In their current forms, these programs have not had a material impact on our financial performance or business prospects, in part due to the limited nature of the pilots and their current focus on lender-paid Single Premium Policies as well as the operational changes required for lenders to switch from traditional mortgage insurance execution to this new form of execution. The financial impact of these programs has been further mitigated as a result of the shift away from lender-paid singles and the increasing use of our borrower-paid Single Premium Policies. We believe there are significant challenges to the long-term sustainability of the IMAGIN and EPMI programs, including for example that the IMAGIN structure relies on a reinsurance market that, in contrast to traditional mortgage insurance, may not be committed to serving the first-loss mortgage insurance market through various economic and credit cycles. However, if these pilot programs or other alternatives to traditional private mortgage insurance were to expand and become broadly accepted alternatives to traditional private mortgage insurance, they could reduce the demand for private mortgage insurance in its traditional form. See “Item 1A. Risk Factors-Our mortgage insurance business faces intense competition.”
future, subject to availability and our evaluation of risk-adjusted returns. We will only experience claims under these Front-end and Back-end credit risk transfer transactions if the borrower’s equity, any existing primary mortgage insurance (if applicable) and the GSEs’ retained risk are depleted. The GSEs retain the first losses on these credit risk transfer transactions, ranging from 35 to 60 basis points. Generally, Radian would then be responsible to cover the next layer of losses, which ranges in size from approximately 225 to 325 basis points. In participating in these GSE transactions, we assume incremental risk (beyond that which we typically cover in our traditional mortgage insurance business) associated with the risk of defaults caused by physical damage, including natural disasters such as hurricanes and wildfires, which is not covered by the underlying primary mortgage insurance. We regularly evaluate this risk, including the geographic diversity of the loans included in these transactions and our remote risk position, in assessing our participation in these transactions.
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. 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. See Note 15 of Notes to Consolidated Financial Statements for additional details on our share repurchase program.
During the first quarter of 2018, Radian acquired EnTitle Direct, the owner of EnTitle Insurance, a national title insurance and settlement services company. EnTitle Insurance is qualified to write title insurance business in 39 states and the District of Columbia. By adding the capabilities of 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.
Our Mortgage Insurance segment provides credit-related insurance coverage, principally through private mortgage insurance, as well as other credit risk management solutions, to mortgage lending institutions and investors nationwide. The chart below highlights certain key drivers affecting our Mortgage Insurance revenue. The following sections discuss these revenue drivers, as well as other key factors affecting our results.
The ultimate profitability of our Mortgage Insurance business is affected by the impact of mortgage prepayment speeds on the mix of business we write. The measure for assessing the impact of policy cancellations on our IIF is our Persistency Rate, defined as the percentage of IIF that remains in force over a period of time. Assuming all other factors remain constant, over the life of the policies, prepayment speeds have an inverse impact on IIF and the expected revenue from our Monthly Premium Policies. Slower loan prepayment speeds, demonstrated by a higher Persistency Rate, result in IIF remaining in place, providing increased revenue from Monthly Premium Policies over time as premium payments continue and we recover more of our policy acquisition costs. Earlier than anticipated loan prepayments, demonstrated by a lower Persistency Rate, reduce IIF and the revenue from our Monthly Premium Policies. Prepayment speeds may be affected by changes in interest rates, among other factors. An increasing interest rate environment generally will reduce refinancing activity and result in lower prepayments, whereas a declining interest rate environment generally will increase the level of refinancing activity and therefore increase prepayments.
Premiums. The premium rates we charge for our insurance are based on a number of borrower, loan and property characteristics. The mortgage insurance industry is highly competitive and private mortgage insurers compete with each other and with the FHA and VA with respect to price and other factors. We expect price competition to continue throughout the mortgage insurance industry and future price changes from private mortgage insurers or the FHA could impact our future premium rates or our ability to compete.
Diluted Net Income Per Share. The changes in diluted net income per share across all periods presented are primarily due to the changes in net income. The change in net income from 2016 to 2017 was partially offset by the decrease in average diluted shares from 229.3 million shares in 2016 to 220.4 million shares for 2017. See “Results of Operations-Consolidated-Net Income” for more information on the changes in net income.
Adjusted diluted net operating income per share. The increase in adjusted diluted net operating income per share for 2018, compared to 2017, is primarily due to the increase in our Mortgage Insurance segment’s adjusted pretax operating income, which increased to $772.6 million in 2018, from $651.0 million in 2017. The increase in adjusted diluted net operating income
See “Results of Operations-Mortgage Insurance-Adjusted Pretax Operating Income” for more information on our Mortgage Insurance segment’s results.
During 2016, our purchases of Convertible Senior Notes due 2017 and 2019 and redemption of Senior Notes due 2017 resulted in a loss on induced conversion and debt extinguishment of $75.1 million consisting of: (i) a market premium of $41.8 million, representing the excess of the fair value of the total consideration delivered to the sellers of the Convertible Senior Notes due 2017 and 2019 over the fair value of the common stock issuable pursuant to the original conversion terms of the purchased notes; (ii) a loss on debt extinguishment of $17.2 million, representing the difference between the fair value and the carrying value, net of unamortized issuance costs, of the liability component of the purchased Convertible Senior Notes due 2017 and 2019; (iii) a loss on debt extinguishment of $15.0 million on the redemption of the Senior Notes due 2017; and (iv) expenses totaling $1.1 million for transaction costs.
Trends in the profitability of our fundamental operating activities can be more clearly identified without the fluctuations of these realized and unrealized gains or losses and changes in fair value of other financial instruments. We do not view them to be indicative of our fundamental operating activities. Therefore, these items are excluded from our calculation of adjusted pretax operating income (loss).
Includes allocation of corporate operating expenses of $80.1 million, $55.4 million and $45.2 million for 2018, 2017 and 2016, respectively.
Our IIF is one of the primary drivers of 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. See “Key Factors Affecting Our Results-Mortgage Insurance-IIF; Persistency Rate; Mix of Business” for more information.
Represents inception-to-date losses incurred as a percentage of net premiums earned on mortgage insurance.
Represents the percentage of Single Premium IIF, after giving effect to all quota-share reinsurance ceded. See Note 8 of Notes to Consolidated Financial Statements for additional information about reinsurance transactions.
Our mortgage insurance provision for losses for 2018 decreased by $31.7 million as compared to 2017. Reserves established for new default notices were the primary driver of our total incurred losses for 2018 and 2017. Current period new primary defaults decreased by 12.9% in 2018, compared to 2017. Our gross Default to Claim Rate assumption for new primary defaults, was 8% at December 31, 2018, compared to 10% as of December 31, 2017. This reduction in the estimated gross Default to Claim Rate assumption, which was based on observed trends, contributed to the reduction in the portion of our provision for losses related to new defaults in 2018, compared to 2017.
Includes payments to commute mortgage insurance coverage on certain performing and non-performing loans. For 2017, includes payments that, as expected, were made in connection with the final settlement of the Freddie Mac Agreement, as well as payments to commute mortgage insurance coverage on certain performing and non-performing loans on which we had Pool Insurance risk.
Represents total first-lien direct claims paid, excluding impact of reinsurance and LAE.
The GSEs and state insurance regulators impose various capital and financial requirements on our insurance subsidiaries. These include Risk-to-capital, other risk-based capital measures and surplus requirements, as well as the PMIERs financial requirements discussed below. Failure to comply with these capital and financial requirements may limit the amount of insurance that our mortgage insurance subsidiaries may write or prohibit our mortgage insurance subsidiaries from writing insurance altogether. The GSEs and state insurance regulators also possess significant discretion with respect to our mortgage insurance subsidiaries and all aspects of their business. See Note 19 for additional regulatory information.
Securities lending agreements, in which we loan certain securities in our investment portfolio to third parties for short periods of time in exchange for collateral consisting of cash and other securities, are treated as collateralized financing arrangements in our consolidated balance sheets. In all of our securities lending agreements, the securities that we transfer to Borrowers (loaned securities) may be transferred or loaned by the Borrowers; however, pursuant to the terms of these agreements, we maintain effective control over all loaned securities, including: (i) retaining ownership of the securities;
We account for the purchases of our outstanding convertible debt as induced conversions of convertible debt in accordance with the accounting standard regarding derecognition of debt with conversion and other options, and the accounting standard regarding debt modifications and extinguishments. The accounting standards require the recognition through earnings of an inducement charge equal to the fair value of the consideration delivered in excess of the consideration issuable under the original conversion terms. The remaining consideration delivered and transaction costs incurred are required to be allocated between the extinguishment of the liability component and the reacquisition of the equity component. Therefore, we recognize a loss on induced conversion and debt extinguishment equal to the sum of: (i) the inducement charge; (ii) the difference between the fair value and the carrying value of the liability component of the purchased debt; (iii) transaction costs allocated to the debt component; and (iv) unamortized debt issuance costs related to the purchased debt.
We perform an evaluation to determine whether we are required to consolidate the VIE’s assets and liabilities in our consolidated financial statements, based on whether we are deemed to be the primary beneficiary. The primary beneficiary of a VIE is the variable interest holder that is determined to have the controlling financial interest as a result of having both (i) the power to direct the activities of a VIE that most significantly impact the economic performance of the VIE and (ii) the obligation to absorb losses or right to receive benefits from the VIE that potentially could be significant to the VIE. See Note 8 for additional information.
Accounting Standards Adopted During 2018. In May 2014, the FASB issued an update to the accounting standard regarding revenue recognition. In July 2015, the FASB delayed the effective date for this updated standard for public companies to interim and annual periods beginning after December 15, 2017, and subsequently issued various clarifying updates. Our adoption of this standard, effective January 1, 2018, had no impact on our financial statements. The disclosures required by this update are included above in “-Revenue Recognition-Services.”
of a liability resulting from a change in the instrument-specific credit risk (also referred to as “own credit”) when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. The update also eliminates the requirement to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. This update is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. In February 2018, the FASB issued technical corrections related to this update, which addresses common questions regarding the application and adoption of the new guidance and the subsequent amendments. As a result of adopting these updates, equity securities are no longer classified as available for sale securities and changes in fair value are recognized through earnings. Consequently, we recorded a cumulative effect adjustment to retained earnings from accumulated other comprehensive income representing unrealized losses related to equity securities in the amount of $0.2 million, net of tax. In addition, we elected to utilize net asset value as a practical expedient to measure certain other investments, which resulted in an increase to other invested assets with an offset to retained earnings in the amount of $2.3 million, net of tax. Our adoption of both of these updates, effective January 1, 2018, resulted in a net increase to retained earnings of $2.1 million. See Notes 5 and 6 for additional information.
Effective December 31, 2017, we amended the 2016 Single Premium QSR Agreement to increase the amount of ceded risk for performing loans under the agreement from 35% to 65% for the 2015 through 2017 vintages, resulting in a reduction of $145.7 million in net premiums written.
and other factors. These securities are generally categorized in Level II of the fair value hierarchy or in Level III when market-based transaction activity is unavailable.
earnings during the years ended December 31, 2018, 2017 and 2016, there were no other-than-temporary impairment losses recognized in accumulated other comprehensive income (loss) for those periods.
For the year ended December 31, 2016, we recorded other-than-temporary impairment losses in earnings of $0.5 million due to our intent to sell certain corporate bonds at a loss. While we recognized other-than-temporary impairment losses related to our intent to sell securities in earnings, there were no credit-related other-than-temporary impairment losses recognized in earnings during the year ended December 31, 2016.
All cash collateral received has been reinvested in accordance with the securities lending agreements and is included in short-term investments in our consolidated balance sheets. Amounts payable on the return of cash collateral under securities lending agreements are included within other liabilities in our consolidated balance sheets.
RMBS, CMBS, and Other ABS are shown separately, as they are not due at a single maturity date.
For additional information on our accounting policies for goodwill and other acquired intangible assets, see Note 2.
During the fourth quarter of 2017, we elected to perform a qualitative annual goodwill impairment analysis, which requires us to assess all relevant events and circumstances that could affect the significant inputs used to determine the fair value of the reporting unit. We considered factors such as: (i) the increase in and timing of revenues during the third and fourth quarters of 2017 (as compared to the forecasted amounts for the same periods); (ii) the impact to projected cash flows, a significant input used to determine the fair value of the reporting unit, associated with the TCJA enacted in the fourth quarter of 2017; (iii) our recent interim goodwill impairment test and recognition of impairment charges; and (iv) the recent sale of a business line. Based on our qualitative assessment in the fourth quarter of 2017, we concluded that it was not “more likely than not” that the fair value of the Services reporting unit was less than its carrying amount as of December 31, 2017.
Amount Payable on the Return of Cash Collateral under Securities Lending Agreements
minimum net worth and statutory surplus, a maximum debt-to-capitalization level, limits on certain types of indebtedness and liens, minimum liquidity levels and Radian Guaranty’s eligibility as a private mortgage insurer with the GSEs. At December 31, 2018, Radian Group was in compliance with all the covenants and there were no amounts outstanding under this revolving credit facility.
At December 31, 2018, there were no future minimum receipts expected from sublease rental payments.
On June 29, 2016, Radian Group’s board of directors authorized a share repurchase program to spend up to $125 million to repurchase Radian Group common stock. In order to implement the program, Radian adopted a trading plan under Rule 10b5-1 of the Exchange Act during the third quarter of 2016. During the second quarter of 2017, 380 shares were purchased at an average price of $15.59 per share, which represented the only purchases made under the plan. This share repurchase program expired on June 30, 2017.
The Risk-to-capital ratio for our combined mortgage insurance operations was 12.8 to 1 as of December 31, 2018, compared to 12.1 to 1 as of December 31, 2017. In addition to Radian Guaranty and Radian Reinsurance, this combined ratio also includes Radian Guaranty Reinsurance, Radian Mortgage Assurance, Radian Investor Surety Inc., Radian Insurance and Radian Mortgage Guaranty Inc. Radian Insurance is the only other entity that had any remaining RIF as of December 31, 2018, totaling $15.0 million. The aggregate statutory net income, statutory policyholders’ surplus and contingency reserve for these five subsidiaries as of and for the years ended December 31, 2018, 2017 and 2016 were as follows: