, which represents a right of use asset, and a corresponding net increase in other liabilities for the same amount. The net increase of approximately $50 million in other liabilities represents a discounted lease liability of approximately $74 million from operating leases, primarily for our various facilities, which represents the present value of these future lease payments discounted at our incremental borrowing rate, partially offset by an adjustment for unamortized allowances and incentives. Additionally, upon adoption we expect to expand our financial statement disclosures as required by the amendments, as well as implement any necessary changes to our control environment and reporting processes to reflect the requirements of the amendments. See Note 14 for additional information about our leases.
In June 2016, the FASB issued an update to the accounting standard regarding the measurement of credit losses on financial instruments and certain other assets. This update requires that financial assets measured at their amortized cost basis be presented at the net amount expected to be collected. Credit losses relating to 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 update is effective for public companies for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. This update is not applicable to credit losses associated with our mortgage insurance policies. We are currently evaluating the impact on our financial statements and future disclosures as a result of this update.
In August 2018, the FASB issued an update to the accounting standard regarding the accounting for long-duration insurance contracts. 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, 2020, including interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the potential impact of the adoption of this update.
In August 2018, the FASB issued an update to the accounting standard regarding 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. Early adoption is permitted, including adoption in an interim period. We are currently evaluating the potential impact of the adoption of this update and do not expect it to have a material effect on our financial statements and disclosures.
The calculation of basic and diluted net income per share was as follows:
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:
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) all interest expense (except for interest expense related to an intercompany note with terms consistent with the original issued amount of $300 million from the Senior Notes due 2019 that were used to fund our purchase of Clayton, all of which is allocated to our Services segment); and (iii) all corporate cash and investments.
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) the allocated interest expense related to the intercompany note as described above. No corporate cash or investments are allocated to the Services segment. Inter-segment activities are recorded at market rates for segment reporting and eliminated in consolidation.
Loss on induced conversion and debt extinguishment. Gains or losses on early extinguishment of debt and losses incurred to purchase our convertible 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. Therefore, these items are excluded from our calculation of adjusted pretax operating income (loss).
Summarized operating results for our segments as of and for the years ended, as applicable, were as follows:
Net of ceded premiums written under the QSR Program, the Single Premium QSR Program and the Excess-of-Loss Program. See Note 8 for additional information.
Results from inclusion of the operations of EnTitle Direct, a national title insurance and settlement service company, acquired in March 2018.
Excludes net losses on investments and other financial instruments of $42.5 million, not included in adjusted pretax operating income.
Does not include impairment of long-lived assets and loss from the sale of a business line, which are not components of adjusted pretax operating income.
The decrease in total assets for the Services segment at December 31, 2017, as compared to December 31, 2016, is primarily due to the impairment of goodwill and other acquired intangible assets. See Note 7 for further details.
The reconciliation of adjusted pretax operating income (loss) to consolidated pretax income is as follows:
As of December 31, 2018, California is the only state that accounted for more than 10% of our mortgage insurance business measured by primary RIF. California accounted for 12.3% of our Mortgage Insurance segment’s primary RIF at December 31, 2018, compared to 12.4% at December 31, 2017. California accounted for 11.9% of our Mortgage Insurance segment’s direct primary NIW for the year ended December 31, 2018, compared to 14.1% and 14.8% for the years ended December 31, 2017 and 2016, respectively.
The following is a list of assets that are measured at fair value by hierarchy level as of December 31, 2018:
Does not include certain other invested assets of $0.3 million, primarily invested in limited partnerships, accounted for as cost-method investments and not measured at fair value. Includes cash collateral held under securities lending agreements of $19.4 million reinvested in money market instruments.
At December 31, 2018 and 2017, 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, 2018 and 2017. Activity 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, 2018 and 2017.
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.
The carrying value and estimated fair value of other selected assets and liabilities not carried at fair value in our consolidated balance sheets were as follows as of the dates indicated:
Includes securities with a fair value of $10.7 million serving as collateral for FHLB advances.
Includes $7.4 million of fixed maturity securities loaned to third-party Borrowers under securities lending agreements, classified as other assets in our consolidated balance sheets, as further described below.
Includes $14.7 million of fixed maturity securities and $13.2 million of equity securities loaned to third-party Borrowers under securities lending agreements, classified as other assets in our consolidated balance sheets, as further described below.
securities under securities lending agreements that are classified as other assets in our consolidated balance sheets, as further described below.
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 we recognized other-than-temporary impairment losses in
For the year ended December 31, 2017, we recorded other-than-temporary impairment losses in earnings of $1.4 million. These losses comprised $0.4 million due to our intent to sell certain corporate bonds at a loss and $1.0 million due to credit deterioration, which included $0.5 million related to a convertible note of a non-public company issuer included in debt securities and $0.5 million related to a privately-placed equity security.
At December 31, 2017, includes a de minimis amount of loaned securities under securities lending agreements that are classified as other assets in our consolidated balance sheets, as further described below.
The Borrower generally may return the loaned securities to us at any time, which would require us to return the collateral within the standard settlement period for the loaned securities on the principal exchange or market in which the securities are traded. We manage this liquidity risk associated with cash collateral by maintaining the cash collateral in a short-term money-market fund with daily availability. The credit risk under these programs is reduced by the amounts of collateral received. On a daily basis, the value of the underlying securities that we have loaned to the Borrowers is compared to the value of cash and securities collateral we received from the Borrowers, and additional cash or securities are requested or returned, as applicable. In addition, we are indemnified against counterparty credit risk by the intermediary.
Key balances related to our securities lending agreements at December 31, 2018, consisted of the following:
Prior to the 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.
As of December 31, 2018, Radian had an aggregate amount of $88.4 million of U.S. government and agency securities and RMBS, classified as fixed-maturities available for sale within our investment securities portfolio, serving as collateral for our FHLB advances. There were no FHLB advances outstanding at December 31, 2017. See Note 13 for additional information.
We generally perform our annual goodwill impairment test during the fourth quarter of each year, using balances as of the prior quarter. However, if there are events and circumstances that indicate that it is more likely than not that the fair value of a reporting unit is less than the carrying amount, we will perform additional analysis on an interim basis. As part of our goodwill impairment assessment, we estimate the fair value of the reporting unit using primarily an income approach and, at a lower weighting, a market approach. The key driver in our fair value analysis is forecasted future cash flows.
As part of our annual goodwill impairment assessment in 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, which were less than originally had been expected at the acquisition date. We considered both positive and negative factors and concluded that, after considering all of the factors and evidence available, there is no impairment of goodwill as of December 31, 2018 because the estimated fair value of the reporting unit exceeded our carrying amount.
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, as discussed below and (ii) shift the strategy of the Services segment to focus on core products and services that, in the current market environment, are 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. Our strategic decisions included an intent to scale back or, in certain cases, discontinue certain planned or existing initiatives, such as discontinuing a new product line which, based on a market study received in the second quarter of 2017, would have required significant additional investment to achieve the growth rates that had been expected. The impact of the strategic decisions determined during the second quarter resulted in a meaningful reduction in the fair value of the Services segment since the previous annual impairment test.
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. As discussed further below, 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. See “-Other Acquired Intangible Assets,” below. Substantially all of our goodwill and other acquired intangible assets will continue to be deductible for tax purposes in accordance with the originally scheduled amortization period of approximately 15 years.
Client relationships represent 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 the three months ended June 30, 2017, we recorded an impairment charge of $14.9 million related to the segment’s client relationships, primarily due to the changes in estimated client revenues based on the factors discussed above. The remaining carrying value of client relationships is supported by projected earnings.
For the three months ended June 30, 2017, we also recorded an impairment charge of $0.9 million related to technology, representing the estimated unrecoverable value of a portion of the acquired proprietary software used to provide services in a product line impacted by the factors described above. The remaining carrying value of technology was supported by technology that we expected to continue to use in its current form, in either the same or an alternative capacity.
In our mortgage insurance business, we use reinsurance as part of our risk distribution strategy, including to manage our capital position and risk profile. Premiums are ceded under the Single Premium QSR Program, the QSR Program and the Excess-of-Loss Program.
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 amounts of our ceded premiums and ceded losses. RIF ceded under the 2016 Single Premium QSR Agreement was $6.3 billion as of December 31, 2018, compared to $6.9 billion and $3.8 billion as of December 31, 2017 and 2016, respectively.
The following tables show the amounts related to the Single Premium QSR Program and the QSR Program for the periods indicated:
In November 2018, Radian Guaranty entered into a fully collateralized reinsurance agreement with Eagle Re, an unaffiliated special purpose reinsurer domiciled in Bermuda. This reinsurance agreement provides for up to $434.0 million of aggregate excess-of-loss reinsurance coverage for the applicable percentage of mortgage insurance losses on new defaults on an existing portfolio of eligible Monthly Premium Policies issued between January 1, 2017 and January 1, 2018, with an initial RIF of $9.1 billion. In addition, Radian Guaranty entered into a separate excess-of-loss reinsurance agreement for up to $21.4 million of coverage, representing a pro rata share of the credit risk alongside the risk assumed by Eagle Re on those Monthly Premium Policies.
Radian Guaranty and its affiliates have retained the first-loss layer of $204.9 million of aggregate losses. Eagle Re and a separate third-party reinsurer provide 90% and 10% coverage, respectively, on the mezzanine layer of up to $214.1 million of losses (in excess of the retained losses of $204.9 million). Eagle Re also provides 100% coverage on the next layer of $241.4 million of aggregate losses. Radian Guaranty and its affiliates will then retain losses in excess of the outstanding reinsurance coverage amount. The aggregate excess of loss reinsurance coverage decreases over a ten-year period as the principal balances of the underlying covered mortgages decrease and as claims are paid by Eagle Re. The outstanding reinsurance coverage amount 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 agreement upon the occurrence of certain events, including an option to terminate on or after November 25, 2023.
The reinsurance premium due to Eagle Re 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. Radian Guaranty will also pay an additional annual premium to reimburse Eagle Re for expenses in connection with the issuance of the Notes and Eagle Re’s annual anticipated operating expenses, which are not expected to be material. If the reinsurance agreement is not terminated after five years from issuance, the reinsurance premium’s risk margin payable to Eagle Re increases by 50%.
In connection with our excess of loss reinsurance agreement with Eagle Re, we concluded that (i) the risk transfer requirements for reinsurance accounting were met as Eagle Re is assuming significant insurance risk and has a reasonable possibility of a significant loss; and (ii) Eagle Re is a variable interest entity (“VIE”). Based on the accounting guidance that addresses VIEs, because Radian does not have: (i) the power to direct the activities of Eagle Re that most significantly affect its economic performance or (ii) the obligation to absorb losses or the right to receive benefits from Eagle Re that potentially could be significant to Eagle Re, we have not consolidated Eagle Re in our consolidated financial statements. We have also concluded that the reinsurance agreement contains an embedded derivative, which we have accounted for separately as a freestanding derivative. See Note 2 for additional accounting policy information.
Eagle Re’s assets are required to be invested in U.S. government money market funds, cash or U.S. Treasury securities. Eagle Re’s liabilities consist of its mortgage insurance-linked notes of $434.0 million, as described above.
Represents the fair value of the related embedded derivative, included in other assets in our consolidated balance sheets.
secure our potential cash recoveries. 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 to Radian Guaranty related to the Single Premium QSR Program are expected to be realized from this account.
In 2018, Radian utilized its “qualified deposits” with the U.S. Treasury to settle its $31 million obligation to the IRS, and in 2019, the Company expects the IRS to refund to Radian the remaining $58 million that was previously on deposit. As such, the remaining balances of the deposits with the IRS as of December 31, 2018 are included in current federal income tax receivable. In January 2019, we received $33 million of the $58 million refund from the IRS and expect to receive the remaining $25 million in the coming months. See Note 10 for additional information regarding the IRS Matter.
Internal-use software, at cost, has been reduced by accumulated amortization of $60.3 million and $48.4 million at December 31, 2018 and 2017, respectively, as well as $5.1 million of impairment charges in 2018. Amortization expense was $11.4 million, $10.7 million and $6.0 million for the years ended December 31, 2018, 2017 and 2016 respectively.
The reconciliation of taxes computed at the statutory tax rate of 21% in 2018 and 35% in 2017 and 2016 to the provision for income taxes is as follows:
On December 22, 2017, H.R.1, the TCJA, was signed into law. In accordance with the provisions of the accounting standard regarding accounting for income taxes, changes in tax rates and tax law are accounted for in the period of enactment, which, for federal legislation, is the date the President signed the bill into law. Effective January 1, 2018, the TCJA, among other things, reduced the federal corporate income tax rate from 35% to 21%, repealed the corporate alternative minimum tax and modified certain limitations on executive compensation. Under GAAP, the effect of tax rate changes on deferred tax balances is recorded as a component of the income tax provision related to continuing operations for the period in which the new tax law is enacted.
Accordingly, in 2017, we recognized a non-cash income tax expense of $102.6 million related to the remeasurement of our net deferred tax assets, which was included as a component of the income tax provision for the year ended December 31, 2017. Additionally, as a result of finalizing our interpretation of related guidance, we completed our accounting in the fourth quarter of 2018 during the one-year measurement period from the enactment date, as provided under Staff Accounting Bulletin No. 118, “Income Tax Accounting Implications of the Tax Cuts and Jobs Act,” issued by the SEC staff in December 2017. No material adjustments to our provisional amounts were required.
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 $64.5 million at December 31, 2018 and $65.0 million at December 31, 2017.
We currently have a tax benefit preservation plan, together with certain amendments to our amended and restated bylaws and our amended and restated certificate of incorporation (collectively, our “Tax Benefit Preservation Measures”), that was established to protect our ability to utilize our NOLs and other tax attributes by attempting to prevent an “ownership change” under U.S. federal income tax rules. Our Tax Benefit Preservation Measures expire in 2019.
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. The IRS opposed the recognition of certain tax losses and deductions that were generated through our investment in a portfolio of non-economic REMIC residual interests and proposed denying the associated tax benefits of these items.
Our total net unrecognized tax benefits decreased by $90.4 million from December 31, 2017 to December 31, 2018, primarily due to a $43.1 million decrease in prior year tax positions and a $52.4 million decrease due to settlements with taxing authorities. The settlement of the IRS Matter was the primary contributor to both of these decreases. These decreases were partially offset by an increase of $26.5 million in our net unrecognized tax benefits related to prior years. This net increase primarily reflects the impact of unrecognized tax benefits associated with our recognition of certain premium income. Although unrecognized tax benefits for this item decreased due to the expiration of the applicable statute of limitations for the taxable period ended December 31, 2014, the related amounts continued to impact subsequent years and resulted in a corresponding increase to the unrecognized tax benefits. Over the next twelve months, our unrecognized tax benefits may decrease by approximately $6.5 million due to the expiration of the applicable statute of limitations relating to the 2015 tax year. The statute of limitations related to our federal consolidated income tax return remains open for tax years 2015-2017. Additionally, among the entities within our consolidated group, various tax years remain open to potential examination by state and local taxing authorities.
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 the acquisition of EnTitle Direct, completed on March 27, 2018. See Note 8 for information about our use of reinsurance in our title insurance business.
Represents ceded losses on reinsurance transactions, including the QSR Program and the Single Premium QSR Program. These amounts are included in the reinsurance recoverables reported in other assets in our consolidated balance sheets.
Includes reinsurance recoverable of $17 thousand and $35 thousand as of December 31, 2018 and December 31, 2017, respectively.
Does not include our second-lien PDR that is included in other liabilities.
would be considered a current year default. For 2017, includes payments made on pool commutations, in some cases for loans not previously in default.
Our loss reserves at December 31, 2017 declined as compared to December 31, 2016, primarily as a result of the amount of paid claims and Cures continuing to outpace losses incurred related to new default notices reported in the current year. Reserves established for new default notices were the primary driver of our total incurred loss for 2017, 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, which, except as discussed above for FEMA Designated Areas associated with Hurricanes Harvey and Irma, declined from 12% at December 31, 2016 to 10% at December 31, 2017. The provision for losses during 2017 was positively impacted by favorable reserve development on prior year defaults, which was primarily driven by a reduction during the period in certain Default to Claim Rate assumptions for these prior year defaults compared to the assumptions used at December 31, 2016. The reductions in Default to Claim Rate assumptions resulted from observed trends, primarily higher Cures than were previously estimated.
As our insurance written in years prior to and including 2008 has become a smaller percentage of our overall insured portfolio, a reduced amount of Loss Mitigation Activity has occurred with respect to the claims we receive, and we expect this general trend to continue. As a result, our future Loss Mitigation Activity is not expected to mitigate our paid losses significantly. Our estimate of such net future Loss Mitigation Activities, inclusive of claim withdrawals, reduced our loss reserve as of December 31, 2018 and 2017 by $32 million and $31 million, respectively. The amount of estimated Loss Mitigation Activities incorporated into our reserve analysis at any point in time is affected by a number of factors, including not only our estimated rate of Rescissions, Claim Denials and Claim Curtailments on future claims, but also the volume and attributes of our defaulted insured loans, our estimated Default to Claim Rate and our estimated Claim Severity, among other assumptions.
Our reported Rescission, Claim Denial and Claim Curtailment activity in any given period is subject to challenge by our lender and servicer customers. We expect that a portion of previous Rescissions will be reinstated and previous Claim Denials 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 of $11.3 million and $10.4 million at December 31, 2018 and 2017, respectively, includes reserves for this activity.
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, 2018:
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 connection with our privately negotiated purchases of Convertible Senior Notes due 2017 in March 2016, we terminated a corresponding portion of the capped call transactions we had entered into in 2010 related to the initial issuance of the Convertible Senior Notes due 2017. As a result of this termination, we received consideration of 0.2 million shares of Radian Group common stock, which was valued at $2.6 million based on a stock price on the closing date of $11.86. In accordance with the accounting standards regarding equity and contracts in an entity’s own equity, the total consideration received was recorded as an increase to additional paid-in capital. The shares of Radian Group common stock received were retired, resulting in a decrease in shares issued and outstanding and a corresponding increase in unissued shares.
Senior Notes due 2019. In May 2014, in anticipation of the Clayton acquisition, we issued $300 million principal amount of Senior Notes due 2019 and received net proceeds of $293.8 million. These notes mature on June 1, 2019 and bear interest at a rate of 5.500% per annum, payable semi-annually on June 1 and December 1 of each year, commencing on December 1, 2014.
Covenants in Senior Notes. The Senior Notes due 2019, 2020, 2021 and 2024 have covenants customary for securities of this nature, including covenants related to the payments of the notes, reports, compliance certificates and modification of the covenants. Additionally, the applicable indentures include covenants restricting us from encumbering the capital stock of a
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, 2018, we had $82.5 million of fixed-rate advances outstanding with a weighted average interest rate of 2.73%. Interest on the FHLB advances is payable quarterly, or at maturity if the term of the advance is less than 90 days. As of December 31, 2018, $60.5 million of the FHLB advances mature in 2019, $3.0 million mature in 2020, $8.0 million mature in 2021, $9.0 million mature in 2023 and $2.0 million mature in 2024. 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.
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 (based on the eligible collateral we have provided at December 31, 2018, which consisted of an aggregate amount of $88.4 million in U.S. government and agency securities and RMBS from fixed-maturities available for sale within our investment securities portfolio).
We are routinely involved in a number of legal and regulatory claims, assertions, actions, reviews, audits, inquiries and investigations by various regulatory entities involving compliance with laws or other regulations, the outcome of which are uncertain. These legal 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. 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.
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, and unjust enrichment claims and seeking monetary damages and declaratory relief. The Complaint lists 3,014 mortgage insurance certificates issued under multiple insurance policies as subject to disputes involving insurance coverage decisions. The Complaint further lists 2,231 mortgage insurance certificates issued under multiple insurance policies as subject to disputes involving premium refund requests. Radian Guaranty believes that Nationstar’s allegations and claims in the legal proceedings described above are without merit and legally deficient, and plans to defend these claims vigorously. We are not able to estimate a reasonably possible loss, if any, or range of loss in this matter because of the preliminary stage of the litigation.
Securities regulations became effective in 2005 that impose enhanced disclosure requirements on issuers of ABS (including mortgage-backed securities). To allow our customers to comply with these regulations at that time, we typically were required, depending on the amount of credit enhancement we were providing, to provide: (i) audited financial statements for the insurance subsidiary participating in the transaction or (ii) a full and unconditional holding company-level guarantee for our insurance subsidiaries’ obligations in such transactions. Radian Group has guaranteed two structured transactions for Radian Guaranty involving $87.8 million of remaining credit exposure as of December 31, 2018.
On August 16, 2018, Radian Group’s board of directors approved a new share repurchase program that authorizes 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. As of December 31, 2018, the full purchase authority of up to $100 million remained available under this program, which expires on July 31, 2019.
In the first quarter of 2016, we announced and completed a share repurchase program. Pursuant to this program, we purchased an aggregate of 9.4 million shares of Radian Group common stock for $100.2 million, at a weighted-average price per share of $10.62, including commissions. No further purchase authority remains under this share repurchase program.
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, 2018, from time to time we also purchased shares on the open market
In each of the quarters during 2018, 2017 and 2016, we declared quarterly cash dividends on our common stock equal to $0.0025 per share.
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 7,906,190 shares available for grant under the Amended and Restated Equity Compensation Plan as of December 31, 2018 (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 11,108,244 shares as of December 31, 2018. 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.
The following table reflects additional information regarding all share-based awards for the years indicated:
Information with regard to RSUs to be settled in stock for the periods indicated is as follows:
The vesting of the performance-based RSUs granted in 2018 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.
The following table summarizes information concerning outstanding and exercisable options at December 31, 2018:
The following assumptions were used in our calculation of Employee Stock Purchase Plan compensation expense during 2018:
As of December 31, 2018, unrecognized compensation expense related to the unvested portion of all of our share-based awards was $23.9 million. Absent a change of control under the Equity Plans, this expense is expected to be recognized over a weighted-average period of approximately 2.1 years.
We contributed immaterial amounts to other postretirement benefit plans in 2018.
The following table shows the rollforward of accumulated other comprehensive income (loss) as of the periods indicated:
Radian Group serves as the holding company for our insurance subsidiaries, through which we conduct our mortgage insurance business. 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. The 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. As of December 31, 2018, the amount of restricted net assets held by our consolidated insurance subsidiaries (which represents our equity investment in those insurance subsidiaries) totaled $3.6 billion of our consolidated net assets.
On March 31, 2017, we reallocated $175 million of capital, in the form of cash and marketable securities, from Radian Guaranty to Radian Reinsurance. The reallocation was accomplished by way of an Extraordinary Distribution, approved by the Pennsylvania Insurance Department, from Radian Guaranty to Radian Group, and a simultaneous capital contribution from Radian Group to Radian Reinsurance in the same amount. These transactions resulted in a $175 million decrease in Radian Guaranty’s statutory policyholders’ surplus (i.e., statutory capital and surplus) and a corresponding increase in Radian Reinsurance’s statutory policyholders’ surplus. Until September 30, 2017, the reallocation of capital had no impact on Radian Guaranty’s Available Assets under the PMIERs, because Radian Reinsurance was considered an exclusive affiliated reinsurer of
At December 31, 2018, although Radian Guaranty and Radian Reinsurance had statutory policyholders’ surplus of $814.1 million and $356.2 million, respectively, both companies had negative unassigned surplus balances, due primarily to the need for mortgage guaranty insurers to establish and maintain contingency reserves. Radian Guaranty had negative unassigned surplus of $701.9 million at December 31, 2018, compared to negative unassigned surplus of $765.0 million at December 31, 2017. Radian Reinsurance, which began operations in December 2015, had negative unassigned surplus of $84.8 million at December 31, 2018, compared to negative unassigned surplus of $112.1 million at December 31, 2017. If either of these insurers had positive unassigned surplus as of the end of the prior fiscal year, such insurer only may pay dividends or other distributions during any 12-month period in an aggregate amount less than or equal to the greater of: (i) 10% of the preceding year-end statutory policyholders’ surplus; or (ii) the preceding year’s statutory net income. Due to the negative unassigned surplus balances at the end of 2018, no dividends or other distributions can be paid from Radian Guaranty or Radian Reinsurance without approval from the Pennsylvania Insurance Commissioner. In addition to the payment of the $175 million Extraordinary Distribution by Radian Guaranty in 2017, as described above, on December 21, 2018, Radian Guaranty distributed $450 million in capital, in the form of cash and marketable securities, to Radian Group. This transfer was approved by the Pennsylvania Insurance Department as an Extraordinary Distribution and resulted in a $450 million decrease in Radian Guaranty’s statutory policyholders’ surplus. Radian Reinsurance did not pay any dividends or other distributions in 2018 or 2017.
Radian Guaranty is domiciled and licensed in Pennsylvania as a stock casualty insurance company authorized to carry on the business of credit insurance, which includes the authority to write mortgage guaranty insurance. It is a monoline insurer, restricted to writing first-lien residential mortgage guaranty insurance.
Radian Guaranty’s statutory net income, statutory policyholders’ surplus and contingency reserve as of or for the years ended December 31, 2018, 2017 and 2016 were as follows:
Excludes risk ceded through all reinsurance programs (including with affiliates) and RIF on defaulted loans.
The net increase in Radian Guaranty’s Risk-to-capital in 2018 was primarily due to the growth in IIF combined with the smaller overall increase in statutory capital due to the $450 million distribution of capital to Radian Group. Radian Guaranty’s net RIF increased during the year due to strong growth in NIW and IIF, partially offset by the increased reinsurance benefit pursuant to the Single Premium QSR Program and the Excess-of-Loss Program.
In December 2017, Radian Group transferred $100 million of cash and marketable securities to Radian Guaranty in exchange for a Surplus Note issued by Radian Guaranty. This Surplus Note has a 0% interest rate and is scheduled to mature on December 31, 2027. The Surplus Note may be redeemed at any time upon 30 days prior notice, subject to the approval of the Pennsylvania Insurance Department.
Radian Reinsurance is domiciled and licensed in Pennsylvania as a stock casualty insurance company authorized to carry on the business of credit insurance, which includes the authority to reinsure policies of mortgage guaranty insurance. Radian Reinsurance is only licensed or authorized to write direct mortgage guaranty insurance in Pennsylvania. Radian Reinsurance is required to maintain a minimum statutory surplus of $20 million to remain an authorized reinsurer in all states.
Radian Reinsurance’s statutory net income, statutory policyholders’ surplus and contingency reserve as of and for the years ended December 31, 2018, 2017 and 2016 were as follows:
EnTitle Insurance’s statutory policyholders’ surplus and statutory net loss were $27.0 million and $1.8 million, respectively, as of and for the year ended December 31, 2018.
The differences between the statutory financial statements and financial statements presented on a GAAP basis represent differences between GAAP and SAPP principally for the following reasons:
Under SAPP, mortgage insurance companies are required to establish a contingency reserve equal to 50% of premiums earned in each year, generally to be maintained for 10 years, whereas no such reserve is required under GAAP.
Under SAPP, deferred tax assets are only recognized to the extent they are expected to be recovered within a one- to three-year period subject to a capital and surplus limitation. Changes in deferred tax assets and deferred tax liabilities are recognized as a direct benefit or charge to unassigned surplus, whereas under GAAP changes in deferred tax assets and deferred tax liabilities are generally recorded as a component of income tax expense.
Under SAPP, fixed-maturity investments are generally valued at amortized cost. Under GAAP, those investments are generally recorded at fair value.