NMI Holdings, Inc. annual report, FY2013

NMI Holdings, Inc. — FY 2013 Form 10-K

Reporting period: Fiscal year ended December 31, 2013. This is an annual filing; it also provides unaudited fourth-quarter results. NMI is a recently launched private mortgage insurer and began writing insurance in April 2013, so results reflect start-up operations and a short operating history.

Financial results and key metrics

Metric	FY 2013	FY 2012
Net premiums earned	$2.1 million	None
Net investment income	$4.8 million	$6 thousand
Total revenue	$5.6 million	$0.3 million
Operating expenses	$60.7 million	$27.8 million
Net loss	$55.2 million	$27.5 million
Loss per share	$0.99	$0.73
Operating cash flow	$(36.3) million	$(14.6) million

Fourth quarter: Net premiums earned were $1.6 million, investment income $1.5 million, operating expenses $15.3 million, and net loss $13.1 million.
Margins and claims: The reported expense and combined ratios were 2,900%, reflecting very low premium volume against start-up costs. No claims or claims reserves were recorded for 2013; consequently, the filing reports no loss ratio.
Insurance written and exposure: Primary insurance written was $162.2 million; pool insurance written was approximately $5.2 billion. Year-end insurance-in-force was $5.3 billion and risk-in-force $129.6 million. The Fannie Mae pool accounted for $93.1 million of risk-in-force.
Balance sheet and liquidity: Year-end assets were $481.2 million and shareholders’ equity $463.2 million, down from $542.8 million and $488.7 million, respectively, in 2012. Cash and cash equivalents were $55.9 million; fixed-maturity investments at fair value were $409.1 million. Including short-term investments, management reported cash and investments of approximately $465 million. About $193 million of consolidated net assets was held in regulated insurance subsidiaries.
Cash flows: Investing activities used $419.9 million, primarily as cash was invested in fixed-income securities. Financing provided $26.3 million, principally IPO proceeds. The resulting cash decrease was $429.9 million. The filing reports no debt obligations at year-end.
Capital: NMIC reported statutory capital of approximately $182 million and a risk-to-capital ratio of 0.6:1; the combined insurance-company ratio was 0.7:1. These were below applicable limits at year-end.

Material changes versus prior period

Compared with 2012, NMI began insurance operations, generated its first premiums, and added the Fannie Mae pool transaction. Primary and pool risk-in-force were both new in 2013.
The net loss more than doubled as the company hired staff and incurred technology, licensing, legal, and other launch costs. Management identified payroll and related expenses as a major operating cost.
NMI completed its November 2013 IPO, receiving approximately $28 million in net proceeds, and began trading on Nasdaq. Its investment portfolio shifted from largely cash and short-term holdings to a diversified fixed-income portfolio.

Outlook, commentary, risks, and unusual items

Management expected annual losses to continue in the near term and did not expect operating profitability through at least 2014. It anticipated liquidity to fund growth and expenses through 2015, after which it expected to consider capital options. Additional capital could be needed sooner if risk or costs exceed expectations.
Longer-term targets include an expense ratio of 20%–25% and an average unlevered return on equity in the mid-teens; these are targets, not assured outcomes. Management’s estimated lifetime loss ratio for primary books was 20%–25%, based on assumed claim frequency of 3%–4% and claim severity of 85%–95%; actual experience may differ materially.
Business execution depends on gaining and retaining lender customers, completing technology and customer integrations, maintaining state licenses and GSE eligibility, and complying with capital requirements. Approximately 20 of 37 targeted National Accounts had indicated intent to do business, but only four had supplied limited business as of the filing.
Customer and portfolio concentration are notable: one insured represented 97% of 2013 new insurance written; Fannie Mae and Quicken each exceeded 10% of consolidated revenue. California represented 28.5% of pool insurance-in-force.
GSE rules required minimum statutory capital of $150 million, a risk-to-capital ceiling of 15:1 through 2015, and restricted subsidiary dividends through the end of 2015; certain state restrictions extended into 2016. Proposed GSE and housing-finance reforms, capital-rule changes, and competition from the FHA could materially affect the market.
NMI announced rescission relief after 12 timely monthly payments, reducing the prior 18-month period. The endorsement and new master policy were subject to state regulatory approvals; reduced time to identify defects could increase exposure to claims.
A lawsuit brought by the receiver of PMI Mortgage Insurance alleges, among other claims, misappropriation of trade secrets and seeks injunctive relief and unspecified damages. NMI disputes the allegations; the trial was scheduled for September 29, 2014. The company said it could not estimate potential losses and recorded no litigation provision.
Investments had $7.3 million of gross unrealized losses, which management attributed generally to rate and credit-spread movements and did not consider other-than-temporary. A $1.5 million loss from revaluing warrant liabilities reduced 2013 results. The company also recorded a $1.2 million software-related impairment in 2012.
Auditors issued an unqualified opinion on the financial statements. Auditor attestation of internal control over financial reporting was not provided under the transition rules for newly public companies.

Most important facts for investors to verify

Whether lender onboarding and integrations convert stated customer interest into sustained primary insurance growth, while reducing reliance on a small number of customers.
Whether reported liquidity, statutory capital, and risk-to-capital headroom remain adequate as risk-in-force expands and subsidiary assets remain subject to regulatory and GSE restrictions.
Whether the Fannie Mae pool performs as expected and how quickly primary business becomes a larger share of risk and revenue.
Whether NMI obtains required regulatory approvals for the revised master policy, maintains GSE eligibility, and obtains the required financial-strength rating by July 31, 2015.
Developments in the PMI litigation, Wyoming licensing, and proposed GSE, FHA, QM/QRM, and mortgage-insurer capital-rule changes.