NMI Holdings' (NMIH) CEO Bradley Shuster on Q1 2016 Results - Earnings Call Transcript

| About: NMI Holdings, (NMIH)

NMI Holdings, Inc. (NASDAQ:NMIH)

Q1 2016 Earnings Conference Call

April 26, 2016 4:30 PM ET

Executives

John Swenson - Vice President, Investor Relations and Treasury

Bradley Shuster - Chairman and Chief Executive Officer

Glenn Farrell - Executive Vice President and Chief Financial Officer

Analysts

Patrick Kealey - FBR Capital Markets

Bose George - Keefe, Bruyette & Woods, Inc.

Mackenzie Kelley - Zelman & Associates

Amy DeBone - Compass Point Research

Christine Worley - JMP Securities

Operator

Good day, ladies and gentlemen, and welcome to the NMI Holdings, Inc. First Quarter 2016 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]

I would now like to introduce your host for today’s conference, Mr. John Swenson. Please go ahead, sir.

John Swenson

Thank you, Christy. Good afternoon and welcome to the 2016 first quarter 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 first quarter were released after the close of the market today. We also published supplemental information highlighting certain current and historical performance metrics as well as an illustration of a loan level profitability model. The press release as well as the supplemental information may be accessed on NMI’s website 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 website 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 take your questions.

With that, let me turn it over to Brad Shuster. Brad?

Bradley Shuster

Thank you, John, and thank you all for joining us on the call today. National MI delivered excellent results in the first quarter. New insurance written of $4.3 billion with a record first quarter result and was up more than a 150% over the same quarter last year. We grew our monthly borrower paid business by 23% over the prior quarter. This was on top of 28% growth in monthly product in the fourth quarter.

Just as we did in Q4, we achieved this in a market that we believe was seasonally – down seasonally, suggesting further market share gains for us in the monthly market segment. Although industry figures are not yet available, in the first quarter, we believe we maintained the overall market share of 9% achieved in our record fourth quarter last year, while significantly changing our product mix.

As we have discussed previously, effective January 1, we increased our rates for lender-paid singles product. We were the first to announce this higher pricing. As expected, the market has begun to adjust to these higher prices. This response combined with our strong performance in monthly product drove a meaningful shift in mix. Consistent with the trends we described on our last call, monthly product represented 59% of NIW in the first quarter, up from 45% in the prior quarter. We have targeted a product mix that roughly mirrors the mix of the market and we are rapidly tracking towards that goal.

Since the PMIERs became effective January 1, we have seen the rest of the industry largely address premium rates to the PMIERs asset requirements. We like our rate structure and we do not anticipate making additional changes to our premium rates.

In the first quarter, we surpassed 1,000 approved master policies ending the quarter with 1,023, an increase of 59 over the prior quarter. We generated NIW with 69 new customers in Q1, driving the number of customers generating NIW ever to date to 594. These are great accomplishments for our team and a big part of how we are continuing to grow in a competitive market.

We believe we have the opportunity to continue to add and activate new customers at a solid pace in 2016. We are seeing good gains from customers that have begun doing business with us for less than a year, many of whom just became active in the second-half of 2015. In general, we expect to continue to see gains from many of these customers throughout 2016. Because of the strong growth we are experiencing, we are implementing a reinsurance program as a key component of our capital planning.

We have received proposals from multiple reinsurers. Based on the feedback we have received, we are confident that we will be able to execute a placement at reasonable terms. Importantly, reinsurance will allow us continue to grow internal capital and profitability, while deferring indefinitely the need for an equity capital raise. Glenn will share more details on our planned program in his comments.

In summary, we had another excellent quarter of growth in NIW, insurance-in-force and premiums. We continue to anticipate a healthy market in 2016, and we believe National MI is on pace to have a very strong year as measured by every objective metric. I’ll have some closing comments after Glenn provides more detail on the financial results. Glenn?

Glenn Farrell

Thank you, Brad, and good afternoon, everyone. I’m pleased to share with you a review of our first quarter results. As Brad mentioned, Primary NIW in the quarter was $4.3 billion, down slightly $4.5 billion in the fourth quarter last year, and up 153% over the first quarter of 2015. The small sequential decline was solely attributable to a 30% decrease in our singles NIW, as monthly product increased 23% quarter-on-quarter.

Looking at product mix, monthly premium product represent 59% of Q1 NIW, up from 45% in the fourth quarter. The mix of applications which are a precursor to NIW continues to shift toward monthly product, reaching 69% month-to-date in April. We expect our NIW mix to continue to migrate towards the overall industry mix as we mature.

In terms of purchase refinance mix, for the quarter, purchase represented 69% of NIW with refinance 31%. This compares with a 72%, 28% mix in the fourth quarter. Total policies in -orce as of the end of the quarter increased to 80,000, up 25% from 64,000 in the prior quarter. Primary insurance-in-force at quarter end was $18.6 billion, which compares with $14.8 billion at the end of the fourth quarter.

Pool insurance-in-force as of the end of the first quarter was $4.1 billion, which compares with $4.2 billion as of the end of the fourth quarter. Weighted average FICO of risk in force as of the end of Q1 was 752, flat with the prior quarter. And overall persistency in the first quarter was 86%, up from 84% in Q4.

Premiums earned for the quarter were $19.8 million, up from $16.9 million in the prior quarter. The annualized premium yield for the quarter was 45 basis points, down from 49 bps in the fourth quarter. This range of premium yield is consistent with our expectations, because of the size and mix of our current book, we expect that premium yield will continue to be influenced by short-term factors, such as the average quality of business we are writing, the mix of single versus monthly policies and cancellations.

Over time, we expect premium yield will settle around 50 basis points. It is worth noting that just as our average premium rate is based on the high credit quality of our NIW, our weighted average PMIERs asset charge declined in the first quarter consistent with this high quality.

Investment income in the first quarter was $3.2 million, up from $2.1 million in the prior quarter. The increase reflects the investment of the proceeds of our term loan, as well as near full investment of assets in the insurance company, which is now generating positive cash flow. Total revenues in the first quarter were $22.2 million, up from $18.9 million in the prior quarter.

Underwriting and operating expenses in the first quarter were $22.7 million, including share-based compensation expense of $1.4 million. This compares with underwriting and operating expenses of $21.7 million, including $2.3 million of share-based comp in the prior quarter. We had 55 notices of delinquency in the primary book as of the end of the first quarter, up from 36 at the end of the prior quarter. We recorded 458,000 for claims expense and there were no paid claims in the quarter. Our first quarter loss ratio defined as claims expense divided by premiums earned was 2%. As mentioned last quarter, we expect our loss ratios over the next several years to be in the low to mid single-digits.

Now moving to the bottom line. Net loss for the first quarter was $3.9 million, or $0.07 per share, which compares with a net loss of $4.8 million, or $0.08 per share in the prior quarter. We crossed the threshold of profitability before stock-based comp and interest expense during the first quarter. This is a significant milestone in our development and consistent with our guidance that $15 billion to $17 billion of insurance-in-force would provide profitability on this basis.

At quarter-end, cash and investments were $630 million, which compares with $617 million in the prior quarter. As of quarter-end, we had $84 million of cash and investments in the holding company. Book equity as of the end of the first quarter was $410 million, equal to $6.94 per share, which compares with $403 million, or $6.85 per share at the end of the fourth quarter.

The increase in book value was primarily the result of unrealized gains in the investment portfolio. 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. As of quarter-end, total available assets under PMIERs were $434 million and required assets based on current risk-in-force were $303 million.

Now with some brief comments on our outlook. Based on the strong start to the year and the positive momentum we are seeing across our customer base, we currently expect to write in the range of $19 billion to $20 billion of new insurance in 2016. This would represent growth of more than 50% over the $12.4 billion we wrote in 2015.

As Brad mentioned, to support this growth, we’re negotiating a reinsurance program under which we would cede 25% to 30% of our risk on a quota share basis. We are excited about this capital approach for three reasons – three primary reasons. First, by helping to drive high-levels of internal capital generation, while simultaneously giving capital release, it can put off our need for equity capital indefinitely.

In fact, we believe that over the next several years, we can continue to build insurance-in-force and reach solid mid-teens ROEs using only internally generated capital, reinsurance, and debt. Second, it will provide capital release to allow National MI to continue to grow market share and NIW in the primary market. And third, reinsurance has a relatively low cost of capital estimated to be in the mid single-digits and boost our return on equity over the long-term.

As we mentioned on our last call, we estimate that $21 billion to $23 billion of insurance in-force is the threshold for GAAP profitability, including interest and stock compensation expense. We expect across this threshold by the end of the second quarter, which would position us for profitable Q3 and possibly a profitable full-year 2016. This is a stronger profit outlook than we described on our last call and it takes into account, both insurance and higher expenses related to our increased NIW volume. We now expect expenses in 2016 will be approximately $96 million.

In summary, we had another excellent quarter and have started off the year in a good way. We are excited about the growth we’re seeing and the accretive capital opportunity we have in front of us.

With that, let me turn it back over to Brad for his closing remarks.

Bradley Shuster

Thank you, Glenn. We have said previously that we believe we can drive a highly profitable and self-sustaining mortgage insurance business with market share in the high single-digit to low double-digit range. After two consecutive quarters of 9% market share, we believe, we have demonstrated that the market wants and needs our unique value proposition, and we have achieved the level of market penetration necessary to assure our continued success.

Assuming we execute the reinsurance program Glenn has outlined and that we maintain an expected level of NIW growth through 2017. We believe we’re positioned to achieve approximately $1 of pre-tax income per share in 2017. This earnings power is being generated by operating leverage as we continue to scale into expenses and by the largely flat share count we would expect to maintain over that horizon. We expect to continue to expand profitability at a rapid pace in the ensuing years as we drive the operating leverage inherent in our business model.

Given the volatility of valuations in the equity market, we’re pleased to be in a position to reach our financial targets and enhance shareholder value without the need for new equity capital. Our customers give us praise everyday for our great customer service and our people. They are rewarding us with an increasing share of their business. It is exciting that just as we are seeing our hard work acknowledged in the marketplace, we’re also able to control our own destiny in the capital markets. We’re off to a great start in what we think will be another excellent year for National MI.

We thank you for your interest and support. And now we turn it back to the operator, so we can take your questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from line of Patrick Kealey of FBR. Your line is open.

Patrick Kealey

Good afternoon. Thanks for taking my questions.

Bradley Shuster

Sure, Patrick.

Glenn Farrell

Hey, Patrick.

Patrick Kealey

So, first off, just on the reinsurance and I appreciate the color around that. Can you maybe give us a sense of when you are expecting on maybe timing to execute on the first or maybe a couple or one transaction would that be something we can expect in 2Q maybe second-half of this year, or I guess, just trying to get a sense as to when we should be thinking about that rolling in?

Bradley Shuster

So, Patrick, we’re not going to put a hard deadline out there today for having an agreement in place, as we’re in a negotiation, and we don’t want to put a deadline out there that could affect that. But we expect that we’ll have this arrangement in place sometime in the second-half of this year.

Patrick Kealey

Okay, great. And then just switching over to your guidance of $19 billion, $20 billion in NIW this year. You’ve kind of laid out the target of 75% monthly, 25% single, kind of given where you’ve started off the year, I mean, do you think you can hit that for this year, or is it, you’re ramping into that 75%, 25% kind of exiting 2016 and heading into 2017. I guess, just trying to get a sense of mix with the net number?

Bradley Shuster

Well, Patrick, we didn’t layout a target of 75%, 25%. Well, the target we laid out was that, our mix would approximate that of our industry as a whole, which is more like 70%, 30%. So we’re virtually there. And as we’ve said all along that’s what we expected as we mature as a company.

Glenn Farrell

And I think that regard, I would add that 70%, 30% is kind of a target for the end of the year. If you look at our full 2016 production that will not probably have the 70%, 30% balance that we would like to see because of the first quarter here as we said was 59%, 41%. So that will string out during the year, and I think we’ll then towards the end of the year get to that down as you’re talking about.

Patrick Kealey

Okay, thanks. That’s helpful. And then if I can just sneak one last one, and I think in your supplement you have in April kind of percent monthly actually jumps up to 68%, which is kind of part of why I asked the last question. Anything in particular so far in April that’s kind of led to that jump, or is it just essentially mix from your customers and nothing really worth reading into?

Bradley Shuster

Yes, I think we had the pipeline effect from the late – latter part of 2015 of singles coming through in our NIW this quarter or the first quarter Patrick. And so in April, as we saw in March and then we’ve seen thus far in April, that mix has continued to just reflect what we think is the right balance of business vis-à-vis the monthly and singles.

Patrick Kealey

Okay, great. Thank you for the time.

Bradley Shuster

Thank you.

Glenn Farrell

Thank you.

Operator

Thank you. Our next question is from Bose George of KBW. Your line is open.

Bose George

Hey, guys, good afternoon.

Bradley Shuster

Good afternoon, Bose.

Bose George

Hey. Just wanted to go back to the commentary on your earnings guidance for next year. Is that actually did I hear that right? So you basically you expect $1 of pre-tax earnings for 2017?

Glenn Farrell

Yes, Bose, as we stated with the assumption that we execute a reinsurance program along the parameters that Glenn outlined and that our NIW continues on the trajectory and the expectation that we have now, then that would produce approximately $1 per share pretax income next year.

Bose George

Okay, great. And then the just in terms, when I think about that dollar presumably since you’re just breaking even in the back half of this year, it will be kind of at the lower end of that range earlier in the year, higher than that later in the year, is that a reasonable assumption?

Glenn Farrell

Yes, we haven’t really spread it in detail quarter-by- quarter, but I think the message here is that the trajectory of profitability going into next year and the years thereafter is going to be quite steep.

Bose George

Okay, that’s great. And actually just one on the reinsurance – is there a way to kind of think about how much that is going to contribute to the ROE? Is that going to be a few points of the ROE as well?

Glenn Farrell

I think over time, Bose that could provide an additional one or two percentage point of ROE I would think. We haven’t specifically modeled it out and it’s tough since we’re in the middle of negotiations to really kind of pinpoint it. But yes, we do see it as definitely being accretive.

Bose George

And then just actually one more quick one on the reinsurance, is that just new business that’s going to be ceded? Is there anything existing that’s going to be ceded?

Glenn Farrell

Yes, we’re looking at both our options there. I think it wouldn’t be far out of line to suppose that we’d look at some of the back book as well as the forward book.

Bose George

Okay, great. Thanks.

Glenn Farrell

Thank you.

Operator

Thank you. Our next question is from Mackenzie Kelley of Zelman & Associates. Your line is open.

Mackenzie Kelley

Thanks and congrats on a solid quarter.

Glenn Farrell

Thank you.

Mackenzie Kelley

First, just in terms of the capital, I’ll appreciate the color on the reinsurance and I know you mentioned that as well in order to postpone any need for equity. Can you just give a little more color on assuming that the reinsurance is executed in the second half? How soon would debt also be necessary and how should we be thinking about the right mix between reinsurance and debt going forward?

Glenn Farrell

So Amy, what I think we discussed was that we see a scenario where we do not need to think about equity at all and can rely on reinsurance. As you know, end of 2018, we would – our term loan would be due, so we would envision end of 2018 either refinancing and upsizing that and then, if we had further growth needs, we could certainly look at increasing the seed on reinsurance as well. So, as we envision it right now, equity isn’t the necessary option in our capital plan.

Mackenzie Kelley

Okay, and there wouldn’t be any debt as well other than the existing term loan that you have really?

Glenn Farrell

I think we’d be opportunistic with it, Mackenzie, in terms of – if the debt markets open up to any extent it allows us to look at the possibility of refinancing and upsizing that that something we certainly look at. But I think what we’re viewing now is that we’re pretty well status core with the debt.

Mackenzie Kelley

Okay, makes sense. And now on pricing, can you just give a sense now that the industry really has kind of met your rate card, how is pricing trending? Does it seem to have stabilized and also are you offering any variations in a rate cards on customer-by-customer basis or has the new rate card really took hold?

Bradley Shuster

This is Brad. We’re seeing a good degree of stability in the pricing environment now that PMIERs has been in effect for some months, and the industry has coalesced around a rational pricing scheme and we are proud of our position within the industry as the leader of that movement. So we feel like the market is stable.

Mackenzie Kelley

Okay, and then just lastly on the investment yield, it looks like it jumped up this quarter. Is that a better kind of go forward run rate in the 2% range, kind of high 2%?

Glenn Farrell

Yes, I think right around 2.5% or so, Amy, and that’s the right way to think about it and in dollar terms, that’s about the right way to think about it to going forward.

Mackenzie Kelley

Okay, great. Thanks.

Bradley Shuster

Thank you.

Glenn Farrell

Thank you.

Operator

Thank you. Our next question is from the line of Amy DeBone of Compass Point. Your line is open.

Amy DeBone

Hi, thanks for taking my questions. I just have one follow-up on reinsurance. So last year at the Investor Day, you guys guided to $70 million of capital translating to about $1 billion of NIW or around $250 million of new risk. How does that translate to reinsurance? Like is there a way to think about how much risk needs to be ceded, maybe from the back book in order to write $1 billion of NIW or new NIW or is it too early on to really pinpoint those metrics?

Glenn Farrell

Amy, we can spend more time, but the piece that’s missing from kind of the simple math is the profitability you generate from the ceded business and how that contributes to capital and if you will, sort of creates additional leverage to right new insurance. So are happy that sort of walk through some of the math just based on terms you’ve seen for other providers. That would be a reasonable basis we think to start to modeling.

Amy DeBone

Okay, and then in terms of you have about $100 million PMIERs cushion around $100 million. How much NIW do current capital level allow you to write? Is it still around like $10 billion to $15 billion or closer to $10 billion at this point?

Glenn Farrell

So with current capital, Amy, we could have insurance in force of probably say $27 billion to $28 billion and that takes over to $18 billion now, right. We’ll have some runoff, so you could probably right at least $10 billion to $12 billion.

Amy DeBone

Okay, and then just in terms of the trajectory as of premium yield, so we – you’re currently at 45% over time you said, you’ll settle in at 50%. But at what point or how should we think about when the yield contraction will start to reverse?

Glenn Farrell

I think Amy, the expectation for us going into this year was that the first couple quarters would be a little bit lower. But I think you can really start to see the ramp up probably closer to the end of the second quarter, really third quarter. But it’s going to be a slow ramp up to get there.

Amy DeBone

Okay, and then one last one, do you guys have any thoughts on originators potentially bidding out BPMI. Is that something that is…?

Glenn Farrell

We haven’t seen any trend there at all, so.

Amy DeBone

Okay.

Glenn Farrell

I don’t really have any thoughts about it.

Amy DeBone

Great, thanks for taking my questions.

Glenn Farrell

Thanks.

Operator

Thank you. Our next question is from Christine Worley of JMP Securities. Your line is open.

Christine Worley

Thank you. Most of my questions have been asked and answered. But I just had one follow-up on the reinsurance. In your negotiations, are you sort of looking at any ceding flexibility over time with the contract as you continue to generate more internal capital?

Bradley Shuster

Yes, I just say early on, we’re in negotiations now and our goal will be to maximize flexibility so that we can adjust to, if, for example our writings continue to outperform our expectations. We want to have the flexibility to take up this flat.

Christine Worley

Okay, great. Thank you very much.

Bradley Shuster

Thanks.

Operator

Thank you. And I’m not showing any further questions on the phone lines at this time.

Bradley Shuster

Okay. Well, with no further questions, we would like to thank you all for joining us on the call today. We look forward to reporting to you soon on our reinsurance program. We will be on the road meeting with current and prospective investors on the East Coast and the Midwest in May. And we will be presenting at the KBW conference on June 1. Thank you again for joining us on the call today.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program. You may all disconnect. Everyone have a great day.

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