NMI Holdings, Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014. Unless stated otherwise, financial amounts below are in millions of dollars. NMI is an early-stage private mortgage insurer; it began writing insurance in April 2013, so the prior-year quarter had no premium revenue.
Business context and operating progress
The company provides mortgage guaranty insurance through National Mortgage Insurance Corporation (NMIC), with Re One providing reinsurance to NMIC for certain statutory requirements. At quarter-end, NMI reported $514.8 million of primary insurance in force (IIF), $5.0 billion of pool IIF, and $208.6 million of total risk in force (RIF). Primary new insurance written (NIW) was $354.3 million in Q1 2014. The Fannie Mae pool transaction accounted for most pool exposure; no new pool insurance was written in the quarter.
Financial results and liquidity
| Metric | Q1 2014 | Q1 2013 / comparison |
|---|---|---|
| Total revenue | $4.25 | $0.47 |
| Net premiums written | $5.18 | $0 |
| Net premiums earned | $1.90 | $0 |
| Net investment income | $1.49 | $0.41 |
| Other revenue: warrant fair-value and settlement gains | $0.85 | $0.04 |
| Total expenses | $19.30 | $12.43 |
| Net loss | $(15.06) | $(11.95) |
| Basic and diluted loss per share | $(0.26) | $(0.22) |
| Net cash used in operating activities | $(11.99) | $(13.24) |
Operating expenses substantially exceeded earned premiums; a meaningful operating margin is not yet established. Management said expenses are expected to remain high relative to premiums while the business scales. Its long-term target expense ratio is 20%–25% of premiums written.
At March 31, 2014, total assets were $471.2 million, including $42.8 million of cash and cash equivalents and $410.9 million of available-for-sale investments. Shareholders’ equity was $453.5 million and total liabilities were $17.7 million; the filing reports no debt. Cash and investments totaled approximately $453.7 million. Approximately $246 million was held at the holding company, while about $204 million of consolidated net assets were held in restricted insurance subsidiaries. Operating cash use was partly offset by premium collections; cash declined $13.1 million during the quarter.
Insurance subsidiaries reported combined statutory surplus of $196.9 million and a combined risk-to-capital ratio of approximately 1:1 at quarter-end. NMIC’s ratio was 0.9:1, below its GSE limit of 15:1. NMI contributed $20 million to NMIC during the quarter. The company had no established claims reserves because it reported no primary notices of default and the pool transaction’s deductible had not been exceeded.
Changes versus the prior comparable period
- Revenue increased from $0.47 million to $4.25 million, primarily because the company had begun writing mortgage insurance after the prior-year quarter.
- Net loss widened by $3.10 million, principally as staffing, compensation, professional, and other operating costs rose as the business developed. Q1 2014 results included $0.85 million in warrant-related gains.
- Net investment income increased to $1.49 million from $0.41 million, reflecting the larger invested portfolio.
- Operating cash outflow narrowed to $11.99 million from $13.24 million. Investing cash outflow was much lower than in Q1 2013, when the company was deploying capital into fixed-income securities.
Outlook, risks, and unusual items
- Management does not expect operating profitability through at least 2014. It expects cash and investments and projected cash flows to fund anticipated growth and operating needs through 2015, while noting that additional capital may be needed sooner if expenses or RIF exceed expectations or capital requirements tighten.
- Management expects primary IIF and RIF to grow as customer relationships mature. It anticipates a decline in the overall mortgage-origination market in 2014, but expects private mortgage insurance penetration and NMI’s business to grow. Persistency is estimated at 80%–85%.
- Management estimates lifetime claims frequency of 3%–4% for initial primary books, claim severity of 85%–95% of coverage, and lifetime loss ratios of 20%–25% of earned premiums. These are estimates, not reported experience; management expects reported loss ratios below 10% during the first two to three operating years.
- GSE approvals require NMIC to maintain at least $150 million of capital, keep its risk-to-capital ratio within specified limits, and refrain from paying dividends to NMIH through December 31, 2015. State and GSE capital standards may change; revised GSE eligibility requirements were expected to be developed in 2014.
- A pending lawsuit originally brought by PMI’s receiver alleges, among other claims, breach of duty and misappropriation of trade secrets. Arch is now described in pleadings as the real party in interest. Trial was set for September 29, 2014. The company disputes the allegations but says it cannot estimate potential losses; no litigation reserve was recorded. An adverse outcome could involve damages or an injunction affecting NMIC’s operations.
- Other risks include competition from private insurers and FHA, changes to the GSEs or housing-finance regulation, interest-rate and investment-market exposure, geographic concentration, and the company’s limited operating history. California was the largest state concentration in both primary and pool portfolios.
- Unrealized investment losses were $4.7 million at quarter-end; management attributed them primarily to interest-rate movements and did not consider the securities other-than-temporarily impaired. The warrant liability was a Level 3 fair-value estimate; its $0.82 million quarterly remeasurement gain depended on valuation assumptions.
Important facts for investors to verify
- Whether new business, premiums earned, and customer submissions are growing fast enough to absorb the company’s substantial operating cost base.
- Whether liquidity and holding-company resources remain sufficient to fund NMIC’s capital needs while subsidiary dividends are restricted.
- How actual defaults, claims, persistency, and loss experience compare with management’s early-stage estimates as the insurance books season.
- Whether the GSEs or state regulators change eligibility, capital, or master-policy requirements, and the resulting effect on required capital and growth.
- The status and potential financial or operational impact of the Arch/PMI litigation, including any developments affecting the trial or possible losses.
- The assumptions underlying Level 3 warrant valuations and the investment portfolio’s sensitivity to interest rates and credit conditions.