NMI Holdings, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Amounts below are in U.S. dollars; financial statement amounts are generally converted from thousands to millions.
Business context
NMI provides private mortgage insurance through its insurance subsidiaries and limited outsourced loan-review services. Its primary insurer is eligible to insure loans purchased by Fannie Mae and Freddie Mac and is licensed in all 50 states and Washington, D.C. The company is expanding its mortgage-insurance portfolio, principally in low-down-payment residential loans.
Financial results and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $35.5 million | $14.7 million | $87.2 million | $34.7 million |
| Net premiums earned | $31.8 million | $12.8 million | $77.7 million | $28.6 million |
| Net income (loss) | $6.2 million | $(4.8) million | $4.3 million | $(23.0) million |
| Diluted earnings (loss) per share | $0.10 | $(0.08) | $0.07 | $(0.39) |
| Net investment income | $3.5 million | $1.9 million | $10.1 million | $5.2 million |
| Claims and claim expenses | $0.7 million | $0.2 million | $1.6 million | $0.3 million |
- Reported loss, expense and combined ratios were 2%, 76% and 78% for Q3 2016, versus 1%, 153% and 155% in Q3 2015. For the nine-month periods, the respective ratios were 2%, 90% and 92%, versus 1%, 206% and 207%.
- At September 30, total assets were $792.2 million, including $641.6 million of investments and $44.5 million of cash and cash equivalents. Shareholders’ equity was $430.3 million. Total liabilities were $361.9 million.
- The term loan’s outstanding principal was $148.5 million; its balance-sheet carrying amount, net of unamortized discount and issuance costs, was $144.2 million. The loan bears a variable rate, reported at an all-in 8.5% through September 30, 2016, and matures November 10, 2018.
- Nine-month operating cash flow was $52.2 million, investing cash flow was $(63.7) million and financing cash flow was $(1.3) million. Cash decreased $12.8 million from year-end 2015.
- The company reported $686.1 million of cash and investments consolidated, of which $77.3 million was held at the holding company. PMIERs available assets were $488.6 million against net risk-based required assets of $320.6 million.
Material changes versus the prior comparable period
- Revenue and earned premiums rose substantially as insurance in force and customer allocations grew. Primary new insurance written was $5.9 billion in Q3, up 61% year over year; total insurance in force was $32.1 billion at quarter-end, versus $19.1 billion at December 31, 2015.
- The company reported its second consecutive profitable quarter and $4.3 million of year-to-date net income, compared with a $23.0 million year-to-date loss in 2015. Management attributed the improvement mainly to portfolio growth and higher earned premiums.
- Q3 net premiums written fell to $9.2 million from $35.4 million, despite higher new business, primarily because the September 2016 quota-share reinsurance transaction ceded premiums and associated unearned premiums. The transaction also affected underwriting expenses and capital requirements.
- Investment income increased with the larger portfolio. Nine-month realized investment results shifted to a $0.8 million loss from a $1.0 million gain in 2015. The nine-month 2016 results also included $11.1 million of term-loan interest expense; the loan was entered into in November 2015.
- The balance sheet reflected the new reinsurance arrangement, including $36.1 million of prepaid reinsurance premiums, $29.0 million of funds withheld and $6.7 million of deferred ceding commission. Accumulated other comprehensive income improved to $11.0 million from a $7.5 million loss at year-end 2015, largely reflecting investment fair-value changes.
Outlook, risks and unusual items
- Reinsurance: Effective September 1, the company ceded 25% of eligible existing and new policy risk, and all existing Fannie Mae pool risk, under a quota-share arrangement. GSEs and Wisconsin regulators approved the transaction subject to conditions; the company said those approvals and capital credit remain subject to review. Management estimated a net Q3 reinsurance cost of about $0.6 million and an implied after-tax cost of capital of approximately 3%–4%, which may vary with losses.
- Growth and underwriting: Management expects operating expenses to rise as the business expands, but to grow more slowly than new insurance written over time; it expects the expense ratio to decline as the portfolio matures. It anticipates a reported loss ratio below 10% while the portfolio remains young, and estimates lifetime loss ratios of 20%–25% per book. These are expectations, not guarantees.
- Premiums and persistency: The product mix shifted toward monthly premiums; 65% of nine-month new insurance written was monthly. Portfolio persistency was 81.8%. Management noted that low interest rates can drive single-premium cancellations and accelerate recognition of unearned single premiums; higher rates could reduce those cancellations.
- Claims: The reserve for claims and claim expenses was $2.1 million for 115 primary loans in default, versus $0.4 million for 20 loans a year earlier. Management attributed the increase principally to portfolio growth and seasoning. It reported favorable prior-year reserve development of $0.2 million for the first nine months. No pool claims reserve was established, in part because the remaining pool deductible was $10.2 million.
- Capital and liquidity: The company reported compliance with term-loan covenants at September 30, including a defined minimum liquidity covenant of $28.4 million. NMIC’s statutory risk-to-capital ratio was 12.6:1, and the combined statutory ratio disclosed in the financial-statement note was 11.7:1. NMIC could not pay dividends to the holding company through December 31, 2016 without Wisconsin regulatory approval, following its 2015 statutory loss.
- Taxes: A valuation allowance remained against net deferred tax assets. Management said sustained operating improvement could provide evidence to release substantially all of it, which could materially increase net income in the period recognized; timing and amount were uncertain.
- Key risks: Reinsurer nonperformance or downgrade, loss or reduction of GSE/regulatory capital credit, mortgage-market and interest-rate changes, claims exceeding estimates, competition, and compliance with PMIERs and state requirements could affect results, capital needs or growth. The company reported no material legal accrual and did not then expect pending matters to result in a material liability, while noting litigation outcomes remain uncertain.
- No specific earnings or revenue guidance was provided. Management cautioned that interim results may not indicate full-year results. Disclosure controls were assessed as effective, and no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether the quota-share reinsurers continue to perform and the GSEs and Wisconsin regulators maintain the expected capital credit.
- Whether growth in insurance in force and new business translates into sustainable earnings after reinsurance costs, acquisition expenses and term-loan interest.
- How defaults, claims, reserve development and pool-deductible exposure evolve as the portfolio seasons.
- PMIERs asset headroom, statutory capital and risk-to-capital ratios, and holding-company liquidity relative to debt service and covenant requirements.
- The sensitivity of investment values, variable-rate debt expense, policy persistency and single-premium cancellations to interest-rate changes.
- Whether continued profitability supports release of the deferred-tax valuation allowance, and the resulting timing and financial-statement impact.