NMI Holdings, Inc. (NASDAQ:NMIH)
Q2 2016 Earnings Conference Call
August 02, 2016, 16:30 ET
John Swenson - VP, IR & Treasury
Bradley Shuster - Chairman & CEO
Glenn Farrell - EVP & CFO
Patrick Kealey - FBR Capital
Mackenzie Kelley - Zelman & Associates
Amy Debone - Compass Point
Bose George - KBW
Welcome to the NMI Holdings, Inc. Second Quarter 2016 Earnings Conference Call. [Operator Instructions]. I would now like to introduce your host for today’s conference, Mr. John Swenson. Please go ahead, sir.
Thank you. Good afternoon and welcome to the 2016 second quarter conference call for National MI. I’m John Swenson, Vice President of Investor Relations and Treasury. Joining us on the call today are Bradley Shuster, Chairman and CEO; Glenn Farrell, our Chief Financial Officer; Rob Fore, our Controller and Rob Smith, our Senior VP of Pricing and Portfolio Analytics.
Financial results for the second quarter were released after the close of the market today. We also published supplemental information highlighting certain current and historical performance metrics. 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 Bradley Shuster. Brad?
Thank you, John. And thank you all for joining us on the call today. In the second quarter National MI generated it's first ever quarterly profit. This is a key milestone in our development second only to the day we wrote our first mortgage insurance policy just three years ago. It also represents the realization of the founding vision for this company. From the beginning we have pursued four goals, supporting affordable home ownership for 100s of 1000s of American consumers, providing a differentiated value proposition to our customers and policy holders, delivering great customer service to develop long term sustainable customer relationships and providing solid returns to build capital and reward shareholders.
At a milestone of this magnitude it is important to acknowledge the many people who have helped us achieve our goals We’re grateful our employees for all their efforts in making this possible. We’re also grateful to our customers for believing in National MI and our shareholders and business partners for supporting us since our founding. This $2 million profit in the second quarter is just the beginning. Our continued strong growth in insurance-in-force is driving new record premiums every quarter, a trend we believe will continue for the foreseeable future.
As we continue to prudently manage both risk and expenses we expect to deliver solid earnings growth for many years to come. Continuing with our quarterly results, in Q2 we grew insurance-in-force by 27% over the prior quarter. We continue to lead the industry in the rate of growth for insurance-in-force and now that we’re profitable it will be a key metric and a leading indicator of the trajectory of our growth in both premiums and profitability.
Year-to-date we have added 72 new customers and we ended the second quarter with 161 approved master policies. In Q2 we surpassed 500 customers generating NIW and exceeded a 100,000 policies in-force. In addition we continue to move our product mix into alignment with the industry average. Monthly product represented 63% of NIW for the quarter and our application volume is now in the range of a 70:30 mix of monthlys versus singles.
This mix transition is a function of our leadership in designing a risk based rate card consistent with the new PMIERs capital framework. We raised pricing on both monthly and single premiums for higher risk loans and lower pricing on higher quality loans. We also raised pricing on all lender paid single to address the additional PMIERs capital charges for singles. As expected we have seen our volume in lender paid singles moderate helping to rebalance our mix. We will continue to take a disciplined approach to this product segment.
In monthly premium the rest of the industry aligned with our PMIERs base rate card as of April and we see price stability in the monthly segment of the market which presents 70% to 75% of industry volume. Returns ultimately are built from quality customer relationships, disciplined pricing, prudent risk management and controlling expenses.
We manage and monitor each component to insure that we’re developing an insurance book in a business model that will deliver sustainable mid-teens returns over the long term. The underwriting environment continues to be very high quality more than half of the business we’re riding is at FICO scores of 760 plus and 90% is above 700. In addition, we fully underwrite more than 80% of the loans we insure which is a far greater %age than the industry norm. This gives us a high degree of confidence in the quality of our portfolio. It also reinforces our view of that the business we are writing today should generate very low default rates and low loss ratios over a full economic cycle.
With regard to FHA competition we have not heard an indication out of Washington that potential FHA. rate actions or cancelability of FHA premiums are being contemplated. That said there continues to be some discussion in the marketplace that if we were to see a change and he says change would occur prior to the election in November. We continue to believe that any such action would not have a material impact on our business. As a reminder the private mortgage insurance industry did not see a meaningful market share impact from the FHA premium decrease in early 2015, instead we saw largely refinancing churn within the FHA book, even with our industry's price increases for higher risk loans private MI continues to have a pricing advantage across approximately 20% of the FHAs current production. On the subject of front end risk sharing or deep cover mortgage insurance, the industry has received the FHFA's requests for information. We are pleased to see that the FHFA is considering expanding the role of private mortgage insurance within the GSEs risk management framework.
Although the Deeper MI Coverage would help to expand the market National MI does not need a larger market to fulfill our primary financial objective of growing insurance-in-force and delivering mid-teens targeted returns. In addition to our solid results, we announced today that we have entered into a close share reinsurance agreement with a panel of third party reinsurance providers. The agreement has been approved by our primary regulator. Fannie Mae and Freddie Mac are completing their reviews and we expect they will allow full credit under the PMIERs for the seated risk. We expect to receive full confirmation from them shortly and to commence sessions end of the agreement as a September 1st. The terms of our agreement are similar to other reinsurance transactions that have been executed in our industry.
It will result in approximately $150 million of capital released at the outset with a retained margin equal to approximately 80% of seated premiums. We estimate our after-tax cost of capital on reinsurance is approximately 3% making it a highly attractive part of our ongoing capital structure. Based on the growth we are achieving and the attractive terms of our reinsurance agreement we currently expect to report pretax income tax of approximately $7 million to $10 million for the full year 2016.
We’re also reaffirming our expectations of delivering at least $60 million of pretax income in 2017 which is roughly $1 per share based on our current shares outstanding. I will have some closing comments after Glenn provides more detail on the financial results. Glenn?
Thank you, Brand and good afternoon everyone. As Brad mentioned primary insurance-in-force at quarter end was $23.6 billion up 27% from 18.6 billion at the end of the first. Pool insurance-in-force as of the end of the second quarter was $4.0 billion. Premiums earned for the quarter were $26 million up from $19.8 million in the prior quarter. Annualized premium yield for our primary book in the quarter was 47 basis points up from 45 bps in the first quarter.
Before the impact of reinsurance we expect premium yield on our primary book to continue to migrate upward to around 50 bps over the next several quarters. As a reminder there is an inverse correlation between premium rate and credit quality which drives both loss expectations and capital requirements. For the risk we are taking and the capital we are required to hold these premiums will drive our targeted mid-teens returns over time. We were accorded $3.5 million of revenue from cancellations of single premium policies in the second quarter which compares with $2.3 million in the prior quarter. We have a large book of singles much of it written in 2015 which in the current rate environment is likely to drive continued strong cancellation revenue. NIW in the quarter was $5.8 billion up 37% from $4.3 billion in the prior quarter and up 129% over the second quarter of 2015. The growth was driven primarily by monthly product which was up 49% over the prior quarter.
Looking at product mix, monthly premium product represented 63% of second quarter NIW up from 59% in the first quarter. The mix of applications which are a precursor to NIW continue to shift towards monthly product reaching 70% in July. In terms of purchase refinance mix for the quarter purchase represented 72% of an NIW with refinance 28%. This compares with a 69:31 mix in the first quarter. Total policies in force as of the end of the quarter increased to 101,000 up 26% from 80,000 in the prior quarter. Our weighted average FICO primary risk in force as of the end of Q2 was 753 roughly flat with the prior quarter. Overall, persistency in the primary book was 83% also roughly flat with Q1. Investment income in the second quarter was $3.3 million up from 3.2 million in the prior quarter. Total revenues in the second quarter were $29.5 up 33% from 22.2 million in the prior quarter.
Underwriting and operating expenses in the second quarter were 23.2 million including share based compensation expense of 1.8 million. This compares with underwriting operating expenses of 22.7 million including 1.4 million of share based compensation in the prior quarter. Gross expenses continue to track with our prior guidance of approximately 96 million for the full year however reported expenses net of the seeding commission are expected to be approximately $94 million. We had 79 notices of delinquency in the primary book as of the end of the second quarter up from 55 at the end of the prior quarter. We recorded $470,000 per claims expense and there were three claims paid in the quarter. Our second quarter loss ratio defined as claims expense divided by premiums earned was 1.8%. 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 income for the second quarter was $2 million or $0.03 per share which compares with a net loss of $3.9 million or $0.07 per share in the prior quarter. At quarter end cash and investments were $654 million up from $630 million in the prior quarter and as of quarter end we had $78 million of cash and investments in the holding company.
Book equity as of the end of the second quarter was $422 million equal to $7.14 per share which compares with $410 million or 694% per share at the end of the first quarter. The increase in book value is attributable to net income as well as unrealized gains in the investment portfolio. This book value excludes any benefit attributable to our deferred tax asset of approximately $66 million as of December 31, 2015. With profitability in Q2 and now expected for the full year we have additional support for reversal of the valuation allowance on our deferred asset sometime over the next year. As of quarter-end total available assets under PMIERs were $432 million which compares to risk based required assets of $377 million.
Now I'd like to provide some details on our reinsurance agreement. Firstly it is a quarter share structure with a panel of eight strongly capitalized and highly rated third party reinsurers. The lead on our program has led several other US mortgage insurance trees and four of the participants are new interns to our sector. They see national MI as an attractive partner for their first domestic MI treaty and we expect they will be receptive to future transactions with us. We will also seed the approximately 95% of the risk associated with our GSC pool and 23% of our primary back book as of August 31 of this year. Commencing September 1, we will also seed approximately 23% of forward production through the end of 2017. We expect to receive full capital credit under PMIERs for the risk seated under this agreement. This will provide approximately 150 million of initial capital relief including coverage on future in NIW we now have the capacity to scale to approximately $15 billion of insurance-in-force.
The general economics of the agreement provide for National MI to retain a margin of up to 80% of the seated premium. Our 80% breaks down as follows, a seating commission equal to 20% of the seated premiums which will be recorded as an offset to expenses and an additional margin up to 60% of the seated premium. At the outset we would expect approximately 58% in the form of profit commission to be recorded as earned premium and 2% to be recorded as seated loss depending on actual losses incurred. Finally, just a couple of comments on outlook. We currently expect to meet or exceed the high end of our guidance for NIW which was $19 billion to $20 billion for 2016. And as Brad mentioned, we currently expect to earn in the range of $7 million to $10 million of pretax profit this year. We are also reaffirming our prior guidance of at least $60 million of pretax income in 2017 both of these estimates include the full impact of reinsurance beginning in September of this year.
In summary, we have another excellent quarter highlighted by our first quarterly profit and our tracking to a highly profitable second half of 2016.
With that let me now turn it back over to Brad for his closing remarks.
Thank you, Glenn. This has been an exciting time at National MI. In addition to our strong Q2 financial result and establishing a reinsurance agreement. We recently were named as one of Fortune Magazine's Best Places to Work. We specifically were ranked as Number 15 nationally in the financial services and insurance sector. This is a great achievement for our young company. It reflects the culture of collaboration and mutual respect that we embody in our workplace and that we project in our dealings with customers. We are very proud of the quality of our people and our culture and we believe it is a continuing competitive advantage for us in the marketplace.
In closing, I will repeat one of the themes from last quarter. With our strong growth in insurance-in-force laying the foundation for future growth in premiums and net income we have achieved the level of market penetration we need to build a profitable and self-sustaining business. By focusing on what we do well, providing outstanding service to customers, prudently managing risk and controlling expenses we look forward to many years of increasing profits and higher returns to shareholders. 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]. Our first question will come from the line of Patrick Kealey from FBR. Your line is open.
So I guess starting off the reinsurance transaction, if I recall you had talked about this being kind of somewhere in the second half of this year obviously got done you know sooner than later if anything in the early end of it. So can you maybe talk about the dynamics of that, what kind of drove this to get done as quick as it did and again when we talk about the terms you expected versus what you got, can you remind us how this stacks up versus expectation?
In terms of timing, Patrick, I think it was pretty much as we kind of envisioned. I think there were a couple of elements that moved in the actual transaction in terms of the pool agreement versus the go forward book. So I think putting it all together the September date was an optimal time for us to start.
In terms of comparison the terms of the deal, I think we’re very happy with the results there. They seem to be very much in-line with what competitors have gotten previously and we’re quite pleased with them.
And kind of touching on NIW for the year, obviously happy to hear kind of the high-end at 20 billion potentially better depend on the market, but going back whenever you had talked NIW you had always talked about in the sense of gaining deeper penetration with existing accounts but looking at 2Q you obviously converted a few more. So when we think about 20 billion plus, are you still viewing that in the context of just deeper penetration of existing accounts or is it fair to assume that you maybe adding an account here or there in the back half of this year to get to that 20 billion plus?
We see it both. We have got tremendous momentum in the marketplace, we’re adding some very significant new accounts over the course of this year, but we’re also seeing share increases in instances where we have had long standing relationships. So you will always see us driving a combination of those and we think we have got room to grow in terms of adding new accounts in the marketplace so it's a lot of momentum right now.
Our next question will come from the line of Mackenzie Kelley from Zelman & Associates. Your line is open.
I guess first just around the balance sheet now that we have the reinsurance in place. Can you talk little about how you envisioned potentially, if there is any optionality, around the term loan, potentially upsizing our refine kind of -- be thinking about that at this point.
I think right now we're very satisfied with what the reinsurance gives us in terms of go-forward capital strength. In terms of the upsize of the term loan that's not necessarily something we would be considering at this stage. And I think we're looking primarily to the reinsurance to help us there. If something came along that something we can be very opportunistic with, I think that we would certainly look at it, but at this stage, that's not necessarily in our cards.
Separately, around just pricing, Brad, I know you mentioned you’ve seen instability in the borrower pay, can you just comment a little bit about what you're seeing in the vendor feed market?
Yes, so we took actions which I described to raise our pricing to align with the capital required under PMIERs for single premiums, and that's driven that shift in our mix which exactly what we designed it to do. So we're really happy with where we're playing in a single premium lender paid environment right now. We're getting great amount of business, but it's that returns that we're very comfortable with. So we see that as being a very stable environment as well.
And if I could just ask one more on operating expenses, how should we be thinking about kind of longer term over the next two years, is the sales force fully scaled or really where do we be thinking about potential areas for operating expenses to be growing in rate of chance in that number over the next two to three years?
Yes, we really haven't given guidance to that yet, Mackenzie. I think what we'll see -- as you've seen over the last 18 months, some stabilization in kind of the rate of growth, I think that rate would continue more or less, so we really haven't come to any conclusion on that at this stage.
Yes, I think, I'd just add to that. I think we basically fully scaled at our business and increases you would see from this point forward, would be more volume-related things we need to do to operate. We feel like we're at a very good position from an operating standpoint, right now.
Our next question will come from the line of Amy Debone from Compass Point. Your line is open.
So how much NIW can you write based on current capital level?
I think that the comments that we made in the calculation we've done is that we're good up to about $50 billion of insurance-in-force, Amy.
Including the reinsurance agreement, is that right?
Okay, excluding the impact of the reinsurance agreement, you have an estimate of how much capacity have as of right now.
Amy that insurance-in-force would be, that on an as reported basis, right. So the assumption 50% as the 25% of the risk is seated, right. And we disclosed the difference between available assets and required assets in our release. So, that tells you where we are right now with our reinsurance in terms of capacity.
Okay. And then given that the reinsurance agreement extends the back book and that are going to be reserve a low losses over the near term. How would your pre-tax profit estimate of $7 million to $10 million for 2016 change, if the reinsurance agreement didn't start until the first quarter of 2017? Just trying to find the better understanding impact of the reinsurance agreement on the back book?
Well, I mean that's sort of hypothetical Amy we'll do fully expected that go into effect on September 1 that's our basic plan.
I guess, Amy are you trying to get a sense of how much impact this has on our bottom line, if when we put this in place?
Exactly right. So in a longer term I'm just trying to understand the impact and so a lot more prior to losses actually coming through.
Yes, I mean if you figure that roughly 23%, 24% of our premiums are being seated, but we're retaining 80% of that. And on the back book we're seeing off the current monthly and singles what that translates into 2016 is about a $2 million pre-tax impact on the bottom line.
[Operator Instructions]. Our next question will come from the line of Bose George from KBW. Your line is open.
I didn't have guess our thoughts, but what was the contribution from the calculation to the premium.
In Q2 cancellations were about $3.5 million.
And then just in terms of the premium going forward, that the 50 basis points. It just represents different pieces that are driving that, -- the singles were coming down, you've got the reinsurance and also got the premium on the new insurance that you rise, sort of talk about the different pieces that are impacted each of them.
There is two things in that gross number, if you will its -- as the singles previously written as well as the new stuff we're riding began to sort of equalize and then the other is that the credit mix on the monthlies. The monthly pricing is inching up as -- heavily part of our volume recently was in 760 plus zone, we were now -- that the competition has matched us as of August, we're expecting that mix to normalize, a little bit -- we will be seeing some higher premiums as we get down below 760. Reinsurance doesn't have an impact on those two things we are talking about and getting to 50, but reinsurance will going forward impact that net premiums earned number. So as you work at yield calculation, you'll start to see some impact from the reinsurance right on that 50.
Okay. So the 50 is a number excluding the impact by reinsurance?
Before reinsurance, yes.
And actually just in terms of your market share for the quarter. Do you think it changed much quarter-over-quarter?
We're still seeing the numbers come out Bose, but as you know, we've never been that focused on market share, we've been focused on the NWI. We need to drive insurance-in-force growth to meet our goals and we're very happy about where we are in relation to those metrics.
Our next question will come from the line of [indiscernible]. Your line is open.
I didn't have question, I just thought after all the kind of detailed questions. I'd just like to congratulate you and thank you for setting expectations at a reasonable level and hitting them and also congratulate you for getting an excellent reinsurance deal and look forward to the continued success here throughout the rest of the year and very happy as a shareholder to move into profitability with you guys, so that's all I have.
Thanks for sharing those thoughts Jason. We certainly appreciate and we appreciate your support.
Thank you. And at this time, I'm showing no further questions, I'd like to turn the conference back over to management for any closing remarks.
Well, thank you everybody for joining us today and we will be presenting at the Susquehanna Financial Conference later this month in New York. And at the Zelman Conference in Boston in September and thank you again very much for joining us on the call today.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone have a great day.
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