NMI Holdings, Inc. (NMIH) Q4 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the NMI Holdings Fourth Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we'll 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.

Thank you, Skyler. Good afternoon, everyone. Welcome to the 2017 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; 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 at 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 is current at any time other than the time of this call. Also note that in today's press release and on our website, we have provided a reconciliation of certain non-GAAP measures used in 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 will take your questions. With that, I'll turn the call over to Brad Shuster.

Thank you, John. And good afternoon, everyone. I'm pleased to report that in the fourth quarter, National MI again delivered record financial results and exited 2017 with significant positive momentum in customer development, portfolio growth and return on equity that we expect to continue in 2018. In the fourth quarter, we wrote $6.9 billion of new high-quality mortgage insurance, up 12% over the third quarter. This included record monthly premium NIW of $5.7 billion, which was up 19% over the third quarter, and up 47% over the fourth quarter of last year. Primary insurance-in-force of $48.5 billion was up 12% over the prior quarter and up 51% over the fourth quarter of 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 $50 million, up 12% sequentially and up 53% over the fourth quarter of 2016. This top line growth drove record adjusted net income of $14 million, equal to $0.22 per diluted share, after normalizing for the impact of tax reform on our deferred tax asset and the change in the fair value of our warrant. Our adjusted return on equity for the fourth quarter was up - was 11%, up from 10% in the prior quarter and ahead of our 10% year-end target. With the benefit of tax reform and the continued growth of our high-quality portfolio of insurance-in-force, we expect that our financial performance will accelerate, driving a mid-teens return on equity for the full year in 2018, surpassing our prior target of a mid-teens ROE exiting the year. In the fourth quarter, lenders continued to respond to our strong team and unique customer value proposition, which prioritizes certainty of coverage and sensible servicing. As of the end of the quarter, we had nearly 1275 approved master policies and approximately 840 active customer relationships. We activated 29 new customers in the fourth quarter, bringing our total activations in 2017 to 127 new accounts, representing approximately $20 billion of NIW opportunity. We also continued to expand our business with existing accounts, through increasingly recognize our growing presence in the market, our strength as a counterparty, our superior customer service and the value of our commitment to a broad-based underwriting approach. Looking at the broader mortgage insurance landscape, 2017 was a good year for our market. With continued strength in purchase originations, more than offsetting the year-over-year decline in refinancing activity. Our purchase volume was up 7% over the third quarter, and up 52% over the fourth quarter last year. For the quarter, purchase mortgages comprised 83% of our NIW. With a strong economy and the demographic tailwind of millennials buying their first homes, we expect continued growth in the purchase market this year, which bodes well for our growth in the overall market in 2018. Loss development in our portfolio continues to be better than expected. We nonetheless continue to take a long-term view of the credit cycle and continuously monitor the flow of business to identify and address emerging risks, before they become an issue in our portfolio. Shifting to Washington matters, we are encouraged by recent statements from the administration. We believe the tone from Washington suggests that the FHA is unlikely to expand its footprint in 2018 and that the direction of future policy decisions will be benign to positive for the private mortgage insurance sector. In December, our industry received a summary of the proposed changes to the PMIERs requirements that the GSEs are developing with the FHFA. We have engaged in conversations with the FHFA and the GSEs about the proposed changes and expect to continue to provide feedback to them in the coming months. Once any changes for the PMIERs requirements are finalized, we expect the industry will be afforded a 6 month implementation period and currently anticipate any new rules will take effect no sooner than the fourth quarter of this year. If the summary changes, as generally outlined to us by the GSEs, were applied to our portfolio as of yearend 2017, we would have remained in a surplus position given our current resources. We also expect to be in full compliance upon effectiveness and anticipate we will continue to maintain an access position based on our current capital plan. A final note. In light of the benefits that we expect to realize from the recently enacted tax reform, I'm proud to share that in the first quarter, we've paid a onetime $1000 cash bonus to all of our full time employees, other than our senior executive team. We have an extremely talented, dedicated group of people at National MI. All of our employees are shareholders and they work hard every day to deliver value to our customers and other stakeholders. Our people have truly earned this reward and I am excited about what this team can accomplish in the years ahead. 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 another strong quarter and achieved record results across every key financial metric. We generated record NIW of $6.9 billion and continued our rapid growth in high-quality insurance-in-force. This drove record net premiums earned to $50.1 million, record adjusted net income of $14 million or $0.22 per diluted share and record return on equity of 11%. Now to the detailed results. Primary insurance-in-force was $48.5 billion at quarter end, up $5.2 billion or 12% from $43.3 billion at the end of the third quarter and up 51% compared with the fourth quarter of 2016. As of year-end, monthly product represented 69% of our primary insurance-in-force, which compares with 66% as of the third quarter, and 60% as of the fourth 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 3.9%, up from 3.8% in the third quarter. 12 month persistency in the primary book was 86.1%, up from 85.1% last quarter. Total NIW of $6.9 billion was up 12% compared with the third quarter. Monthly product represented 83% of NIW, which compares with 79% in the third quarter and 75% in the fourth quarter last year. Premium earned for the quarter was $50.1 million, up 12% compared with $44.5 million in the third quarter and up 53% compared with the fourth quarter of 2016. We earned $4.2 million from the cancellation of single premium policies in the fourth quarter, down modestly from $4.3 million in the third quarter. Reported yield for the quarter was 43.7 basis points, up from 43.5 basis points in the prior quarter. This was driven primarily by the strength of our monthly NIW volume and resulting increase in our mix of monthly insurance-in-force. Gross premium yield, which is before the impact of reinsurance was 50.4 basis points, up from 49.9 basis points in the third quarter. Weighted average rate on NIW across all products in the fourth quarter was approximately 50 basis points, consistent with the past several quarters. We expect net yield will continue to trend in the range of 43 to 44 basis points, depending on cancellation activity and the pace at which our primary insurance-in-force trends towards the long-term 80-20 mix that we've achieved in our NIW. Investment income in the fourth quarter was 4.5 - $4.4 million, up from $4.2 million in the prior quarter. Underwriting and operating expenses for the full year were $107 million, modestly inside of our $108 million guidance and consistent with our comments last quarter. Underwriting and operating expenses in the fourth quarter were $28.3 million compared to $24.6 million in the third quarter. The quarter-over-quarter increase was in line with our outlook for the year and reflects the shift in certain spending from Q3 to Q4 that we previously highlighted. Our fourth quarter expense ratio was 56.5%, which compares with 55.4% in the prior quarter and 70.9% in the fourth quarter of 2016. We expect to drive our expense ratio meaningfully lower in the coming quarters, as growth in our insurance-in-force and premium revenue continues to far outpace the growth in our operating expenses. Claims expense was $2.4 million in the quarter. We had 928 notices of default in the primary book as of year-end, including 533 notices related to loans in FEMA-declared disaster areas for Hurricane Harvey and Irma and California wildfires. Excluding these, we had 395 notices of default at year-end, up from 350 at the end of the third quarter. While some fraction of the 533 defaults in the storm and wildfire impacted areas would likely have occurred in the normal course, we believe a large majority would not have occurred and will ultimately cure. And this is reflected in our best estimate reserving for anticipated claims on this population of loans. We paid 11 claims in the quarter, which compares to 4 claims paid in the third quarter, bringing ever-to-date claims paid to 38. Our fourth quarter loss ratio, defined as claims expense divided by net premiums earned, was 4.7% reflecting the impact of the disaster-related NODs. As mentioned last quarter, we expect our loss ratio to be in the low to mid-single digits over the next few years. Other expenses of $6.8 million in the quarter, included $3.4 million of interest expense and nearly $3.4 million, attributable to changes in the fair value of the warrant liability. The fair value of the warrant liability is primarily tied to fluctuations in our stock, price with the expense generally increasing as our stock price rises. Our tax expense for the quarter includes a onetime non-cash charge of $13.6 million, related to the re-measurement of previously deferred tax assets and liabilities following the enactment of the Tax Cuts and Jobs Act in late December. Moving to the bottom line. Adjusted net income for the fourth quarter, which excludes the impact of the net DTA write-down and warrant fair value charged was $14 million or $0.22 per diluted share. This compares to $12.6 million of adjusted net income or $0.20 per diluted share in the third quarter. At quarter end, cash and investments were $735 million, up from $713 million in the prior quarter. As of quarter end, we have $51 million of cash and investments at the holding company. Book equity at the end of the fourth quarter was $509 million, equal to $8.41 per share, down from $511 million or $8.53 per share at the end of the third quarter due to the net DTA write-down. As of quarter end, total available assets under PMIERs grew to $528 million, which compares with risk-based required assets of $446 million. In summary, we achieved record results in volume, premiums earned, adjusted net income and return on equity. As we continue to grow our book of high-quality mortgage insurance and manage risk and expenses, we expect that our embedded operating leverage will continue to drive margin expansion and increasing returns on equity. With that, let me turn it over to Brad for his closing remarks.

Thank you, Adam. We are excited about our record performance in the fourth quarter and the positive momentum we are carrying into 2018. We believe market conditions remain favorable with regard to demand for our product, credit quality and the tone in Washington. We are executing on our business plan, and against this backdrop, we are well positioned to continue to win with our customers, drive strong growth in our high-quality portfolio and deliver strong results for our shareholders. With that, let's bring back the operator, so we can take your questions.

[Operator Instructions] Our first question comes from Phil Stefano with Deutsche Bank. Your line is now open.

Yeah, thanks. And good evening. So you have the $533 million defaults associated with the hurricane and wildfire impacted areas. Do you have a reserve number that you can give us around that? Or claims rate, you assumed on those or maybe you can help us think about the core or the underlying claims rate that you're putting on the new notices, excluding these impacted areas? Any context you can help us think about around that?

Yes, why don't we just give you some specific help perhaps that makes it easy to digest. So on the 533 NODs related to hurricane and wildfire impacted areas, we incurred a little over 800,000 of net losses on that population, which accounts for about a - a little over a third of our total fourth quarter claims expense. Adjusting for those exposures, our fourth quarter loss ratio would have been approximately 3%.

Okay. That's perfect. And then it feels like the new insurance written growth picked up pretty materially in fourth quarter '17. Can you help us think about the levers they are driving this, being new customer growth or just growth with existing customers. Is there one that really drove this? Or is there some combination of the two?

Phil, its Brad. Yes, the answer is yes. As we always say, growth for us comes from growing our wallet share with existing customers and adding new customers. We've made some important strides in the market on both fronts and feel good about how that's translated into the success you see in our NIW numbers. We believe we have the best sales force and the best customer service in the industry. And if you think about it, over the last 2 years, we've activated 300 new customers and we end the year with, as I said earlier, 840 active lender relationships. So we've done a lot of hard work to win and grow these customers and it's really starting to bear fruit for us. So we're proud of the results we've delivered and this is all with the backdrop that we paid a significant strides in terms of improving our overall mix between monthly and single product. So particularly proud of that.

Understood. It feels like two of the peers that - at least, I've been expecting to see that you have finally begun to do so. Are you hearing from the field that the conversations are getting easier? The doors opening more easily for the people that have been out there banging on them?

Yes. You'll never really hear from people that have challenges in front of them at it's just getting easy. But we are just seeing - we continue to see relationships open up for us that we may have been working on for years. And so that's really gratifying at this point. And I think, our footprint in the marketplace has grown to the level where market participants and customers can't really ignore us. So that's helped kind of add some additional momentum to the success you're seeing.

Well, congrats on the momentum. Looking forward to adjusting more than '18 and '19

Thanks very much.

Our next question comes from Bose George with KBW. Your line is now open.

Hey, guys. Good afternoon. Sorry if you mentioned this in the prepared remarks, but what's your expected tax rate going forward?

Sure, Bose. We would expect, for the full year 2018 and beyond that we'll see approximately a 21% effective tax rate. I think, as you saw for us in 2017, and as we've talked about a bit, we would expect to see a bit lower first quarter effective rate due to the accounting requirements for equity compensation, where we record discrete items related to the vesting of shares in period on which those shares vest. But overall, we would expect a 21% effective rate for the year in 2018 and periods forward.

Okay, great. Thanks. And then as you come back to the ROE, you guys - thanks for guidance, on the updated guidance. Just wanted to try and tease out where the ROE could be at the end of 2018? Since your earlier guidance, obviously, some tax rates have come down, your growths are little stronger. So is it fair to think, you'd have the mid-teens exit ROE even on the old tax rate. So at the very least, your ROE exiting '18, should benefit by the tax rate and then we could sort of add any potential growth on top of that?

Yes, sure, Bose. Well, I'll clarify. So in previous calls, the guidance that we had shared around our ROE performance had always been in the context of an exit for the year, exiting 2017 or exiting 2018. The comments that Brad made in our prepared remarks pivot that and we're now expecting that we'll achieve a mid-teens return for the full year. Call it approximately plus 15% for the full year. And to the question around how that build, we would expect that, that will build somewhat during the course of the year. So we maybe modestly below that level in 1Q, but likely in excess of that, as we get into the back of the year. And - but that, obviously, depends on a number of variables NIW production, the growth in the in force, what we can achieve from a pricing and yield standpoint, how we manage our expenses and how claims development, plus obviously, how capital requirements develop. But we got a high degree of visibility into those items, particularly for 2018 and feel good about our ability to perform and deliver on that. We'll call it plus 15% return expectation for the full year.

Great. Thanks. And actually just let me turn one more just on capital. On our Investor Day, you had provided guidance that suggests that you need capital by mid-2018. Given, what you guys have seen with PMIERs 2.0, and with the growth you are having et cetera, any updated thoughts on capital?

No. Look, I think we don't at this stage. It's obviously, quite early days in terms of conversations around PMIERs 2.0 and so it would be, I'll say both premature and wander NDA, so difficult for me to provide any specific comments in light of that. But we feel good about our capital position and our capital options and importantly, how that match the changes that we might emerge under PMIERs 2.0. So nothing specific to mention relative to the comments we shared during our Investor Day.

Bose, its John. Just to be specific, what we alluded to on Investor Day was if we expected to be in the market for an ILN transaction, as opposed to a capital transaction.

Okay, great. Thanks, guys.

Thanks, Bose.

Our next question comes from Mackenzie Aron with Zelman & Associates. Your line is now open.

Thanks, good afternoon. Congrats on the quarter. I guess, my questions both are around operating expenses. I know you had mentioned you expect to see additional cost leverage. Is there any kind of dollar figure you can give us you're expecting for the full year? And then secondly on the cash bonuses in 1Q. Can you just give us what the full amount will be or the number of employees, so we can frame that?

Sure. Why don't I touch on the first one to start. We won't be able to give a specific dollar amount of guidance I think, that was a bit unique that we provided in the middle of '17 as the business is developing. But perhaps that the right way to think about it is, there's obviously a significant move between the third and the fourth quarter. But again, that was consistent with our expectations, where we expected a portion of the Q3 out-performance that really related to timing items. The shifting in certain projects and new hires from the third quarter into the fourth quarter actually coming through. And I know that, that makes it a little bit more challenging to establish a view as to how we'll perform on the expense side in 2018. So the guidance that perhaps I can offer is that our second half 2017 operating expenses are a good baseline to build from, because if - because the timing differential really just shifted items between third and fourth quarter, but in total, the second half of the year, which was about $53 million as a starting point, annualizing that and then layering a growth expectation for a business development and we are growing, right? And the growth will drive, expenses beyond that second half annualized run rate in a few ways, we'll certainly be making investments in our people, in our systems to support all the positive momentum and value that we're driving with our NIW and the insurance-in-force. We had certain headcount additions towards the tailwind of 2017. We ended the year with 299 employees versus 276 at the end of 2016, so have a full year impact of those salaries coming through in 2018 versus a partial year in 2017. And while we are largely a fixed cost business, we do have certain variable costs. So as our NIW and insurance-in-force continues to grow, you'll see growth from - modest growth, but growth related to these variable costs. So overall, if you sort of put all of that into the mix, we would expect to see high single digit to double-digit growth in our operating expenses, off of that second half annualized run rate. In terms of how that actually plays through - in 2018, quarter-to-quarter, what we will typically see is slightly higher expenses in Q1, then we do through the remainder of the year, because of the reset of certain employee benefit items like our 401k match and payroll taxes that hit in more size in the first quarter.

Okay. That's helpful. Thank you.

Thank you.

Our next question comes from Randy Binner with B. Riley. Your line is now open.

Hey, thanks. Good evening. So I just wanted to do a couple of cleanup questions. So the - on the buffer, the 18% PMIERs 1.0 buffer, you mentioned in the prepared comments that you thought that would be adequate under the 2.0 environment. Is there any more color you can provide on kind of how adequate that can be? I think what I heard from other MIs on the report is that something like half of that buffer would be left under 2.0, is that the right way to think of it?

No. And Randy, just remember for us, obviously, we are in a significant growth phase. So even before consideration of PMIERs 1.0 or changes that might emerge under PMIERs 2.0, we are consuming capital to support that growth. We're building a significant amount through organic cash flow and organic equity built, but there's still an amount in excess of that, which is the ILN that John alluded to, that we have talked about in our November Investor Day. So we're still in growth. So it's not quite the same perspective and I think, as I said, it is - it's early so the [indiscernible] so it would be both premature and candidly difficult for me to give - to comment with too much specificity, but I'd reiterate that, we feel good about our capital position and our capital options and how that maps to any changes that might emerge under PMIERs 2.0.

So, I guess, can I take that to mean that your comfort under 2.0 would be including the perspective capital transaction?

Yes.

Okay, good. And then - on the quarter, the - just kind of getting into the core earnings number or the adjusted number, was there a core tax rate in the quarter? I came up with something not 35%, like 31%, was there anything unusual just on outside of the DTA item?

Yes, it was about 32% and the - in the fourth quarter, we had - and so this will emerge when you get a copy of our K tomorrow. We had certain market conditions, our SEU's which vest on the achievement of certain stock price thresholds. And so in the fourth quarter, we had those items vested, which drove a smaller but similar dynamic to the windfall benefit that we see outlined - that we typically see and have outlined to you in the first quarter. And then in the normal course, we do a small amounts of investment income that relate to tax examinees [ph] And so both items contributed to an effective rate for the fourth quarter on an adjusted basis that was modestly below 35%.

Right. Got it. Thank you.

Thanks, Randy.

Our next question comes from Chris Gamaitoni with Compass Point. Your line is now open.

Hi. Thanks for taking my call. I wonder if you had any perspective on kind of the persistency outlook for your book, given the growth dynamics and writing rates, yours is a little bit more difficult for us to kind of have an outlook on what is going to be sort of next year or so?

Yes, so persistency for us in the fourth quarter was 86%. Over the next few years, I think we expect our persistency to remain above long-term historical averages for the sector, which we peg at around 80%. I think for the issues that you're alluding to, the large amount of our insurance-in-force that relates to our most recent vintages. And also they'll, obviously, emerging over the last several weeks is, what's happening in the broader interest rate in refinancing environment. I think over the longer-term, probably out past a few year horizon, we would expect our persistency to be in line with the rest of the market. Although again, the markets persistency level will move year-to-year based on those variables, particularly the interest rate environment.

Right. And then if you could give us your view of how the competitive dynamics are in the market from a return standpoint? Would be great.

Yes. Sure, Chris. Our markets always competitive. 6 participants, so that's a constant. We know we have to do a good job to win with those customers. So we're always trying to do that. Pricing - market pricing generally stable as it has been and it offers up an opportunity for us to generate the kind of returns we're talking about earlier on today's call. So from an overall standpoint, no real change in the overall competitive dynamic.

All right. Thank you so much.

Thank you.

Our next question comes from Geoffrey Dunn with Dowling & Partners. Your line is now open.

Good evening, guys.

Hey, Geoff.

Adam, with respect to the first quarter tax rate, are we looking at a similar delta versus, if we look at '17 1Q versus 2Q, under the new, kind of run rate 21%, are we bidding at a similar delta? Or was there an abnormal kind of adoption impact in the 1Q '17 that made that impact larger than we should see going forward?

No. Geoff, so this will - right, so obviously the starting point is 21% effective rate on which we are going to be scaling off of in the first quarter and future periods. The magnitude of that windfall benefit and the impact in particular quarter really is driven by where our stock price is at the vesting date, which for us is largely concentrated in the first quarter, because when we make our rewards versus the stock price underpinning the awards at grant. The dynamic that you're seeing play through if that for tax purposes, the expense is crystallized and recognized based on the valuation at vest, whereas in for GAAP purposes, the expense is crystallized and recognized based on the grant date fair value. And so it's likely, I don't have in front of me candidly, that you will see a similarly scaled effect on our first quarter '18, because of where our valuation is today related to if you look back where we were in each of the first quarter's over the past several years and what that means relative to the grant date fair value versus the likely fair value at the vesting date. When you get to 2019 and 2020, let's say, it really depends on where is the stock price in the first quarter of '18, first quarter of '19, first quarter of '20, and how does that relate to what will be the grant date fair value for awards that are made in the future periods.

Okay. So I just want to - obviously, depending on what people guess, you could have some [indiscernible] EPS substance for Q1, but I think if we put a similar pattern on it. Is just the first quarter tax rate could be something down like 12%, 13%. Does that seem reasonable?

Yes. Maybe a touch low, but that seems reasonable.

Okay, great. And I'm not sure I got the clear answer, only the employee bonus, did you accrued for that in Q4? Or is that going to be incremental expense in the first quarter and did that included in your commentary.

It's a first quarter item.

Okay.

So just - we've got 300 employees, we consider our executive committee to be, call it 10 or so individuals to $1000, pretax for the rest of the population.

Got you. All right. Thank you.

Thanks, Geoff.

At this time I'm showing no further question. I'd like to turn the call back over to Mr. Brad Shuster for closing remarks.

And I would like to thank you all for joining us on the call today.

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