Radian Group: Strong Capital Returns Reflected In Valuation

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Radian Group remains a "hold" due to resilient home prices, low insured losses, and strong investment income, despite potential peak earnings in 2024.The company’s profitability is driven by minimal ...

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I last covered RDN in May, moving shares from a \"buy\" to \"hold,\" though this caution was premature on my part, with the stock returning 11% vs the market's 7% gain. However, with the Federal Reserve now cutting interest rates, it is a good time to revisit Radian. I remain a hold. Seeking Alpha In the company's second quarter, reported on July 31st, Radian earned $0.99. This beat consensus by $0.11. Radian has continued to be exceedingly profitable, driven by essentially no loan losses and the benefit of higher interest rates. In fact, the company had -$2 million of net provisions, allowing it to reduce reserves, though this was smaller than the $22 million of releases a year ago. As a private mortgage insurer, Radian insures mortgage balances when a consumer makes a down payment of less than 20%. Government agencies like Fannie Mae insure mortgages up to 80% of a home's value, and companies like Radian provide the rest. So, when a homebuyer puts 5% down, Radian insures the mortgage balance between the 80% and 95% mark of the home's price. Accordingly, two things have to happen for Radian to take a loss. First, the homeowner needs to become delinquent on the mortgage. So long as monthly payments are made, there is no loss. Second, in a foreclosure, the home has to be sold for less than the outstanding mortgage. These two events have been especially rare over the past three years. While unemployment has risen in recent months, it remains quite low by historic standards. So long as homeowners have a job, delinquencies tend to be quite low. This is consistent with what Radian is seeing. It has just 20,300 units in its default inventory, down nearly 600 from Q1. This translates to just a 2% default rate from 2.1% in Q1. However, the biggest benefit to Radian's financials has been the strong rise in home prices. As long as home prices are elevated, even stressed homeowners may be able to sell their home for more than the mortgage, resulting in no losses for Radian. That is largely what has occurred over the past few years. As you can see below, home prices are a record, up 14% since the end of 2021 and dramatically above pre-COVID levels. With home prices at a record, there are likely very few mortgages that are currently \"underwater\" (i.e. with a principal balance in excess of the home value). While home prices dipped a bit when the Fed began its aggressive rate hiking cycle, they have since rebounded. With the Fed now cutting rates, this potential pressure on prices is lifting. St. Louis Federal Reserve One reason I moved to a \"hold\" was my concern that the benefit from reserve releases would be fading. To an extent, this has happened - the reserve release declined from last year. However, Radian is still effectively a no-loss business given where home prices are. It has brought reserves down to $357 million, and further declines are likely to be modest. Still, with home prices at a record and likely to continue to rise, absent a recession, actual losses are likely to stay small. I do continue to believe that it is important to focus on Radian's exposure by year of origination. Given the rise in home prices and the fact some principal is repaid each month, loans issued during and before 2021 are protected unless national home prices fall in excess of 20%. This is an extremely unlikely scenario, and with each month that passes and more principal is repaid, the margin of safety increases. These loans account for 52% of Radian's insured loan book. Radian Insofar as Radian has loss exposure, it largely comes from 2022 policies to the present, which by definition are transactions closer to current market levels. With each passing month, as Radian issues new policies and its old loan book rolls off, the share of what I call \"zero-loss\" policies shrinks. This is one reason why I do continue to believe we are near the end of reserve releases, even as I do not expect large losses. Additionally, it is a slow transition, in part because home purchase activity has remained quite muted. Last quarter, Radian issued $13.9 billion of new policies, down from $16.9 billion a year earlier. It now has $273 billion of policies, up a modest $6 billion from a year ago. Given policy growth, RDN earned $235 million of premium revenue, up 11% from last year. One question is the extent to which lower mortgage rates lead to a surge in homebuying, which will increase Radian's issuance trends, all else equal. As you can see below, mortgage applications to buy a home have bounced from the bottom, but they remain at extremely low levels, lower than ten years ago. While mortgage rates have fallen from nearly 8% to just over 6%, this level does not seem sufficiently low to bring many more buyers to the market, as the rise in home prices has strained affordability. Bloomberg Interestingly, in the wake of the Fed's 50bp rate cut, 10-year treasury yields are actually higher by several basis points. This is because long-term bond yields are already discounting a sizable cutting cycle toward 3%. Long-term bond yields are more tied to 30-year mortgage rates than Fed funds. As such, absent a substantially sharper rate cutting cycle (likely coinciding with a recession), we are unlikely in my view to see mortgage yields move into the low-5% area. Seeking Alpha Given this, I do not expect a significant increase in the pace of home transactions, slowing the transition in Radian's mortgage book, a positive. At the same time, if mortgage rates do not fall much further, we are unlikely to see rapid home price appreciation, meaning recent policies will continue to be exposed to potential losses in the event of a default. Accordingly, I expect quarterly provisioning to be between -$5 and $10 million on average over the next year - still exceptionally low but higher than the past year. The other tailwind for Radian has been higher rates, leading to higher investment income on its $6.6 billion investment portfolio. RDN generated $74 million of net investment income from $63 million last year. Its portfolio has a 4.2% yield from 3.9% last year. This portfolio is high quality, with just 0.4% of the portfolio below investment grade. As you can see below, its portfolio has significant short-term investments, which will quickly reflect Fed rate cuts. Its longer-term portfolio was bought when rates were lower, meaning it can reinvest maturities at higher yields. Radian With a 50bp rate in September and 2 more 25bp cuts likely this year in my view, I expect Q3 to represent the peak in its portfolio yield and for investment income to gravitate towards $68-70 million/quarter next year. Radian does continue to have a solid balance sheet. Its operating company has $2.2 billion of excess capital. The holding company has $1.2 billion of liquidity and 25.2% debt to capital. Radian has paid off a $450 million maturity in September, which will bring debt to capital down to 19.2%, a strong level. I was impressed to see RDN make a $200 million dividend from the operating company to the Holdco from a $100 million quarterly pace previously. It is the Holdco that makes dividend payments on RDN shares and does share repurchases, and it depends on dividends from the operating company to do these activities. I had expected RDN to do $500 million of intercompany dividends, but management now expects to exceed this dividend guidance. With $300 million of H1 dividends and at least $186 million of Q3 dividend capacity, it should do $600 million this year, leaving the Holdco with $1 billion of liquidity at year end. With this liquidity, its 2.9% dividend yield is very secure, as that costs just about $150 million per year. Radian did $50 million of Q2 buybacks, and it has $667 million of authorization through June 2026, for a ~$80 million/quarter pace, suggesting it could accelerate the pace. Thanks to buybacks, there has been a nearly 4% share count reduction over the past year. Based on H1 results and my expectations for insured losses and interest income, I now see $3.85-$3.90 in 2024 earnings power from $3.70 previously. Frankly, the speed at which it has been able to move capital to the Holdco has been a larger positive surprise than its earnings trajectory. I do continue to believe that 2024 likely will represent peak earnings as net interest income begins to moderate and reserves bottom. Still, assuming 4+% share count reduction, EPS should remain at least $3.60 in 2025. I also expect capital returns to be at least $450-500 million per year through 2026, given dividend capacity and excess capital at the holding company. That leaves shares at ~9x forward earnings and with a ~9-10% capital return yield.  Given long-term market returns of about 8%, I have viewed 10% long-term returns as my threshold for a stock to be a \"buy,\" as investors should want some outperformance to own a single stock vs just owning an index. I see RDN delivering at least market-like returns but with the potential for some outperformance. But to be a buy, I would want shares below $32.50-$33, or a 10% capital return yield to provide sufficient upside, given the likelihood earnings have peaked. As such, I believe RDN can continue to be \"held\" in portfolios but would wait for a pullback before adding shares.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2472343659"}