NMI Holdings, Inc. (NASDAQ:NMIH)
Q4 2015 Earnings Conference Call
February 18, 2016 16:30 pm ET
John Swenson - VP of Investor Relations and Treasury
Brad Shuster - Chairman and CEO
Glenn Farrell - CFO
Patrick Kealey - FBR
Bose George - KBW
Amy DeBone - Compass Point
Christine Worley - SMP Securities
Mackenzie Kelley - Zelman
Good day, ladies and gentlemen and welcome to the NMI Holdings Fourth Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference may be recorded.
I would now like to turn the conference over to our host of today’s call, Mr. John Swenson. You may begin.
Thank you. Good afternoon and welcome to the 2015 fourth quarter and year-end conference call for National MI. I’m John Swenson, Vice President of Investor Relations and Treasury. Joining us on the call today are Brad Shuster, Chairman and CEO; Glenn Farrell, our Chief Financial Officer; and Rob Fore, our Controller.
Financial results for the fourth quarter and full year were released after the close of the market today. The release may be accessed on NMI’s Web site located at www.nationalmi.com under the Investors tab. During the course of this call, we may make comments about our expectations for the future. Actual results could differ materially from those contained in these forward-looking statements. Additional information about the factors that could cause actual results or trends to differ materially from those discussed on the call can be found on our Web site under the Investors tab or through our regulatory filings with the SEC.
If and to the extent the Company makes forward-looking statements, we do not undertake any obligation to update those statements in the future in light of subsequent developments. Further, no interested party should rely on the fact that the guidance of forward-looking statements is current at any time other than the time of this call. Now to our conference call.
Brad will open with an update on the state of the business and then Glenn will discuss the financial results in detail. After some closing remarks from Brad, we will then take your questions.
With that, let me turn the call over to Brad Shuster. Brad?
Thank you, John, and thank you all for joining us on the call today. In the fourth quarter, National MI achieved another record result, writing $4.5 billion of new insurance. This represents 25% growth over the prior quarter. For the year, we achieved $12.4 billion of new insurance written which is nearly four times the volume we did in 2014. We believe these results reflect growing recognition among customers of our great people and our unique value proposition.
Every day we are earning the trust of our customers through our sensible servicing, forward-thinking and innovative products, and great customer service. We owe our success to the relationships we have forged with our customers and to the hard work of our entire National MI team.
For the full year, we achieved market share of approximately 6% in 2015, up from 2% in 2014. We also continued our strong pace of customer development. In 2015, we signed up 229 new customers ending the year with 964 approved master policies. In the fourth quarter, customers delivering NIW grew to 427, up from 391 in the third quarter and up more than 50% compared with the fourth quarter of 2014. This gives us a strong base on which to grow in 2016.
Consistent with what we shared on our last call in October, in the fourth quarter, our mix began to shift toward monthly premium product and the trend is continuing in 2016. We attribute this mix shift to the market’s anticipation of the additional capital requirements for lender-paid singles under PMIERs as well as customer adoption of our more balanced risk-based rates for monthly premium products. We expect the transition of our mix to continue this year.
We generated $41 million of cash flows from operations in 2015 and we were fully compliant with all of our PMIERs financial requirements as of year-end. We also continue to expect GAAP profitability during the second half of this year. Glenn will provide more detail on our financial results and expectations in his comments.
We estimate that the market for private mortgage insurance in 2015 was approximately $215 billion, up 30% over 2014. This was despite a sequential decline in the fourth quarter which appeared to be down in the range of 20% versus the third quarter. We believe some of the decline was attributable to the originators adjusting to the new TILA-RESPA Integrated Disclosures or TRID that took effect in the fourth quarter.
Looking at 2016, we agree with the forecast of the MBA and the GSEs which call for purchase market growth in the 5% to 10% range. Given the high penetration of mortgage insurance in the purchase market, 5% to 10% growth in purchase is equivalent to a 20% to 40% increase in refinancing in terms of the impact on the mortgage insurance market size. That being said, with the recent decline in rates, we believe there is a reasonable opportunity to see a good refinance market such as we saw early last year. As a result, we are now assuming a private mortgage insurance market similar in size to what we had in 2015.
The underwriting environment continues to be solid. Our delinquencies are very low and we have paid only two claims to date. Roughly half of our volume is at 760 or higher FICOs and 90% of our volume is at 700 or higher. As we have grown, the weighted average quality of our book has improved. And we believe there is ample opportunity for us to continue to grow in the higher quality end of the market. As you all know, there is a direct correlation between the quality of loans we underwrite and the capital we are required to hold under PMIERs which has positive implications for our expected returns in the timing of our need for future capital.
On the subject of potential FHA premium reductions, we are not seeing any indications of impending cuts. We also believe that private mortgage insurance continues to have the opportunity to gain share in those credit bands where we have better execution than the FHA. This is true even after the risk-based pricing adjustments to the lower FICO bands that we and others have announced.
As we discussed on our last call, in response to the new PMIERs capital requirements, we went through a very thoughtful process to determine an appropriate pricing strategy in a post-PMIERs environment. The goal is to develop a transparent and easy to understand rate structure that would deliver mid-teens returns on PMIERs capital across all the FICO, LTV combinations. In general, this resulted in higher rates in the higher risk FICO, LTV bucket and lower rates in the lower risk FICO, LTV combinations.
We were the first mortgage insurer to file new lender-paid single premium rates which became effective as of January 1st. We are in the process of filing our signature monthly rates which have become our new national rate card for BPMI monthly product. We believe our new rates are rational because they correlate to the very clear and granular risk-based capital requirements under PMIERs.
Our strategy also enhances our unique value proposition to customers in three ways. First, we can offer better execution for our customers’ most credit-worthy borrowers. This helps make our customers more competitive for the most attractive loans that are quick to close. Second, our new rate card is easy for customers to understand and compared to a Black Box, is more transparent, which we believe is attractive in a post-TRID environment. Third and most importantly, our balanced risk-based pricing allows us to be relatively agnostic about the mix of loans we receive. This allows us to have more elevated conversations with customers about how we can help grow their businesses without being burdened by conversations about the mix of loans they are sending us.
We are committed to achieving mid-teens unlevered returns on PMIERs capital. This is the level of return we have consistently targeted and we recognize that delivering these returns benefits our cost of capital and our long term strength as a counterparty.
Looking now to 2016, our goal is to achieve GAAP profitability during the second half of the year, and in doing so, to lay the foundation for rapid growth in profitability in 2017 and beyond. As a result, we are focused on the growth of high quality new insurance written with both the pricing and risk characteristics that line up with our mid-teens return target. We have set challenging NIW goals for the year which we intend to drive through the continued penetration and activation of new customers as well as increasing share with existing accounts.
In summary, we have exciting plans for 2016, building on our successes in 2015. I will return with some final remarks as well as some thoughts on capital planning. But first let me turn it over to Glenn for more on the financial results for the quarter. Glenn?
Thank you, Brad, and good afternoon, everyone. I’m pleased to share with you a review of our fourth quarter and full year results. As Brad mentioned, primary NIW in the quarter was $4.5 billion, up 25% from third quarter NIW of $3.6 billion. With estimates of the market in Q4 contracted roughly 20%, we believe our growth in the fourth quarter evidenced solid market share gains especially in the monthly premium segment.
We continue to demonstrate our ability to add new customers contributing new insurance written and to grow our share with these accounts over time. In the fourth quarter, we saw NIW contributions from 247 customers who were new to us in 2015. This is up from 197 customers through the third quarter. These new customers contributed 38% of flow NIW in the fourth quarter and 26% for the full year. This is up from 29% and 19% respectively through the third quarter.
Looking at existing flow customers as of the end of 2014, we grew our volume in 2015 roughly fourfold and saw them represent 74% of total NIW for the year. We ended 2015 with a strong base of both new and more seasoned customers generating NIW, giving us a solid platform for growth in 2016.
Looking at product mix, monthly premium product represents 45% of Q4 NIW, up from 44% in the third quarter. In addition, the mix of applications which are a precursor to NIW began to shift toward monthly as the quarter progressed. New applications for monthly product went from 44% in October to 47% in November and 50% in December. With the introduction of our higher LPMI singles rate as of January 1, the application mix for January shifted to 63% monthly. As Brad mentioned, in 2016, we expect our NIW mix to continue to migrate toward the overall industry mix as we mature as a company.
In terms of purchase-refinance mix for the quarter, purchase represented 69% of NIW with refinance 31%. This compared with a 72%-28% mix in the third quarter. Total policies in force as of the end of 2015 were approximately 64,000, up 39% from 46,000 in the prior quarter. Primary insurance in force at year-end was $14.8 billion which compares with $10.6 billion at the end of the third quarter. Pool insurance in force as of the end of the fourth quarter was $4.2 billion which compares with $4.3 billion as of the end of the third quarter.
Weighted average FICO of risk in force as of the end of the year was 754, up from 750 as of the end of Q3, demonstrating the continuing quality of the business we wrote in 2015. Overall persistency as of the fourth quarter was 84%, up from 77% as of Q3.
Premiums written for the fourth quarter were $45.6 million, up 29% from $35.4 million in the prior quarter. And premiums earned for the quarter were $16.9 million, an increase of 32% from $12.8 million in the prior quarter. Approximately $1.4 million of premiums earned were attributable to cancellations in the quarter, which compares with $900,000 in the prior quarter.
Annualized premium yield for het quarter was 49 basis points, down from 52 basis points in the third quarter. This is consistent with the quality of our book which has slightly lower premium rates commensurate with the very low expected losses.
Investment income in the fourth quarter was $2.1 million, up from $1.9 million in the prior quarter. And total revenues in Q4 were $19 million, up from $14.7 million in the prior quarter.
Underwriting and operating expenses in the fourth quarter were $21.7 million, including share-based compensation expense of $2.3 million. This compares with underwriting and operating expenses of $19.7 million, including $1.8 million of share-based compensation in the prior quarter. For the full year, we incurred $80.6 million of total operating expenses, which is approximately $2 million less than what we expected at the start of the year.
We had 36 notices of delinquencies in the primary book as of the end of the fourth quarter, up from 20 at the end of the prior quarter. We recorded $371,000 of proclaims expense in the quarter which comprised $321,000 of increased reserve and $50,000 for one claim paid. Our claims expense continues to be modest. We’ve had two claims on 64,000 policies in force, accumulative loss frequency of 0.3 basis points of 3/1000 of a percent.
Based on long term historical averages as well as recent actuarial studies, the ultimate loss frequencies on our current book as well as new business we are writing are expected to be in the range of 1.5% to 2.5%. All of our pricing, risk management and financial planning assume these loss frequencies even though our experience to date and that of others were similar, quality books has been lower. Even at the higher predicted loss frequencies over the next several years, we expect our loss ratio defined as losses as a percentage of premiums earned to be in the low to mid-single digits.
Now moving to the bottom line. Net loss for the fourth quarter was $4.8 million or $0.8 per share which includes $2 million of interest expense related to our term loan established last November. The fourth quarter result compares with a net loss of also $4.8 million or $0.8 per share in the prior quarter and a net loss of $10 million or $0.17 per share in the fourth quarter of 2014.
At year-end, cash and investments were $617 million, which compares with $447 million at the end of the third quarter. This reflects the proceeds of our term loan as well as $25 million of cash generated from operations in the fourth quarter. For the year, cash flow from operations was $41 million. And as of year-end, we had $100 million of cash and investments in the holding company.
Book equity as of the end of the fourth quarter was $403 million, equal to $6.85 per share. This book value excludes any benefit attributable to our deferred tax asset of approximately $66 million equivalent to $1.12 per share as of December 31, 2015. At the quarter-end, our PMIERs risk to available assets ratio in the primary insurance company was approximately 8.5 to 1.
Now for some brief comments on our outlook. We have talked previously about needing $15 billion to $17 billion of insurance in force to reach profitability before stock-based compensation and interest expense. We expect to cross this threshold in the current quarter. If we include all the components of full GAAP expenses including stock based compensation and interest expense, we would target approximately $21 billion to $23 billion of Insurance-in-Force as a threshold for GAAP profitability.
This is the level we expect to achieve in the second half of the year. From that point onward, we expect to grow book value and deliver increasing profitability as we leverage our largely fixed expense base. Assuming we achieve and maintain profitability as expected, we anticipate being in a position to evaluate the potential reversal of our valuation allowance on our deferred tax asset in 2017.
For NIW, we are expecting solid growth in 2016 led by growth in our monthly premium product with single premium product decreasing as a percentage of the total. We currently expect the underwriting and other expenses including stock based compensation expense will be approximately $92 million for the year. This would represent expense growth of approximately 14% over 2015, a rate of growth significantly lower than our expected growth in NIW and reflective of our efficient and highly scalable business model. In addition, interest expense in our term loan will a little over $40 million for the year.
In summary, we are pleased with the financial results for the fourth quarter and the full year. And we are looking forward to achieving profitability and increasing book value during the second half of 2016.
Now, let me turn the call back over to Brad for his closing remarks.
Thank you, Glenn. We believe that our fourth quarter results clearly demonstrate our ability to win new customers, grow quality NIW and display capital at attractive mid-teens returns. We are highly focused on providing long-term value to our shareholders as well as our customers and policy holders.
For all these stakeholders, the key to success is for National MI to continue to grow into its fixed expense base while appropriately managing risk. We will need additional capital to achieve this goal.
With a continued prospect of deploying this capital at mid-teens returns, we are confident that the capital markets will be available to support our growth. This includes opportunities we have identified in the reinsurance market where we are engaged in discussions to develop ongoing strategic relationships.
Reinsurance carries an attractive cost of capital and we expect to use it to manage capital and risk as we go forward. Reinsurance also provides optionality with respect to timing and sources of future capital raises.
In closing, we had an outstanding year in 2015. We tripled our market share by providing a differentiated value proposition to our customers. We wrote over 12 billion of high quality new mortgage insurance. We raised capital and achieved full compliance with PMIERS as of yearend. And we positioned the company to reach GAAP profitability later this year.
We believe 2016 will be another great year for National MI as we went over more customers and begin to unlock the powerful profitability that is inherent in our business model. We thank you for your interest and support. And now, let me turn it back to the operator so that we can take your questions.
[Operator Instructions] And our first question comes from Patrick Kealey of FBR. Your line is open.
Good afternoon, thanks for taking my question. So for our first question, just on NIW, the color by month I think was pretty helpful. So when we think of you guys hitting your target of kind of three quarters monthly, one quarter singles, I mean is that something we can expect on a quarterly basis maybe in the first half of the year? Or should we expect that maybe to blend in that it’s something we should expect maybe as we exit to fiscal 2016 and look into 2017?
Well, hi Patrick, this is Brad. It’s a little hard to say the exact timing quarter by quarter of how that will further in. We did disclose that application in the month of January so you can see we’re seeing a pretty dramatic shift here at the beginning of the year. But that needs to be considered in the context of our higher rates on lender-paid singles that went into effect January 1st.
Some of our competitors have filed similar rates but they aren’t effective immediately. So it’s not completely clear of how the timing is going to go, but we do believe the trend will play out as we’ve indicated.
Okay. Great. And apologize if I missed this, but you talked about seeing significant growth in 2016 just on NIW, is there a range that we should maybe be thinking about on total NIW for fiscal 2016 or were you speaking more broadly as we think about that?
Yes, Patrick, this is Brad. We are not going to put out a NIW guidance number but we are expecting significant overall growth for the year. And so we gave you several data points that can help you understand what we’re thinking about.
But the growth engine is still operating very well here and we’re really excited about the prospects for this year.
All right. Great. Thank you for the time.
And our next question comes from Bose George of KBW. Your line is open.
Hey guys, good afternoon. Just on the reinsurance market, have you seen any changes in that market in terms of availability? Just curious of any of the broader market issues and the public markets we’re seeing has had any impact over there?
Both our initial indications are that there’s strong demand for product like we would have to offer to those markets. So we’re pretty encouraged and we will continue to update as we make progress for actual transaction of some type in the future. So all the market conditions seem to be pointing to positive outcome there.
Okay. Great. And then just switching to the rate card. When you deal with lenders, are lenders comfortable with the fact that it looks like there are multiple rate cards up there from the different MIs? Or do you think there’ll be some sort of convergence over time? Or how do you think this is going to evolve?
Well, as we said, consistently we were kind of the first one to develop a rate card that we think is rational and has durability in a closed PMIERS environment. So we’ve had it out there. We’ve seen some competitors matching it in some specific cases. We’ve seen others come with rate cards that are pretty close to it.
So I think we’ll continue to see a migration towards what we’ve done over the first part of this year. And actually in our planning, we never expect to have a significant kind of advantage just directly from our rate card for any extended period of time. The industry tends to kind of coalesce around pricing. And we think our rate card is a great place for things to level out.
Okay. Great. And then actually just going back to your earlier comments, so you haven’t seen any sort of shift to the FHA on the lower end because of the price changes?
We aren’t seeing any real shift there and as I’ve mentioned it in our remarks. We still think there’s an opportunity there vis-à-vis FHA because they’re still getting a significant amount of production that would be better executed with a conventional loan. So it would be better for the borrower and everyone else. So we see that as an opportunity to grow market size for private mortgage insurers going forward.
Okay. Great. Thank you.
And our next question comes from Amy DeBone of Compass Point. Amy, your line is open.
Hi. Thanks for taking my question. So in terms of the NIW mix, it looks like 53% was singles. What percentage was targeted LPMI this quarter?
Can you repeat that Amy? I didn’t quite catch that. You said 53% from what period?
For singles for this quarter. I was just wondering what percentage of the singles were targeted LPMI program.
Well, the targeted, we’re not disclosing that split anymore because that piece of our business is getting smaller and smaller. So I think the actual figure for the fourth quarter, I think I said the fourth quarter was a 45% BPMI which means that was 55% LPMI. And as I said, that targeted LPMI you described is a shrinking portion of our overall singles business.
Okay. Okay. And then in terms of the breakeven Insurance-in-Force. So we have 21 to 23 as the new level. Is that related more to the term loan or does that also relate to the targeted LPMI program, the different mix of the entire portfolio?
No, it’s actually the former. Amy, as you recall, the 15 billion to 17 billion guidance or information was really related to breakeven before stock based comp. So since we’ve layered on the term loan, we not only have the stock based comp expense to overcome now, but also the interest expense. So it’s the combination of those two that increase that to the 21 billion to 23 billion.
Okay. And then so breakeven is still expected for the second half of 2016. Is it safe to assume that for the full year, earnings will be positive?
I don’t think that that would be likely in terms of if we’re still incurring this additional interest expense particularly through the first three quarters, that’s probably not likely.
Okay. And then last question, LPMI, I think that the last update was that it was showing improved return prospects, I think 3% above the forecasted ROE. I know you mentioned upticking cancellations. Is the LPMI products still performing above expectations?
Yes, Amy, this is Brad. Yes, our actual returns on our LPMI portfolio has been consistently above expectations. And with recent changes in the tenure, there’s probably a little bit more to go there. But we’re very happy with our LPMI prices that we put post PMIERS. We think they’re appropriate returns there. And as we’ve talked about before in the aggregated single markets, returns have firmed out nicely. So the return pictures I think is very stable there.
Okay. Great. Thank you for taking my questions.
And our next comment comes from Christine Worley of SMP Securities. Your line is open.
Many of my questions have been asked and answered. But I want to dig in a little bit more on the volume that you saw in BPMI. How much of that sort of like grosses from the new rate card allowing you to be more competitive in the market and sign on new clients and how much is from sort of turning up the dial on existing clients? Thanks.
Yes, Christine, this is Brad. It’s a combination of both. We opened up a lot of new client relationships in the second half of 2015. And with those starting out, we started to roll out our new signature monthly rates in the latter part of the year. And those got great traction. So they’ve allowed us to open a number of new client relationships. But importantly, as I think we demonstrated in the comments earlier, we’ve grown share significantly with our existing customers and we’re looking forward to continuing that in 2016.
Great. And on the application increase that you’re seeing in the BPMI product especially in January, do you think that that’s just sort of a general market shift given the increase in the LPMI pricing filing PMIERS implementation?
I think it’s a little early to reach conclusions. But that’s generally our expectations about how things will unfold over the course of 2016. So early indications are consistent with what we expect it, but there’s still a fair number of things to shake out in the market about competitors establishing their long-term pricing going forward. But it is developing as we would have expected.
Okay. Great. Thank you very much.
[Operator Instructions] Our next question comes from Mackenzie Kelley of Zelman. Your line is open.
Thanks. Good afternoon. Just a few questions, Brad, on really capital. First, can you provide an update on the NIW capacity that the company currently has and roughly could you estimate what runway of potential reinsurance deal could provide? And then just lastly kid of longer-term, how would you evaluate and think about the various capital options that you have particularly with the stock trading below book? And I believe there are being some restrictions with the debt.
So first question, how much runway do we have? If you recall back in our investor conference in New York, we said we thought we could get out to late 2016, early 2017 with our existing capital resources. And I think that that is still sort of what we’re thinking. And that’s without reinsurance. I think reinsurance offers the opportunity to expand that timeframe somewhat. But we don’t have a specific transaction modeled out yet. But I think it only allows us to extend that period of time.
With regards to the stock price, I think the most important thing that we can continue to do here is deliver that kind of results we’re discussing with you today and future periods and continue to develop customer relationships and penetration in the market and we’re confident that the share price will take care of itself over time.
And in any capital raise going forward, we will array all the various options available to us and select the one that we believe creates the greatest amount of shareholder value.
And I’m showing no further questions at this time. I’d now like to turn back the [indiscernible]
[Indiscernible] the Sanford Bernstein conference in March and we hope to see some of you then. Thanks very much. Bye.
Ladies and gentlemen, this concludes today’s conference. Thank you for your participation and have a wonderful day.
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