NMI Holdings, Inc. (NMIH) Q1 2017 Earnings Report, Transcript and Summary

Good afternoon ladies and gentlemen and welcome to the NMI Holdings Inc First Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host John Swenson. Please go ahead.

Thanks you. Good afternoon and welcome to the 2017 first quarter conference call for National MI. I’m John Swenson, Vice President of Investor Relations and Treasury. Joining us on the call today are Brad Shuster, Chairman and CEO; Glenn Farrell, our Chief Accounting Officer; Adam Pollitzer, our new CFO; and Rob Fore, our Controller. Financial results for the first quarter were released after the close of the market today. The press release may be accessed on NMI’s website which is that 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. Brad?

Thank you John and good afternoon everyone. We had another great quarter at National MI delivering record financial results and continuing to build our franchise with an expanding and more diverse customer base, and a high quality and growing portfolio of insurance-in-force. Primary insurance-in-force of $35 billion was up 87% over the first quarter of last year. We are continuing to grow insurance-in-force at a faster rate than anyone in the industry. Premiums earned for the quarter increased 68% over the first quarter last year to a record $33.2 million. We continued our strong momentum in expanding our business with existing customers and adding new customers. NIW of monthly product was up 16% year-over-year and represent more than 80% of our production in the quarter. We also signed 46 new customers to master policies in the first quarter. Over the past few months, we've strengthened our capital position and continue to reduce our cost of capital. In February, we amended our term loan, obtaining a lower interest rate and an additional year of maturity to November 2019. We were pleased that our lender group recognized our significant strides today and the strength of our outlook. In March, Moody's upgraded our insurance company and the holding company citing our progression to profitability and capital flexibility as drivers of the upgrade. In April, we completed the issuance of our first insurance-linked notes or ILN. This innovative capital markets vehicle provider’s reinsurance against adverse loss development, significantly strengthening our financial profile. We also anticipate that it will provide approximately $200 million of capital relief, which we will use to write new business. This structure effectively caps our exposure to losses in an extreme adverse scenario such as financial crisis. Based on our internal modeling and the unlikely event the great recession repeated itself tomorrow, our reinsurance covers would cap and net loss ratio at 50% on all of our risk written proved 2016. Because this type of risk is remote, we sought to cover it with a low-cost solution, bringing up significant capital to write new business. We estimate that the after-tax cost of capital for the ILN is approximately 3%. We believe the strong reception to this offering is a testament to the high credit quality of our originations and our superior underwriting model. Having initiated a quota share reinsurance program with a panel of reinsurers in 2016, we now have two attractive low cost channels for reinsuring our risk and supporting growth in insurance-in-force. As we discussed on our February call, the origination market was impacted by the backup in interest rates post-election. In the first quarter, this drove a greater than seasonal market decline relative to the fourth quarter of 2016, especially in refinance originations. That said, our first quarter monthly product application volume for purchase mortgages was up 19% over the first quarter last year and the growth trend continued in April. With good job and wage growth, we believe the fundamentals are in place for a healthy purchase market in 2017. Also, as rates have moderated over the past month, we could see a rebound in refinance activity, although likely not to the levels we saw last year. On a government and regulatory front, we welcome the discussion of corporate tax reform which would help to level the playing field for domestic insurers competing with offshore providers. We are also pleased to see the nomination of Pamela Hughes Patenaude as HUD Deputy Secretary. She has a strong background in housing policy and has demonstrated support for putting private capital in front of tax payer risk. We are hopeful that among other things, she will examine the role of the FHA and potentially refocus FHA on its primary mission of home affordability for lower income borrowers. The overall pricing environment for mortgage insurance continues to be stable and constructive to mid-teens returns. Lender paid singles have always been the smallest, but also the most price competitive segment of the market. Over the past year pricing in singles has generally trended up as market players have adjusted to P. Myers. We were the first mortgage insurer to introduce true risk based pricing early last year, and we believe we are a leader in bringing more transparency to the pricing discussion. In our experience, the vast majority of the market prefers the transparency and predictability of a rate card because it is consistent with their loan origination process. We continue to focus our sales efforts on growing with these customers, which we believe over the long-term yields more sustainable and durable customer relationships and market share. The success of our approach is validated by our demonstrated ability to continue to win new customers at a rapid pace and to grow our business with existing customers. Our disciplined approach to customer development and product mix is fundamental to how we manage returns. The other components of return that we manage daily are risk and expenses. We have a superior approach to managing risk as we have underwritten or conducted a post close review on approximately 85% of our portfolio. This is far more than any other mortgage insurer and it was a founding principle when we started the company. As an insurance company, we believe it is critically important to underwrite the risk we are taking and to provide certainty of coverage to our policy holders. The breadth of our underwriting also gives us high confidence in our long run loss assumption and the single digit loss ratios that we expect over the next several years. To facilitate our underwriting mission, we have developed a state of the art IT platform that we believe gives us the most efficient underwriting and archiving capability in the industry. We believe the investment we are making in risk management ultimately will lead to better loss performance and far better customer relations over a full credit cycle. We also received indication that our underwriting model contributed to the over subscription and tight execution of a recent ILN transaction. On expenses, we continue to manage in a way that supports our rapid growth and our near-term goal of achieving a 50% combined ratio. Adjusted for financing related cost in the first quarter, our operating expenses were up only 7% over the last year, in line with our expectations, despite our nearly doubling of policies in force over the same time frame. In summary, we are pleased with our performance in the first quarter, both in the results we delivered and the foundation we lay to support future growth. I will be back with some closing remarks after Glenn provides more detail on the financial results. Glenn?

Thank you Brad, and good afternoon everyone. I'm pleased to share the financial results for the first quarter 2017. Primary insurance-in-force at quarter end grew to $34.8 billion, up nearly $2.6 billion or 8% from $32.2 billion at the end of the fourth quarter and up 87% from the first quarter of 2016. Premiums earned for the quarter were $33.2 million, up from $32.8 million in the prior quarter. We earned $2.5 million from cancellation of single premium policies, down from 5.1 million in Q4 and consistent with the drop-in refinance activity. Excluding the effect of cancellations, premium earned was up approximately 11% quarter on quarter. Before the effect of reinsurance, premium yield in the first quarter was 44 basis points, down from 48 basis points in the prior quarter. The decline is attributable to the reduced cancellations in the quarter. After reinsurance, reported net premium yield was 40 basis points down from 44 basis points in the prior quarter. Excluding the effect of cancellations, we expect gross premium yield will rebound in the second quarter, driven primarily by higher yield on monthly premium policies, and the amortization schedule of our singles book. We also have seen increased cancellation activity in April. If that trend continues and recent interest rate suggest that they could, we expect gross premium yield will return to the high 40 basis points range in the second quarter. After reinsurance, including seeded premium related to the insurance link notes, we expect that net yield will be approximately 40 basis points. It is important to see premium yield in the context of target returns as it is highly correlated to credit quality, expected losses and the related capital charges. We have a high-quality book and therefore have relatively lower premium rates, but also low expected loss ratios and relatively low capital charges. With the added consideration that the book is reinsured, these yields are consistent with our expectations, and our mid teens return targets. The weighted average rate on NIW across all products in the first quarter was 50 basis points, up from 46 basis points in Q4. And the weighted average rate on monthly product in Q1 was 54 basis points, up from 52 basis points in the fourth quarter. In the first quarter, monthly product represented 81% of total NIW, up from 75% in Q4 2016 and up from 59% in the first quarter of 2016. This mirrors what we believe was the industry mix in Q1 and represents the achievement of our strategic goal was regard to product mix. As Brad mentioned in Q1 2017 monthly NIW volume was up 60% compared with first quarter of 2016. And consistent with our strategic mix objective, single premium NIW was down 50% versus the prior quarter, and down 62% from the prior year. Primary insurance-in-force at quarter end was 62% monthly, a significant increase over the 50% mix of monthly as of the end of Q1 2016. In terms of purchase refinance mix, in the first quarter, purchase represented 84% of NIW, with refinance 16%. This compares with a 72/28 mix in the fourth quarter of 2016. Total policies-in-force as of the end of the quarter increased to $146,000, up 8% from $135,000 in the prior quarter. And run off for the quarter was approximately 3% with 12-month persistency in the primary book at 81.3%, roughly flat with 80.7% in Q4 2016. The weighted average FICO of primary risk-in-force as of the end of Q1 was 753, essentially flat with the prior quarter. Investment income in the first quarter was $3.8 million, up from $3.6 million in the prior quarter, and total revenues in the first quarter were $37.1 million, up from $36.6 million in Q4. Underwriting and operating expenses in the first quarter were $26 million, which compares with $23.3 million in the prior quarter. In the first quarter, we recognized approximately 1.6 million of fees and expenses related to repricing of our term loan and the insurance linked note transaction. Excluding these, expenses were up approximately 5% over the prior quarter and 7% over the first quarter last year. Note that in this coming second quarter, we expect to recognize an additional 3 million of upfront fees related to the closing of the RON [ph] transaction. This is different from our quota share reinsurance where these costs are amortized. We had 207 notices of delinquency in the primary book as of the end of the first quarter, up from 179 at the end of the prior quarter. We had four paid claims in the quarter, which compares with three paid claims in Q4, bringing ever to date claims paid to 15. Our first quarter loss ratio, defined as claims expense divided by premiums earned was 2%. As mentioned last quarter, we expect our loss ratios over the next several years to be in the low to mid-single digits. Now moving to the bottom-line. Net income for the first quarter was $5.5 million or $0.09 per diluted share. This includes the impact of the $1.6 million of financing cost, as well as $0.2 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 $671 million, down from $677 million in the prior quarter, attributable to the payout of certain accrued expenses. As of quarter end, we had $59 million of cash and investments in the holding company. Book equity as of the end of the first quarter was $484 million, equal to $8.09 per share, up from $476 million or $8.04 per share at the end of 2016. As of quarter end, total available assets under PMIERs grew to $467 million, which compares with risk based required assets of $399 million. With that, let me now turn it back over to Brad for his closing remarks.

Thank you, Glenn. We had a great first quarter and show solid year-over-year increases in the key metrics that we managed. It is especially satisfying that we continue to grow in monthly product, which reflects our continued strategic focus on transitioning the mix of our insured portfolio. We feel good about the market dynamic and our strong market position heading into the critical part of the calendar for purchase market demand. We also completed a capital markets transaction that will support our ability to meet that demand while protecting policy holders and shareholders from adverse loss development. We are well positioned to execute on our vision for expanding margins, and increasing returns throughout the year, and are looking forward to reporting our progress toward those goals on our next call. In closing, I want to again acknowledge the contributions of Glenn Farrell as the first quarter was his last full quarter as CFO. We will have the benefit of his continued engagement as our Chief Accounting Officer through July. Earlier this week Adam Politer officially joined as our new CFO and we look forward to his full participation on our second quarter call. With that let's bring back the operator so we can take your questions.

[Operator Instructions] And our first question comes from the line of Randy Binner from FBR. Your line is open.

Hey thanks good evening. I guess the first one is just picking up on that comment about the 17% increase in purchase, and that continued to grow in April. Is that seasonally adjusted, that 17% increase, you quoted, because the book is so much bigger than it was last year. It's not clear to me if that's just kind of growth or if that’s kind of a seasonally adjusted growth number.

Randy it’s John. One of the reasons we quoted the year-over-year was to try to take the seasonality out of it a little bit, and it was 19% growth in dollar volume purchase mortgages.

19% okay, 19%. Okay great, and then on the premium yield comments, I think you said that if cancellations increase, you could expect to see that back in the high 40 basis point range in the second quarter. I just want to make sure that was correct, and if there was anything else that might net it down to the low 40s.

No, Randy this is Glenn. I think yes, if cancellations do increase, certainly the average yield will creep up, but I think we're also saying that we expect that it will creep up to the mid-40s growth for the next, excuse me, high 40s for the gross in the next quarter, which when you adjust for the reinsurance transaction, it would bring you down to mid-40s.

So Randy, it's John. Just to maybe clarify a little bit. So the -- we expect gross premium yield to be in the high 40s in Q2. Most of that is organic reasons. It’s higher yields on monthlies it’s getting into better part of the amortization schedule on singles. Only about a point or so of improvement is what we're thinking is coming out of cancellations. Most of that is just organic if you will. But then after the effective reinsurance we're thinking right around 40 will be the net that we show.

And then, then on the fees for the ILS deal, that's another $3 million in that. Would that maybe the end of the upfront cost of the deal? And have you -- do you have any way to help us think about kind of the maybe often and economic benefit that comes from the ability to have 200 million of capital really?

This is Brad, Randy. That will be the full recognition of the cost to the ILN, will be in the quarter and as Glenn mentioned, that differs from reinsurance accounting where you advertise those costs over the.

They were affectively amortized through the brokers.

Brokers yes, but I mean the economic benefit is that, we have freed up substantial amount of capital under PMIERs that will go and write new business. And that is as we said a roughly 3% estimated cost of capital. So the economic advantages are pretty evident there.

And Randy, this is where you were getting to. It's without the need either to add leverage or to issue equity.

Your next question comes from the line of Bose George from KBW. Your line is open.

Just wanted to go back again to the premium comment. So if cancellations remains unchanged, the premium from that is $2.5 million, the net number you reported this quarter, the 40 basis points, so are you guys saying that the 40 goes to something like 45 next quarter?

The growth climbs up to that range but then -- when you back off the reinsurance cost, you're down to the 40. We have an incremental amount of premiums ceded due to ILN transaction, Bose. And so that’s causing an additional reduction in the net premium yield.

Okay, and what's sort of the incremental impact of the ILN transactions on premiums?

In the first, we will have about 7 months of that effect in this year, and its approximately I believe about a $5 million after tax cost Bose, all in. And so on a premium basis I don’t think we’ve done that calculation. It's probably about 2 bps on the premium yield, 2 to 3 bps.

Okay, and than in just in terms of trajectory for the premium, so you guys reported a net 40 this quarter. You've said in the past and I guess you said it earlier, on the call as well that mid-40s is kind of the yearend target. Is that right?

That’s correct.

So on a net basis, next quarter you will be closer to 40 but it's -- you still get to sort of that 45 by year end on the net basis on the premium.

No, it's Glenn. So the 45 was where we were going to get to with just the quota share deal in place. And now that we also have the ILN it will be more like 40 is where we're going to bounce to in Q2 and where we think will be throughout the year.

Okay so the effective cost of the ILN is probably around 5 basis points?

Maybe 4.

And just actually just on the NIW, year-over-year it was down a reasonable amount, and the peers who reported seems to be kind up flat to up reasonable amount. Any thoughts on that? Was there any, do you think there was any share loss or any commentary there?

No. I think the NIW was driven by the growth that we had in the monthly premium product, offset by the decline in the single premium product, which is something we’ve been very upfront about and have indicated numerous accounts, it's been strategic goal for us. So I think, that’s the story of NIW. We feel very good about our market positioning and actually have number of significant sized new customers coming online this year.

Okay, great. And that makes sense. And actually just one more. In the past, you’ve guided basically 10 for spend ROE, exit ROE this year and ’15 with the end of next year. Are those numbers still good?

Yes Bose, that still what we’re trending toward, and that’s our goal, to try and approach double-digits as we exit the year, and then the sort of mid-teens next year.

Your next question comes from the line of Mackenzie Aron from Zelman & Associates. Your line is open.

Great. Thank you. I think just the main question I have is around, with this new ILN, the reinsurance that was already in place, can you just kind of walk through when will the company be sell funding in terms of new business and how does this new IL kind of bridge to gap relative to what was in place last quarter?

Mackenzie, it’s Glenn. This is, I think is another step in the processes that we committed to last year in saying that we were going to be using reinsurance to affect our growth and funding, the capital that we need as we grow. The actual self-funding is not probably on the near-term horizon. And so this ILN transaction is one that I think, we would have had to enter into some capital transaction, sometime during 2017. This will provide us an additional out of capital to probably sometime later in 2018. So there will be other needs for capital, but I think we would reiterate that we’re very pleased with this -- the flexibility afforded by this transaction as well as the quota share. So we anticipate doing other types of these transactions down the road.

Okay. That makes sense. Just to clarify, going forward on the P&L. So it’s only going to flow through with the 4 to 5 basis points impact on the premium yield and then the additional $3 million of the cost next quarter, but otherwise there won't be any other flow through. Is that right?

That’s correct. Yes, Mackenzie. But we do have --we'll have continuing ceded premiums associated with that. And then also, there will be certain months coming through, that we would get back from losses as well.

Okay. The loss rate. Okay. That’s all I had. Thank you.

Your next question comes from the line of Jeffery Dunn from NERF [ph]. Your line is open.

Thanks. Good evening. Obviously a lot of focus on premiums and premium yield. So can you just give the specific details of your reinsurance impact this quarter, the ceding commission, profit commission ceded or ceded written. And would you consider adding that to your press release from now on?

So Jeff rather than having you wait on the call until we find it, we'll be happy to provide that after, that's reported in the Q, correct? Which is out Jeff. The Q is out. So you should be able to find that. But we'll look at providing that detail in the press release going forward.

Great, and then I want to make sure I understand the economic impact of the ILS. Obviously the ceded premium impact on a go forward basis, there's not typically any ceding commission or anything like that, accompanying these type of deals, correct?

That's correct Jeff. It’s just a strict consideration as a ceded premium.

Okay and then, this 3 million cost in the second quarter, is that just banking fee type of stuff or is that something having to do with the economics of the transaction as well?

No it's a deal fee. So all deal fees setting up the reinsurer, the underwriters that sort of thing.

And with respect to the drop in the singles mix you have been moving that down. A drop from 25 to 18 is still a big drop. Did you back away from any particular client or the non-bank sector in general to cause that much of a shift in one quarter?

We've been pretty consistent at our approach to the singles market. So there has been a important initiative for us. So we’re very happy that we've kind of got to that target where we're at a mix that we expect will be very close to the industry average.

[Operator Instructions] And we have no further questions at this time, I’ll turn the call back over to the presenter.

So this is Brad. I want to thank you all for joining us on the call today. We will be presenting at the KBW financial conference in New York on June 1, and we hope to see you there. Thanks very much.

Thank you for your participation and have a wonderful day. You may now disconnect.