by Lsigurd on September 26, 2012
The liquidity of an insurance sub
Before getting into the issues specific to Radian, let’s talk a bit about liquidity risk. For some reason liquidity is not at the forefront of discussion during conference calls and in brokerage reports on mortgage insurance companies. Questions and comments focus on risk to capital ratios and loan loss reserve methodologies, which, while providing important clues, do not in themselves allow you to conclude whether a company will have the cash available to pay the claims. The author of the SeekingAlpha article, Darren Oliver, suggested that this was because the mortgage insurance industry is not very well understood. This could be the case, I don’t know. I just find it surprising.
As a mortgage insurer, the bottom line is that you have the cash available to pay claims and that the regulator who watches over you believes that this is the case. Over time, the cash and short term investments on hand plus the premiums paid need to be enough to pay out claims made as well as operating expenses incurred. If there is a concern that the cash and future premiums will not be enough to cover the expected claims, the insurer will either be taken over by the regulator or put into run off.
Having the ability to pay claims out “eventually” is different than having the ability to pay claims promptly as they come in. While premiums trickle in every month, claims can be skewed disproportionately to the near term. This can lead to a situation where the cash immediately available is not sufficient to pay claims, even though over the long run there may be enough cash generated from premiums to meet all the claims over that time.
The argument that Darren Oliver makes is that something along these lines is going to happen at Radian Guaranty. While Radian Guaranty may have enough cash to pay claims in the long run, they will not have enough cash freed up and available to pay the claims that come due over the next couple of years. This shortfall will be caused by cash that is on-hand but is not immediately available because it is held in another insurance subsidiary, Radian Asset Assurance.
Radian Asset Assurance is a wholly owned subsidiary of Radian Guaranty. As a subsidiary, the capital at Radian Asset Assurance counts as capital available to Radian Guaranty. Thus, if one looks at Radian Guaranty claim paying resources, it includes cash and investments at Radian Asset Assurance.
But Radian Asset Assurance is also an insurance company. As an insurance company it has regulators that control the amount of cash it can release to its parent as a dividend. It’s exactly the same way that Radian Guaranty is regulated in the amount of capital it can dividend up to its parent, Radian Group. Even though there may be a lot of capital in the form of cash and investments on-hand at Radian Asset Assurance, getting that capital into the coffers of Radian Guaranty requires approvals of the insurance regulator.
Radian Asset Assurance has consistently been upstreaming capital to Radian Guaranty over the last 4 years. Below is a table of the capital transfers that have taken place.
While I expect that Radian Asset Assurance will continue to upstream capital going forward, the amounts are, at best, going to stay constant. And $40 million per year is not a lot of money in relation to the claims that Radian Guaranty will have to pay.
Therefore, the current cash and investments on the balance sheet of Radian Guaranty and the premiums received, need to be sufficient to pay claims over the next couple of years.
I really didn’t have a good idea of whether this would be the case. So I decided to create a spreadsheet that looks forward to the end of 2014, estimates the claims paid over that time offset by premiums collected, and comes up with a cash balance at RG in 2015.
The model
Unfortunately, to come up with a forward looking model, I had to make a lot of assumptions. First I had to make assumptions with respect to the insurance business itself. I had to assume how much new insurance will be written (I extrapolated the Q3 numbers going forward), the margin on that business (I assumed 0.58% of primary insurance in force), and the run-off of insurance in force from the existing book of business (I used $3.8 million per quarter). All these assumptions were based on the historical trends.
Additionally, I had to make assumptions with respect to how the company wide business translates to the Radian Guaranty operating company. Radian discloses limited statutory data about each of their insurance subsidiaries. While it’s enough to come up with a gross picture of what’s going on at Radian Guaranty, it’s not enough to create a detailed model of how the RG operating unit will perform going forward. In order to do that, what is needed are some assumptions about how the company wide premiums and claims translate into the Radian Guaranty sub.
I used the historical data as a guide. In the last 4 available quarters of data (which is unfortunately only Q1 and Q2 2012 and Q1 and Q2 2011 because Radian doesn’t provide the quarterly statutory filings for prior years) are as follows:
The above table shows the premiums collected at Radian Guaranty as a percentage of insurance written within the Radian Group. Insurance written is the best proxy I have to premiums collected. In my projections I assumed 86% of insurance written would premiums collected at Radian Guaranty.
For claims data, for each of the 4 quarters where data is available I took the dollar value of claims paid at Radian Guaranty, assumed that the average amount paid per claim within Radian Group was the same as at Radian Guaranty, and from that backed out how many claims were incurred at Radian Guaranty. Since I have no real insight into the make up of claims at Radian Guaranty versus the other insurance subsidiaries this is the best I can do. After backing out the number of claims that were incurred at Radian Guaranty, I calculated the percentage of claims at Radian Guaranty versus at Radian Group.
In my forecast going forward I assumed that 88% of claims incurred by Radian Group would be attributable to Radian Guaranty.
As I mentioned, I’m going to assume that the amount paid per claim at Guaranty is the same as at Radian Group. Radian Group has paid the following amounts per claim each quarter for the last 6 quarters:
In my worst case scenario I assume that the amount paid per claim is $57,000. In my base case scenario I assume $52,000 per claim paid. The base case estimate would be consistent with what Radian has been paying on average over the last couple of quarters.
With respect to how premiums and claims at Radian Group translate to Radian Guaranty, I think that together my assumptions should be a little on the conservative side if anything. I am assuming the RG only receives 86% of the premiums, but is effectively paying 88% of the claims.
Next I had to come with the number of claims I expected to be paid at Radian Group. I broke up the claims into 3 buckets. First, to create a base claim rate forecast going forward I extrapolated the current claim paying trend. In the past year and a half claims have averaged 5.1% of delinquencies. In the worst case scenario I assumed that claims would average 6% of delinquencies going forward, while in the base case I assumed 5.5%.
Next I added claims that would result due to past denials coming back. Radian has said that servicers have 12 months to come up with the documentation on a denial. Therefore, to estimate denials on a quarterly basis, I simply added back a percentage of the denials from the quarter one year prior. In the worst case scenario I assumed 75% of denials would return as claims. In the base case I assumed 50%.
Sentiment: Strong Sell
Odd that you would opt for a September post by Lsigurd. When looking over his "Reminiscences of a Stockblogger"
His last two post on Radian were in March and April of 2013.
On March 10 he wrote, "I reduced my position in both Radian and MGIC by a little more than half during the early part of this week. My sales of MGIC occurred around $5.20 while those with Radian were at a little over $10. I don’t have plans on selling any more of either.
I sold the positions down because they were getting very large (particularly in the case of MGIC) and because my thesis, that these companies would be able to survive, has now played out. What is going to drive the stocks going forward is the long-term potential of the mortgage insurance business and how well each company can capitalize on it."
On April 28th, he told us he exited RDN.
If I were cynical, I'd think you were posting old information on purpose. I'll give you a break and just assume you are inept..
Sentiment: Buy
This is a very interesting argument and I'd like to see the rest of it. You will note the it was written on September 26, 2012 and needs to be updated. I thin k the real data is significantly better than the assumptions made.
Sentiment: Buy
The company did a stock offering this year idiot to eliminate the liquidity problem..you are a dope.
Get a life dude! How long did it take you to write all that BS. You a paid basher? Rising real estate prices going to eliminate or reduce paid claims going forward. Smart on SA's part to delay paying claims and the bulk of which are fraudulent.