Radian: Bullish Now, but Proceed with Caution
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Radian Group, Inc. (NYSE: RDN) operates in the mortgage insurance, bond reinsurance, and mortgage lending risk management business sectors. Just the presence of the words “mortgage” and “bond reinsurance” may spur flashbacks to the 2008 financial crisis and the mortgage sector meltdown, and well they should: Radian Group’s share price was badly punished starting in the second half of 2007. Even a quick glance at a five-year price chart shows that its shares, which had traded in a band from $42 to about $63 since mid-2003, fell off a cliff in the summer of 2007. From a high of $57.03 during the week of June 25, it ended the week of August 27 at $17.64. After a brief dead cat bounce into the mid-twenties, Radian fell below $20 during the week of October 15, 2007 and has remained there since — spending the vast majority of that time below $10, in fact.
The companies in Radian’s peer group, Mortgage and Title Insurers, are in similar (or worse) straits. MGIC Investment Corp. (NYSE: MTG) suffered exactly the same stock price pattern as Radian, plunging from a $60-plus trading range into what the SEC defines as penny stock range — less than $5 per share. The PMI Group, Inc. (PPMIQ) is a penny stock by anyone’s definition of the term, currently hovering around $0.03 per share with price fluctuations measured in the hundredths of a cent.
While the Financials sector has rebounded relatively well since 2009, the Thrifts & Mortgage Finance sub-industry remains flatlined. Certainly there have been positive — if faintly positive — developments in the housing market, and the tighter credit standards being applied to mortgage lending mean a less risky environment for mortgage insurers, albeit with the tradeoff of a substantially smaller market. Many of the collateralized debt obligations (CDOs) and credit default swaps (CDSs) that proved so toxic have been marked-to-market or absorbed by the Federal Reserve. Yet despite interest rates hovering around 4%, the mortgage industry remains moribund, and the looming supply of foreclosures that has yet to fully flood the market stands to suppress prices for years to come.
S&P has assesses that Radian still has the resources to repay debt that will come due in February 2013, and the company recently announced its intention to repurchase part of that debt. However, S&P analysts stand by their opinion that debt coming due in 2015 and 2017 will be more problematic. Poor 2011 financial performance combined with a high delinquent loan inventory and a rate of new delinquencies that is not slowing quickly enough point to a future lack of capital. Whether the housing market will come around quickly enough to rebuild Radian’s capital reserves to the point that it can meet those obligations remains to be seen.
What is even more difficult to predict is exactly what the $25 billion settlement involving lenders, 49 states, and the federal government that was agreed to in mid-February will do. On the one hand, the loan modifications and refinancing mandated by the agreement should help halt the fall in home prices, stabilizing the market. On the other, many experts predict that banks will now accelerate the pace of foreclosure. That would push more houses onto the market and would place downward pressure on prices. Yet pricing is not the primary issue for companies like Radian — prices have been low for a long time now. What is critical is the ability (and willingness) of consumers to buy, and both remain anemic.
Nevertheless, on February 27 the National Association of Realtors reported a 2% increase in the pending existing home sales index for January. This number was double the median analyst expectation. Coming as it does on top of three months of positive employment news, perhaps it is yet another herald of better things to come. No matter what happens, the backlog of foreclosures must be cleared from the market, but that issue is less significant for a company like Radian. It’s not a homebuilder trying to sell new-construction properties; it’s a mortgage insurer. It doesn’t care whether the loans it covers are on new or existing homes.
For that reason — and others — in the shorter term I think Radian may be a mildly positive play. It now holds the #1 market share position in its sub-industry, and the shakeout in the mortgage industry has cleared the field, meaning Radian has fewer customers it has to chase. It recently reported financial results for 2011, and revenues shot up noticeably — $1.948 billion compared to $417.5 million for 2010. Net income was $2.26 per share versus a loss of $15.74 per share in 2010. However, it is important to note that the $302.2 million in income included $821.7 million resulting from the change in fair value of its derivatives and other financial instruments.
The one piece of the puzzle that concerns me — and the one I don’t see anyone discussing — is the impact that tighter lending standards could have on Radian. Private mortgage insurance is normally required when the loan-to-value ratio exceeds 80%. As it happens, 20% is the “magic number” for a down payment that will pretty much assure mortgage approval. If a large proportion of borrowers are required to put 20% down — or for that matter, think they are required to and act accordingly — what then happens to the PMI market? Companies like Radian are dealing with a shrinking customer base as it is, so a trend that further reduces that base would mean yet another blow to revenue.
While Radian may not be a bad buy, I would advise that there are plenty of fatter fish in the sea — all of them outside this particular sub-industry.
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