NMI Holdings Inc (NMIH) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the NMI Holdings third 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 be given at that time. (Operator Instructions) As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference Mr. John Swenson. Sir, you may begin.

Thanks very much. Good afternoon and welcome to the 2016 third 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 third quarter were released after the close of the market today. The press release 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 as current at any time other than the time of this call.

Now, to our conference call. Brad will open 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.

Thank you, John and thank you all for joining us on the call today. In the third quarter, National MI generated record net income and returns, the early stages of what we expect will be many years of new records on both of these metrics. We are at an exciting inflection point in our development having crossed the breakeven point last quarter, the majority of incremental premiums are now dropping to the bottom line. This leverage will drive a rapid increase in our underwriting margin and net income as well as returns on equity. As a de novo insurer with no legacy risk and sound risk management guidelines, we expect that our results will be highly predictable with minimal volatility, attributes that we believe will deliver rewards to our shareholders in coming years.

We increased insurance-in-force by $5 billion to a record $28 billion, which drove a 22% increase in earned premiums for the quarter. We wrote approximately $6 billion of new insurance written for the quarter and currently expect to write [$21 billion] of NIW this year.

In the third quarter, we continued to rapidly transition our mix of new insurance written to high return monthly premium product. Monthly premium NIW was up 12% over our record [growth] in the second quarter and up 163% compared with the third quarter of last year. Meanwhile, single premium declined by 21% from the prior quarter and 17% versus the third quarter of 2015. This is consistent with our strategic objectives and follows our decision to raise pricing on single premium products with the introduction of the PMIERs capital charges last January.

This trend was also evident in our application mix for October, which was 75% monthly and 25% single, roughly in line with the long-term industry average. At the end of the third quarter, we had 1,100 master policies in place with customers, an increase of approximately 150 year-to-date.

The healthy origination market continued in the third quarter with a tailwind from strong purchase activity. We are optimistic about the strength of the purchase market going into 2017. This is good for the industry as purchase drives roughly four times the penetration rate of mortgage insurance versus refinance. The underwriting environment continues to be very high quality. Roughly half of our new insurance is above 760 FICO and 90% is above 700. More importantly, these new writings [are supported a] full documentation of income and include none of the exotic products that existed pre-crisis.

What is unique about National MI is that we have underwritten [approximately 85%] of loans in our portfolio, far more than any other mortgage insurer. As a result, we have directly validated the documentation supporting the lenders' underwriting decision. This provides us with several unique benefits including better knowledge of the loans in our portfolio, efficient claims handling, and enhanced oversight of lenders' underwriting practices. We believe our portfolio will perform better than the rest of the industry over a full credit cycle and that this capability will continue to differentiate us with lenders and the GSEs.

In general, our portfolio to date is performing far better than we have modeled. Based on the weighted average credit quality of our portfolio, our pricing assumes approximately a 2% ultimate default frequency. This would be expected to result in a 20% loss ratio over a full economic cycle. The claims experienced to date is substantially better than this. However, we believe this is a result of low loss development driven by a healthy economy and healthy home price appreciation.

We priced our insurance to deliver targeted returns over a full economic cycle, which includes cyclical recessions and regional downturns. We assume that over a multi-year economic cycle, we will see loss development accelerate as a result of an economic slowdown and this is what we insure for. In a potential stress scenario, we have the ability to cover approximately four times the normal defaults with premium revenue. In other words, we could accommodate as much as an 8% ultimate lifetime default rates before we would begin to exceed lifetime premiums.

On the subject of FHA competition, we continue to hear nothing out of Washington indicating that officials are contemplating a cut to premiums or a change in the cancelability of premiums. In general, we believe that pricing is not the primary factor that swings a borrower from private mortgage insurance to the FHA. The FHA is part of the government's affordable housing mission and does roughly 80% of its endorsements below 720 FICO. We do only 20% of our volume in that credit band.

The industry did not see a meaningful share impact from the FHA premium cut in early 2015. If there were an FHA rate cut, we believe that industry market share relative to FHA would not be materially affected and then our industry would maintain its commitment to risk-based pricing that would not chase the lower credit bands. We also believe that the industry has an opportunity to gain share versus the FHA over time as nearly 20% of FHA production is above 720 FICO where private MI generally offers better value.

Recently, we have been pleased to see announcements of an industry consolidation and the potential acquisition of another competitor. It is a very healthy development to be an industry of seven players go to six rational competitors. This should drive some redistribution of the combined [companies] pro forma market share as lenders look to diversify counterparty risk. It is also helpful to hear in the industry commentary on delivering higher returns with increasing market share. Since we led our industry with a risk-based rate card designed to deliver a uniform mid-teens return on PMIERs capital, we have seen stability in pricing for monthly premium products.

Finally, we initiated sessions under our reinsurance agreement in the quarter. This reinsurance program initially gives us approximately $150 million of capital relief to support our growth. With an after-tax cost of capital of roughly 3%, we expect reinsurance transactions will be our most advantageous form of growth capital going forward. I'll have some closing comments after Glenn provides more detail on the financial results. Glenn?

Thank you, Brad, and good afternoon everyone. As Brad mentioned, primary insurance-in-force at quarter-end grew to $28.2 billion, up nearly $5 billion or 19% from the $23.6 billion at the end of the second quarter. Premiums earned for the quarter were $31.8 million, up from $26 million in the prior quarter. Annualized premium yield for our primary book in the quarter was 48 basis points, up from 47 basis points in the second quarter.

Before the impact of reinsurance, we expect premium yield on our primary book to continue to migrate upward to around 50 basis points although this can be volatile depending on cancellations of single premium policies and credit quality, which impacts premium rate. With reinsurance, we expect that reported net premium yield will be approximately 5 basis points lower.

We grew monthly NIW by 12% over the prior quarter and 163% compared with the prior year. Total NIW was essentially flat with Q2 as single premium product was down 21% versus the prior quarter. This is consistent with our objective of shifting our NIW and insurance-in-force mix to mirror the long-term industry average.

In the third quarter, monthly premium product represented 71% of NIW, up from 63% in the second quarter. The mix of applications, which are a precursor to NIW, continued to shift toward monthly product reaching 75% in October. In terms of purchase refinance mix, for the quarter, purchase represented 75% of NIW with refinance 25%, which compares with a [72%, 28%] mix in the second quarter.

Total policies-in-force as of the end of the quarter increased to 119,000, up 18% from 101,000 in the prior quarter. Weighted average FICO primary risk in force as of the end of Q3 was 753, roughly flat with the prior quarter. Overall persistency in the primary book was 82%, roughly flat with the 83% in Q2. Investment income in third quarter was $3.5 million, up from $3.3 million in the prior quarter.

Total revenues in the third quarter were $35.5 million, up 20% from the [$29.6 million] in the prior quarter. Underwriting and operating expenses in the third quarter were $24 million, including share-based compensation expense of $1.8 million. This compares with underwriting and operating expense of $23.2 million, including $1.7 million of share-based compensation in the prior quarter.

Gross expenses continued to track with our prior guidance of approximately $96 million for the full year. However, reported expenses net of the ceding commission are likely to be in the range of [$92 million to $93 million]. We had 115 notices of delinquency in the primary book as of the end of the third quarter, up from 79 at the end of the prior quarter. We recorded $664,000 for claims expense and there were three paid claims in the quarter. Our third quarter loss ratio defined as claims expense divided by premiums earned was 2.1%. 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 third quarter was $6.2 million or $0.10 per share, which compares with net income of $2 million or $0.03 per share in the prior quarter. At quarter-end, cash and investments were $686 million, up from $654 million in the prior quarter.

As of quarter-end, we had $77 million of cash and investments in the holding company. Year-to-date, we generated $52.2 million of cash from operations, which compares with $16.2 million over the same period last year. Book equity as of the end of the third quarter was $430 million equal to $7.28 per share, which compares with $422 million or $7.14 per share at the end of the second quarter. This book value excludes any benefit attributable to our deferred tax asset for which we have recorded a valuation allowance of approximately $66 million as of December 31, 2015. With profitability over the past two quarters and expected for the full year, we have additional support for likely reversal of the valuation allowance on our deferred tax asset sometime over the next year and possibly as early as the fourth quarter of 2016.

We would expect that the amount of the valuation allowance actually reversed will be reduced slightly from the $66 million as a result of current income as well as amounts attributable to state taxes that would not be absorbed by future income. As of quarter-end, total available assets under PMIERs were $489 million, which compares to the risk-based required asset of $321 million.

In summary, we had another excellent quarter. As Brad mentioned, we now expect to report NIW of approximately $21 billion for 2016 and we continue to expect pre-tax income of approximately $60 million for 2017. With that, let me now turn it back over to Brad for his closing remarks.

Thank you, Glenn. In closing, I want to reiterate our financial objectives for the business. We are highly focused on delivering strong mid-teens returns for our shareholders. This is what drives every decision of the Company, including choosing the customers who appreciate our value proposition, how we price our product, and how we manage risk and expenses.

We are always building new customer relationships and seeking to expand our existing relationships, which positions us to achieve our return objectives on behalf of shareholders. With our continued focus on doing 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.

Thank you. (Operator Instructions) Bose George, KBW.

Actually, first question just on the DTA, is there a certain number of quarters you need to have earnings before that reverses or it's not a hard and fast rule?

Bose, this is Glenn. No, it's not a hard and fast rule, it's just the positive evidence [outing] the negative evidence and that has a variety of different interpretations throughout practice. So there is no hard and fast line on that.

Okay but the expectation is it could happen in the fourth quarter or otherwise just spills over into the first?

We're looking at it very seriously and we do expect it to be sometime in the next four quarters, but we are looking at it.

Okay, great. Then can I just get the dollar amounts for the earnings that came from cancellation of singles this quarter?

We were roughly $5.7 million in cancellations.

Okay, thanks. And then, can you remind the warrant liability expense, what does that represent?

We have approximately 990,000 warrants that were exchanged back in the early days of the Company in the acquisition of the original business. Those are accounted for on the liability method and those will fluctuate with the change in our stock value.

Randy Binner, FBR.

Actually I had a quick follow-up on the DTA. The 4Q16, is that -- had it been communicated as being that early before or were you all talking about more like early to mid-2017 before?

Hey, Randy. I think this is the first time we've actually communicated it could be as early as Q4. Previously, we were signaling sometime in the next year and so I think that was probably the expectation, but as I said to Bose's question, we've been looking at it hard and have been trying to build the positive evidence to recognize it or realize it sooner.

And so the earnings were good this quarter, but they probably weren't dramatically better than you all may have thought I think. I think somewhere in the opening text or something about a more favorable tax items there, is there something else just beyond pure earnings that's changing that potential calculus around when to recapture?

No, no, it's just the earnings. I think one of the things that's occurred too was that Q2 was a profitable quarter that was a quarter ahead of our expectations. So that kind of shifted things up a little bit and as we continue to look at it, as I said, building the evidence that we have.

Okay that's great. Then I have a couple market share type questions. I guess, first is, in response to the commentary around there's consolidation and then potential M&A in the MI space and so, is there any way that you can quantify how that would increase your share of the MI market and then the other piece of that is, any initial thoughts on the size of the MI market in 2017. I think, you're refi mix is a little bit lower and I think another writer saw that and so that's a piece of the puzzle about the overall market. So do you see the overall market being flat to a little bit bigger or smaller in 2017 and any way to kind of think of the quantification of how your role would change in light of the consolidation potential M&A?

Yes, Randy, this is Brad. With respect to consolidation, we can't really quantify what the effect of that's going to be. We do believe there will be some positive benefit attributing to us just from customers wanting to spread their counterparty risk a little more evenly throughout the marketplace. So we'll just have to wait and see how that plays out, but I think the initial commentary by the acquiring company was, we took as positive, and so we're looking forward to that having some positive benefit next year.

In terms of market size itself, we see the same estimates, the Fannie, the Freddie, the MBA everybody else does, but we're not overly focused on that. As a driver, we really focus on how much NIW we have to get to grow our insurance-in-force rapidly and drive the premium earnings to drive profitability and return. So you won't see us celebrating if the market gets bigger or wringing our hands if it gets smaller. We're just focused on getting what we need to get to be successful.

And then just on the refi piece, is that something -- would you expect that to be a lower part of the NIW mix going forward?

Yes, I think what we hear is that the purchase side of the market, which obviously is a better penetration for the MI side, that's going to probably grow with the refi side settling down a little bit so that the overall market probably would be roughly the same. We're not going to prognosticate I think any further than that.

Mackenzie Aron, Zelman & Associates.

Just a few questions. First, just a follow-up on the comments around the consolidation. I know it's still a little early for lenders to be reacting and maybe it was way too soon to really show up in the 3Q numbers, but can you just talk about it, about what you've seen and kind of the conversations that you're having more recently with your customers and potential new customers about the option to really benefit from potentially the overlap between the UG and Arch customer base and how meaningful that would be to customers that you don't already have master policies with?

Yes, so Mackenzie, obviously we had -- at the MBA meeting last week, we had a full slate of customer meetings and that was certainly a topic on many, if not all of those agendas. The transaction hasn't closed yet, so the integration hasn't begun and so it's really too early for us to try and put numbers around it.

So, one thing we have pointed to over several years now post crisis, the shares among the players in the industry were distributed much more widely than they have historically been with similar number of market participants and as the last couple years have elapsed, you've seen the shares tend to kind of be much more narrowly distributed and so we would expect that to continue over time and with six competitors rather than seven, I think that bodes well for the amount of business we will be writing.

Okay, thanks, appreciate that. Additionally, on the single premiums, how much of the decline of just the single premium NIW was truly intentional by just trying to get the percentage of the NIW down below that 30% mark that you've laid out in the past versus maybe a reaction to any pricing or competitive dynamics in the market where you intentionally stepped back from more of a ROE perspective?

Well, it's very hard to look back and say exactly how much was from our intention. I will say, I think the important message is, we are laser focused on returns and we have rate cards that drive us toward that mid-teens return and as you know, there tends to be incrementally more price competition in the single premium space, in the monthly space, so in those cases where we encounter that competition, we're perfectly happy to go and provide our product to other customers where we can get the full return. So, we will continue to do that.

Okay and then I guess if I could just squeeze in one more. Just as you kind of look out over the next two years to three years and once you get to the $50 billion in insurance-in-force that you've laid out as being adequate right now under the existing capital [on] reinsurance, can you just talk a little bit about how you think about the growth trajectory post that and how we should be thinking about the different capital options available to you?

Well, as we said in the opening comments, we were really pleased with the reinsurance panel we were able to put together to spur our growth going forward. We had a number of new names in that, that hadn't participated previously and all indications are that there'll be additional capacity there at similarly attractive rate to support growth going forward.

We're also exploring other reinsurance type solutions that can be provided by capital markets and we're excited about our preliminary work there and then we also have our debt, which is available or can be refinanced without prepayment penalty in another couple of weeks and so, there's a whole variety of options available to us, but I think you'll find us continuing to focus on the lowest cost, most attractive sources of growth capital so that we can maintain returns at a very high level.

(Operator Instructions) Amy DeBone, Compass Point.

Congrats on the beat. Could you guys just provide an update on NIW capacity including the future impact of the reinsurance agreement and then just maybe a few comments on how sensitive that number is to refi volume and persistency levels?

Hi Amy, its Glenn. In terms of capacity, we've said that we believe that the reinsurance vehicle gives us the capacity to continue to grow at the rate we have been growing and supply the next -- or supply us with capital into the foreseeable future. I think as Brad pointed out, as opportunity arises or other opportunities come along that we may also look at potential capital relief from other types of reinsurance at this stage. So from a growth perspective, we're seeing a similar type of growth that we've had. We've obviously seen the seasonal aspects in this quarter so far, but we expect that the next quarter or next 12 months [should] see a very similar growth pattern that we've seen in the last few months. That said, the equity and capital that we have at our disposal now is sufficient for that growth and as I said, we'll explore other opportunities as they arise. And you also asked the question about refi -- what you asked about persistency of refis?

Right, how sensitive that number is to changes in those inputs?

We use kind of the historical average of about 80% persistency in our modeling for the future. So I think that's pretty much what we've seen the industry -- how the industry has behaved. So, if we see some upticks in the interest rates over the next few months that should have an obviously increased that persistency a little bit, but we've incorporated those types of assumptions into our modeling as well.

Amy, if it's helpful, this is John. So, we definitely think about the capital base in the context of how much insurance-in-force that supports and obviously if persistency ends up being stronger than expected, you need to write less in order to get to those levels. And conversely, if persistency is lower than expected, then you're writing more over time to reach that insurance-in-force number. So, we're thinking about this less in the context of how much writing capacity if you will than insurance-in-force.

Okay, great and then on the FHA cut, the annual rate in January of 2015, did you see any indication that there would be a change prior to the announcement from HUD?

Amy, it's Brad. Recall there were rumors in the marketplace sometime leading up to that, but if memory serves, the rumors about the rate cut -- we're discussing about sometime in the future, if ever, those rumors have been going on for over a year now, I mean, I remember hearing this a year ago at the MBA convention in San Diego, had a steady stream of rumors and now, but nothing concrete or actionable.

Geoffrey Dunn, Dowling.com.

Thanks, good afternoon, it's Dowling Partners. I apologize if its redundant, I got knocked off for the first question or two but, can you provide some of the financial [BCL's] of the reinsurance impact on the quarter as well as the refunded premium impact.

Hey Geoff, its Glenn. We had about $600,000 less to our bottom line as a result of the one month of reinsurance activity. As you recall, it was incepted on September 1. So, yes we had [about $600,000] effect on that. And what was the second part of the question I'm sorry.

Refunded premium.

Oh cancellation. It was $5.8 million in the quarter.

Okay and with respect to singles, I think you indicated kind of a [75:25] as the longer-term mix, get rid of UGC and looking at people more recently, it seems like that trends more to 20. Would you expect your book to generally follow the average of the industry if we do see singles continue to trend down to a smaller piece of overall books?

Geoff, this is Brady. Yes we would, I think we said the long-term mix has been about [75:25] and it may be trending down a little bit, but we don't see any reason why over the long haul we'll be any different than the industry there.

And I am showing no further questions. At this time, I would now like to turn the call back over to management for any closing remarks.

Well, thank you all for joining us on the call. We will be hosting our Investor Day in New York on the morning of November 18 and we hope to see you there. We will also be presenting at the JPMorgan Specialty Finance Conference in late November. Thank you again for joining us on the call today.

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