Radian Stock: Likely Fairly Valued As Legacy Tailwinds Peak (Downgrade) (NYSE:RDN) (2024)

Shares of Radian (NYSE:RDN) have been a solid performer over the past year returning 22%. Recently, Radian increased its buyback, which points to ongoing and meaningful capital returns to shareholders. I last covered RDN in February, rating shares a buy, and since then they have rallied 14% vs the market’s 4% gain. With shares above my $30 price target, now is an opportune time to determine if investors should take profits. I am moving shares to a hold.

In the company’s first quarter reported on May 1^st, Radian earned $1.03, which beat consensus by $0.18 as revenue rose by 3% to $319 million. This was up 5% from last year, and a significant driver of earnings growth has been its buyback program. During Q1, management executed on $50 million of buybacks, and there has been 3.3% share count reduction over the past year. On top of this, its dividend costs $37 million a quarter, and shares yield 3.2%.

The company’s core mortgage insurance business continues to perform extremely well, thanks to elevated home prices and low inflation. Radian is a private mortgage insurer. Fannie Mae and Freddie insure a mortgage up to 80% of the home price—hence the standard 20% mortgage down payment. For borrowers who put down less 20%, they need to buy private insurance from a provider like RDN to insure the balance. So if a borrower puts down 5%, RDN would insure the losses from that 5% to the 20% level with Fannie/Freddie taking the rest of the exposure.

From a new policy standpoint, activity is relatively muted because the level of home transactions is fairly low, given light inventories and high interest rates reducing affordability. Still, we have seen some improvement from last year when activity was particularly muted. Radian sold $11.5 billion of new insurance in the quarter, up 2% from last year. As a result, its primary insurance in force rose $1 billion sequentially to $271 billion and up about 3% over the past year. Due to higher insured balances, Radian’s $234 million in earned premiums is up 1% from last year.

Because mortgages are typically 30 years, Radian’s policies tend to last several years on average. This has been especially the case recently because the rise in interest rates has significant reduced refinancing, which pays off the original loan and eliminates insurance exposure. Similarly, with fewer house transactions, fewer people are selling their homes reducing turnover. While quarterly data is noisy, the annual trend has been one of steadily rising persistency, as people maintain their mortgages for longer.

This has been a beneficial trend for Radian’s financials, and it is likely to continue to be, though we are nearing a turning point. A key source of my bullishness toward RDN over the past year has been my view that its legacy book of insurance policies will have essentially no losses. That is because home prices have risen substantially. For Radian to lose on an insurance policy, the borrower needs to default, and the home needs to be worth less than the existing mortgage balance. With unemployment low, defaults are likely to stay low. Additionally, with home prices rising, even troubled borrowers likely have positive equity in their home. As a result, they can sell their house for more than the mortgage, paying it off, and leaving RDN with no losses. From pre-COVID levels, home prices are up by more than a third, and since the end of 2021, home prices are up by 13%.

I highlight the end of 2021 increase because that year is its median policy year with 44.4% of its insurance written in 2022 and onward. Given the rise seen since the end of 2021, the ~56% of its portfolio from that point and earlier is highly unlikely to see any material losses. Remember, each month a mortgage holder pays down some principal. So a mortgage with a 97% loan-to-value in 2021 is likely down to about 80-82% today given the rise in home prices and principal payments, meaning prices need to fall back below 2021 levels for RDN to take a loss. We would likely need to enter a significant and prolonged recession for home prices to fall that much, particularly given the structural shortage in the mortgage after years of underbuilding in the 2010s. With unemployment low and a “softish” landing appearing most likely, I do not view such a risk as significant. With every month that passes, more principal is paid down on these mortgages, increasing the required magnitude of the home price drop for RDN to have losses. Each month the housing market does not fall its loss protection grows.

Importantly, this continues to play out in practice. The company reduced reserves by $7 million to $362 million given the lack of losses, due to both low delinquencies and elevated recoveries. It has just a 2.1% default rate, which is flat from a year ago. In the quarter, there were just 92 claims paid, which speaks to how little loss exposure it has. This is about as good as it can get.

I mentioned we are nearing a turning point because recent policies by definition have greater loss risk than older policies as they have just modest equity cushions rather than the large built-up cushions of its older policies. As each day passes and it writes more new policies, the 2021 and earlier portion of its portfolio becomes a smaller weighting. As such, while I expect that back book to generate essentially no losses, its overall portfolio will gradually face some losses. That said, I believe new policies are likely to be profitable. Long-term rates appear to have peaked—while the Fed may not cut rates, it seems unlikely to raise rates again. That should support home prices, and recent data from homebuilders point to reasonable housing market conditions. Even stable prices provides protection for Radian as home prices need to fall several percent for its policies to face losses in the event of defaults. That said, we are likely near the end of reserve releases, and I expect RDN to flip to reserve builds over the next 12-18 months as newer policies become a larger weight of its portfolio.

One other tailwind for the company has been elevated interest rates as it has a $6.3 billion investment portfolio, largely in fixed income. This portfolio generated $69 million investment income, which was flat sequentially and up from $58 million last year. Its yield of 4.1% has been flat for several quarters. It has few maturities this year, though mortgages pay principal every month. Given the lack of near-term maturities, I do not expect investment yields to move much over the next 12 months. This provides some protection from a sudden drop in the Fed funds rates, though that seems unlikely. I would expect investment yields to be broadly flat over the next 24 months. Because Radian bought bonds at lower yields, it has unrealized losses, which sit in accumulated other comprehensive income (AOCI), but given low claims, I do not view it as likely it will have to take losses. Its portfolio is also high quality; 40% is AAA and over 80% is A or higher. Just 1.1% is below investment grade. 45% is in corporate debt and just 8% in commercial mortgages. I do not expect material credit losses.

Because interest rates rose in Q1, the drag of AOCI on book value was $2.89 from $2.16 last quarter. Still, Radian has a $29.30 book value, up 12% from last year. Radian has $1.1 billion in holding company liquidity, which was up $100 million from Q4. It is the holding company that does buybacks and dividends to shareholders. For the fifth straight quarter, the holding company received a $100 million dividend from the insurance entity. This should begin ramping in Q2 aided by reserve releases—and management expects $400-500 million of intercompany dividends this year. This year may represent a peak in dividends in my view, unless home prices continue to rise.

Its holding company has excess liquidity, and so it expects to repay its $450 million October maturity with cash. That will leave it with a ~19.3% holding company debt to capital, which is a strong level. Radian carries $2.3 billion of excess assets, flat sequentially, vs regulatory minimums, which support shareholder payouts.

On May 22nd, Radian enlarged and extended its buyback authorization. It now can buy back $900 million of stock from $300 million previously, and this authorization was extended by 17 months to June 30, 2026. This would imply a $400-450 million annual pace of potential repurchases. Given its dividend payment and interest expense, I expect RDN to do a bit less than this, assuming it retains at least $500 million in cash on its balance sheet. That implies about 300-400 million in buybacks. RDN is likely giving it flexibility to do more repurchases, though it could potentially exceed my estimate if it maintains a $500 million intercompany dividend in 2025-2026, which will depend on the pace of new business.

Back in February, I saw $3.50 in earnings power. I now see about $3.70, given slightly higher interest income considering the Fed is likely to cut rates 0-2 times in my view. Shares are just under 9x earnings and have a ~10% capital return yield. They are just about at book value ex-AOCI. I view this as fair value as earnings are likely to moderate, simply because an insurance company cannot draw down reserves forever as long as it writes new policies. The company has done an excellent job riding up home prices, protecting its back book of business, but as it writes more new policies, this benefit is fading. I would expect reserve builds, or at least stabilization, to occur next year. For a business with peaking earnings but strong credit quality, I view a 9-10% capital return about fair.

After outperforming, I expect RDN to be more of market performer, given this valuation. As such, I am moving shares to hold. There is no urgency to sell, as RDN is not-overvalued, but I no longer see a compelling opportunity or case for outperformance. I would rather be in insurers with clearer earnings growth stories, like Chubb (CB), or for investors bullish on housing, homebuilders may offer more direct upside. For now, RDN is likely a market-performing stock, and I would want shares to dip back below $29 to consider adding.

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