NMI Holdings, Inc. Q2 FY2022 Earnings Call

Thank you, operator, good afternoon, and welcome to the 2022 second quarter conference call for National MI. Joining us on the call today are Brad Shuster, Executive Chairman; Adam Pollitzer, President and Chief Executive Officer; Ravi Mallela, Chief Financial Officer; and Julie Norberg, our Chief Accounting Officer. Financial results for the quarter were released after the close today. 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 have provided a reconciliation of these measures to the most comparable measures under GAAP.

Thank you, John, and good afternoon, everyone. We had a terrific second quarter with strong operating performance, significant growth in our insured portfolio, and record financial results. During today's call, as we always do, we'll share with you the details behind our numbers and the implications for the periods ahead. I'd like to focus, however, on the macroeconomic environment. I've been in this business for almost 30 years. I have seen a number of economic cycles over that time. And importantly, I've seen how the mortgage insurance industry overall and National MI specifically, have learned from and been transformed by past experience. We do see an emerging set of macro headwinds. However, we do not expect the economy or the housing market to deteriorate as they did in the financial crisis. For more than a decade now, underwriting standards have been disciplined and responsible across the mortgage market. Regulatory guardrails have been enacted and the toolkit to assist borrowers through stress has grown meaningfully. Our borrowers today have a strong credit profile, a significant equity position in their homes given the recent run of house price appreciation, and benefit from record low 30-year fixed-rate mortgages with manageable debt service obligations. From the start, we have been focused on building National MI in a durable risk responsible manner. We've worked hard to establish a comprehensive credit risk management framework, and in doing so, we have built the highest quality insured portfolio in the MI industry, and have secured comprehensive reinsurance protection for nearly the entirety of our book. I'm confident in our ability to perform across all market cycles. We will continue to invest in our employees, support our customers and their borrowers, and deliver for our shareholders, no matter how the economy develops. Shifting to Washington matters. In early June, the GSEs each released their equitable housing finance plans, which are designed to promote equitable access to affordable and sustainable housing and address long-standing disparities in homeownership. We commend their efforts. At National MI, we believe that providing all borrowers with an equitable opportunity to access the housing market, establishing community identity, and building long-term wealth through homeownership in a manner that appropriately guards against systemic risk is critically important. National MI and the broader private mortgage insurance industry play a uniquely valuable role in the housing finance system, providing borrowers with down payment support and equal access to mortgage credit while also placing private capital in front of the taxpayer to absorb risk and loss in a downturn. Since our formation, we've helped more than 1.4 million low-down-payment borrowers gain fair access to mortgage credit. And, in doing so, have helped open the door to affordable and sustainable homeownership in communities across the country. We are committed to equally supporting borrowers from all communities and are actively engaged in discussions with policymakers, regulators, the GSEs, lenders, and consumer advocacy groups. We look forward to continuing to work with the GSEs as they put their equitable housing finance plans into action, and develop specific initiatives to support increased access and affordability in a manner that appropriately guards against systemic risk.

Thank you, Brad, and good afternoon, everyone. National MI continued to outperform in the second quarter, delivering significant new business production, strong growth in our high-quality insured portfolio, continued success in the reinsurance market, and record results across every key financial metric. We generated $16.6 billion of NIW volume and ended the quarter with a record $168.6 billion of high-quality, high-performing insurance in force. We achieved a record GAAP net income of $75.4 million or $0.86 per diluted share and a record adjusted net income of $74.3 million, also $0.86 per diluted share. During the quarter, we also entered into a new quota share reinsurance agreement securing incremental risk protection for a portion of our in-force portfolio. The transaction builds upon the broad success that we've had in the risk transfer markets to date and provides us with approximately $150 million of incremental PMIERs funding capacity at an attractive cost of capital. Overall, we had an exceptionally strong quarter and are optimistic as we progress into the second half. Our lenders and their borrowers continue to rely on us for critical down payment support, purchase demand remains strong, and we see a significant opportunity to continue writing high-quality, high-return, high-value, new business. We expect our persistency will continue to improve meaningfully driving sustained growth in our in-force book and a further increase in the embedded value of our insured portfolio. Our credit experience continues to trend in a favorable direction with the performance data from our portfolio remaining resoundingly strong. Taken together, we see a clear opportunity for continued outperformance. We do, however, also see increased risk in the macro environment. Rising rates and the record run of house price appreciation have strained affordability for many new borrowers and some prospective buyers are recalibrating due to the emerging economic uncertainty. We expect the pace of home price appreciation to moderate from record levels and we may see a modest decline in certain local markets. The existing homeowners, however, are well-positioned with strong credit profiles, record levels of home equity, sustainable fixed payment obligations at record low mortgage rates, and a favorable job market all providing foundational support. While we can't control how the economy or housing market develops, we can control how we're positioned to navigate through a period of stress, and we've taken action and made investments from day one to secure our performance across all cycles. We have a talented and dedicated team to drive our success every day. We've earned the trust and partnership of our customers with our focus on service, value-added engagement, and technology leadership. We've prioritized discipline and risk responsibility as we've grown our in-force portfolio building the highest quality insured book in the MI industry. We've led with innovation in the risk transfer markets securing comprehensive reinsurance coverage on nearly all of the policies we've ever originated, and we've established a strong balance sheet with a robust funding position and sizable regulatory capital buffer. In the second quarter, and in the month since we've taken further steps to bolster our business. We have selectively increased policy pricing to reflect the emerging risk environment, we've made targeted changes to manage our mix of new business by risk cohort and geography, and we secured additional reinsurance protection and strengthened our PMIERs position among other actions. More broadly, we've been encouraged by the discipline that we've seen across the private MI market. Underwriting standards remain rigorous and the pricing environment has generally hardened in response to emerging risks. Overall, we had a terrific quarter, delivering strong operating performance, significant growth in our insured portfolio, and record financial results and are optimistic as we enter the second half of the year. We are well-positioned to continue to serve our customers and their borrowers, invest in our employees and their success, drive growth in our high-quality and short portfolio, and deliver strong performance for our shareholders. Before turning it over to Ravi, I want to note how proud I am that for the seventh consecutive year, National MI has been recognized as a Great Place to Work. Great Place to Work is a global authority on workplace culture, employee experience, and leadership, and partners with Fortune Magazine to produce the annual Fortune 100 Best Companies to Work For list. We believe that the quality of our team and the culture that we've established are key competitive advantages and it's gratifying to again be recognized for these strengths.

Thank you, Adam. We achieved record financial results in the second quarter, driven by strong new business volume, significant growth in our insured portfolio, robust credit performance, and expense efficiency that led to record profitability. Net premiums earned were a record $120.9 million, adjusted net income reached a record $74.3 million or $0.86 per diluted share, and adjusted return on equity was 19.4%. We generated $16.6 billion of new insurance written in the second quarter, which is a 17% increase from the first quarter. Purchase new insurance written was $16.2 billion during the quarter. Primary insurance in force increased to $168.6 billion, up 6% from the end of the first quarter and 23% compared to the second quarter of 2021. The 12-month persistency in our primary portfolio improved to 76% from 71.5% in the first quarter. We anticipate that persistency will continue to improve significantly as we move through the year, which is a positive factor that will support sustained portfolio growth and embedded value gains in the second half. Net premiums earned in the second quarter were $120.9 million, increasing from $116.5 million in the first quarter. We recognized $2.2 million from the cancellation of single premium policies in the second quarter, compared to $2.9 million in the first quarter. The reported yield for the second quarter was 30 basis points, unchanged from the first quarter. Investment income was $10.9 million in the second quarter, up from $10.2 million in the first quarter. Underwriting and operating expenses were $30.7 million in the second quarter, reduced from $32.9 million in the first quarter. Our expense ratio reached a record low of 25.4% for the quarter, emphasizing the significant operational leverage in our business and our effective cost management as we scaled our insured portfolio. We have consistently indicated our goal to achieve and maintain a mid-20s expense ratio, and we are proud to have delivered on this promise. Our credit performance continues to improve. We reported 4,271 defaults in our primary portfolio as of June 30, down from 5,238 at March 31, with our default rate decreasing to 77 basis points at the end of the quarter. Cure activities during the quarter remained robust, allowing us to release some reserves we had set aside for potential claims related to our early COVID defaults, resulting in a $3 million net claims benefit for the quarter. Simultaneously, we adopted a more cautious approach for setting reserves across our remaining default population, increasing our average carried reserve per default as of June 30 in response to the changing risk environment. Interest expense for the quarter was $8.1 million, and we recorded a $1 million gain from changes in the fair value of our warrant liability during the period. All remaining unexercised warrants expired in the second quarter, so we will not incur any future changes in warrant fair value in our financial results. GAAP net income was a record $75.4 million or $0.86 per diluted share for the quarter, with adjusted net income also at a record $74.3 million or $0.86 per diluted share. Total cash and investments were $2.1 billion at quarter-end, which included $114 million of cash and investments at the holding company. We have $400 million of outstanding senior notes, and our $250 million revolving credit facility remains undrawn and fully available. In July, Moody's upgraded our financial strength and holding company debt ratings to Baa1 and Ba1, respectively, recognizing our strong credit profile, operational performance, financial results, and balance sheet position. Shareholders' equity as of June 30 was $1.5 billion, and book value per share was $18.01. The book value per share, excluding net unrealized gains and losses in the investment portfolio, was $19.91, representing a 5% increase from the first quarter and a 19% increase from the second quarter of last year. In the second quarter, we repurchased $25 million of our common stock, retiring 1.4 million shares at an average price of $17.61, below our book value per share. We have $95 million of repurchase capacity left under our existing authorization and plan to remain flexible and disciplined in our future share repurchase activities, considering both the attractive opportunities at our current valuation and the changing macroeconomic environment. During the quarter, we established a new quota share reinsurance agreement mainly covering the portion of our in-force portfolio previously ceded under our first and fourth ILNs. We exercised our option to call these ILNs and reestablished risk protection through the new quota share treaty. This transaction effectively renews the coverage we previously had under the retired ILNs on more efficient terms, offering a lower risk attachment point, cheaper capital costs, and improved PMIERs efficiency. The new quota share agreement is anticipated to yield an additional $150 million of PMIERs credit at an estimated weighted average lifetime pre-tax capital cost of 3%. The premium began on July 1, and it is worth noting that it will affect various income statement line items differently compared to the ILN it replaces. The estimated impact of the new treaty on pre-tax income, reflecting its total cost, is approximately $1 million per quarter as opposed to $1.6 million from the first and fourth ILNs in their last full quarters. However, the new treaty will have a more significant effect on our ceded premiums, offset by a substantial ceding commission, which will appear as a benefit to our net operating expenses. Reinsurance continues to be a vital component of our credit risk management strategy, providing us with significant protection against losses during stress scenarios and an efficient growth capital source for our business. At quarter-end, we reported total available assets under PMIERs of $2.2 billion and risk-based required assets of $1.2 billion. Excess available assets totaled $929 million; our new quota share reinsurance agreement is not included in these figures, as it was completed post-quarter-end, and this new treaty will enhance our excess position, offering us more funding flexibility and financial strength in the future. In summary, we reported record results in insurance in force, net premiums earned, total revenue, expense ratio, net income, and adjusted net income. Our credit performance continues to be notably strong. We are actively seeking favorable terms in the reinsurance market and maintain an exceptionally solid balance sheet. We believe we are well-positioned to succeed across various market cycles.

Thank you, Ravi. Overall, we had a terrific quarter with significant new business production, increasing persistency, and growth in our high-quality insured portfolio driving record revenue, favorable credit performance, and expense discipline driving record profitability and strong returns. We're optimistic about the opportunity we have to continue to outperform in the second half. Stepping back, this is an interesting time, one where the strength of our current performance and near-term outlook stands in contrast to prevailing economic themes. It's important to focus on our current results as they highlight the value of our strategy and long-term potential, while at the same time it's equally important to acknowledge and plan for potential macroeconomic outcomes. We've long been successful managing National MI with discipline and a focus on through-the-cycle performance and believe we're well-positioned to continue to serve our customers and their borrowers, invest in our employees and their success, drive growth in our high-quality insured portfolio, and deliver strong performance for our shareholders. Thank you for joining us today. I'll now ask the operator to come back on so we can take your questions.

Yes, thanks. I wanted to drill down a little more on some of the different moving pieces. You highlighted some of the comments around the premium. It sounds like there have been some selective price increases, but also like at least the latest QSR is going to weigh on premiums in the near term. How should we think about the net impact on the average premium over the next couple of quarters?

Sure. Maybe I'll start, Mark, by just saying that our premium yield in Q2 was 30 basis points, and it was flat. Just thinking about the mechanics for Q2, we had the impact of the new XOL, and we had a little bit of a decline in our cancellation earnings in the quarter, which summed up to about a basis point impact on yield. That was offset by the amortization of the cost of the QSRs that we have and the ILN that we have in place, so we ended up at 30 basis points. Touching on the moving parts with respect to the premium yield for Q3, the impact of the season QSR, we've talked about it in our scripted remarks, it's more efficient and it's a fantastic deal for us, but it does impact us differently than the ILNs. With the season QSR, 35% of our ceded premiums come back in the form of ceded commissions, which impacts our expense line. With ILN, all of the ceded premiums come back as net premiums earned. So there is an impact on the premium yield with the season QSR; it's more efficient, and it provides us with benefits but those benefits flow through experience and impact our premium yield. In Q3, we estimate the impact of the season QSRs to be about 1.5 basis points on net yield. Balancing these comments, the hardening environment could provide us with some benefit, but that's mostly on new production and will greatly depend on the risk mix, how NIW evolves, and how cancellation earnings trend, which are currently trending down.

Just one question from me. What was the driver behind the positive reserve development this quarter? And what's your outlook going forward for reserves and curious for the rest of 2022?

Yes, I mean, we reported a $3 million net claims benefit in the quarter. We're continuing to see progress with respect to our default population; our default rate declined to 77 basis points in the quarter, down from 99 basis points in Q1. The total number of defaults has declined; we're down to 4,271 this quarter. Cure activity has been relatively strong; in Q2, it was slightly higher than what we saw in Q1, reflecting about 2000 cures. It is pretty strong performance when we view it all together. When we combine those pieces, we think about the cure activity in the pre-COVID default population and the decline in defaults quarter-over-quarter driven by stable cure rates; that's what drove our thought process regarding Q2.

Hi guys, thanks for taking my questions this afternoon. As we move through earnings season, every once in a while, something idiosyncratic comes up in terms of either pockets of strength or weakness. Is there anything you're seeing that you would call out on a positive or negative side that's a little bit surprising, either positive or negative within the portfolio?

Yes. It is an interesting time. There is so much current data that we look at, both internally and externally, is telling quite a positive story, but there are emerging risks that we're all tuned into, that we hear about every day. Today, the job market is still healthy, consumer spending remains strong, household balance sheets are in better shape than they were before the pandemic, and most importantly, our credit performance continues to trend favorably. We do think there is a higher likelihood that growth will slow rather than accelerate, that unemployment will increase from here instead of decreasing further, and that consumer fundamentals will soften rather than strengthen. All of this will have some bearing on our business affecting volume trends, credit performance, and house price performance across the mortgage spectrum. However, we're not seeing any signs that indicate a turn is on the horizon.

Just one more follow-up on the expenses. I mean now that you're at the 25% target, as it continues to grow, could we see that closer to 20% that we see from some larger peers?

Well, we mentioned low to mid-'20s as long-term goals. If we're successful in doing that, we expect to see continued improvements in our expense ratio over the long term. However, I can't provide guidance on the timeline for when that will occur.

Hi, thanks, and good evening everybody. I was hoping to get your updated thoughts on or quantification of where you think persistency can go, and expand on what a meaningful improvement in persistency means.

As of Q2, our persistency was at 76%, which is up from 71.5% in Q1. We think we're trending toward 80% given the current rate environment. This provides tremendous value to us as it extends the life of many of our policies, which adds to the embedded value in our portfolio. Assuming our strong credit performance continues to trend positively, this will build embedded value in our portfolio, which is a significant upside for us.

I wonder if you can comment on how the higher interest rates are affecting the need for private mortgage insurance. Are you seeing this as increasing the demand for your product?

What I would say is the need for our support is much more driven by down payment support than it is by what the monthly carrying cost of the home will be. Movements in interest rates themselves don't necessarily impact the market opportunity. On the purchase side, they do affect refinancing opportunities, but the increase in house prices has significantly increased the demand for our support, and we have been able to provide the necessary assistance to borrowers.

I was hoping to get some insight on home price appreciation trends throughout the quarter and into July.

Generally speaking, we expect the pace of house price appreciation to slow and may begin to see modest declines in certain markets. We are carefully monitoring this on a market-by-market basis, as we assess where credit is headed, while taking into consideration the performance of nearly 1,000 MSAs nationally. We expect to see differentiated outcomes across various markets as conditions evolve.

In your comments in the press release, you referenced significant new business production. Could you discuss that in more detail?

When we refer to significant new business production, we are focusing on the NIW that we generated in the period. We wrote $16.6 billion of high-quality, high-return, high-value new business in the quarter, which is up over 17% compared to the first quarter. We feel great about what we achieved from a customer support standpoint.

Can you quantify the reserve strengthening actions you took in the quarter? What portion of the $8.7 million current period provision is related to that?

If you look at it, the average reserve we established for each new default was roughly double this quarter compared to last quarter. We have seen a significant divergence leading to the adjustments we've made.