Mgic Investment Corp Q1 FY2021 Earnings Call

Good day and thank you for standing by. Welcome to the MGIC Investment Corporation’s First Quarter 2021 Earnings Call. At this time all participants are in a listen-only mode. Please follow the instructions. And I would now like to hand the conference over to your speaker today, Mike Zimmerman, Senior Vice President, Investor Relations. Please go ahead.

Thanks, Laurie. Good morning and thank you for joining us this morning and for your interest in MGIC Investment Corporation. Joining me on the call today to discuss the results for the first quarter of 2021 are Chief Executive Officer, Tim Mattke; and Chief Financial Officer, Nathan Colson. I want to remind all participants that our earnings release of last evening, which may be accessed on our website, includes additional information about the company’s quarterly results that we will refer to during the call and includes the reconciliation of non-GAAP financial measures to the most comparable GAAP measures. We have posted on our website a presentation that contains information pertaining to our primary risk in force, new insurance written, reinsurance transactions, and other information that we think you’ll find valuable. I also want to remind listeners that from time to time, we may post information about our underwriting guidelines and other presentations or corrections to past presentations on our website that investors and other interested parties should be aware of. During the course of this call, we may make comments about our expectations of the future. Actual results could differ materially from those contained in these forward-looking statements. Additional information about those factors, including COVID-19, that could cause actual results to differ materially from those discussed on the call are contained in the Form 8-K and Form 10-Q that were filed last night. If the company makes any forward-looking statements, we are not undertaking an obligation to update those statements in the future in light of subsequent developments. Further, no interested party should rely on the fact that such guidance or forward-looking statements are current any time other than the time of this call or the issuance of the Form 8-K or Form 10-Q. With that, I’d like to introduce Tim Mattke.

Thanks Mike, and good morning. I’m pleased to report that we produced another quarter of very strong financial results. After my opening remarks, Nathan will provide more detail about those financial results and about our capital position. Then before we open the line for questions, I’ll wrap up by discussing the current operating environment, including activities related to housing policy. During the quarter, we reported GAAP net income of $150 million, which reflects a strong credit profile and performance of our insurance in force, favorable housing and mortgage market trends, improving economic conditions, and our market presence. For some time now our main business objective has been to use our resources to provide critical support to the housing market, especially for first-time and low- to moderate-income homebuyers. We try to achieve that objective by, among other things, providing competitive offerings and best-in-class service to mortgage originators and servicers and by maintaining a sharp focus on the sources and uses of our capital. This strategy has allowed us to capitalize on the strong demand for single-family housing. Our new insurance written (NIW) continued to be weighed more heavily towards purchase transactions versus refinance transactions, accounting for 60% of our NIW in the first quarter. While interest rates were higher in the first quarter than at times in 2020, they are still very attractive for many borrowers, whether to purchase a home or refinance. As a result, our industry continued to enjoy a relatively larger market share of refinances than in prior periods. These strong housing and mortgage market conditions led to another very busy quarter for our customers, and as a result of this and our market presence, we wrote nearly $31 billion of NIW in the first quarter. While the first quarter provided a strong start for new business in 2021, we do expect that higher interest rates and the recent gains in property values will slow the volume of refinance transactions available to us. In fact, we have begun to see the mix shift towards more purchase transactions in our application pipeline, a leading indicator of NIW, with purchase transactions making up more than 75% of the applications in recent weeks. The level of new business we wrote in the quarter more than offset the pressure of lower annual persistency that our existing book of business faced due to refinance activity, resulting in our insurance in force growing to $252 billion, which is more than 11% higher than the same period last year. While the supply of housing inventory available for purchase is low, we still expect robust purchase market conditions to continue as demand remains strong. I expect that those conditions will continue to allow our insurance in force to grow, although perhaps at slower annual rates than we have become accustomed to in recent quarters. Reflecting the underlying economic conditions, the quality of our existing book of business, and the number of new delinquency notices received, our loss ratio declined to 15.5% in the quarter. I continue to be encouraged by the trends we are seeing in credit performance, including the delinquency rate, which continues to decline as fewer loans become delinquent and existing delinquent loans continue to cure. This trend continued through April, where we saw our lowest level of new delinquency notices in more than a decade, accompanied by strong cure activity on previously delinquent loans. As a result of credit performance, reinsurance transactions, and continued strong cash from operations, we estimate that the spread of our PMIERs Available Assets over PMIERs Minimum Required Assets increased by approximately $500 million in the quarter, with our PMIERs efficiency ratio at 169% at the end of the quarter. While we remain keenly focused on maximizing the near-term business opportunities and navigating the outstanding COVID-related challenges, we are committed to the long-term success of the company. We have a strong balance sheet, we are confident in our position in the market, and we like the risk-reward equation that the current conditions offer. With that, let me turn it over to Nathan.

Thanks, Tim, and good morning. As Tim mentioned, the results show that we had another strong quarter of financial results, as the impact on our business from the effects of COVID-19 continues to diminish. In the first quarter, we reported $150 million of net income or $0.43 per diluted share and generated an annualized 13% return on beginning shareholders’ equity. This compares to $150 million of net income or $0.42 per diluted share with an annualized 14% return on beginning shareholders’ equity in the same period last year. Adjusted net operating income per diluted share in the first quarter was a $0.001 lower than the reported GAAP amount; a detailed reconciliation of GAAP net income to adjusted net operating income can be found in the press release. During the quarter, total revenues were $298 million compared to $307 million last year, with the decrease primarily due to lower investment income and lower net premium earned. Investment income was lower as the larger investment portfolio was more than offset by lower yields. Net premiums earned decreased primarily due to a lower net premium yield and an increase in the amount of premiums at risk ceded through our reinsurance transactions. These effects were partially offset by an increase in accelerated premiums earned from single premium policy cancellations compared to the first quarter of 2020 and higher average insurance in force. The net premium yield for the first quarter was approximately 41 basis points, down sequentially by approximately two basis points, primarily because the in-force premium yield continues to decline through the attrition of the older policies, which generally have higher premium rates. We also realized less benefit from accelerated premiums earned from single premium policy cancellations compared to the fourth quarter of 2020. Single premium policies now represent a smaller percentage of our in-force portfolio than in 2020 due to the increased level of refinances occurring over the last several quarters, and there was also a smaller percentage of our new business being generated from these policies. During the quarter, accelerated premiums from single premium policy cancellations were $28 million compared to $32 million last quarter and $18 million in the first quarter of 2020. I expect the direct in-force premium yield to continue to trend lower throughout 2021 as the older policies generally have higher premium rates runoff and are replaced with new policies that typically have lower premium rates. However, due to the recognition of accelerated single premiums, the level of profit commission, and the impact of new business, forecasting the change in the net premium yield is complex but is also expected to decline over time. Despite lower premium rates on newer policies, we expect to earn attractive risk-adjusted returns on our new business written. Shifting over to credit, we incurred net losses of $40 million in the first quarter compared to $61 million for the same period last year. In the first quarter, we received approximately 13,000 new delinquency notices, which represents 1.2% of the number of loans insured as of the end of 2020, the same percentage that rolled from current to delinquent in the first quarter of last year. We are encouraged by the fact that this ratio has returned to its pre-COVID level. The estimated claim rate on new notices received in the first quarter of 2021 was approximately 7.5%, compared to 9% in the first quarter of 2020. As we do each quarter, we reevaluated our loss reserves on our existing delinquency inventory, and in the first quarter of 2021 determined that there was immaterial loss reserve development compared to $3 million of unfavorable development in the first quarter of last year. We reduced our reserve for incurred but not reported (IBNR) delinquencies in the first quarter of 2021 by $4 million to approximately $24 million, compared to an increase of $8 million in the first quarter of 2020. As a reminder, we adjust the IBNR reserve as we re-estimate the number of loans whose borrowers missed a payment but that had not yet been reported to us as delinquent. Of the 53,000 loans in our delinquency inventory at quarter end, approximately 61% or 32,200 loans were reported to us to be in forbearance. Based on the information reported to us, we estimate that most of the loans in forbearance at the quarter's end will reach the end of their forbearance terms in the latter part of 2021. More specifically, we estimate that over 60% of the loans in forbearance will reach their 12-month anniversary of being in forbearance in the second quarter of 2021. Although we expect that some of those plans will be extended either for three or six months, we continue to observe loans exiting forbearance without a claim payment. Future economic conditions, including unemployment and home prices, will impact the ultimate outcome for the remaining loans in forbearance. While it is uncertain how the current delinquency inventory will resolve, I am pleased that favorable delinquency and cure activity has continued through April, and that downside earnings and capital risk has been materially less than it was at the end of the second quarter last year. The number of claims received in the quarter remained very low and was down nearly 64% from the same period last year, primarily due to foreclosure and eviction moratoriums. Primary paid claims declined to just under $12 million and consisted primarily of short sales and deeds in lieu of foreclosure. At some point, the foreclosure moratoriums will expire; however, we expect claim payments to remain modest for several quarters after they expire, because on average, it takes approximately 18 months to complete a foreclosure should it become necessary. Moving on to operating expenses, they totaled $51 million in the first quarter compared to $45 million during the same period last year. Last quarter, we informed you that we have been making and plan to make further investments in our infrastructure to capture the value that comes with improved data, analytics, and operational improvements in an increasingly digitized mortgage finance industry. While the rate of spending to date is a bit lower than the guidance we previously provided, I expect that the pace of investment will increase in the coming quarters, and that the full year underwriting and other expenses will still be in the range of $220 million to $225 million, but more likely towards the lower end of that range. Reflecting our current debt outstanding, interest expense was $18 million in the quarter compared to $13 million in the same period last year. Assuming no additional transactions, the annual debt service costs will be approximately $70 million. We had approximately $800 million of cash and investments at the holding company as of March 31, 2021. At the most recent board meeting, the holding company board approved a cash dividend of $0.06 per share, payable on May 27. Any future common stock dividends will also be determined in consultation with the board. We continue to believe that our balanced approach in maintaining a strong balance sheet, which includes the use of forward commitment quota share treaties and by accessing the capital markets for excess of loss reinsurance via ILN transactions, provides the most flexibility to maximize the long-term value of both the operating company and holding company, whether by writing more primary mortgage insurance, pursuing new business opportunities, retiring debt, paying dividends, or repurchasing stock. At quarter end, our consolidated cash and investments totaled $7 billion, including the cash and investments at the holding company. The consolidated investment portfolio consists of 84% taxable and 16% tax-exempt securities, with a pre-tax yield of 2.5% and a duration of 4.5 years. Reflecting interest rate movements in the quarter, the net unrealized gain declined to $226 million at March 31, 2021, compared to $345 million at year-end. Shifting to the financial requirements of the private mortgage insurer eligibility requirements (PMIERs) of the GSEs, MGIC’s available assets totaled approximately $5.5 billion, resulting in a $2.3 billion excess over the minimum required assets of $3.2 billion, and a PMIERs efficiency ratio of 169%, as Tim said. The $3.2 billion minimum required assets at the end of the first quarter reflects a 70% reduction for loans in a COVID-19 related forbearance plan as allowed under the PMIERs. This provided approximately $620 million of PMIERs relief, net of reinsurance. This excess of available assets over minimum required assets grew by approximately $500 million in the quarter as a result of the $360 million reduction in required assets associated with the ILN transaction that closed in February, and approximately $200 million in available assets generated organically through our results of operations, partially offset by the increase in required assets to support the increased risk in force in the first quarter. In summary, we remain encouraged that as the economy continues to recover, the favorable trends in credit performance and in the housing market will continue. We feel we are well-positioned to capitalize on the market opportunities that our robust housing market should make available to us, given our strong market presence, a growing enforced book of business that is currently generating low levels of delinquencies, a comprehensive reinsurance program, and the quality of new business being written. With that, let me turn it back to Tim.

Thanks Nathan. Before moving to questions, let me address a few additional topics. There continues to be a lot of activity in housing policy circles, but meaningful progress is slow. This could be in part due to the fact that the housing finance system, while it could be improved, is operating relatively efficiently and providing critical support to the economic recovery. As widely expected, it appears that the new administration is focusing its policy efforts on continued loss mitigation efforts for homeowners impacted by COVID-19 and ensuring a successful economic recovery, rather than large-scale changes to housing finance infrastructure and policy. Today, we are not aware of any policy initiatives that would provide new challenges to our company or industry. Meanwhile, we will continue to advocate for the increased use of private mortgage insurance in the housing finance industry in order to reduce taxpayer exposure to housing, while still maintaining a resilient housing finance system. Long-term, I remain encouraged about the future role that our company and industry can play in housing finance, and I believe that other regulators and policymakers share a similar view. The COVID-19 pandemic reminds all participants that some market options for credit enhancement can be scarce or unavailable at various points in the economic cycle. While our company and industry are organized solely to provide credit enhancement solutions to lenders, borrowers, and the GSEs under all economic cycles, private mortgage insurance provides dedicated capital day-in and day-out to the housing industry, offering many solutions and a great value proposition for lenders and consumers to overcome the number one barrier to home ownership: the down payment. As I mentioned at the beginning of my remarks, we are focused on continuing to provide critical support to the current housing market, especially to low- and moderate-income and first-time homebuyers. Currently, we are writing high levels of new insurance and are experiencing decreasing levels of delinquencies, both duly reported and open inventory. We have a book of business that has strong underlying credit characteristics supported by a balance sheet that features a low debt-to-capital ratio, an investment portfolio of nearly $7 billion, a contractual premium flow, and a robust reinsurance program. I am confident in our positioning in this market, and we like the risk-reward equation that the current conditions offer. We have the right team in place to build off our solid foundation to continue to deliver competitive offerings and best-in-class service to our customers and generate strong returns for our shareholders. With that operator, let’s take questions.

Please follow the instructions for questions, and our first question is from Mark DeVries of Barclays. Please ask your question.

Yes, thank you. I was hoping you could give us a sense of why you think in terms of insurance in force grew so much in April, what you’re seeing in terms of pricing, and whether you think any pricing adjustments might’ve impacted the business you wrote in April?

Mark, it’s Tim. I guess it’s tough to know exactly what the overall size of the April market is. I think we continue to be encouraged that home purchase volume seems to remain strong, even though, as we’ve talked about in the comments, refinance activity seems to be slowing down at least for mortgage insurers. But I think it’s really because home purchases remain strong. I think interest rates are still very attractive for home buyers. For the most part, I think we attribute this strength to that sustained demand.

Okay. And you’re not seeing any signs that pricing has shifted in a way that might be moving business towards you this month?

I mean, not that I would point to. I think it’s more that we’re getting into the time of the year where that demand remains strong. We think interest rates, even though some headlines say that interest rates are going up and making things less affordable, are still attractive for many potential home buyers.

Yes, Mark. This is Mike. Just a reminder that the NIW rate is clearly a trailing indicator, so that’s coming from applications and activity from April, which originates in February and March. It's essential to consider this when evaluating our performance.

Got it. And then on a separate topic, Nathan alluded to the fact that 60% of borrowers in forbearance are coming up on their scheduled end of their forbearance periods, but did you expect some borrowers will have that extended? Could you talk about your expectations, what you’re hearing out of Washington, and if they don’t extend, what’s your strategy for those loans moving forward?

Sure. Mark, it’s Nathan. I think with the GSEs extending the forbearance period up to 18 months for most borrowers, it doesn’t seem like there will be many borrowers that exit forbearance after 12 months and enter foreclosure, partly due to the moratoriums and partly due to the option of extending it to 18 months. So, we don’t expect to see many borrowers exiting forbearance in a negative manner in the near term. If borrowers do exit forbearance and head towards foreclosure, that’s likely pushed out towards the end of the year.

Okay. And are you having conversations with your servicers about what their approach will be? Whether it’s starting to do things like deed in lieu, or will the first effort be to restructure the mortgage to achieve a payment that the borrower can make?

Hey, Mark, it’s Mike again. Yes, we engage with servicers, and we actively participate in the housing policy council. Clearly, there’s a lot of discussions with the CFPB looking to make more active reviews from a borrower perspective. What service strategies will be implemented are traditional loss mitigation methods. We have new tools like the deferral option within the forbearance arrangement. It’s too early to tell the exact strategies being undertaken. However, deeds in lieu and short sales are happening, where borrowers find those solutions to be most sensible.

Great. Thank you.

Our next question is from Bose George of KBW. Please ask your question.

Hey guys, good morning. I just wanted to follow up on the pricing-related question. There’s also been a kind of movement in market share among your peers this quarter; you guys felt fairly stable. I wanted to get your thoughts on competition and pricing in the market. And specifically, do you think that price increases post-COVID have been given back as the credit outlook has improved?

Yes, Bose. It’s tough to say where everybody else stands. It’s a competitive marketplace. Generally speaking, the concerns that people had at the onset of COVID have likely dissipated in the industry regarding risks and pricing. It’s challenging for us to speculate on market share with other participants, but we’re happy with the capital we deployed this last quarter and the strong returns we achieved. We look forward to the remainder of the year.

Okay, fair enough. So, it’s safe to say that you’re seeing returns consistent with your hurdles, and there was no change this quarter, given what was happening in the market?

Yes, I think it’s safe to say that we are achieving returns that meet or exceed our hurdle rates, and we view this as a very good market to participate in.

Okay, great. Thanks. And then just one on capital return, so you guys obviously have a lot of excess at the holding company. How are you thinking about potential capital return there? While the FHFA has been a constraint on dividends up to now, you obviously have flexibility with the cash that’s already there.

Yes, Bose, this is Nathan. It’s a good question; something we discuss often. We have continued to pay the shareholder dividend as a form of capital return during this period. We have about $800 million at the holding company, so we have options. However, meaningful capital return, given our business scale, really can’t start until dividends from the operating company resume. We’re focused on what happens after the expiration of the GSE temporary rule that requires their approval. We’ve had constructive conversations with our regulator, and we’re evaluating our capital return plan longer term.

Okay, great. Makes sense. Thanks.

Our next question is from Doug Harter of Credit Suisse. Please ask your question.

Thanks. You mentioned you expect premium yields to continue to drift lower; any sense as to how long until we kind of bottom out and reach a new equilibrium?

Yes, it’s Nathan. It’s a good question. I would point you to the direct enforced portfolio yield rather than the net yield, which can move around for other reasons. Historically, it’s been coming down about a basis point a quarter over the last several quarters. That run rate seems reasonable for the remainder of 2021, but it will be influenced by refinance activity. If we end up in an environment with much lower refinance activity, that would likely slow that pace. However, if we continue with a high refinance environment, we may see the pace continue.

Understood. Thanks, Nathan.

Our next question is from Philip Stefano of Deutsche Bank. Your line is open.

Yes, thanks. And good morning. Hopefully, a quick geography question for you. The IBNR adjustment that was done, where does that show up? Is it in the current period or prior period loss provisioning?

That’s included in the current period.

Okay. Thank you. And Nathan, you mentioned expenses and I appreciate the updated thoughts around that. As we look at the path towards the 2020 to 2025 goals, will there be sequential upticks throughout the year? How should we think about what the fourth quarter number is? Is that an exit run rate we should contemplate for the full four quarters? And do you expect that inherently digitization is more expensive from an operational perspective to run this business, or is there some kind of catch-up in 2021, and perhaps expenses might decrease as we contemplate 2022 and beyond?

Yes, that’s a good question. I don’t see any significant seasonality or a direct upward trend in expenses quarter over quarter in 2021. We are a little lower than the guidance we provided, but not significantly. What we’re saying is that in the second, third, and fourth quarters, the average expenses will likely be a bit higher than what we reported in the first quarter. In the longer term, much of this investment aims to capture increased efficiencies, which should start to become apparent in the latter half of this year, though they may be masked initially by the incremental investment. However, the fourth-quarter results are not anticipated to establish a new long-term expense run rate.

Okay, that makes sense. And then just one more philosophical question: as we think about deed in lieu in short sales versus the strength we have in the broader housing market, is there an opportunity to acquire properties and sell them at a gain, given the optionality inherent in the MI policies? Can you be more aggressive if you want to in this market? Does it make sense considering the strengths of the broader housing market and rising home prices?

Hey, Phil, it’s Mike. You’re right; we always have the option to acquire properties. However, when markets are strong, while we have those opportunities, we often see others outbidding us because we aim to mitigate our losses to maximize potential recoveries, rather than to profit from property sales. We recognize opportunities exist, but the numbers involved are relatively small, so it doesn’t necessarily make sense to be aggressive in turning that into a profit center.

Yes, just curious. Thank you so much.

Our next question is from Ryan Gilbert of BTIG. Please ask your question.

Hi, thanks, guys. I jumped on a little late, so sorry if you addressed this. But going back to that April insurance in force growth, it sounded like in response to a previous question that the improvement in April IIF was really driven by stronger NIW growth and less so from declining cancellations. Is that the right way to think about it, or did you see a pickup in persistency in April?

Yes, persistency didn’t pick up in April, considering the rate environment. It’s more a function of the market opportunity available. The April NIW reflects activity from February and March; we should think of it that way. Rates were just starting to rise and experience some volatility.

Got it. Thanks. Second question is on premium yield; do you think that once the pre-2018 book fully runs off, we’ll continue to see reductions in the premium yield, or do you think that yield will stabilize?

Ryan, it’s Nathan. I would say our experience shows that those portfolios never fully run off. They have a long tail. Even if you generalize that those are primarily running off, the yield has trended down due in part to newer policies being written with a better risk profile than the older in-force stocks, typically at lower premium rates. Once our in-force contains only the newer policies, the yield may adjust accordingly, but many factors can influence this evolution.

Okay, got it. Thank you very much.

Our next question is from Mihir Bhatia of Bank of America. Please ask your question.

Hi, good morning, and thank you for taking my questions. I just had one quick one. I wanted to ask about the April delinquency and the delinquent inventory declining so much. Is there something unusual about that time period due to the expiration of foreclosure and moratoriums being extended, or do you think that April is indicative of the kind of improvement we could see for the next two or three months? Because I imagine there’s a lot of loans coming up to the 12-month mark in the next few months. Thank you.

Hey Mihir, it’s Mike. Certainly, seasonality plays a role in credit, with new notices and cures typically exhibiting seasonal patterns. Regardless of economic conditions, we generally see trends aligned with seasonality at the beginning part of the year. It is challenging to distinguish how much is driven by seasonality versus organic changes. However, I believe seasonality has an impact when we look at sequential month-over-month trends.

Got it. Okay. Thank you.

There are no further questions on queue, presenters. You may continue.

I want to thank everyone for their interest and their questions. It was another great quarter financially, and I hope everyone is staying happy and healthy as we move through COVID-19. Again, thank you for your interest in MGIC Investment Corp.

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.