NMI Holdings, Inc. (NMIH) Q4 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the NMI Holdings Fourth Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference maybe recorded. I’d now like to introduce your host for today’s conference, Mr. John Swenson of National MI. Sir, please go ahead.

Thanks you operator. Good afternoon and welcome to the 2016 fourth 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 fourth quarter and year 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 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 the call over to Brad Shuster.

Good afternoon everyone. I'm very pleased to report that in the fourth quarter of 2016 we once again delivered record performance in insurance-in-force, premiums earned and pretax income. We also continued to shift the mix of our NIW to align with the long-term industry averages achieving a 75% mix of monthly product in the fourth quarter. This fulfilled a key 2016 goal. By these most important metrics, 2016 was a great year and we believe we are set up for an even stronger 2017. We want to thank our customers, employees, business partners and shareholders for helping to make this happen. As we have said previously, we are focused on achieving higher returns which for us means three things. First, we build high quality relationships with customers where our customer service and reliability as a counterparty are valued. We added 167 new customers in 2016, growing our customer base by 17%. Second, we are committed to managing expenses in a way that supports our growth and our long-term vision for efficiency and returns. In 2016, we more than doubled insurance-in-force, policies-in-force and premiums earned, while increasing operating expenses by only 16%. And third, we believe we have a superior approach to managing risk as we have underwritten or conducted a post closure view on roughly 85% of our portfolio. We believe this is far more than any other mortgage insurer. This practice was a fundamental principle when we started the company. It gives us a better understanding of the loans in our portfolio, enabled us to offer 12-month rescission relief and we believe ultimately will lead to better loss performance and far better customer relations over a full credit cycle. Our strong execution is evident in our increasing margins and operating leverage. When we compare our performance in the second half of 2016 with the first half of the year, 75% of our incremental revenues dropped through to underwriting profit. We expect this powerful operating leverage to drive lower combined ratios and higher returns in the next several years. Assuming we continue to have a healthy origination market, we believe we can achieve our goal of mid teens return on equity within two years. We currently are targeting return on equity of approximately 10% by the end of 2017 and mid teens return on equity by the end of 2018. Now I have a few comments on the market. The sharp back up in rates that occurred after the presidential election did slowdown refinance activity. This was evident in our mix of commitments which declined to 17% refinance in January. This is down from roughly 25% for most of 2016. Although rates have leveled off recently, they are still the highest we have seen since mid-2015 and are likely to be a headwind for refinance activity this year. Changes in refinance activity are less impactful to the size of the private mortgage insurance market. Only about 5% of refinancing transactions carry mortgage insurance while the purchase market has roughly 20% penetration of mortgage insurance. The purchase market is generally less sensitive to rates and is driven primarily by job growth and household formation. We continue to believe that there is significant pent up demand among millennials and other potential first-time homebuyers and that we will see a healthy purchase market in 2017 and beyond even at higher rates. With the trends in refinance and purchase mortgage origination pushing the market in different directions, it's too early to forecast this year's private mortgage insurance market with any precision. What we can’t say is that regardless of the market size we are targeting industry leading growth in insurance-in-force this year. Regarding recent government developments, we are pleased to see increased attention on the FHA and its role in the low-down payment housing market. We are hopeful that the new administration and Congress will refocus the FHA on its primary mission which is subsidizing affordable housing for borrowers with lower credit scores and smaller loan balances. We strongly believe the FHA should not be providing government subsidies to more credit worthy borrowers especially those with higher loan balances which exceed $600,000 in some markets. With the new administration, we are again hearing talk of potential GSC reform. Although potential reforms would likely be decided and implemented over a period of multiple years, we are encouraged by the current dialog in Washington. Any serious reform proposal today has included a prominent role for private mortgage insurance to take a first loss position in front of taxpayer exposure. We are confident that any new proposals will maintain private mortgage insurance as a critical pillar in housing finance reform and we are well positioned to take a leadership role in any future structure. The new administration and Congress have set a course to adjust the corporate tax structure. Clearly a lower tax rate would benefit all American companies and we believe it would be especially beneficial to companies with high pretax margins such as National MI. Reform could also eliminate the current tax advantage for non-US insurers potentially leveling the playing field for domestic insurers. Finally, we are pleased to begin the year with one fewer competitor in the industry. As customers begin to adjust the diversification of their counterparty risk, we are well positioned to take on more of their business. In summary I am very proud of our performance in the fourth quarter and for the full year. We are excited about our growing operating leverage and returns profile which is a realization of our founding vision. With that let me turn it over to Glenn Farrell.

Thank you Brad, and good afternoon everyone. I'm pleased to share with you our financial results for the fourth quarter and full-year 2016. As Brad mentioned, we had a great fourth quarter and it allowed us to end the year with record numbers in our most important metrics of performance. Primary insurance-in-force at quarter end grew to $32.2 billion, up nearly 4 billion or 14% from 28.2 billion at the end of the third quarter and more than double where we were at the end of last year. Premiums earned for the quarter were $32.8 million, up from 31.8 million in the prior quarter. Annualized premium yield for our primary book in the quarter was 44 basis points and includes the impact of a full quarter of reinsurance. As a reminder, our reinsurance program commenced last September and as a result we saw only one-month of impact from reinsurance in the third quarter results. Excluding the impact of reinsurance, premium yield of 48 basis points was essentially flat quarter over quarter. In the fourth quarter, we continued to shift our mix of NIW to monthly product. Monthlies represented 75% of total NIW for the quarter, up 71% in Q3 and 45% in the fourth quarter of 2015. In Q4, monthly NIW volume was up 92% compared with the fourth quarter of 2015. Single Premium NIW was down 21% versus the prior quarter and down 47% from the prior year. This is consistent with our objective of shifting our NIW and insurance-in-force mix to mirror the long-term industry average. And the primary insurance-in-force at year-end was 60% monthly, a significant increase over the 47% mix of monthly we had as of the end of 2015. In terms of purchase refinance mix, in the fourth quarter, purchase represented 72% of NIW with refinance 28%. This compares with a 75/25 mix in the third quarter. As Brad mentioned, Q4 NIW was little affected by the increase in interest rates in November, but we are now seeing refinance mix come down in our commitments. Total policies-in-force as of the end of the quarter increased to 135,000, up 13% from 119,000 in the prior quarter. Weighted average of FICO of primary risk-in-force as of the end of Q4 was 753, roughly flat with the prior quarter. Overall persistency in the primary book was 81% also roughly flat with 82% in Q3. Investment income in the fourth quarter was $3.6 million, up from $3.5 million in the prior quarter. And total revenues in the fourth quarter were 36.6 million, up 3% from 35.5 million in the prior quarter. Underwriting and operating expenses in the fourth quarter were 23.3 million, including share-based compensation expense of $1.8 million. This compares with underwriting and operating expenses of 24 million, including 1.8 million of share-based compensation in the prior quarter. For the year, gross expenses of 95 million before the impact of the ceding commission came in slightly better than our guidance of 96 million. Net of the ceding commission, expenses of 93 million were at the low end of the guidance range we provided last quarter. We had 179 notices of delinquency in the primary book as of the end of the fourth quarter, up from 115 at the end of the prior quarter. We recorded $800,000 for claims expense and there were three paid claims in the quarter. Our fourth 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 income for the fourth quarter was $61.6 million or $1.01 per diluted share. This includes a $54.5 million tax benefit, resulting from the reversal of the valuation allowance on our deferred tax asset or DTA. We expect to provide for taxes at an annual rate of 35%. However, we will be paying only minimal cash income tax for the next couple of years. In the fourth quarter, we saw a full quarter’s impact of reinsurance, which reduced pretax income by $2.2 million. Results for the quarter also include a pretax non-cash charge of $1.7 million related to the change in the fair value of our warrant liability, resulting from the increase in our stock price. At quarter end, cash and investments were $677 million, down from $686 million in the prior quarter. The decline primarily relates to unrealized losses on the portfolio due to the November spike in interest rates and offset by cash generated from operations. As of quarter end, we had 74 million of cash and investments in the holding company. And in 2016, we generated $71.9 million of cash from operations, which compares with 41.5 million in 2015. Book equity as of the end of the fourth quarter was 477 million, equal to $8.07 per share, which compares with 430 million or $7.28 per share at the end of the third quarter. The large increase in book value relates primarily to the reversal of the DTA. As of quarter end, total available assets under PMIERs were $454 million, which compares with risk based required assets of 367 million. And with regard to consolidated capital planning, earlier this month, we amended our term loan at the holding company, which reduced the interest rate by 75 basis points from LIBOR plus 750 to LIBOR plus 675. We also extended the maturity of the loan by one year to November of 2019. With regard to funding growth in the primary insurance company, we continue to believe that reinsurance is our most attractive capital alternative to support growth in insurance in force. And with that, let me now turn it back over to Brad for his closing remarks.

Thank you, Glenn. It is clear that 2016 was a great year for National MI. We achieved profitability, more than doubled insurance in force and premiums earned, negotiated a reinsurance treaty to support our growth and solidify our position as a strong returns oriented mortgage insurance provider. We are very pleased with these results. Looking ahead, we believe 2017 will be an even better year, as we continue to execute on the business model, layering on more high quality insurance in force and driving strong revenue growth, while prudently managing expenses and risk. With our largely fixed expense base, we believe that the operating leverage we have already demonstrated is going to drive increasing profits and returns throughout the year. We look forward to reporting those results to you as the year unfolds. Finally, you all should have seen our recent announcement that Glenn Farrell will be retiring in July of this year. I want to acknowledge Glenn and what he has meant to the company over the past two years. Glenn is a great personal friend. He came out of retirement to join us at an important time in our journey, as we were moving from a start up to a mature company. He helped to bring world-class controls and professionalism into what was already a strong finance function. He also brought a unique and valuable perspective to our management team based on his decades of business experience. Glenn will be in the CFO role until May, which is when we will welcome Adam Pollitzer, our new CFO. Glenn, you are a great leader and a valued friend and we are so grateful for your contributions to National MI. You all will hear from Glenn again on our next conference call. Now, a little about Adam Pollitzer. Adam comes to us from JP Morgan where he was a Managing Director on their insurance coverage team. He knows the mortgage insurance sector very well and he comes to us with a deep understanding of the dynamics in our industry. He is a smart and talented executive and we are excited to have him join our team. I believe our ability to attract someone like Adam is a reflection of our opportunity to continue to grow and create value for all of our stakeholders. With that, let's bring the operator back, so we can take your questions.

[Operator Instructions] The first question comes from the line of Mackenzie Aron with Zelman & Associates.

Thanks. First question, on the premium yield, can you just help remind us as to where we should be expecting that to go over the next year, given the impact of reinsurance and potentially any volatility around the single premium line?

Yeah. Mackenzie, this is Glenn. I think we’ve stated earlier that that should be trending upwards towards the 50 basis point before reinsurance. The reinsurance does take about five basis points off of the gross premium earned number. So I would expect it to trend towards the 45 basis point level.

Okay, great. And then on the operating expenses, just any way to be thinking about the year-over-year growth that we could see in ‘17?

I don't think that we're going to be giving guidance per se, but I think we will expect to see some increases as we continue to grow. And as you saw in or you heard in the script, we were up about 16% year-over-year, not anticipating that sort of growth, but it is going to be moving upward.

Your next question comes from Randy Binner, FBR.

Hey, thank you. I guess I'd like to ask expense ratio improvement potential in 2017 and I think it's, the ROE guidance you gave us is a helpful way to think about it. But can you kind of dimension for us a little bit how you think about that rate of improvement in ’17 and maybe ‘18. And I guess maybe another way of asking it is, I mean is the fixed expense base really fixed at this point and we can just model that down based on how the earned premium comes in?

Hey, Randy. It’s Glenn. I think the expense ratio you saw come down significantly in 2016. We still will continue to see that driven down. With the ROE kind of targets that we've laid out for you, I think that kind of drives based on where we are with the premiums earned versus of what the overall combined ratio would be and then also with the low loss ratio we do expect that that expense ratio to be coming down significantly.

Thank you for that. And then on the FHA, I think that their December data came out and there was an elevation or a spike in losses there. Do you have any view on that data? We've just, I think, come to see a very benign loss environment for MI and for housing in general, it's very credit positive, but that was a little bit of a blip. So don't know if you have any comment there and do you think that may have affected the new administration's decision to reverse the proposed 25 basis point rate cut or do you think that that decision was more based on kind of the politics of preserving the private market?

Randy, this is Brad. No, we don’t have any comment on their results that you were referring to, but I do think that the decision to act by the new administration was very sound. And I’m very encouraged by the potential to again reexamine the mission of the FHA and to get it focus more squarely on lower income buyers with lower value mortgages. So we're very encouraged as things develop here, but we’ll monitor it carefully.

[Operator Instructions] Your next question comes from the line of Bose George with KBW.

Hey, guys. Good afternoon. Let me just throw one more on future expenses. In terms of your guidance, when you hit the mid-teens ROE by the end of 2018, what sort of combined ratio does that envision?

Bose, it's John. So we’re thinking something around 50% at that point for a combined ratio.

Okay, great. And I guess your earlier commentary was on the loss ratio presumably is that that will still be a very important number at that point?

Sorry, one more time Bose.

Just on the loss ratios, a piece of that, I guess you did say earlier that the loss ratio will be a very small part of, it will be a very small number still through 2018?

Yeah. I think what we said was low to mid-single digits. So yes, that will be a small part of that 50%.

Okay. Great. Thanks. And then actually what was the dollar amount of premium that you recognized from cancellation of singles this quarter and can you just remind us where that was last quarter?

It was about approximately $5 million, both in Q3 as well as Q4, Bose.

I'm showing no further questions in queue at this time. I’d like to turn the call back to management for any closing remarks.

Okay. We thank you for joining us on the call today and we appreciate your support. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone, have a great day.