NMI Holdings, Inc. annual report, FY2016

NMI Holdings, Inc. — 2016 Form 10-K

Reporting period: Fiscal year ended December 31, 2016. This is an annual report, not a standalone fourth-quarter filing. NMI provides private mortgage insurance, primarily on low-down-payment U.S. residential mortgages sold to Fannie Mae and Freddie Mac.

Financial and operating highlights

Metric	2016	2015
Total revenue	$123.8 million	$53.6 million
Net premiums earned	$110.5 million	$45.5 million
Net investment income	$13.8 million	$7.2 million
Pre-tax income (loss)	$11.5 million	$(27.8) million
Net income (loss)	$65.8 million	$(27.8) million
Basic earnings (loss) per share	$1.11	$(0.47)
Operating cash flow	$71.9 million	$41.5 million
Investing cash flow	$(79.8) million	$(230.2) million

• Net income included a $54.4 million income tax benefit, principally from releasing valuation allowances on federal and certain state deferred tax assets. The company reported a pre-tax profit of $11.5 million; the tax benefit was a major contributor to reported net income.
• The loss ratio was 2%, expense ratio 84%, and combined ratio 87%, compared with 1%, 177%, and 179%, respectively, in 2015. Expense ratios remain affected by the company’s relatively young, growing business and operating cost base.
• At year-end, total assets were $841.7 million, shareholders’ equity was $477.3 million, and the term-loan carrying amount was $144.4 million. Cash and cash equivalents were $47.7 million; total investments were $629.0 million. Management reported $677 million of consolidated cash and investments, including $74.1 million held at the holding company.
• Net premiums written were $134.7 million. Primary new insurance written increased 71% to $21.2 billion. Total insurance-in-force grew to $35.8 billion from $19.1 billion; total risk-in-force increased to $7.9 billion from $3.7 billion.
• Year-end reported available assets under PMIERs were $453.5 million against net risk-based required assets of $366.6 million. NMIC reported statutory capital of $473 million and a 12.4:1 risk-to-capital ratio; the combined insurance operations’ reported ratio was 11.6:1.

Changes versus 2015

• Revenue rose substantially as the insured portfolio, customer base, and premiums earned expanded. Master Policy holders increased to 1,131 from 964, and 56.4% delivered business during 2016 versus 51.9% in 2015.
• The company moved from a $27.8 million net loss to net income of $65.8 million, reflecting higher premiums and the deferred-tax-asset valuation-allowance release. The tax benefit means the year’s net result is not solely indicative of recurring operating profitability.
• Primary IIF more than doubled, to $32.2 billion from $14.8 billion. Monthly premium policies represented 67% of 2016 new insurance written, as product mix shifted away from single-premium LPMI amid higher PMIERs capital charges and pricing changes.
• Claims and claims expenses increased to $2.4 million from $0.7 million as the portfolio grew and matured. Year-end default inventory rose to 179 loans from 36; the reported share of loans in default remained 0.1%.
• The September 2016 quota-share reinsurance transaction ceded 25% of eligible primary risk and 100% of pool risk, reducing net exposure and capital requirements. The company reported a $2.8 million pre-tax net cost of reinsurance for 2016.

Outlook, risks, and unusual items

• No specific earnings or revenue guidance was provided. Management expected continued portfolio and customer growth, lower expense ratios as premiums grow, and continued use of reinsurance to support new business while managing PMIERs capital needs.
• Management expects claims to rise as the relatively young portfolio matures; industry claim frequency has historically been highest roughly three to six years after origination. Its stated expected lifetime loss ratio of 20%–25% is an estimate, not a guarantee.
• Key risks include housing-price declines, unemployment, interest rates, competition from FHA and other providers, changes in GSE requirements or housing-finance policy, customer concentration, geographic concentration, and the possibility that claims exceed reserves. Quicken Loans generated more than 10% of 2016 consolidated revenue; California accounted for 13.6% of primary risk-in-force.
• The reinsurance capital benefit depends on reinsurer performance and continued GSE and Wisconsin regulator approval. NMIC remains directly responsible to policyholders for claims if reinsurers fail to pay.
• The $150 million term loan had a November 2019 maturity after a February 2017 amendment extended the term and reduced the Eurodollar margin to 6.75% (plus a 1% floor). The company said holding-company cash and liquid investments could cover scheduled payments but not repay the full principal at maturity; refinancing or other funding may be needed. The debt is variable-rate and subject to restrictive covenants.
• Management released most of its deferred-tax valuation allowance based on expected future taxable income and utilization of NOLs; this judgment is a material estimate. Federal NOL carryforwards were $121.1 million, and their use could be limited by an ownership change under Section 382.
• Management reported no material accrued liability for ordinary-course legal matters and did not then expect a reasonably possible material liability, while noting litigation outcomes are uncertain. The audit opinion was unqualified; management concluded disclosure controls and internal control over financial reporting were effective. The auditor did not attest to internal controls because the company was an emerging growth company.

Important facts for investors to verify

• How much of 2016 earnings reflects sustainable insurance operations versus the $54.4 million tax benefit, and whether future tax benefits and NOL utilization assumptions remain supportable.
• Whether portfolio growth can be funded while maintaining PMIERs and state capital compliance, including the actual cushion after asset deductions and any changes in requirements.
• Claims, defaults, reserve adequacy, and loss development as the 2013–2016 books mature; current reported claims are limited relative to the expanding portfolio.
• Reinsurance recoverability, counterparty strength, and continued regulatory and GSE recognition of capital credit under the quota-share transaction.
• Holding-company liquidity, compliance with loan covenants, and the plan to refinance or repay the term loan at maturity, given restrictions on insurance-subsidiary dividends.
• Customer and geographic concentration, competitive pricing and product mix, and the impact of future FHA, GSE, or housing-finance policy changes.