NMI Holdings, Inc. (NMIH) Q1 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the NMI Holdings, Inc. First Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to your speaker today, John Swenson. Thank you. You may begin.

Thank you, Dorothy. Good afternoon, and welcome to the 2020 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, Executive Chairman; Claudia Merkle, CEO; Adam Pollitzer, our Chief Financial Officer; and Julie Norberg, our Controller. Financial results for the quarter were released after the close 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 one 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 on this call, we refer to certain non-GAAP measures. In today's press release and on our website, we provided a reconciliation of these measures to the most comparable measures under GAAP. Now I'll turn the call over to Brad.

Thank you, John, and good afternoon, everyone. As I get started, I want to recognize that this is an extremely challenging time, and our thoughts at National MI are with all of those who have been affected by this global pandemic, particularly those suffering from COVID-19 and the healthcare workers and first responders who are on the front lines of the crisis. In addition to reviewing our first quarter results on today's call, we will share with you how we're responding to this crisis and our current expectations for how COVID-19 will impact the housing market, the mortgage insurance market and our business performance and financial position going forward. Stepping back and looking at the bigger picture, we built National MI to be a credible and sustainable counterparty across all market cycles. From the start, we have focused on building a durable franchise in a risk responsible manner. We have worked hard to establish a comprehensive credit risk management framework. And in doing so, we have built the highest quality insured portfolio in the mortgage insurance industry. Well before this crisis emerged, we were actively targeting a higher quality mix of business through individual risk underwriting and granular rate GPS pricing and had sourced and secured comprehensive reinsurance protection for nearly the entirety of our in-force portfolio. Our conservative stance heading into this period gives me confidence about the strength of our business today and our ability to continue supporting our lenders, their borrowers and the overall housing market through this period of uncertainty. And it's not just a function of our credit risk management framework. It's the conservatism with which we've managed our investment portfolio, the robust liquidity profile that we have built at both our holding company and operating company levels and the strength of our balance sheet and regulatory funding position. Together, these elements are what position us to continue serving our customers and driving long-term value for our stakeholders. While we've taken steps all along the way to position National MI to perform through a severe stress cycle for an open-ended period of time, we are optimistic that the environment will begin to heal itself as shelter-in-place directives are lifted and medical advances give the population at large the confidence to resume day-to-day activity. Importantly, we do not believe that the housing market will experience a level of strain anywhere close to that seen during the 2008 financial crisis. The housing market came into this downturn in a dramatically better position than it did in 2008. Entering 2020, the market had real pricing balance driven by a sustainable supply/demand dynamic. Lenders were disciplined, and underwriting was responsible. Paired with this is the immediate application of massive fiscal stimulus and direct borrower assistance programs. We applaud the speed and magnitude of the government response to this crisis, notably the forbearance, foreclosure moratorium and other assistance programs codified under the CARES Act. This broadly coordinated public policy effort, along the similar private initiatives implemented by lenders and servicers, will help bridge borrowers past the point of acute stress and ensure they are able to remain in their homes and resume their lives with limited interruption once the crisis has passed. Overall, while we may see some degree of housing price decline nationally, we expect the market to be far more resilient than it was in the aftermath of the 2008 financial crisis, with a far more muted level of price decline and a far quicker stabilization. With that, let me turn it over to Claudia.

Thank you, Brad. In response to the COVID-19 outbreak, we have taken steps to protect the health and safety of our employees and ensure our continued ability to seamlessly support our lenders and their borrowers. In mid-March, we activated our business continuity program and instituted work-from-home practices for our Emeryville staff. We have transitioned our operations seamlessly and continue to positively engage with customers on a remote basis. Our IT environment, underwriting capabilities, policy servicing platform and risk architecture has continued without interruption, and our internal control environment and internal controls over financial reporting are unchanged. We have achieved this transition without incurring any additional cost, and we believe our current operating platform can continue to support our newly distributed needs for an extended period without further investment beyond that planned in the ordinary course. To address the shifting credit environment, we have adopted changes to our underwriting guidelines, including changes to our loan documentation requirements, our asset reserve requirements, our employment verification process and our income continuance determinations. We expect these changes will further strengthen the credit profile of our new business production. We have also taken action to increase our pricing on all new business production and believe that others in the sector have generally pursued similar changes. Overall, the new business environment is evolving in a positive way. Policy pricing is up across the board. Risk is improving as underwriting guidelines tighten and the capital demands of new business production are declining. Now to our first quarter, where we delivered record results. GAAP net income for the quarter was $58.3 million or $0.74 per diluted share, and adjusted net income was $52.7 million or $0.75 per diluted share. GAAP return on equity was 24.5% for the quarter, and adjusted ROE was 22.1%. We generated record first quarter NIW of $11.3 billion, down 5% seasonally from the fourth quarter, but up 63% compared to the first quarter of 2019. Primary insurance in-force was $98.5 billion at quarter end, up 4% compared to the fourth quarter and 34% compared to the first quarter of 2019. Operationally, the first quarter was very much a tale of two cities, with a strong business-as-usual environment in January and February, disrupted by the pandemic in March. On the business-as-usual side, we continue to expand our customer franchise, activating 24 new lenders in the quarter. We are now doing business with a broadly diverse group of over 1,100 high-quality originators, supporting them at a time of uncertainty with our same focus on differentiated service and consultative engagement. And we continue to emphasize rate GPS as our platform for engagement. More than 95% of our customers are currently using the platform, and over 90% of our first quarter NIW volume was delivered through the engine. We have long noted the value that rate GPS provides as a risk management tool, allowing us to directly shape the credit mix of our portfolio and the positive impact it has on our customer engagement. In this environment, the engine provides us with additional value, the ability to implement pricing changes dynamically and make the adjustments that we believe are appropriate in real-time as opposed to a long delayed lagging basis through rate cards. Going forward, we expect the COVID-19 outbreak will have a different effect on the U.S. housing market, with existing homeowners facing challenges related to the pandemic and the volume and timing of future purchase transactions negatively impacted as buyers reassess their ability and willingness to purchase homes and sellers reevaluate or postpone planned sales. Balancing this are the early signs of stabilization that are emerging in the purchase market and our expectation for a significant increase in refinancing activity given the rate environment. Against this backdrop, we expect total U.S. mortgage insurance origination volume will decline modestly in 2020 before stabilizing and recovering in future periods. Before turning it over to Adam, I want to note how proud I am of the National MI team. Our people have maintained the same high level of focus and service as they always have for our customers even as they were transitioning to a newly distributed work environment and adjusting to significant changes in their personal lives. Our team is a huge part of our success and I am deeply grateful for their resiliency and continued dedication. As Brad said, our founding goal and our continuing mission is to be a credible and sustainable counterparty for our customers and policyholders across all market cycles. Everything we have done to build a durable and profitable business, recruiting and retaining great talent, establishing the right culture, engaging with customers in a consultative way and managing risk, expenses and capital has positioned us to continue to deliver for all of our stakeholders through this stress. With that, I'll turn it over to Adam.

Thank you, Claudia. We achieved record results across a number of key metrics in the first quarter, and while there maybe a temptation to look past these results given the pandemic that has now emerged, we take note of the strength of our performance going into this crisis because, one, the strength of our historical performance and the capital position we have built provides us with valuable resources to carry through the duration of this stress; and two, it highlights the value of our strategy and the performance we can expect to deliver when the macro environment stabilizes in the future. We generated $11.3 billion of NIW in the quarter and grew our primary insurance in-force to $98.5 billion at March 31. This drove $98.7 million of net premiums earned, adjusted net income of $52.7 million, or $0.75 per diluted share, and adjusted return on equity of 22.1%. Primary insurance in-force of $98.5 billion was up 4% from $94.8 billion at the end of the fourth quarter and up 34% compared to the first quarter of 2019. 12-month persistency in the primary portfolio was 72%, with the current interest rate environment continuing to spur refinancing turnover. In this uncertain environment, turnover helps to reduce the overall risk exposure embedded in our in-force portfolio. Total NIW was $11.3 billion, with monthly products contributing $10.5 billion or 93% of our total volume. Refinancing originations represented 29% of our volume in the quarter, up from 24% in the fourth quarter. This trend is continuing as refinancing activity accelerates. Refinancing volume accounted for over 40% of our NIW production in April. Net premiums earned in the first quarter were $98.7 million, including $8.6 million from the cancellation of single premium policies. Reported yield for the quarter was 41 basis points, roughly flat with the fourth quarter. While our first quarter yield is higher than we anticipated when we shared full-year 2020 guidance on our last call, we are withdrawing our premium yield estimate for the remainder of the year due to the uncertainty surrounding the COVID-19 outbreak. We continue to benefit from the work we have done with rate GPS to actively shape the credit mix of our portfolio and manage our concentration of business with layered risk characteristics. At quarter end, our concentration as a percentage of total primary risk in-force of greater than 45 DTI business was 10%, and our concentration of 97 LTV and below 680 FICO risk were 10% and 4%, respectively. Investment income was $8.1 million in the first quarter compared to $8 million in the fourth quarter. Underwriting and operating expenses were $32.3 million compared to $31.3 million in the fourth quarter. Expenses in the first quarter included $474,000 of costs related to capital markets transaction activity that we were contemplating prior to the onset of the COVID crisis and the dislocation it caused in the markets. Excluding these costs, adjusted underwriting and operating expenses were $31.8 million, our GAAP expense ratio was 32.7% and our adjusted expense ratio was 32.2% for the quarter. We had 1,449 notices of default in the primary portfolio at the end of the first quarter, essentially flat from 1,448 at the end of the fourth quarter. Claims expense was $5.7 million in the quarter, reflecting a strengthening of the reserves held against our existing and new default populations. As an insurance company, we do not establish reserves against performing risk in the same way a lender does through its loan loss provision. Instead, under GAAP, we wait to establish a reserve against an in-force policy until the underlying insured mortgage is delinquent at 60 days or more past due. We expect that we will see a significant increase in our default population going forward, as borrowers face challenges related to COVID-19 and access the forbearance program for federally backed loans codified under the CARES Act or other programs made available by private lenders. As of April 30, our default population had increased to 1,610, which represented a 43 basis point delinquency rate. While we are not yet able to forecast the ultimate level of forbearance-driven delinquencies that we will receive or the timing in which they will develop, we note two important points. First, we're seeing a slowdown in the weekly progression of forbearance uptake rates in the external data we've been monitoring. Survey data published by the Mortgage Bankers Association indicates that the number of new forbearance requests made to servicers is declining, and the share of GSE loans in forbearance programs is growing at a slowing pace. And second, we've observed a correlation between the risk profile of the underlying borrower and the incidence of forbearance in the data we've received through April 30. Borrowers who are self-employed and those with higher debt-to-income ratios and lower FICO scores appear to be accessing forbearance programs with notably higher frequency. This trend is further supported by the forbearance data being reported by Black Knight's McDash, which indicates that a meaningfully higher concentration of mortgages covered by the FHA and VA are in forbearance status compared to the loans purchased by the GSEs. If this pattern holds, we expect that the dramatically higher credit quality of our insured portfolio, where we have no legacy precrisis exposures, and a fraction of the concentration of higher risk loans will drive favorable delinquency and loss experience on a comparative basis. As our default population grows in future periods, we expect to establish increasing loss reserves and incur additional claims expense. The level of reserves we establish for these delinquencies will, as with all NODs, reflect our best estimate of eventual claims exposure. Our claims exposure is triggered by a property foreclosure. We don't fund delinquencies, and it's ultimately a function of the number of delinquent loans that progress to claim, which we refer to as frequency, and the amount we owe to settle such claims, which we refer to as severity. We generally observe that a significant majority of borrowers who access forbearance programs in the wake of specified disaster events are eventually able to resume timely payment of their mortgage obligations and remain in their homes. And this is the overarching goal driving housing policy decisions today, a stated desire by politicians, regulators and lenders to help bridge borrowers past this point of acute stress and provide them with a pathway to avoid foreclosure and keep their homes. Experience tells us that forbearance programs work, and enhanced accommodations, such as the FHFA's recent announcement that borrowers would not owe a lump sum payment at the end of their forbearance period, will further their effectiveness. This dynamic, coupled with our view of general house price resiliency, will inform our reserve setting as NODs develop. Interest expense was $2.7 million in the quarter, and we recorded a $6 million gain from the change in the fair value of our warrant liability. Moving to the bottom line. GAAP net income for the quarter was $58.3 million or $0.74 per diluted share. Adjusted net income was $52.7 million or $0.75 per diluted share compared to $52.6 million or $0.75 per diluted share in the fourth quarter and $38.5 million or $0.56 per diluted share in the first quarter of 2019. Year-on-year, we grew adjusted net income by 37%. Total cash and investments were $1.2 billion at quarter end, including $44 million of cash and investments at the holding company. Our investment strategy has always prioritized capital preservation alongside income generation, and our investment portfolio is well positioned to perform through a period of significant market volatility. Our portfolio is 100% fixed income, 100% investment-grade and has a weighted average credit rating of A+. It is highly liquid and highly diversified with no Level 3 asset positions and no single issuer concentration greater than 1.5%. We have limited exposure to individual issuers, sectors or asset classes across a broadly defined set of COVID-19 risk categories. At March 31, our portfolio had an aggregate unrealized gain of $11 million which grew to approximately $29 million at April 30. Our liquidity position is equally strong at both the holding company and operating company level. During the 12-month period ended March 31, NMIC, our lead operating subsidiary, generated $216 million of cash flow from operations and received an additional $252 million of cash flow from the maturity, sale and redemption of securities held in its investment portfolio. Our operating subsidiaries reimburse our holding company for substantially all of its cash expenses under long-standing tax expense and debt service agreements that have been approved by our primary regulator in Wisconsin. Given the strength of our overall profile, we do not believe that servicer liquidity issues, which have been discussed as a possible knock-on consequence of COVID-related forbearance programs would have any notable impact on our business or financial position. Shareholders' equity at the end of the first quarter was $975 million, equal to $14.15 per share. We have $147 million of outstanding debt under our term loan, and our GAAP leverage was 13% at quarter end, providing us with significant incremental capacity to carry additional indebtedness. On March 20, we amended our revolving credit facility, increasing its size from $85 million to $100 million, expanding our lender group, extending its maturity to February 2023 and reducing its cost. The amendment provides us with more funding capacity at a lower cost with a longer maturity date. No amounts are currently drawn under the facility, and the full $100 million remains available to us. In April, we secured further consent from our revolving credit lenders to permit us to issue up to $400 million of senior debt alongside the facility. And we secured expanded approval from our primary regulator in Wisconsin to allocate incremental holding company interest expense to our operating subsidiaries should we choose to pursue additional debt financing opportunities and downstream proceeds to support our operating business. At quarter end, we reported total available assets under PMIERs of $1,070 million and risk-based required assets of $912 million. Excess available assets were $157 million. Our PMIERs risk-based required asset amount is determined at an individual policy level based on the risk characteristics of each insured loan. Loans with higher risk factors, such as higher loan to values or lower borrower FICO scores, are assessed a higher charge. Non-performing loans that have missed two or more payments are generally assessed a significantly higher charge than performing loans regardless of the underlying borrower or loan risk profile. However, special consideration is given under PMIERs to loans that are delinquent on homes located in an area declared by the Federal Emergency Management Agency, FEMA, to be a major disaster zone. The PMIERs charge on non-performing loans that enter delinquent status after a FEMA major disaster declaration benefits from a 70% haircut. FEMA has made a major disaster declaration in all 50 states in response to the COVID-19 pandemic. As such, the PMIERs risk-based required asset charge for all newly delinquent loans nationwide, including those that go delinquent under a federal or private forbearance program will be reduced by 70%. Our PMIERs risk-based required asset amount is also adjusted for approved reinsurance transactions. Under our quota share reinsurance treaties, we receive credit for the PMIERs risk-based required asset amount on ceded risk in force. As our gross PMIERs requirement on ceded risk increases, our PMIERs credit automatically increases as well. Under our ILN transactions, we generally receive credit for the PMIERs requirement on ceded risk to the extent such requirement is within the subordinated coverage layer or excess of loss detachment threshold, as we term it, of the transaction. We've structured our ILN transactions to be over collateralized, such that we have more ILN notes outstanding and cash equivalent held in trust than we currently receive credit for under PMIERs. To the extent our PMIERs requirement on ceded ILN risk grows, we receive increased credit under the treaties. The increasing PMIERs credit we receive under the ILN treaties is further enhanced by a structural feature, which we refer to as their delinquency lockout triggers. In the event delinquencies exceed 4% of ceded risk, the ILN notes stop amortizing and the cash equivalent assets held in trust are secured for our benefit. As the underlying ceded risk continues to run off, this has the effect of increasing the overcollateralization within an excess PMIERs capacity provided by each ILN structure. This is nuanced, but critically important to understanding how our PMIERs position will develop in the event of a rising level of COVID-related delinquencies. At March 31, we had $98 million of aggregate over collateralization across our three ILN transactions. This is over and above the $157 million of PMIERs excess assets we've reported. And assuming the 4% delinquency lockout trigger is activated in each deal and our underlying ceded risk continues to run off at the same rate it did during the month of March, we estimate that our total over collateralization will increase by up to $70 million per quarter. Our PMIERs funding requirement will go up in future periods based on the volume and risk profile of our new business production and the performance of our in-force portfolio. However, we estimate that we will remain in compliance with our PMIERs requirement even if default rates in our in-force portfolio materially exceed the current forbearance rates reported by each of the GSEs and the FHA, given the significant $157 million funding cushion we reported at March 31, the nationwide applicability of the 70% FEMA disaster haircut on newly delinquent policies and the increasing PMIERs relief automatically provided under each of our quota share and ILN treaties. Add to this the excess funding we have at our holding company level and our $100 million of undrawn revolving credit capacity, and we have a great opportunity to continue supporting our customers and capitalize on the increasingly attractive new business environment. Overall, the current environment is unlike any we've seen before. While this introduces general uncertainty, we believe that the conservative nature with which we've managed our business across the board will be valuable as we navigate through this stress. With that, let me turn it back to Claudia.

Thanks, Adam. The COVID crisis has brought into sharp focus the important role that National MI and the broader private mortgage insurance industry play in supporting a healthy and functioning housing finance system that works for borrowers, lenders and taxpayers across all market cycles. We came into this stress in a position of strength, bolstered by the conservatism with which we have managed our business, and we are here to provide support through this challenging period. Thank you for joining us today. I will now ask the operator to come back on so we can take your questions.

[Operator Instructions] Our first question comes from the line of Mark DeVries with Barclays.

I hope you're all doing well. Adam, all the commentary on the impact on reserves, given that this crisis is clearly different in some ways from a natural disaster, I mean natural disasters kind of come and go quickly. How are you thinking about what's the ultimate frequency that you might reserve for looks like when you compare it to like a garden-variety default versus a more traditional national disaster?

Yes, Mark, it's a great question. And certainly, this is a different environment than what we have in the wake of a natural disaster. We're facing a mobile pandemic and a nationwide economic slowdown. The reference I made to prior disasters isn't to draw a direct analogy to the level of ultimate cures or claims that we'll face. Rather it's to highlight how significant public policy can be in driving positive outcomes for impacted borrowers. So the events we're seeing now are markedly different than a typical natural disaster, but the level of support being offered up is different as well. It's scaled up dramatically given the significance of this crisis. I think as we think about reserve setting, one, we have to see what is the level of defaults that come through. We have to consider that against, one, the overarching housing policy goal that we see today, which is to ease the disruption of the COVID crisis for homeowners to give them a path to avoid foreclosures and stay in their homes, but the huge level of government assistance will be valuable. I think overall, we expect this to be more of a delinquency event than we do a claims event. We expect the roll rate of initial delinquencies progressing into foreclosure and claim will be much lower than we see in the ordinary course, not as a reference to disasters, but just in the ordinary course. And we need to also layer on to that what Brad talked about is our view of a general resiliency in the housing market and the house price environment ultimately when we're making our loss picks.

Okay. Got it. And then given this knowledge that it's also, that it's different than your normal natural disaster, any concerns or risks that the FHFA may not recognize that and even though FEMA's made the proper designation and give you that kind of 70% haircut on the impact to the required assets?

Yes. Certainly, it's within the purview of the FHFA and the GSEs to amend the PMIERs framework. But right now, it is codified in PMIERs. It's not a subjective thing. Look it up, Exhibit A, table 8 footnote 1. If FEMA has made a major disaster declaration then all loans that go delinquent in that area, including those that are in forbearance or otherwise, benefit from a 70% haircut, so there's no judgment call or subjective approval that's needed. Again, it certainly is within their purview to come out with an amendment. That's not our expectation at this point in time, though.

Okay. That's helpful. Thank you.

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

Good afternoon. Just a follow-up on that question on capital. Do you have a view on how long that capital treatment lasts? Is it just a period in forbearance? If the natural disaster period continues after that, is it clear when this – the capital treatment sort of that period ends?

Yes. So it's another good question. It depends on the nature of the event, the duration of the FEMA designation and also, I'll call it, the umbrella under which a delinquency comes to us. All delinquencies benefit from that FEMA haircut, as we'll call it for up to 120 days after their initial default date. Loans that are delinquent under a forbearance program in a state that has been – or an area that has been declared not just a major disaster area by FEMA, but it also benefits from individual assistance, then those loans receive a haircut for the duration of that forbearance program. Our expectation here is that almost all loans that come into us in delinquent status will be under a forbearance program, either at the outset or immediately thereafter. And so the duration in which we benefit from that haircut will be significant.

Okay. No, that makes sense. And then just a follow-up on the provision question as well. Do you have a default-to-claim expectation at the moment for this stuff that comes in? Or is that still kind of a work in progress?

I'd say it's a work in progress, and it's not going to ever be a static item, right? We're making a best estimate at a point in time that we're establishing our reserves and setting our claims expense based on the information that's available to us at that point in time. The environment is not going to be static. The information that we're looking to, to triangulate for that estimation is not going to be static. And so our assumptions, broadly speaking, will naturally evolve. But right now, again, we expect this to be much more of a delinquency event than we do a claims event.

Okay. And given that, is it fair to say that the default-to-claim expectation is probably lower than what it was for the stuff that was coming in until March 15 as a typical delinquency?

Yes, absolutely. We expect that the role to claim will be meaningfully lower than what it would be for a typical default coming into us under normal circumstance.

Okay. Great. Thank you.

Your next question comes from the line of Doug Harter from Credit Suisse.

Just hoping you could touch on kind of the outlook for – the environment for pricing. You said that you've seen increased pricing through the rate engine. Any sense if you could quantify the level of pricing increase that you've seen and expectations around that?

He absolutely does.

Yes. Doug, this is Claudia. So yes, we believe other mortgage insurers have made pricing changes, broadly taking rates up following the onset of the pandemic. So – and we don't have perfect detail here. Much of what we hear is from our customers, but it does appear most everyone is responding logically with pricing changes. For us, one important to note is that the impact of pricing changes made through rate engines, that's not all equal just because all the MIs are sourcing the same amount of business through their engine. So it's nearly all of our new production for us continues to come through rate GPS, which means that any pricing change we make today comes through nearly all of our new applications tomorrow. So that's the competitor outlook. Adam, you wanted to make a comment as well?

Yes. Doug, why don't I give you some specifics on what we've done, obviously in a certain light relative to what others have done. Our rates aren't uniform to begin with. So we haven't just applied a blanket increase, right, of the same amount across the entirety of our risk. In this environment, risk still matters. And so risk selection and risk-based pricing matter. Our prices are up anywhere from 10% to 70% depending on the borrower, the loan and lender risk attributes. Some of the risk at the upper end of that range, right, up 70%, we don't expect to get any more of, and that's part of the goal because we're using price in concert with some underwriting guideline changes to shape the mix of new business coming through. I'd say as a rough mile marker, pricing on new business applications in the first week of May is up about 20% compared to the first week of March. And that's even before adjusting for the differences in the underlying risk profile, right. First week of May, dramatically higher quality risk coming through than the first week of March, and we're just up 19%, 20% comparing one to the other. So in this environment, we're getting higher price, taking less risk and because we're taking less risk, we're required to hold a far lower level of capitalization against our new exposure and this is critical, right. New business environment, unit economics have increased meaningfully, as have the expected returns on new business production.

Great. Thank you for that.

Your next question comes from the line of Chris Gamaitoni with Compass Point.

Thanks for taking my call. Recognizing this is not a normal delinquency, and I took all of your comments on reserving. I was wondering if you could give us any perspective of how you think about a cumulative loss rate in whatever scenario you lay out like Moody's S3 or in a normal scenario where unemployment goes to eight, how do you want to frame it so there's some benchmark of what the expectation would be in a normal type recession, acknowledging the stimulus is way different and programs are different just to conceptualize it.

Yes. Chris, happy to, and what I would – let me preface it by saying, while we do expect this to be more of a delinquency than a claim event, we are expecting claims to come through that are different from what we otherwise would have been facing in the normal course. We do expect the house price environment to take a dip nationally for a period of time. We don't expect this to be anything close to what we saw during the 2008 financial crisis for a variety of reasons that Brad articulated. In terms of a mile marker, we look at a whole variety of stress scenarios. We do run a repeat of the financial crisis on the portfolio. We run the CCAR adverse scenario as an estimation of a more normalized recessionary environment. We also then just come up with some additional stresses that we contemplate. We don't necessarily believe that this is where things will go. But I do think it's instructive to think about a scenario where we have, call it, a down 10% national house price environment that takes hold immediately and stays at that level for 24 months with a very modest recovery thereafter. That type of a stress for us largely doesn't pierce the retained layers on our ILNs, maybe just a touch on our 2019 ILN. Overall, that's less than a 3% cumulative claim rate outcome for us.

When you say cumulative claim rate, were – okay, claim rate on risk in-force, just to be clear.

That's right. That's right.

Okay. Thanks so much. I appreciate it.

Your next question comes from the line of Jack Micenko from SIG.

Hi. Good afternoon everybody. I hope everybody's well. Adam, when we talk about claim rate, that's certainly one thing, and that's going to be a 2021 event at earliest. But curious more, over the next couple of quarters, we need to talk about forbearance take rates. And so curious how you're thinking about forbearance take rates? I guess we can put the spread at 6% to 11%, kind of what we've seen from some of the data you've referred to. What's your internal thought on where that number ultimately goes as you go into 2Q and 3Q?

Jack, let me clarify one item. So the claim dynamic and role to claim, that is a – it's a 2020 item for us. Certainly, we don't expect to be paying claims so ultimate claims payment and the cash impact associated with that for an extended period of time, given the duration of forbearance programs foreclosure moratoriums, right, it's just the natural cycle of progressing towards a foreclosure, but we incur loss and recognize that as a claims expense on a GAAP basis earlier on, and so just a point of clarification there. In terms of forbearance levels – make a few observations. The data isn't perfect at this point. I'd say, generally speaking, servicer data that we get is consistent, it's scrubbed. It's accurate for default reporting, right. What is an actual default status? But the overwhelming majority of borrowers who are now in forbearance have not yet defaulted. Most of them made their last payment and then accessed a forbearance program. And so the servicer detail on loans and workout status is less robust. It comes to us in a bit of a haphazard way from a few different data sources. And so we need to piece together sort of a mosaic of those inputs. What we're seeing right now is trending roughly in line with the data that's been publicly disclosed about the GSEs and their level of forbearance broadly. As to how high things will go, admittedly, anything that I share with you would just be speculative at this point. We don't know how long the stress is going to last. We don't know what's on the horizon from a medical standpoint. We don't know how quickly things are going to normalize after the shelter-in-place directives are lifted. And all of that will drive the macro impact and, by extension, the level of forbearance utilization, how long it persists, how high it goes? So we have seen the data points that others have put out, ranging anywhere from 10% to 20%. And instead of speculating alongside of that, what we've chosen to do is to stress test our portfolio, right, stress our claims paying resources, our liquidity profile, our regulatory capital position so that we know what level of forbearance driven delinquencies we can withstand. And our analysis indicates that we have the wherewithal to absorb in excess of 20% delinquency rates on our in-force portfolio. I'm not putting that out there to say that we expect a 20% delinquency rate. But instead of speculating what we have found to be more useful is for us to stress the portfolio and understand the position that we're in and how high a level we can absorb.

All right. That's helpful and makes sense. On the 70% haircut, that was to your point, pretty much automatic. It was in the documentation. In your conversations in Washington, it's kind of a solid situation, when the FHFA put out this forbearance program, you would wonder if there's something that they would think about incrementally to a natural disaster. Are there any conversations in Washington that are thinking about anything else that would apply to PMIERs in the MI industry, maybe around kind of the seasoning weightings or anything else that you're hearing or thinking about that could partially offset more of that capital charge on the PMIERs side for the industry.

Jeff, it's Brad. Let me start, and then I'll turn it over to Claudia to add to it. But – so we've had a series of ongoing conversations with both the FHFA and the GSEs, both directly as a company and in concert with the rest of the industry through USMI. So we recognize in times like this, it's critical for us to be connected with our counterparties and our policymakers, much the same way that we stay close with our primary regulator in Wisconsin during times like these. So we're not really in a position to speculate about a possible amendment to PMIERs, but I'd make a couple of observations. First of all, PMIERs never contemplated a situation like this, a complete inorganic shutdown of all economic activity, one I would add that was mandated by the government alongside with a massive national forbearance program designed to help homeowners and avoid foreclosures, so really unprecedented situation. Regulators and other financial service subsectors have recognized how unique this is and have made, at least in some cases, temporary and other cases, other than temporary changes to operational capital and other standards that they – to which they hold the people that they regulate. So we think that – it certainly bears consideration. I guess where I leave it with you, we have every confidence that we can pay every claim we will face coming out of this crisis with multiples of capital left over. That's how we built the business and our credit risk management framework that we're so proud of. And as Adam just said, we've stressed ourselves to the point where we can absorb over a 20% take-up on the forbearance programs and still have our PMIERs sufficiency. So we feel we're in a good place from that standpoint. So that regulatory framework will evolve, and we're just going to have to see how things go, but people are working on it.

Okay. Thank you for that, and I'll take a rest on offline later. Thanks.

Thanks.

Your next question comes from the line of Rick Shane with JPMorgan.

Hey, guys. Thanks for taking my question and I hope everybody is doing well. Look, we're going to be in a really interesting environment going forward. Obviously, there's an enormous amount of uncertainty related to credit. And I think you guys have done a good job articulating your views and providing a good capital outlook. We're also going to be in an environment where rates are going to be persistently low. There's going to likely be, at some point, a pretty significant pickup in volume. I'm curious, you guys have demonstrated and talked about the industry showing pricing power. As you look forward to risk-sharing going forward, do you think ILN will continue to be an attractive way to share risk in a more uncertain environment?

Yes, Rick. A very good question and I would say, rest assured, we've been having active conversations with our – its not just ILNs – right, also put reinsurance – traditional reinsurance into the mix. We've been having active discussions with our reinsurance partners, ILN investors, bankers, insurance brokers to gauge this exact issue. We believe that the reinsurance market, the traditional reinsurance market is available today for MI risk and that the ILN market is on a path to near-term recovery. I think what we need to see, obviously, structures, deal sizes and limits, pricing and attachment points will likely change, which is all-natural and to be expected. In much the same way that our primary risk appetite and pricing views have shifted, that's going to be the same that happens in secondary markets. But we have every reason to be confident that those markets will remain available broadly, but in particular, to National MI. And I think our experience here helps, right? Our counterparties on the reinsurance side, our partners know how we've managed our business with conservatism all along. And that becomes a real positive point of differentiation for us now in stress, but we do expect that those markets will be there. Again, the profile of each deal is likely to shift but we do expect them to be available.

Okay. That's helpful. One of my favorite questions right now is just to ask how people are spending their time because that gives you a little bit of insight into how people are looking at their businesses and the fact that you guys are doing that means you're looking pretty far down the road in terms of seeing originations come back.

Yep.

Thank you, guys.

Great. Thank you, Rick.

Your next question comes from the line of Phil Stefano with Deutsche Bank.

Yes. Thanks. Adam, in your prepared remarks, you had mentioned that there was a reserve strengthening in the quarter. I'm not sure that I completely followed that. I was hoping you could just talk me through. Was that a more conservative reserving position on new defaults that came through in first quarter 2020 or – it didn't come through as adverse development. But how should I be thinking about what exactly that strengthening was?

Yes. I think just simplistically, Phil, it's a good question. So our NOD count was essentially flat quarter-to-quarter, right, 1,449 at March 31 compared to 1,448 at December 31, not all the same population, but just think about it as essentially a flat NOD count roughly the same – of the same age, roughly, and our gross reserves increased by 24% from what we carried at December 31 through March 31. And so we did take our best estimate for eventual claims exposure up because of our view of the future macro environment changing. I would say this isn't, though, a 1Q event for us, right? And our approach to establishing a best estimate view in the second quarter and going forward will naturally continue to evolve as more information does come in. But my reference there, it was posting a higher case reserve per NOD for each new default and taking up those that we carried from prior periods as well.

Got it. Okay. In my mind, embedded in that is adverse development, but maybe that's just more of a P&C mentality of thinking about this as opposed to MI accounting. I'll take that offline. And looking at the ILNs, administratively, how does it work? When it feels like the pace of new defaults is going to pick up, do they have to be put on notice at some point that there is potential claims coming? Or are there triggers within there that you have to communicate to them about the changing in the economic environment?

Yes. I would say that there are no disclosure requirements or items that need to be shared that are different than in the normal course. There's a heavy amount of disclosure on the underlying pools of risk that we share and provide updates on, on a monthly basis. So looking at what's the population of loans that still remain so they understand what's the runoff of the risk in-force embedded in each of those transactions at a loan level basis, so there's a loan tape that's passed along. But that's – nothing is different in a period of higher stress, higher delinquency than is otherwise the case in the normal course.

Perfect. Got it. Thank you.

Your last question comes from the line of Mark Hughes with SunTrust.

Yes. Thank you. Good afternoon. Adam, your hesitancy around the premium yield guidance, obviously a lot of moving parts. But I wonder if you could give some thoughts on the puts and takes. As you sit here today, you're obviously getting better pricing, but there's a lot of turnover in the portfolio that's probably putting pressure on that yield. How do we think about how that might progress through the year, not officially just a few of the contours?

So I'll give you contours on a qualitative basis and nothing that gears towards a number, just because it's – there's so much uncertainty right now. But I think you're touching on a lot of points that are there, right? We need to understand what it means for our new business volume, how our new business pricing continues to emerge. What's the rate of portfolio turnover? The portfolio turnover isn't just a negative. In fact, we get a significant contribution from cancellation earnings, where we had $8.6 million of cancellation earnings in the first quarter, which is far higher than what we otherwise had anticipated. And remember, our reinsurance costs run through there. So the answer that I gave on the availability of reinsurance is an important one and an attractive one for us as we think about our funding profile going forward and our risk management program for new business. But also where the cost and the structure of those transactions land will impact what our reported net yield is.

Thank you very much.

And there are no further questions at this time. I'll turn it back over to our speakers for closing remarks.

Thank you again for joining us. We will be participating in virtual investor conferences hosted by SunTrust on May 19, Deutsche Bank on May 27 and KBW on May 28. We look forward to speaking with you at one of these virtual events. Thank you and be safe.

Thank you, ladies and gentlemen. That does conclude today's conference call. We thank you for your participation and ask that you please disconnect your lines.