NMI Holdings Inc (NMIH) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the NMI Holdings Second Quarter 2017 Earnings Conference Call. (Operator Instructions)

I would now like to introduce your host for today's call, John Swenson. You may begin.

Thank you. Good afternoon, and welcome to the 2017 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 Brad Shuster, Chairman and CEO; Adam Pollitzer, our Chief Financial Officer; and Julie Norberg, our Controller. Financial results for the 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 such statements as current at any time other than the time of this call. Also note that on our website, we provided a reconciliation of certain non-GAAP measures used on this call to the most comparable measures under GAAP. Now to our conference call. Brad will open with an update on the state of the business, and then Adam will discuss the financial results in detail. After some closing remarks from Brad, we'll take your questions.

With that, let me turn the call over to Brad Shuster.

Thank you, John, and good afternoon, everyone. I'm pleased to report that in the second quarter National MI again delivered solid financial results and continued to advance the key metrics that will drive realization of our midterm -- mid-teens return objectives. We made significant strides in customer development and continued to build a high-quality portfolio insurance-in-force at a growth rate that leads our industry. We did this while maintaining our focus on prudently and proactively managing product mix, risk, expenses and capital. We grew insurance-in-force to $39 billion, up 11% over our first quarter result and up 64% from where we were a year ago.

Net premiums earned of $38 million were up 14% compared with the first quarter and up 46% over the second quarter of 2016. Our top line growth is driving significant operating leverage as reflected in our record pretax income of $9.5 million, which includes approximately $3.1 million of cost related to our Insurance-Linked Notes transaction or ILN. Pretax income increased 41% over the prior quarter and was up more than 4x over what we achieved in our first profitable quarter just 1 year ago. In the second quarter, we wrote more than $5 billion of new high-quality mortgage insurance including more than $4 billion of monthly premium product. Our total NIW was up 42% over the prior quarter and we maintained the mix of 81% monthly product, consistent with the first quarter and up dramatically from 63% monthly in the second quarter last year.

As we look at our progress over the past year, particularly in the monthly product segment, it is clear that our unique value proposition is resonating with customers with an underwriting mile that allows us to promise and deliver better master policy terms and more sensible servicing as well as a high-touch philosophy that provides a superior customer experience. We are enjoying great success in both expanding our business with existing customers and activating new accounts. We ended the quarter with more than 1,200 approved master policies and a record 576 customers delivering NIW. We activated 36 new customers in the second quarter, building upon the 37 new customers activated in the first quarter. And activation means that we have established connectivity with the customer and generated a first application or first NIW with that account, and sets the stage for future meaningful NIW volume. The 73 new customers activated year-to-date in 2017 generate approximately $17 billion of annual NIW volume and include 19 of the 200 largest lenders in the country. We have proven our ability to expand our business with accounts once they experience our value-added high-touch approach to customer service.

With this proven formula and our continued momentum in new customer activations, particularly among the largest national lenders, we have established a platform for growth that we believe will drive significant shareholder value over time. Looking at the broader mortgage insurance market, growth in purchase volume is more than offsetting softness in refinancing. Our purchase volume was up 51% over the prior quarter and up 8% over the second quarter last year. For the quarter, purchase mortgages comprised 90% of our NIW. At this level, even if there is modest contraction in refinance volume, we are expecting a 2017 mortgage insurance market generally in line with 2016. There is little new to report related to activities in Washington or on a competitive front. We believe the current administration and Congress are biased toward expanding the role of private capital in the housing finance system and are favorably inclined toward including mortgage insurance in any framework of reform.

However, given the hierarchy of current political priorities in Washington, we believe the timing and potential benefit of any reforms are difficult to predict. We are enjoying great success and growth in the current regulatory and competitive environment and believe that any policy development is likely to be constructive. We therefore, are best served by staying focused on the substantial opportunities in front of us, while monitoring the political landscape and participating in the efforts of the U.S. MI trade group. In summary, we had another great quarter. We are continuing to cultivate customer relationships where our reliability as a counterparty and our dedication to customer service are valued. We are adding high-quality insurance-in-force at a faster rate than any other industry participant. And as always, we are staying highly focused on managing risk, expenses and capital to maximize returns.

With that, let me turn it over to Adam for more detail on the financial results.

Thank you, Brad, and good afternoon, everyone. As Brad mentioned, we had a solid quarter. Pretax income was up significantly quarter-on-quarter, particularly after adjusting for the ILN transaction costs. Premium yield improved as expected, losses continued to be modest and expense growth was minimal relative to growth in premium, which drove a further decline in our combined ratio. In addition, we achieved a 5% GAAP return on equity in the second quarter, or 6.5% excluding ILN transaction costs, driven by the inherent operating leverage in our model and marking continuing traction on this important metric.

Now to the detailed results for the quarter. Primary insurance-in-force was $38.6 billion at quarter-end, up nearly $3.9 billion or 11% from $34.8 billion at the end of the first quarter. And up 64% compared with the second quarter of 2016. As of quarter-end, monthly product represented 64% of our insurance-in-force, which compares with 62% as of the first quarter and 53% as of the second quarter of 2016. Given our current NIW mix and portfolio runoff, we expect that monthly product will continue to increase as a percentage of insurance-in-force at the rate of approximately 2 points per quarter. Runoff rate in the quarter was 3.4%, up from 2.9% in the first quarter, reflecting the seasonal uptick in housing turnover. 12-month persistency in the primary book was 83.1%, up from 81.3% last quarter.

Weighted average FICO of risk-in-force was 749, which compares with 753 as of the end of the first quarter. This reflects a modest migration of our book to a normalized FICO distribution, which correlates with the higher average rates on our monthly NIW over the past several quarters. Total NIW of $5 billion, was up 42% compared with the first quarter. The mix was 81% monthly product, consistent with the mix in the first quarter and up from 63% in the second quarter of last year. Premiums earned for the quarter were $37.9 million, up 14% compared with $33.2 million in the first quarter and up 46% compared with the second quarter of 2016. We earned $3.8 million from cancellation of single premium policies in the quarter, up from $2.5 million in Q1.

Reported yield for the quarter was 41.3 basis points, up from 39.7 basis points in the prior quarter. This is consistent with our expectations and was driven primarily by increases in core yield attributable to both a higher mix of monthly insurance-in-force and higher average rate on monthly insurance-in-force as well as higher earned premium from single premium cancellations and amortization. These increases more than offset the impact of the Insurance-Linked Notes, which was in effect for 2 months of the quarter. Gross premium yield, which is before the impact of reinsurance, was 47 basis points, up from 44 basis points in the first quarter. Weighted average rate on NIW across all products in the second quarter was 50 basis points, consistent with the first quarter.

Consistent with our discussion last quarter, for the remainder of the year, we expect net or reported yields to be approximately 41 basis points. This reflects the full impact of the ILN as well as an expectation of a modest drop in cancellation activity as we move into the back half of the year. Invested income in the second quarter was $3.9 million, up from $3.8 million in the prior quarter. Underwriting and operating expenses in the second quarter were $28 million, including $3.1 million of previously discussed costs related to our ILN transaction. This compares with expenses of $26 million in the first quarter, which included $1.6 million of costs related to the amendment of our term loan and the ILN. Adjusting for these financing related costs, expenses were up approximately 2% quarter-on-quarter.

On the same adjusted basis, our expense ratio in the second quarter declined to 66% compared with 73% in Q1. We currently expect full year operating expenses to be approximately $108 million. Additionally, we continue to expect that our expense level in the second half of 2017 and through 2018 will allow us to achieve our targeted combined ratios and returns. Claims expense was $1.4 million in the quarter. We had 249 notices of defaults in the primary book as of the end of the second quarter, up from 207 at the end of the first quarter. We paid 8 claims in the quarter compared to 4 claims paid in Q1 bringing ever to date claims paid to 23. Our second quarter loss ratio, defined as claims expense divided by premiums earned, was 3.6%. As we have said previously, 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 $6 million or $0.10 per diluted share. Excluding the ILN transaction costs, net income for the quarter was $8 million or $0.13 per diluted share. Effective tax rate for the quarter was 37%, which we expect will be our quarterly rate for the remainder of the year. At quarter end, cash and investments were $694 million, up from $671 million in the prior quarter. As of quarter-end, we have $57 million of cash and investments at the holding company. Book equity at the end of the second quarter was $495 million, equal to $8.27 per share, up from $484 million or $8.09 per share at the end of the first quarter. As of quarter end, total available assets under PMIERs grew to $485 million, which compares with risk-based required assets of $298 million. In summary, we had another solid financial performance. We are pleased with the growth and insurance-in-force and premiums as we layer on successive vintages of high-quality mortgage insurance. As we continue to manage risk and expenses, we expect that this layering effect and embedded operating leverage will continue to drive margin expansion and increasing returns on equity in coming quarters.

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

Thank you, Adam. We are excited about our strong performance in the second quarter, both in terms of our success with customers and the results we delivered for shareholders. We also were pleased to receive recognition last week from Standard & Poor's with affirmation of our investment grade rating for the insurance company and an upgrade in our outlook to positive. S&P cited the continued positive advancement of our business profile and capital strength as key drivers of the outlook upgrade. We like the current market dynamic and the economic backdrop, which continue to be favorable to our industry and to the fulfillment of our near and long-term financial goals. We are well-positioned to continue to win with our customers and drive volume from this embedded growth engine of recently activated accounts. To echo Adam's comments, we are also generating increasing leverage from the compounding effect of our insurance-in-force, which is on a trajectory to drive industry-leading growth in premiums and profits for many years to come.

With that, let's bring back the operator so we can take your questions.

(Operator Instructions) Our first question comes from the line of Bose George with KBW.

First one on the new insurance written that was a nice ramp-up from last quarter in new insurance written. I know companies are still reporting but do you think that you've grown market share in monthly new insurance written?

Well Bose, it's Brad. As you know we don't focus on market share we focus on actual quantum of new insurance we need to write in order to reach our financial objectives. So not everybody's reported. So I won't really hazard a guess on share there. But we're really, as I said in my remarks, we're very excited by the new customer activations we've had so far this year, and how those are going to ramp up nicely and add to our future NIW-generating capabilities going forward.

Okay. Fair enough. And then actually just on the insurance-in-force expectation. Can you just remind us, you guys have the mid-teens exit ROE target for next year. What range of insurance-in-force do you need to get to, to hit that?

Bose, obviously, it will depend on a range of factors including premium yields and obviously some other items that flow through the income statement. But roughly, we need to get to about $60 billion of insurance-in-force to see that mid-teens exit ROE.

Okay. And just one more. I think, Adam, you'd mentioned earlier in your prepared remarks, the expectation for expenses for this year. Can you just repeat that?

It was $108 million, approximately $108 million.

Okay. And that includes that $3.1 million (inaudible) this quarter as well, right?

That's correct.

Our next question comes from the line of Randy Binner, FBR.

Just Adam, could you repeat the -- your PMIER buffer? I just -- I didn't get that figure, how far over your minimum PMIER level are you for capital?

Randy, so at quarter-end our PMIERs available assets were $485 million and our required assets were $298 million so it translates to $187 million of a cushion.

Okay. And then the comments, I think from Brad in the call, was that you sign any policy development would be constructive. I guess I'll be curious what leads you to believe that and this would be specifically around PMIERs 2.0. This seems to be kind of the big question and I think, as you're aware, your affiliated companies, the other companies you compete with, have pushed back timing, I'm seeing an exposure draft there, to late 2017 and then there will be 180 day written notice period, we think. So just kind of curious on your thoughts on how that PMIERs 2.0 process might develop and what gives you optimism that it should be constructive?

So specifically, when I was referring to possible changes in terms of the regulatory environment, I was -- I had in mind of GSE reform and tax reform, both of which I think hold potential for some real positive developments for us but are very hard to pin down as to any details or timing. And I said the same on PMIERs, we are -- have the same expectation about timing as the rest of the industry does that we'll see some type of draft around the end of this year and the new rules won't be effective till the end of next year. So as far as I know, nobody's seen any details. So impossible to say whether it's positive or negative or neutral because there simply hasn't been anything exposed.

Do you have any update on how FHA is competing in the market or if that's changed at all since we last -- spoke last quarter?

Well I think that also goes back to -- why I've said possible reforms will be constructive because I think based on my meetings I've had recently in Washington, I think there is a real willingness on the part of policymakers to take a look at the role of the FHA and ensure that it's appropriate in light of the programs that they offer in loan sides and that type of thing. So I know that a number of people who will be heavily involved in GSE reform, when that gets taken up, have indicated the thinking that it makes sense to consider the role of the FHA. At the same time, we're considering new rules for Fannie Mae and Freddie Mac, and that they'll be looking at the entirety of the government involvement in the mortgage market and the fact that we, as a important source of permanent private capital there, we think we are very well-positioned in any kind of reform discussions that may take place.

Our next question comes from the line of Mackenzie Aron with Zelman & Associates.

I guess just a follow-up on the capital and to make sure that the comments last quarter are still consistent. Is the expectation that reinsurance will still be used sometime in 2018 to (inaudible) the growth, and assuming that's the case, what's the approximate impact assuming at the similar cost of capital and the net yield?

Yes, Mackenzie, that is still the expectation. I think more broadly speaking before we get into the anticipated impact. It's our goal to ensure that we always have enough capital to satisfy our regulatory needs. And that we're always in a position to be a strong counterparty for our customers. In terms of the timing and which market within the reinsurance world we choose to tap into, honestly, that will depend upon the development of our portfolio and success that we are having translating activations into NIW flow. But we've had great success so far in translating activations through the NIW flow and also in terms of establishing access to both the quota share market and the ILN market. We would expect that, if and when we do choose to go back to either of those markets, and it may be both, it maybe one or the other that cost will be somewhat in line with our most recent deals.

Okay, that's great. And then I guess just a bigger picture one, Brad, for you. Just interested in what you're seeing from a demand-side in term of the mix of business, seeing the 95% LTV's continuing to take share. What are you seeing from a customer demand perspective. Do you think that FHA is giving up some of that volume or is it really growing the pie?

So Mackenzie, we're seeing some migration to some of the higher LTV loans. And as you can see, we saw a modest migration in our average FICO during the quarter. So I view those as really healthy things because I think that it indicates that the conventional market is less constrained than it has been recently. And I haven't really analyzed to the extent to determine whether that's actually been caused by a pullback at the FHA, but my sense is it's not. It's just some of the natural migration and preferences developing on the part of our customers to do more conventional lending relative to the amount of government lending they do.

Our next question comes from the line of Geoffrey Dunn with Dowling & Partners.

Adam, I just want to make sure, on your reinsurance disclosure, when you're citing $11.5 million of ceded premium earned. Is that gross or net of the profit commission?

That is gross of the profit commission. In the queue we disclosed the profit commission which was just a touch above $6.5 million.

Right. And can you segregate the QSR versus the ILS premium running through that $11.5 million?

Yes. So in fact the $11.5 million is entirely the quota-share. The ILN is a separate amount of just a touch under $1.4 million for the quarter.

Okay. So the disclosure on the press release is just the QSR and then we have, what do you say, $1.5 million on top of that?

It's just a touch under $1.4 million.

$1.4 million, okay. All right. And then with respect to the tax rate, what's get it settling down closer to 37%?

I'm sorry Geoff, could you repeat that?

The tax rate. What's driving it closer to 37% for you?

This is just a quirk to a new accounting standard that's rolled out for the treatment of restricted stock. When we award restricted stock in the first -- and we're on a year-end bonus cycle, so the majority of our restricted shares get awarded. And also vest in the first quarter. That drives down the effective tax rate in the first quarter significantly below 35%. What you then see through the remainder of the year, is a effective tax rate that is north of 35%. Such that on an overall full year basis, we are at 35%. And so the 37% this quarter and the 37% that we expect to see roughly through year-end is simply to bring the overall effective tax rate for 2017 to 35%. We'd expect a similar rhythm to happen in 2018 and going forward.

Our next question comes from the line of Philip Stefano with Deutsche Bank.

In thinking about a new insurance -- and maybe it's a market share question asked a little bit differently, but I'm not trying to breach that term. When we think about the pressure from the singles business shrinking. Does the overall NIW outlook look better in the second half as we lap the actions on taking down singles that started to happen in the second half '16?

Yes. As we said in the prepared remarks, we're very excited about where we are and how we're positioned for the second half of this year. With significant number of new customer activations in the first half, many of those are just starting to produce significant amounts of NIW and as they're given some time to season, our track record has been -- those relationships grow into very meaningful shares of our customers business. So I think that's going to be a real strong growth driver for the second half and beyond.

And Brad, is there anything or any way you can help us qualitatively think about what the growth from new business starting to flow to meaningful looks like? I mean presumably expect it gets slowly opens with time. Any thoughts around that will be helpful?

So well, maybe Adam will give you some more specific. But I think of it, when we look back a year or 2 at customer activations and how we started and how we've ramped up. Overtime, that is producing us into that, I know we don't talk about share but it's double-digit share usually after, given some time for the relationship to mature. And so every customer is different, everyone will ramp up at a different rate so it's very difficult to generalize. But I do know that once you get that first NIW with a given customer, there is a lot more to be had in the future and it depends on doing a great job for them and so far we've been able to do that.

Yes. So I'd echo that, which is -- we have a strong track record of converting activations and new opportunities into real NIW flow over a pretty short timeframe. But as Brad said, every customer is different in both how we win their business and by extension, the pace of that ramp-up. We do track internally, it's not something that we disclose but rest assured, we do monitor how activations in prior periods are translating into NIW flow in subsequent periods. And one of the things we take comfort in is that we do have a track record that as those new accounts are activated and then as you roll forward several quarters -- several years, they materialize into significant share. And so we would expect that over time those new activations that we have today will grow to represent what we call a representative share for us relative to the broader market that we currently access. Thinking about it in simplistic terms, although we don't talk about share today overall, pick the number that you want to assume, do we have a 7% or north market share. But what does that actually mean in terms of the market that we are tapping into today, it's something significantly in excess of that 7% or so percent share. When we layer on new activated accounts, we would expect to achieve the same penetration rate with those accounts, and that translates to growth in our overall market presence.

No. I understood looking forward the thing like growth coming through and (inaudible) the impact (inaudible). It feels like the guidance for the (inaudible) for the year is largely a reiteration of the last guidance we got. But I think the commentary at the times was that we shouldn't expect to see any significant growth going forward. Anything you can point us to from the operating expenses and thinking about that as we go to '17 -- '18 and '19 and start to get these efficiencies from scale? Do operating expenses grow in part with inflation? Is there some investments that may be drive it ahead of that? Anything you can help us through with that perspective?

Sure. Okay, it’s too early to provide you with an indication. But what we would expect is to see our combined ratio continue to trend down in a significant way. We're expecting a loss ratio, as I said, to remain quite modest for the foreseeable future. And the efficiencies that we'll see from a fixed expense base and the inherent operating leverage will translate through. That said, we do expect to be making some investments in our people and systems to support the continued development of our franchise. And in that context, we're always mindful about maximizing our operating leverage and we do expect that you'll see revenue growth that far outpaces our expense growth next year and that will drive the combined ratio. In terms of a bit of a spear, for next year we don't -- it's just too early to give you any indication of a hard and fast number or range. But it's probably useful to note a few items. One, normal expense inflation will tend to run about 2% to 3% per year. We're growing our business, right? That's our key focus is to grow NIW and grow our insurance-in-force in a high-quality way. And although the majority, the large majority of our expenses are fixed, we do have certain variable costs. So as our NIW grows in 2018, we would expect to see a modest uptick in those production-related variable costs. In that context, that we will see modest growth, we would expect in 2018. But importantly, the statements that both Brad and I have made about ROE targets, achieving combined ratio targets and the timing as to how those will develop, already contemplate all of that from an expense dynamic standpoint.

I'm showing no further questions at this time. I would now like to turn the call back over to management for any further remarks.

So we thank you for joining us on the call today. We will be participating in the Susquehanna Conference in New York on August 10, and we hope to see you there.

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