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NMI Holdings, Inc. (NMIH)

Q3 2017 Earnings Call· Wed, Nov 1, 2017

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Transcript

Operator

Operator

Good day, ladies and gentlemen and welcome to the NMI Holdings Third 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] I would now like to introduce your host for today's conference, Mr. John Swenson. Sir, you may begin.

John Swenson

Analyst

Thank you, Bruce, and good afternoon, everyone. Welcome to the 2017 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; 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.

Brad Shuster

Analyst

Thank you, John, and good afternoon, everyone. I'm pleased to report that in the third quarter, National MI delivered record financial results. We continue to build significant momentum with our customers and grow our high-quality portfolio of insurance-in-force. We achieved our record results, while maintaining our focus on prudently and proactively managing risk, product mix, expenses and capital. We wrote a record $6.1 billion of new high-quality mortgage insurance, up 21% over the second quarter. This included record monthly premium NIW of $4.8 billion, which was up 80% over the second quarter and up 60% over the third quarter of last year. Insurance-in-force of $43 billion was up 12% over the prior quarter, and up 53% over the third quarter last year. This is by far the fastest rate of growth of insurance-in-force in our industry. Net premiums earned for the quarter were a record $44.5 million, up 70% sequentially and up 40% over the third quarter of 2016. This top line growth drove a record pretax income of $19.5 million, up 105% sequentially on a reported basis, and up 55% after adjusting for ILN transaction costs in the second quarter. Pretax income was up more than threefold over the third quarter last year. We have delivered on our 2017 exit return on equity goal, a quarter early with a 9.8% return and continued to progress toward our goal of delivering mid-teen returns as we exit 2018. Book value at quarter-end was $511 million or $8.53 per share. Our strong financial performance in the third quarter is a direct result of the values upon which we founded the company, the team we have built and the strong execution our team has delivered for our customers over the past five years. As we look at our success, both over the long-term…

Adam Pollitzer

Analyst

Thank you, Brad, and good afternoon, everyone. As Brad mentioned, we had a record quarter. We achieved record NIW of $6.1 billion, and continued our rapid growth in high quality insurance-in-force. Premium yield continue to improve and we achieved record premiums earned of $44.5 million. Losses continued to be modest and expenses were flat quarter-on-quarter, which drove record underwriting ratios. And we achieved strong growth in net income and book value, delivering a nearly 10% annualized return on equity in the quarter. Now to the detailed results, primary insurance-in-force was $43.3 billion at quarter-end, up $4.7 billion, or 12%, from $38.6 billion at the end of the second quarter and up 53%, compared with the third quarter of 2016. As of quarter-end, monthly product represented 66% of our insurance-in-force, which compares with 64% as of the second quarter and 57% as of the third 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. Runoff rate in the quarter was 3.8%, up from 3.4% in the second quarter, reflecting the seasonal uptick in housing turnover. 12-month persistency in the primary book was 85.1%, up from 83.1% last quarter. Weighted average FICO of risk-in-force was 747, which compares with 749 as of the end of the second 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 $6.1 billion was up 21%, compared with the second quarter. The mix was 79% monthly product, which compares with 81% in the second quarter and 71% in the third quarter last year. Premiums earned for the quarter were $44.5 million, up 17% compared with $37.9 million…

Brad Shuster

Analyst

Thank you, Adam. We are excited about our record performance in the third quarter, both in terms of our success with customers and the results we delivered for shareholders. We believe the macro economic backdrop, healthy housing demand and long-term demographic trends are favorable for our industry, and to the achievement of our near-term and long-term financial goals. We are executing on our business plan and are well-positioned to continue to win with our customers and 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

Operator

[Operator Instructions] And our first question comes from the line of Phil Stefano from Deutsche Bank. Your line is now open.

Phil Stefano

Analyst

Yes. Thanks and good afternoon. So I was hoping you could talk a little bit about the trajectory for new customers has been relatively solid. How does that look as we look into the fourth quarter 2017 and 2018? Should we expect this trajectory to continue or are there pipes that are tied in with some new significant customers that you're thinking about? And then, how could we think about the growth from new customers combined with growth from current customers? Anything qualitatively could help us think about these things as the NIW continues to move forward.

Brad Shuster

Analyst

Sure. Thanks, Phil, this is Brad. So we continue to have a very nice pipeline of new customers coming on. It's – sometimes it's a little hard to pinpoint it to any particular quarter, but, generally, there is a number that we are expecting over the next several quarters. Some of them are quite significant. And then, once we get customers activated, we've had enough history now, as a company, to see how we are able to take that initial activation and then expose the customer to our level of service and create some real satisfaction there that we see migrating into significant wallet share with that particular lender given time. Again, it's difficult to predict the exact level of traction and exact quarters when you get your increase. But over time, once we've had a period of quarters to demonstrate to our customers what we are able to do, we see our traction growing.

Phil Stefano

Analyst

Is it fair to continue to think about, let's see, the flow of business continues to start relatively small with the new customers and picks up with time?

Brad Shuster

Analyst

Yes, that’s the general rule, is that you'll start with a relatively small allocation; then as you prove what you are able to do, it can ramp up and some organizations ramp you more quickly than others, but generally, it applies to all customers in that way.

Phil Stefano

Analyst

Okay. And one more for you. Just looking at the mix of NIW between monthly and singles, it feels like it's shifted to something that's historically more in line with the industry. It feels like at least in the past quarter to the peers are writing less singles they’re more in that 10% range? Is there a reason to think that the proportion you're writing is going to come down? Does the 80-20 still feel about right? Any thoughts you can help, guide us through there will be appreciated.

Brad Shuster

Analyst

Yes, Phil, we are still – at least the number we have seen so far, it still suggests kind of an 80-20 split. And so our performance for the last several quarters has been very much in line with that. We will bounce around a little bit, maybe from 85 level to a 75 level, but we expect to be somewhere in that range. We have not seen an overall shift as you described.

Phil Stefano

Analyst

As we look forward, the remix is largely completed.

Brad Shuster

Analyst

Yes, yes, for us perhaps it is. John?

John Swenson

Analyst

Also, not all the singles volumes is lender paid, there is a meaningful amount of singles volume that is borrower paid. So maybe that's what you're looking at when you look at the peers, is lender paid single.

Phil Stefano

Analyst

Understood. Understood. Okay. Well, thank you so much and best of luck with the rest of the year.

John Swenson

Analyst

Thank you.

Brad Shuster

Analyst

Thanks, Phil.

Operator

Operator

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

Bose George

Analyst

Hey, guys. Good afternoon. A couple for me. First, the average premium after a couple of basis points feels stronger than we've been looking for. Can you just point to drivers of the improvement quarter-over-quarter? And also, just can you talk about how you see that trending over time?

Adam Pollitzer

Analyst

Yes, sure, Bose, it’s Adam, I’ll take that. The increase that we achieved in the third quarter, that we saw in the third quarter was driven by a higher mix of monthly insurance-in-force overall in the portfolio and progressively higher rates on monthly NIW over the past few quarters. The other fees embedded in there, as we thought where we might be in Q3 versus where we actually came out, cancellation activity held a bit stronger later into the third quarter than we had anticipated. So while this is a modest impact, it was another component. As we look forward, we expect net yield at least in the fourth quarter will be in the range of 42 to 43 basis points with the variability within that rate band, primarily coming from cancellation activity. As we look toward next year, we’d expect to maintain roughly these levels, the 42 to 43 basis points, with some upside potential to that based one, on cancellation activity, and then the characteristics of the monthly portfolio itself.

Bose George

Analyst

Okay. Great, that’s helpful. I mean, do you think that your premium expectation has increased a little bit relative to when we spoke on the last call?

Adam Pollitzer

Analyst

Yes. Okay. I think on the last call, we are talking basis points here, but basis points on a large portfolio of notional has significant impact. So we are happy with how it's progressed. Where we're sitting today the guidance that we're providing 42 to 43, that probably is half a basis points to a basis points up from what we otherwise would have guided you, if w e had this particular conversation on the second quarter call.

Bose George

Analyst

Okay. Great, thanks. That’s helpful. And then, actually just going back to the comment you made on the share-based compensation. When we – just from a GAAP standpoint, does that mean for the fourth quarter you'll have the share-based comp, and that $1.8 million number you referred to?

Adam Pollitzer

Analyst

And so, Bose, I should clarify. That reference, the $1.8 million is not related to share-based compensation, it’s related to warrant reliability. So we have a warrant separate from share-based comp, where fluctuations for that warrant liability flow through our income statement because it's reflected on a liability basis versus on an equity basis. There is a nuance to the diluted EPS calculation for warrants that are accounted for on a liability basis, and in particular for those that are required to be settled on our share basis, which is the case for our warrants. Because we include the shares underpinning that warrant in our diluted count, we essentially back out the expense from the numerator when we're running our diluted EPS calculation. And so what we are focusing here on there is the diluted EPS impact. The $1.8 million of pre-tax GAAP expense will still flow through our GAAP income statement.

Bose George

Analyst

Okay. Great, that’s helpful. It’s just one more for me. Can you just remind us how much insurance-in-force you can still write based on the existing capital you have?

Adam Pollitzer

Analyst

We've got $139 million, call it, PMIERs cushion. It's no hard and fast number as for the dollar amount of insurance-in-force, that allows us to write. It's a significant – it gives us a significant amount of runway, well into 2018 before we need to think about supporting continued growth with accessing the markets.

Bose George

Analyst

Okay. Great, thanks a lot.

Brad Shuster

Analyst

Thanks, Bose.

Operator

Operator

And our next question comes from the line of Randy Binner from B. Riley. Your line is now open.

Randy Binner

Analyst

Hey, good evening. Thanks. I wanted to just ask on the expenses, they were better this quarter, your guide for the year is afford to be a little inside $108 million. I just wanted to understand, kind of, what the timing – if it's timing issue or if this is a pattern where a third quarter is lower and fourth quarter is higher, going forward.

Adam Pollitzer

Analyst

Yes, it’s certainly not a pattern as to what you'll see as we go forward from a 2Q to 3Q to 4Q rhythm. Much of it is what we were able to achieve in the third quarter. A portion of the outperformance comes from permanent efficiencies that we can carry into the fourth quarter into 2018. And a portion of it reflects the timing of certain items, the timing of new hires and other projects that have either shifted into the fourth quarter or to 2018. I'll say candidly, as we think about our expense load for the full year of 2017, internally, we are not adjusting our expectations for expenses in the fourth quarter based on the results that we achieved in the third quarter.

Randy Binner

Analyst

And then, yes – so this is – then there’s 2018. Any kind of view you can help us with on how to think about that looking to next year? Just because there's been a little bit of a swing factor, and it's great to see the improvement there, but where do you think that might land in 2018?

Adam Pollitzer

Analyst

We continue to obviously hope to perform well, it’s something that's we are focused on. It's too early to provide you with an indication, a formal indication of expenses for 2018. Although we do expect to be making investment in our people and systems to support the continue development of our franchise. Now we are always mindful about balancing those investments with the goals that we've outlined from a return standpoint, what we like to achieve from an operating leverage standpoint and just general expense discipline. In terms of an early steer, it's probably useful to note a few items. One, normal expense inflation for us runs about 2% to 3% per year. We are growing our business and though the majority of our expenses are fixed, we would expect to have a – we do have certain variable costs that will see an uptick, as our NIW grows and our insurance-in-force grows. Importantly, as we think about all of those items in the mix and we are running our own internal budgeting process, we are mindful and believe we'll be able to achieve the ROE targets that we've outlined on the timeline that we've indicated with the expenses that we expect to incur in 2018.

Randy Binner

Analyst

Think I could sneak one more on FHA. And I've asked this question on other calls as well. But I take it at this point that FHA involvement in the market, the mortgage insurance market, has been really status quo this year, despite a view from the new administration. I think there is a preference for private product, but then there has been some appointments that you all alluded to. And so the question is, can you affirm or confirm that FHA involvement in the markets has been status quo, and if so, when might we expect to see their involvement in the market change?

Brad Shuster

Analyst

Hey, Randy this is Brad. I think our general perception has been is that the FHA involvement in the market thus far has been status quo. Obviously, very difficult to predict timing in Washington these days, as to when any kind of changes would be implemented in the marketplace. But having said that, I just would reinforce our belief that the opportunities exist for the situation to get better relative to the FHA and exactly what form that takes to the exact timing is very uncertain at this time. But we do feel good about the current environment and the possibility that it could get better.

Randy Binner

Analyst

All right, great. I’ll leave it there. Thanks.

Brad Shuster

Analyst

Great. Thanks.

Operator

Operator

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

Mackenzie Aron

Analyst

Thanks and congrats on the strong results this quarter.

Brad Shuster

Analyst

Thanks.

Mackenzie Aron

Analyst

First question quick modeling one, Adam. What was the premiums earned on the pool insurance-in-force that was covered by the QSR?

Adam Pollitzer

Analyst

It was $930,000 for the quarter.

Mackenzie Aron

Analyst

Okay. And then on the utilization rate, looking at the active customer, seems you’ve really jumped, was that anything specific? Do you think you’re benefiting from some of the uncertainty and consolidation that’s going on with some of your competitors? Or is that really just a function of these lenders starting to utilize – you guys as an MI counterparty?

Adam Pollitzer

Analyst

Yes. Mackenzie, we don’t internally have the calculation that we run for utilization rate. So it’s not something that we track what we – and we don’t externally break out the contributions of customers by different groupings. We certainly do track that success internally on a detailed account level basis, and we’ve been quite pleased with the growth that we’ve achieved in each of the accounts that we’ve activated in 2017, as they’d aged through the course of the year. So the NIW volume that we’ve captured from the first quarter activations was higher in Q3 than it was in Q2, which itself was higher than it was in Q1. Over the long-term, we’re focused on new activations because over the long-term, we expect that these accounts will be valuable customers and will contribute a meaningful amount of NIW. Just as we expect from all of the customers that we have on our platform.

Mackenzie Aron

Analyst

Okay. That’s helpful. Thank you.

Adam Pollitzer

Analyst

Thank you.

Operator

Operator

And our next question comes from the line of Chris Gamaitoni from Compass Point. Your line is open.

Chris Gamaitoni

Analyst

Thanks for taking my call. Most of my questions have been answered. So I’ll ask one kind of below. Do you have any color on what’s driving kind of the increased cancellation? Is it still purely from refinance or are you seeing any impact of rising home values and/or pickup in people moving more?

Brad Shuster

Analyst

We don’t have that much, Chris. So don’t have that granularity to point to in terms of why the housing turnover is occurring. But purchase market was robust in Q3. So you saw nice uptick quarter-on-quarter in terms of purchase activity and therefore, housing turnover, right? That resulted in cancellation that are singles?

Adam Pollitzer

Analyst

Chris, the other point to note is that while the dollar volume cancellation revenue that we recorded in the third quarter is up $4.3 million versus $3.8 million in the second quarter. What that represents is a component of our net earned and really want saying there is, what it represents is a component of our net reporting yield is basically flat. So the dollar volume of cancellation revenue that we are generating going forward will have some amount of our natural tailwinds, simply because the size of our portfolio is growing and that’s part of what’s happening for us.

Chris Gamaitoni

Analyst

And then maybe, if you could address, I noticed the 97’s product for NIW was up 108%, the rest of business is relatively flat. So any commentary on that if you are particularly targeting that area or just a natural flow coming to the business?

Adam Pollitzer

Analyst

As we tally it – the NIW that we got from 97s was about 12% for the quarter. I think that’s in the queue maybe in our tables in the earnings release and that really just reflects the mix of the market, our mix and 97s, as we look at it, we believe it’s consistent with what others have reported. And I think more importantly it’s worth noting we’re comfortable with the mix of business that we’re seeing today, we believe we price appropriately for the rest of higher LTV loans and the credit performance of our portfolio remains quite strong.

Chris Gamaitoni

Analyst

Okay. Thank you so much.

Operator

Operator

And our next question comes from the line of Geoffrey Dunn from Dowling & Partners. Your line is now open.

Geoffrey Dunn

Analyst

Thanks. Hi, guys.

Adam Pollitzer

Analyst

Hey, Geoff.

Geoffrey Dunn

Analyst

First I want to clarify, with the respective hurricane, you just said no impact on ultimate claim paid. I just want to clarify that you don’t expect much of an impact on the P&L meaning that you’re going to provision at a much lower instant assumption? Or I guess, can you clarify that with respect to the…

Brad Shuster

Analyst

Yes. So Geoff, we’re going to obviously continue to collect data on the NODs, we expect to have occur. And if we get the right information to suggest that those NODs will not migrate into claims then we will not provide loss reserves on them. Absent the information, we’ll just need to work through and see what we get. But our goal we do not have the P&L disrupted with a large increase provided for losses that ultimately will not flow to claim.

Adam Pollitzer

Analyst

And Geoff, I just want to clarify one nuance, in the question that you asked. I think as you ask the question, you said, you wanted to confirm the statements that we made, that we would not have any claims paid related to the storm. And so that was not Brad’s statement, Brad statement in our remarks that we don’t expect the Notice of Default resulting from the storms or the wildfires a lot of a material impact on our ultimate claims paid. And ultimately as we roll forward, a lot of this is going to be about gathering information. We are GAAP reserves in the claim expense that we take in any given period is based on our view as to what other probable and estimable losses related to the loans that we ensure. So as we get new information, we’re going to be focused on making sure that we have as much detail as possible to come to an informed view as to what is probable and estimable. It is a fair assumption right now to assume that the losses that we reserve for on this particular cohort default. We’ll have a different underlying set of assumptions around what is probable and estimable than what we would normally see in our portfolio.

Geoffrey Dunn

Analyst

Okay. With respect to the premium rate, you are talking about kind of 42, 43 bp net rate right now. If you strip out the reinsurance, the full premium and refundings, is the implication for the core premium yield ultimately is that going to move towards 50 bps you sited on your NIW is that kind of where this tops out or is it something more in the high 40’s.

Adam Pollitzer

Analyst

In terms of where it tops out we don’t run this for an extended period. But if you strip out those items and try to isolate – I think the core yield as you’ve termed it. If you strip out – remember cancellation activity is contributing 3 to 4 point, so you strip that out as well that 42 to 43 basis points translates to call it 46 basis points or so of core yield before the effects of cancellation revenue which would move at higher and before the effects of reinsurance which would then take some amount off of that.

Brad Shuster

Analyst

Geoff, the cancellation contribute about 4 bps in both second quarter and third quarter. So the…

Geoffrey Dunn

Analyst

I understand that. I’m trying to strip out all the noise and find out what your core profitability is on that premium rates about 44 bps this quarter. Just trying to understand if that trajectory has the possibility go into 50, which I think you said it on NIW or at lower amount.

Brad Shuster

Analyst

Geoff, we should align as a follow-up. We calculate that core rate not as 44 in the third quarter but around 45.5 a little bit higher than 45.5.

Geoffrey Dunn

Analyst

Okay. And then lastly with respect to the investment yield, you continue to get gains there. Is that simply just a reinvestment of the profitability each quarter or you continue to make move shifting the portfolio around?

Brad Shuster

Analyst

No meaningful changes in the strategy Geoff, we are investing more – larger and larger percentage of the portfolio, we’re able to go a little bit longer obviously just as a gross and our liquidity needs to be relatively flat. But that’s basically the only driver.

Geoffrey Dunn

Analyst

Okay. Thank you.

Brad Shuster

Analyst

Thanks.

Operator

Operator

And our next question comes from the line of Bose George. Your line is now open.

Bose George

Analyst

Hey, guys. Can you just remind us how the profit commission on your reinsurance is calculated?

Adam Pollitzer

Analyst

Sure. So it’s embedded in the contract that we have, it’s roughly 20% of the seated premiums that we have in a given period.

Bose George

Analyst

Okay. Great. Thank you.

Operator

Operator

[Operator Instructions] At this time I am showing no further questions.

Brad Shuster

Analyst

Okay. Thank you operator. And thank you for joining us on the call today. We look forward to seeing you at our Investor Day in New York on November 17. Thanks again.

Operator

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program. You may all disconnect. Everyone have a great day.