NMI Holdings, Inc. Q3 FY2022 Earnings Call

Hello and welcome to the NMI Holdings, Inc. Third Quarter 2022 Earnings Conference Call. Please note this event is being recorded. I would now like to turn the conference over to John Swenson. Please go ahead, John.

Thank you. Good afternoon and welcome to the 2022 third quarter conference call for National MI. I am John Swenson, Vice President of Investor Relations and Treasury. Joining us on the call today are Brad Shuster, Executive Chairman; Adam Pollitzer, President and Chief Executive Officer; Ravi Mallela, Chief Financial Officer; and Nick Realmuto, our Controller. Financial results for the quarter were released after the close today. The press release is accessible on NMI’s website located at 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. 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’ve provided a reconciliation of these measures to the most comparable measures under GAAP. Now, I will turn the call over to Brad.

Thank you, John, and good afternoon, everyone. We had a terrific third quarter with strong operating performance, significant growth in our insured portfolio, and record financial results. Throughout today’s call, 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 a growing set of macro headwinds. However, we do not expect the economy or housing market to deteriorate as they did during 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 existing borrowers have strong credit profiles, significant embedded equity in their homes, and benefit from having locked in record low 30-year fixed-rate mortgages with manageable debt service obligations. From the start, we have focused on building National MI in a durable, risk-responsible manner. We have worked hard to establish a comprehensive credit risk management framework. In doing so, we have built an exceptionally high-quality insured portfolio and secured comprehensive reinsurance protection for nearly the entirety of our book. I am confident in our ability to perform across all market cycles, and we expect to continue to invest in our employees, support our customers and their borrowers, and deliver for our shareholders, no matter how the macroeconomic environment develops. With that, let me turn it over to Adam.

Thank you, Brad, and good afternoon, everyone. National MI continued to outperform in the third quarter, delivering significant new business production, strong growth in our high-quality insured portfolio, continued success in the reinsurance market, and record financial results. We generated $17.2 billion of NIW volume and ended the quarter with a record $179.2 billion of high-quality, high-performing insurance-in-force. We achieved record net income of $76.8 million or $0.90 per diluted share, and our return on equity was 20.1% in the quarter. Overall, we had an exceptionally strong quarter and are optimistic as we progress towards year-end. However, we do continue to see developing risks in the macro environment and have already begun to see an impact in the U.S. housing market. Mortgage rates are at a 20-year high, straining affordability for many prospective buyers and driving existing homeowners to reevaluate planned moves. We see new tension in the negotiation between buyers and sellers across many local markets, and house prices have begun to trend down sequentially from their pandemic peaks. While the labor market currently stands as a bright spot, and existing homeowners are well-positioned with strong credit profiles, record levels of home equity, and sustainable fixed payment obligations at record low mortgage rates, we would expect unemployment to rise and an increasing number of households to face stress in the event of a recession. While we can’t control how the economy or housing market develops, we can control how we are positioned to navigate through a period of stress. We’re confident, as we’ve taken action and invested from day one, to secure our performance across all cycles. We have prioritized discipline and risk responsibility as we’ve grown our in-force book, building an exceptionally high-quality insured portfolio. We’ve led with innovation in the risk transfer markets, securing comprehensive reinsurance coverage on nearly all of the policies we’ve ever originated. We’ve established a strong balance sheet with a conservative investment portfolio, robust liquidity profile, and sizable regulatory capital buffer, all supported by the significant earnings power of our franchise. We have been proactive, doing even more through the year as the risk environment has evolved and took further steps to bolster our business in the third quarter and months since. We continue to increase policy pricing to reflect the evolving risk environment. We’ve made additional changes to further manage our mix of new business by risk cohort and geography, and we secured additional reinsurance protection and strengthened our PMIERs position. In August, we announced that we had entered into an excess of loss reinsurance agreement covering policies originated during the second quarter. This week, we entered into an additional XOL treaty, securing layered risk protection on our third quarter NIW production and incremental PMIERs funding capacity. With the completion of both deals, approximately 97% of our insured portfolio is now covered by a comprehensive reinsurance solution. More broadly, we have been encouraged by the discipline that we’ve seen across the private MI market. Underwriting standards remain rigorous, and pricing has hardened in response to emerging risks. This is a time when Rate GPS and the broader adoption of rate engines across the mortgage insurance industry prove even more valuable. We have the ability to dynamically set our credit box, define our risk appetite, and adjust rates in real time. Overall, we had a terrific quarter, delivering strong operating performance, significant growth in our insured portfolio, and record financial results. At the same time, we’re taking appropriate steps to prepare for a potential downturn and are well-positioned to continue to serve our customers and their borrowers, invest in our employees and their success, and deliver through-the-cycle performance for our shareholders. With that, I’ll turn it over to Ravi.

Thank you, Adam. We delivered record financial results in the third quarter with strong new business volume, significant growth in our insured portfolio, continued resiliency in our credit performance, and expense efficiency driving record profitability. Net income was a record $76.8 million or $0.90 per diluted share, and our return on equity was 20.1%. We generated $17.2 billion of NIW in the third quarter and our primary insurance-in-force grew to $179.2 billion, up 6% from the end of the second quarter and 25% compared to the third quarter of 2021. 12-month persistency in our primary portfolio improved again, reaching 80.1% compared to 76% in the second quarter. We expect persistency will continue to trend higher through the end of the year. Net premiums earned were $118.3 million in the third quarter compared to $120.9 million in the second quarter. We earned $1.8 million from the cancellation of single premium policies in the third quarter compared to $2.2 million in the second quarter. Net premiums earned in the third quarter reflect a $5.5 million impact from the introduction of the seasoned quota share agreement we announced alongside our second quarter earnings release. As we mentioned at the time, we recapture a significant majority of this top line cost through a ceding commission, which serves to offset our operating expenses. Reported yield for the third quarter, which also reflects the introduction of the new seasoned quota share, was 27.2 basis points compared to 29.5 basis points in the second quarter. Our core yield, which is calculated excluding the impact of our reinsurance treaties and cancellation earnings, was 35 basis points, unchanged from the second quarter. Investment income was $11.9 million in the third quarter compared to $10.9 million in the second quarter. We saw an acceleration in investment income during the quarter as we deployed new cash flows and reinvested rolling maturities at significantly higher new money rates. Underwriting and operating expenses were $27.1 million in the third quarter compared to $30.7 million in the second quarter, and our expense ratio was a record-low 22.9%. Our credit performance continues to trend in a favorable direction. We had 4,096 defaults in our primary portfolio at September 30 compared to 4,271 at June 30, and our default rate declined to 71 basis points at quarter end. Cure activity during the quarter remained strong, and we released a portion of the reserves we previously established for potential claims outcomes on our early COVID default population, recognizing a $3.4 million net claims benefit in the third quarter. At the same time, we continue to take a conservative stance when setting reserves across our remaining default population in light of the evolving risk environment. Interest expense in the quarter was $8 million. Net income was a record $76.8 million or $0.90 per diluted share for the quarter compared to $0.86 per diluted share in the second quarter and $0.69 per diluted share in the third quarter of 2021. Total cash and investments were $2.1 billion at quarter end, including $97 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. Shareholders’ equity as of September 30 was $1.5 billion and book value per share was $18.21. Book value per share, excluding the impact of net unrealized gains and losses in the investment portfolio, was $20.85, up 5% compared to the second quarter and 19% compared to the third quarter of last year. In the third quarter, we repurchased $21 million of our common stock, retiring 1 million shares at an average price of $20.94. In August, we announced that we had entered into an excess of loss reinsurance agreement covering policies originated during the second quarter from a 2.25% attachment point up to a 6.65% maximum detachment point at an estimated 5.4% weighted average lifetime pre-tax cost. This week, we had entered into an additional XOL treaty, securing protection on our third quarter NIW production from a 2.9% attachment point up to a 6.9% maximum detachment. This most recent transaction carries an estimated 6.5% weighted average lifetime pre-tax cost. Our ability to compress the cycle time between transactions and secure coverage for our most recent quarterly production is particularly valuable as it serves to minimize our warehouse exposure and limit the credit risk retained on our high-quality insured portfolio during a period of increased macro volatility. At quarter end, we reported total available assets under PMIERs of $2.3 billion and risk-based required assets of $1.2 billion. Excess available assets were $1.1 billion. In summary, we achieved record financial results during the quarter. Our credit performance continues to stand out in a positive way. We continue to execute in the reinsurance market on constructive terms, and we have an exceptionally strong and well-supported balance sheet.

Thank you, Ravi. Overall, we had a terrific quarter, once again delivering significant new business production, strong growth in our high-quality insured portfolio, and record financial results. Looking forward, we do expect the macro environment will continue to evolve with potential implications for the housing market. We’re confident, however, that the disciplined approach we’ve taken to managing our business from day one will carry our performance through a period of stress. We have a strong customer franchise, a talented team driving us forward every day, an exceptionally high-quality book covered by a comprehensive set of risk transfer solutions, and a robust balance sheet. We’ve been proactive, doing even more from a pricing, risk selection, and reinsurance standpoint as the macro environment has evolved. Thank you for joining us today. I’ll now ask the operator to come back on so we can take your questions.

Thank you. Today’s first question comes from Mark DeVries with Barclays. Please go ahead.

Yes, thanks. I was glad to hear that you’ve been taking up pricing in response to the changing risk. Are you observing your competitors doing the same thing? And also, are you seeing growing disparities in pricing across different buckets? If so, is it layering different assumptions about how the risks are changing?

Yes, Mark, it’s a good question. We absolutely are. Broadly speaking, we’ve been encouraged by the discipline that we see across the market and what we would characterize as a deliberate approach from the industry broadly around price as the risk environment is shifting. Rates that we observed have been hardening. They’ve really been laddering higher as macro volatility has increased. Importantly, within that context, we’ve been able to achieve incremental price where we believe it’s necessary and appropriate. And to your second question, absolutely, not all changes, either that we make or that we observe more broadly across the industry, have been uniform. We continue to make more significant changes for higher-risk loans and higher-risk geographies that we expect would be more severely impacted by a downturn. At the same time, what I’d say is the pricing changes we’re now seeing are more broad-based in nature. While they’re not uniform, they’re spanning far more at the pricing spectrum than we saw in the second quarter.

Okay. That’s really helpful. And then on a separate question, have you had a chance yet to assess the potential impact of these recently announced targeted pricing changes to the enterprise pricing framework and what that could mean for your business?

Yes. Look, we’ve thought for a while now that the FHFA and GSE should review and reform their loan-level pricing adjustments, and we view the elimination of upfront fees for lower-income borrowers that were announced as a constructive step. It’s still early, but in terms of a market impact, some of these are actually fairly significant moves. For some borrowers, it will amount to more than a 3-point upfront pricing change. We expect that this will tilt the line towards GSE execution for many high-LTV borrowers. Our best sense at this point is that approximately 15% of current FHA and VA volume could migrate to the conforming market following the LLPA change.

Okay. Great, thank you.

The next question comes from Rick Shane with JPMorgan. Please go ahead.

Hey guys. Thanks for taking my question. It’s a little bit conceptual, but I’m curious, when you think about lifetime losses and originations, are you able to solve that through your underwriting to your target lifetime cumulative loss targets, or do you have to adjust price?

Yes, it’s a good question. It really has to be through price. We use underwriting as a tool to pressure test to ensure that the loans that are coming onto our books align with our expectations and our initial view of their risk profile, but the risk profile itself and the anticipated loss cost has to be covered through price.

Got it. And so in an environment like we’re in now, you realize upfront, if your assumptions are correct, that you will incur higher cumulative losses. And so the way you achieve your hurdle rate is by resetting price to get there.

That’s right. For us, it’s really about when we’re making price changes; we’re not looking to take from the market by any stretch. In fact, this is a time where we want to make sure that we’re doing everything we can to be balanced to continue to support our customers and support borrowers who are facing higher costs day in and day out. What we’re really focused on, though, is making sure that we maintain rate adequacy. Rate adequacy for us in this environment, and the need to capture incremental price, is because our expectation of loss cost grows as the economy develops.

Adam, that’s perfect. And it actually segues into sort of my more macro question, which is, in an environment where, again, who knows what’s going to happen, but we’re all sitting here saying, okay, well, things are as good as they can get. There are reasons to believe the macro environment will deteriorate. Should we view the industry as a utility that you are there and, to some extent, the PMI industry generally has a responsibility to be in the market? I’m just trying to think about how the industry expands or contracts and how that would impact originations if collectively the industry became uncomfortable with risk that they didn’t feel they could price.

Yes. Look, I think it’s an interesting perspective. First and foremost, what drives our volume as an industry is what’s happening on the origination side, particularly where purchase origination activity goes. Purchase activity is likely to slow as we’ve had rates more than double through the course of this year. With prevailing 30-year note rates sitting north of 7%, it strains affordability for many prospective buyers and also causes existing homeowners who had otherwise planned to move to change course. Those factors will weigh on purchase activity. At the same time, there is a very large group of individuals who will still purchase a home and still need our support or support from other pockets of the market. When we think about the utility aspect, our goal is to ensure that we can consistently support our customers and their borrowers through all market cycles. One of the ways we achieve that is by applying price to ensure rate adequacy. It is also our balance sheet; it is our shareholders’ balance sheet, and we have a responsibility to them to manage it appropriately through periods of stress. That’s what we balance as we look at the current environment where we expect things to get more challenging from a macro standpoint over the next 12 to 18 months.

Okay. Adam, thank you for taking the questions. I really appreciate it.

Thanks, Rick.

The next question comes from Doug Harter with Credit Suisse. Please go ahead.

Thanks. Can you talk about your reserving expectations on new defaults today and how that compares to the past several quarters?

Yes. This is Ravi. I’d just say that with respect to credit and default trends, we’re not really seeing anything notable at this point that’s different. Our cure rates are holding constant; NODs are trending down. We saw our NODs trend down from 4,271 to a little bit less than 4,100 in the quarter. Our default rate declined from 77 basis points to 71 basis points. Our D30s have been flat quarter-over-quarter. As we parse things out and look for reasons to make major changes, we’ve been pretty steady and consistent with respect to how credit trends have been evolving. We continue to monitor, and we’re constantly looking at the story going forward. But right now, the story is strong.

In terms of some of the underlying macro assumptions and perspective and general conservatism that we embedded in Q3, we do reassess our reserving assumptions each quarter. We shifted in the second quarter to a meaningfully more conservative posture for reserve-setting purposes than we had in Q1. We’ve maintained that conservative posture with some incremental adjustments that further bolstered the reserves we’re carrying for remaining NODs as of September 30.

Great. And then just on the COVID vintage NODs and the reserving, how much reserve is left there to the extent that there’s still favorable development? Or just how should we think about where you are in that process?

Yes. A significant majority of our carried reserves today still relate to loans that went into default that we would identify as COVID-related defaults. We’ll see how that population develops as we progress.

And just to add, those early COVID default populations have mostly cured out. Almost 97% to 98% of those defaults have cured over the last two years.

Got it. Thank you.

The next question comes from Bose George with KBW. Please go ahead.

Hey, guys. Good afternoon. Just given your comments on price hardening, are there any updated thoughts on the trend in the premium margin?

Yes. In terms of our view on premium yield, we expect that our core yield is going to be generally stable with perhaps a modest decline through the end of the year. We will get some support from improving persistency and favorable pricing on new business. We expect the trend in our net yields to be a bit more pronounced, primarily due to the introduction of the most recent XOL transaction that we announced today. We’ll see where things develop as we move into next year. Loss performance does impact our yield due to the profit commission dynamics under our quota-share agreements. So, we will see where that goes next year. But through the end of this year, we expect core yield stability, with some impact from the latest XOL.

Okay. Great. Thanks. And then actually, just on persistency, can you talk about where you think that could get to?

Persistency in Q3 was just a hair over 80%, and the trend has been above 80%. We expect it to normalize by year-end. Persistency has been a big positive for us. We work hard to generate that business, underwrite it, and then put it under reinsurance. Credit performance has been strong, leading to increases in lifetime premium revenue. At the margin, we don’t anticipate additional administrative costs to manage them going forward. So, we see persistency normalizing by year-end and continuing to trend slightly up.

Okay. Great. Thanks.

The next question comes from Mark Hughes with Truist. Please go ahead.

Yes. Thank you. Good afternoon. I am not sure whether you gave any detail on this, but anything unusual in the expenses this quarter? And how do we think about the expense ratio on a go-forward basis?

Yes. I will touch on that. Certainly, it’s nice to see a record low expense ratio of 22.9% in the quarter, down from 25.4% in Q2. The overwhelming majority of the quarter-over-quarter difference came from the ceding commission we received from our seasoned quota share, about $3.8 million for the quarter. Overall, we are very happy with where our expense ratio is right now. From a long-term perspective, we have been targeting a range between low and mid-20s, and we are pleased to deliver that in Q3. We are optimistic about opportunities to manage expenses and drive efficiency, continuing to trend the expense ratio down over time.

How much of the hardening comes from just the uptick in broader interest rates, which is obviously impacting the cost of your reinsurance, compared to macro factors just concerning the consumer and what happens with default? Can you disaggregate that?

Yes. It’s easy to say that 100% of it relates to our view of the go-forward economic environment. None of it relates to what’s happening on the reinsurance side. Reinsurance costs are migrating higher. It’s a market where risk-takers need to set their appetite and define their goals from a risk-adjusted return standpoint just as we do on the primary side. But most importantly, whenever we price our business, we do it on a gross line basis, meaning we don’t factor for reinsurance costs. We want to ensure that the rates we capture for the risks we take at the front end is adequate if we have to maintain that risk on our balance sheet without risk transfer. That’s the approach we’ve always taken, and it’s our approach today. So, all of the rate changes we make across the risk spectrum are driven by our macro view, not by the evolving reinsurance market.

I guess I’m thinking about your cost for the transactions. You mentioned the 5.4% up to 6.5% for the recent XOL. How much of that is just influenced by broader interest rates? And again, I apologize if that’s a bad question.

Not a bad question at all. The majority of that is driven by the same dynamic that’s causing us to raise premium rates on the primary side. Our reinsurance partners are looking at the macro environment and the possibility for dislocation to develop in the housing market, and they want incremental rate to account for perhaps a widened view of potential loss outcomes. At the same time, we just achieved coverage at a 6.5% pretax lifetime cost of capital. It’s not just the cost that grows; the benefit grows as well. As the risk environment evolves, the value of that protection, the potential for it to absorb loss, also increases. When we look at it, it doesn’t influence how we price on the primary side, but we see value as both a risk transfer and capital efficiency matter from executing in the reinsurance market.

And Adam, I would just add that with respect to the reinsurance market, we’ve seen capacity evolve throughout the year. We saw the ILN market experience dislocation early in the year, which led many MI companies to pivot to the XOL market, and much capacity was consumed during the year, influencing pricing and availability.

Interesting. Thank you very much.

The next question comes from Geoffrey Dunn with Dowling & Partners. Please go ahead.

Thanks. Good afternoon. Adam, I wanted to ask about capital strategy. I believe NMI is still a capital consumer. You are going into a hard market, or a harder market, yet a riskier potential market. In a world where your capital could face delays in XOL or anything like that, do you have a strategy for pulling back, entering the market? This quarter looks like you gained share. How do you balance that with return on buying stock right now, which is probably approaching the returns on new business? Do you take any money out of the OpCo over an 18-month, 24-month outlook, or take a more conservative approach and put that money to new business? How do you think about the overall capital strategy heading into the environment we are entering?

Yes, Geoff. It’s a very good question. We consider all those factors. Capital for us is key and it’s true at all times, including today against an evolving macro backdrop. Our general philosophy about managing our balance sheet remains conservative. We want to ensure we’re managing our needs carefully. We are working hard to build access across many markets and minimize our cost of capital. We are currently in a strong position and pleased with our repurchase activity since launching the program earlier this year. As we look forward, carrying a bit of excess capital now is valuable given the macro environment. We’ll be balanced in how we make decisions about capital deployment, both organically and through distributions. A lot will depend on how things develop over the next few quarters, as we gather more information about market and macro conditions that could influence our decision-making.

Okay. And then a follow-up on credit. It’s a challenging environment because you’re facing seasoning pressure on your new notices, whether or not we see recessionary pressure. But you also still have a lot of home price built into the existing book of business, not necessarily the more recent stuff but the past book. So, how can you frame the economic impact on the existing book? Do we worry about 6% unemployment with where the built-up equity is in the portfolio, or do we need something much more severe to really move the number on ultimate claim experience because of how the back book looks?

Yes. A very good question. We estimate today that the mark-to-market LTV on our insured portfolio is just under 75%. Borrowers that we have insured to-date generally have a strong position with a significant equity buffer in front of our exposure. So, we monitor a move in unemployment. We would expect that if the labor market deteriorates, more households would face stress. The consequences of that stress, however, for our credit performance and claims experience also need to account for where house prices go. If house prices hold, the equity position remains robust, we may see an increase in default experience that doesn’t translate to ultimate claims outcomes. If house prices deteriorate alongside rising unemployment, we would expect to see an increased impact on claims.

But as the book stands now, does 6% unemployment worry you?

I mean yes, we are at 3.5% today. So, it’s nearly a doubling of the unemployment rate nationally. We run many stress tests. In isolation, a 6% unemployment rate does not lead to a material impact on our expected performance as we progress.

Okay. Thanks.

This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Thank you again for joining us. We will be hosting our Annual Investor Day on Thursday, November 17 in New York, and we will be participating in the Goldman Sachs Financial Services Conference on December 7. We look forward to speaking with you again soon.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.