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Good day, ladies and gentlemen, and welcome to NMI Holdings Second Quarter 2018 Earnings Conference Call. [Operator Instructions]
I would now like to introduce your host for today's conference, Mr. John Swenson. Sir, you may begin.
Thank you, Skyler. Good afternoon, and welcome to the 2018 second quarter conference call for National MI.
I'm John Swenson, Vice President of Investor Relations and Treasury. Joining us on the call today are Brad Shuster, Chairman and CEO; Claudia Merkle, President; Adam Pollitzer, our Chief Financial Officer; and Julie Norberg, our Controller. Financial results for the quarter were released after the close of the market today. The press release may be accessed on NMI's website located at www.nationalmi.com, under the investor staff.
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.
If 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 interested parties should rely on the fact that the guidance of such statements is current at anytime other than the time of this call.
Also note that in today's press release and on our website, we have provided a reconciliation of certain non-GAAP measures used on this call to the most comparable measures under GAAP.
Now to our conference call. Brad will open with an overview of the quarter, Claudia will provide an update on customer development and the market environment, and then Adam will discuss the financial results in detail.
After some closing remarks from Brad, we will take your questions.
With that, let me turn the call over to Brad Shuster.
Thank you, John, and good afternoon, everyone. I'm pleased to report another strong quarter.
In the second quarter, National MI again delivered record financial results and continued momentum in customer development and portfolio growth.
Additionally, we executed on a number of important risk and financing initiatives that provide a strong foundation for our future performance.
Adjusted net income for the quarter was a record $27.4 million or $0.40 per diluted share, and our GAAP net income was $25.2 million or $0.37 per share.
Adjusted return on equity for the quarter was 17.8%, and GAAP ROE was 16.4%.
Our record bottom-line performance was driven by the continued growth of our high-quality portfolio of insurance-in-force, our commitment to disciplined risk management and our consistent focused on organizational efficiency.
In the second quarter, we wrote $6.5 billion of new high-quality mortgage insurance, up 29% over the second quarter of last year.
Monthly NIW was $5.7 billion, up 39% over the same quarter last year.
Primary insurance-in-force was a record $58.1 billion, up more than 50% compared to the second quarter of 2017, and 9% over the first quarter of 2018.
We continue to deliver the fastest rate of growth of insurance-in-force in the industry.
Over the past several months, we successfully executed a number of important initiatives that have further enhanced our product pricing, risk management and technology capabilities as well as our funding profile and capital strength.
On June 4, we launched Rate GPS, our Granular Pricing System. Rate GPS represents a significant evolution in our pricing approach and risk-selection capabilities. It is a fully integrated pricing engine that allows us to dynamically consider a far more granular set of risk attributes in our pricing process. Rate GPS more closely aligns our pricing strategy with our industry-leading underwriting approach through which we already capture a comprehensive due of the loan level risk attributes on a significant majority of our portfolio.
The design, development and rollout of Rate GPS were seamless. Since our formal launch on June 4, we've seen rapid customer adoption, and an immediate and positive impact on our business in terms of vendor engagement and the credit quality of our new origination volume.
As for the recent industry-wide pricing changes, we note that risk-adjusted returns available in the market are now generally aligned with the expected levels prior to the enactment of U.S. tax reform. We believe that this shift when paired with the introduction of increasingly granular and selective pricing strategies is a positive for the long-term sustainability of the private mortgage insurance industry and the opportunity available for National MI.
Last week, we closed Oak town Re II, a $265 million insurance-link notes offering, and obtained additional reinsurance coverage on substantially all of our production from January 2017 through May of 2018. This was our second ILN transaction in the past 15 months, and with it we have now established layered protection against adverse credit losses on nearly all the business we have ever written.
The ILN structure mitigates the potential impact of credit volatility within our insured portfolio and provides us with a deep, secure and efficient source of capital -- growth capital to fund our needs under PMIERs.
Our ability to execute our second offering in larger size on better terms and with a broader investor base highlights the strength of our franchise and the quality of our insurance portfolio.
In May, we've refinanced our $150 million term loan and achieved significant improvement in the pricing terms and maturity profile of the loan.
We also establish an $85 million revolving credit facility that provides us with an immediately available source of capital and serves to further increase our overall financial flexibility.
Concurrent with the term loan refinancing and the establishment of the revolving facility, Moody's upgraded our insurer financial strength rating to investment grade. We are pleased with our continued success in the debt market and positive ratings trajectory.
Shifting to Washington matters. Regarding PMIERs, In June, we received a revised draft of proposed changes from the GSEs and FHFA.
We expect a final draft of the revised requirement will be issued in the third quarter and go effective at the end of the first quarter of 2019.
If the summary changes as outlined in the most recent draft were applied to our portfolio as of June 30, we would have remained in a surplus position at quarter end. We expect to be in full compliance up on effectiveness and anticipate that we will continue to maintain an excess position upon implementation based on our current capital plan.
Fannie Mae recently announced its enterprise PMI pilot program, which we believe to be structurally similar to Freddie Mac's IMAGIN pilot program. Broadly speaking, we continue to support all efforts that provide qualified borrowers with increased access to homeownership, and further, the sustainability of the housing finance system. We did not, however, believe that EPMI or imagine achieve these objectives.
The feedback we have heard in the market from lenders and reinsurance providers reinforces this view. At this stage, we have not observed any impact from these pilots on our business.
We continue to note an increased level of discussion in Washington around GSE reform. It remains a complex topic, and it is still too early to know what if any meaningful policy initiatives may emerge.
We think change in 2018 is unlikely. Though, we also note that all serious reform proposals to date have reinforced the need for more participation of private capital in front of tax payer risk. And we believe that private mortgage insurance will continue to be a preferred source of capital within any framework of reform.
We were encouraged by recent comments from the new FHA Commissioner, indicating that a near-term reduction in FHA premiums is unlikely given concerns about the FHA's capital reserves. The Commissioner's comments reinforce our view that any news out of the FHA through the remainder of 2018 will be benign to positive for National MI in the broader private MI industry.
We had another strong quarter and a great first half. We expect to continue delivering strong mid-teens returns through the remainder of 2018 and are well-positioned to deliver on the goals we set for our business.
Taking a step back and considering the value we are building over the long-term, volume, pricing and competitive factors will naturally fluctuate. That will ultimately drive us -- what will ultimately drive our success is how effectively we manage risk.
Going forward, we believe our ability to evaluate and price risk on a granular basis and our success funding and actively syndicating that risk in the ILN and quota share markets will enhance our return profile, mitigate the impact of credit volatility on our results and drive shareholder value.
With that, let me turn it over to Claudia.
Thank you, Brad.
In the second quarter, lenders continue to respond to our strong team and unique customer value proposition.
As of quarter end, we had more than 1,300 approved master policies. We continue to attract new lenders to our platform, and activated 28 new customers in the quarter, including 4 new top 200 lenders.
Year-to-date, we have added 49 new customers, including 8 from the Top 200, representing more than 5 billion of annual NIW opportunity. This expands our active customer base to well over 900 mortgage originators.
We had a record second quarter with total NIW of $6.5 million, up 29% year-over-year compared to a market that we believe was up approximately 10%.
We continue to focus on growing our monthly business, and our monthly NIW of $5.7 billion was even stronger, up 39% year-over-year.
Our quarter-over-quarter NIW development was impacted by our decision to pivot from a small number of customer situations. These situations delivered us attractive volume in prior periods. However, the risk adjusted return opportunities evolved and we do not believe they represent the best use of our capital at this time.
On June 4, we launched our Rate GPS platform. Customer response and adoption was immediate and positive. At this point, approximately 95% of our customers are using Rate GPS, and more than 80% of our volume is coming through the platform.
We now have nearly 2 full months of experience with Rate GPS, and we're delighted with the early results. We have seen a meaningful uptick in the pace and volume of new policy applications, and suttle but important shift in the credit quality of our new originations.
July was our largest daily application month ever. Applications are a precursor to future NIW volume, and we feel good about the momentum we're achieving with our customers and the opportunities that it signals for future business flow.
Our application volume over the last 2 months has also come with the reduction in the mix of higher LTVs, higher DTI's and lower FICO scores.
We are very quickly seeing the risk management benefit that granular pricing through Rate GPS provides.
We can now actively manage the flow of higher-risk cohorts and ensure that we are paid appropriately for the full range of risk we insure.
Shifting to the underwriting environment. The market remained solid and our in-force portfolio continues to perform better than initially expected and priced. Nonetheless, we continue to take a long-term view of the credit cycle and have invested to develop the tools that will allow us to perform over time and across all markets.
This includes our robust underwriting approach, the development and deployment of Rate GPS and the layering of our quota share and ILN reinsurance programs.
With that, I'll turn it over to Adam.
Thank you, Claudia, and good afternoon, everyone.
We had another strong quarter and achieved record results across every key financial metrics.
We continued the rapid growth in our high-quality book of insurance enforced, and delivered record net premiums earned of $61.6 million, record adjusted net income of $27.4 million or $0.40 per diluted share and record adjusted return on equity of 17.8%. These results reinforced our strong outlook for our business and financial performance.
Now to the details. Primary insurance-in-force was $58.1 billion at quarter end, up 9% from $53.4 billion at the end of the first quarter and up 50% compared with the second quarter of 2017.
At quarter-end, monthly products represented 72% of our primary insurance-in-force, up from 70% at the end of the first quarter and 64% at the end of the second quarter in 2017. Given our current NIW mix and portfolio runoff, we expect our monthly product will continue to increase as a percentage of insurance-in-force.
12 months persistency in the primary portfolio was 85.5%, roughly flat with [Technical Difficulty] Insurance-in-force. We expect that net yield will trend between 42 to 43 basis points through the remainder of the year, reflecting approximately 1 basis point of impact related our second ILN.
Gross premium yield, which is before the impact of reinsurance was 50 basis points compared to 49.2 basis points in the first quarter.
Weighted average rate on NIW across all products in the second quarter was approximately 51 basis points.
Investment income was $5.7 million, up from $4.6 million in the first quarter. We expect investment income will continue to increase as our investment portfolio grows and we realize the benefit of higher new money rates.
Underwriting and operating expenses in the second quarter were $29 million compared to $28.5 million in the first quarter.
Expenses in the quarter include $693,000 of costs related to our ILN transaction. We expect an additional $1.9 million of ILN transaction cost to come through in the third quarter.
Our expense ratio in the quarter was 47.1% compared to 51.8% in the first quarter. This is the first period our expense ratio has been below 50%, an important milestone and the nearly 5 point improvement in just one quarter highlights the significant operating leverage in our financial model.
We have the lowest absolute expense footprint in the industry and continue to focus on efficiently managing our cost base. We expect our expense ratio will continue to trend down in future periods, excluding the impact of periodic financing costs.
Claims expense in the quarter was $643,000, benefiting from strong performance in both our FEMA and non-FEMA default populations.
We had 768 notices of default in the primary book as of the end of the second quarter, including 215 notices related to loans in FEMA disaster areas from last year's natural catastrophes. This compares to 1,000 notice, including 474 from FEMA zones at the end of the first quarter. Excluding storm-related NOVs, we have 553 notices of default at quarter end, up from 526 at the end of the prior quarter.
Our second quarter loss ratio defined as claims expense divided by net premiums earned, was 1%. We continue to expect that our loss ratio will be in the low to mid-single digits over the next few years.
Interest expense in the quarter was $5.6 million, and includes $2.2 million of extinguishment and issuance costs related to our term loan refinancing and revolving credit facility.
As Brad noted, in May, we refinanced our $150 million term loan with the new 5-year facility and achieved significant improvement in the pricing, terms and maturity profile of our debt. We also establish an $85 million 3-year revolving credit facility with a syndicated banking partners that provides us with an immediately available source of capital and increases our overall financial flexibility. No amounts were drawn under the revolver at quarter end.
We're pleased with our ability to access the capital market on increasingly attractive terms.
The spread on our refinanced term loans is 200 basis points tighter than on our previous facility. This translates to $3 million of annual cash interest savings.
Moving to the bottom line. Net income for the second quarter was $25.2 million or $0.37 per diluted share.
Adjusted net income, which excludes periodic transaction costs, warrants fair value changes and net realized investment gains or losses, was $27.4 million or $0.40 per diluted share, up from $22 million or $0.34 per diluted share in the first quarter.
Effective tax rate for the quarter was 21.9%. We expect our effective tax rate will increase modestly to approximately 22.5% through the remainder of the year.
Cash and investments were $855 million at quarter end, up from $826 million in the prior quarter. As of June 30, we have $58 million of cash I and investments at the holding company.
At quarter end, total available assets under PMIERs grew to $653 million, which compares to risk-based required assets of $587 million.
Access available assets at quarter end were $66 million. The ILN issuance we closed last year is not included in these figures as it was completed after quarter end. The $265 million offering will significantly increase our access position and provides funding runway in future periods.
Shareholder's equity at the end of the second quarter was $630 million, equal to $9.58 per share, which compares with $602 million or $9.18 per share at the end of the first quarter.
Our adjusted return on equity was 17.8% in the second quarter compared to 15.9% in the first quarter. We expect that we will deliver a strong mid-teens return on equity for the full year in 2018.
Over the long term, we expect to continue to deliver strong mid-teens returns that are significantly in excess of our cost of capital.
We estimate the pretax cost of funding on our recent ILN to be less than 4%, further reducing our weighted average cost of PMIERs lending.
ILNs in our broader reinsurance program are unique, and that they provide us with a debt-like cost of funding and equity-like loss absorption capacity that insulates us from the impact of adverse credit losses under stress scenarios. If a replay of the financial crises were to occur again today, we estimate that the lifetime loss ratio on our enforced portfolio would be less than 30%.
In summary, we achieved record results in insurance-in-force, net premiums earned, adjusted net income and return on equity.
We successfully completed a comprehensive repositioning of our funding base, tapping the full of capital ratios market in a series of transactions that have reduced our volatility profile, our financial leverage and our cost of capital.
With that, I'll turn it over to Brad for his closing remarks.
Thank you, Adam. We have another strong quarter with continued momentum from the standpoint of customer engagement, risk management, capital planning and bottom line financial results.
I'm especially proud of the success of Rate GPS. Rate GPS provides meaningful benefits to borrowers, our lender customers and National MI.
We believe our increased ability to evaluate and price risk on a granular basis paired with a our robust reinsurance risk management framework will help bolster our returns and minimize the potential volatility of our future results.
We often talk about sustainable mid-teens returns as a key goal and view return on equity as a critical measure of how well we are managing volume, pricing, expenses, risk and capital. It is gratifying to have again delivered a record ROE in the second quarter.
Looking forward, we believe market conditions remain favorable with regard to demand for our products, credit quality and the tone in Washington.
We are executing on our business plan, and are well-positioned to continue to drive industry-leading growth in our ensured portfolio and to deliver strong results for our shareholders.
With that, I'll ask the operator to come back on so we can take the questions.
[Operator Instructions] Our first question comes from Bose George with KBW.
So the first one is just on -- wanted the Adam to just go over what you've said on the outlook for the premium yield, I think you said 1 basis point cost of the ILN. But just, what was the remaining benefit to the premium just from singles continue to normalize?
Sure. So we were 44.2 basis points of net yield in the quarter. We expect to layer in about a point, related to the ILN transaction, and so we're looking at being in the range of 42 to 43 basis points through the remainder of the year, on a net-yield basis.
And then is -- but should we think about any benefit on the singles percentage continue to go down?
Yes. Bose, when we talked about that in the first quarter we highlighted it as, to think about the imbalance with the rate changes that the industry was contemplating at the time. Obviously, with Rate GPS coming live on June 4, we'll see the effects of the new rate delivery and the new rates themselves coming through in a modest way in the back half of the year. And so those will balance a bit with -- what would otherwise be that continued pull of that core yield dynamic because of the monthly singles mix.
Okay, that's helpful. And just in terms of Oaktown, what was the UPB of the loans covered by that transaction?
Sure. Bear with me a moment. So I'll give you the risk-in-force, which -- take that as 0.5% of EPB, it was about $5.6 billion of risk-in-force that was covered by that transaction. So gross it up by 0.25 -- a 4x factor and you get to the UPB.
Okay. And then just one more for me. The -- you noted that 95% of your lenders are using Rate GPS. Are there lenders in there that still want a peck of their rate card that looks like what everyone else's rate card looks like? And is there a way to accommodate them?
Sure, Bose. It's Claudia. Yes. We do have some lenders, not many, but some lenders that can operationalize Rate GPS. So we do provide them a rate card, it's more granular in nature. But yes, we accommodate them.
Our next question comes from Randy Binner with B. Riley FBR.
I guess I'll pick up there. So it sounds like this Black Box Rate GPS program is going quite well for you all so far. And picking up on those last comments, did that -- there's not a lot of pushback from the lenders out there. Would your expectation be that the remaining providers of MI all kind of migrate more to a multivariable pricing model like this? And if so, what you -- what impact do you think that might have on kind of composition and pricing?
Well, Randy, this is Brad, I'll start and then Claudia can jump in if wants to supplement what I say. But we've seen the competition comment on our approach to the market. And so we wouldn't be surprised to see other Black Box pricing mechanisms introduced in the market. But on the other hand, we also wouldn't be surprised to see some competitors sticking with the rate card approach. So we're very happy about what Rate GPS is going to do for us from a risk selection standpoint. And so we're comfortable. And quite frankly, not all of MI providers I think look at risk in the same way. I think you only -- you need only thing to look at our loan-based underwriting that we do, where we underwrite or validate over 80% of what goes in our portfolio. Nobody else does anywhere near that much. But we think it's appropriate, and over long haul it makes us a better risk manager. So just like that, that thinking and that approach went into our development of Rate GPS. Others will have other views about the credit market environment, and that's up to them to make those decisions.
And just related then, you mentioned there was a pivot away from one lender -- some subsegment of the market that affected NIW in the quarter. Can you provide more color on that, or did I get that comment correctly?
Yes. You did get that correctly. There was one or 2 lenders where we be made a conscious decision due to the rate -- risk and return characteristics of their production. We decided we were better off playing elsewhere. And so, those customers have provided meaningful volume to us in prior periods. So it is noticeable on a sequential basis. But we're still very happy about the high quality NIW we were able to write. We're happy about our insurance-in-force being up 9%, sequentially. We're happy about our NIW overall being up 29% year-over-year, and particularly our monthly product up 39% year-over-year. So overall, we think we made the right trade off and we're very happy with that decision.
Our next question comes from Phil Stefano with Deutsche Bank.
I'm thinking about the 5% of the companies aren't signed up for the Black Box pricing delivery mechanism. I guess, does it feel like they're progressing towards that? And it's just in there IT queue? Or is there anything particular about those companies? Are they the largest originators? Anything qualitative you can tell us about that makeup of that 5%.
Yes. Sure, Phil, it's Claudia. Those lenders, many of them are looking to move towards a more granular pricing system, they see the benefits for their borrowers. Some just have to work through their best application models. And we're helping them through that as well. So I think some of them will move towards our Rate GPS.
Got it, got it. Okay. And Adam, I was trying to follow the expenses and the adjustments. The capital markets transaction cost of $2.9 million that were adjusted out in the quarter, those are included in the $29 million of other operating expenses. Is that right?
That's correct.
And then embedded within that, that includes the $700 million of...
Sorry. Let me -- I'm sorry, let me clarify. So the $2.9 million of adjusted financing-related costs without. So in the $29 million of OpEx, is $693,000 of cost related to our ILN transaction that come through as operating expense. The other component that feeds into that $2.9 million adjustment that's related to transaction is $2.2 million of expense that flows through the interest expense line item. So that's why you see also a spike in interest expense from $3.4 million to $5.6 million in the quarter.
Got it, got it. Okay, that make sense. And one last numbers question. You mentioned tax rate 22.5% for the remainder of the year. Is that a full year or second half '18?
That's what we think -- second half '18. We still expect for the full year to be about 21%. But we'll see the effective rate basically tick up a little bit beyond the 21.9% that we had in Q2 when we get into Q3 and Q4. So the effective rates for Q3 and Q4, we expect each of those to be about 22.5%.
Our next question comes from Mackenzie Aron with Zelman and Associates.
I guess I just have one item on the capital. There's obviously a lot done this quarter that should give you guys some runway. But can you just talk about when you anticipate need to go back to capital markets. And then also is the ILN is that something we should expecting on a pretty consistent annual basis as part of the capital management plan?
Yes. Great question, McKenzie. As you noted, we've got a ton of runway ahead of us from a growth capital standpoint. And importantly, we're organically generating capital at an accelerating clip every day. So as to the timing, sizing and nature of any future of capital transactions. Ultimately, we'll need to see how our volume develops, where PMIERs 2.0 lands as well. But our current thinking is that we don't have a specific need to be back in the market, certainly in the back half of 2018 or candidly through 2019. As a growth capital matter, we may choose to pursue addition ILN transaction or do something else on the reinsurance side. But for the end of 2019 as a risk management matter that purely as a growth capital matter, we don't see a specific need to be in the market for the next, call it, 18 months.
[Operator Instructions] Our next question comes from Jack Micenko with SIG.
On the GPS, it's interesting how much volume in recent months has come from that product. So I guess my question would be, how did the weighted average yields out of that side compared to the rate card? I mean, your winning business, the adoption is clearly better than most people would have expected. Is it price? I mean, I think Claudia had said, it also sounds like some of the risk is migrating to higher-quality through this approach as well. So what are you attributing to, I think, what we all would consider better-than-expected results on the mix of your business coming from that?
Yes. Jack, It's Adam. I'll note that we made a wholesale change, right? And so we introduce Rate GPS to our entire customer base. And we strongly encourage that our customers to the extent they could operationalize Rate GPS to adopt it. So essentially, nearly all of our lenders are on Rate GPS at this point, 95%. And some of the lenders who are not, as Claudia mentioned, are on the larger side. So that 80% of our volume is coming through Rate GPS. In terms of what that means and how the returns and how the pricing stacks up, that we continue to price our products whether they're deliver through Rate GPS on the pricing side or on -- what is now also more granular rate card, right, the 5% count of our lenders, who are not on Rate GPS, are also operating under a formal granular rate card than they previously did. We priced all of that business to achieve our mid-teens ROE across the cycle. Rate GPS is a delivery mechanism, it's a risk-management tools. It doesn't change our view on our targeted returns. I mean, in fact, we view Rate GPS as something that has the ability to enhance our risk-adjusted returns and reduce our of overall volatility as we roll forward. Simply put by explicitly considering and pricing for more risk variables up front, we should see more stable performance and better returns over the longer term.
Okay. And then on the available assets, the $653 million so that would include the $70 million that you pushed down, that would include the $150 million term loan, is that correct? But not include the revolver? And then how much of that $265 million from the ILN can we expect into that? And I guess what I'm trying to get at is, sort of, it's 11% buffer stand today, but if I take everything that hasn't been included in that number, what would that ratio look like?
Yes. So the $70 million is included because we downstream that capital in early April, and so it's in the number at quarter end. The $150 million, it's not a net addition or detraction, that was $150 million that had been part of our capital structure, tracing back to the November of '15, when we put our debut term loan in place. So the refinancings doesn't change the capital calculus, it simply -- we get the benefit of better terms pricing and maturity profile. As to the credits that will get for the $265 million ILN offering, I think that's a conversation that is dynamic with the GSEs, but we pursue the deal, and what we think is an attractively attractive level, but also because it provides us with we believe a significant, significant amount of runway, both from a risk standpoint and a capital standpoint. As to what our cushion will become as we roll forward, the cushion will obviously will develop based on our volume and PMIERs 2.0. But you could assume a very large chunk in nearly all of the $265 million offering that will provide us with benefit under the PMIERs calculation.
[Operator Instructions] At this time, I'm showing no further questions. I'd like to turn the call back over to management for closing remarks.
Well, thank you, for joining us on the call today. We will be at the Susquehanna Financial Conference in New York on August 6, and we will be presenting at the Barclays Financial Conference in New York on September 14. We hope you will join us. Thank you.
Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.