NMI Holdings Is A Buy On Any Weakness

As interest rates increased dramatically over the last 15 months, the path of housing prices has really surprised me. Yes, in some of the arguably inflated markets such as Phoenix or Austin, prices have declined by double-digits, but overall residential housing has held up far better than most anticipated given the headwinds. Given that we are likely far closer to the end than the beginning of rate hikes, I think the setup is pretty attractive for mortgage insurance companies such as NMI Holdings, Inc. (NASDAQ:NMIH), which offers attractive earnings and growth at a very reasonable price. A recession will lead to additional defaults, but I believe the market is being overly pessimistic in relation to these companies.

Mortgage insurers play a vital role in promoting housing affordability by lowering the downpayment required to buy a home. Many simply cannot pay the 20% traditional downpayment, which is generally required for the GSEs to buy a mortgage from the mortgage originators. An example of how mortgage insurance works is a buyer putting down $40K for a $400K property, or 10%, instead of the standard 20%. The buyer is required to have private mortgage insurance PMI, which they pay a premium for. A typical amount of MI coverage on this loan would be 25% of the outstanding balance. If the borrower fails to repay the mortgage, the lender or investor can file a claim based on the unpaid loan balance, delinquent interest, and foreclosure costs. From there, the insurer has a few options in how it elects to pay the claims, including a percentage basis, loss on property sale, acquisition option, and an anticipated loss option.

NMIH came into the industry after the GFC in 2011, so it has benefited from arguably the cleanest balance sheet in the industry, without many of the legacy delinquencies that surprisingly still account for a good percentage of delinquent loans for competitors. The company has done a really good job building relationships with originators to enhance market share. A growing net insurance in force book (NIF) has led to increasing net earned premiums, while also growing the investment portfolio. Higher interest rates have reduced refinancing, and in turn written premiums, but it has dramatically increased the persistency of the book, as people continue to pay their mortgage insurance. Credit performance has remained remarkably solid, bolstered by low unemployment and good housing price appreciation over the last several years, until very recently. Most borrowers have locked-in extremely low interest rates, making them very hesitant to sell their home, meaning they are continuing to pay their mortgage insurance premiums. With all of these positives outlined, I do believe a recession is imminent, leading to greater unemployment so I would expect delinquencies to increase, but I believe NMIH is very well suited to dealing with that adversity and thriving in spite of it.

On May 2^nd, NMIH reported a very strong 1^st quarter, generating $8.7B of NIW volumes, and ending the quarter with a record $186.7B of high-quality primary insurance in force, up 1.5% and 17.5% sequentially and YoY, respectively. The company generated $74.5MM of GAAP net income, or $.88 per diluted share, off of $136.8MM in total revenue, resulting in a 17.9% return on equity. Twelve-month persistency improved again to 85.1%, from 83.5% in the last quarter. This impact is driving the embedded value of the insured portfolio higher. Net premiums earned of $121.8MM were up from $119.6MM last quarter. Net yield for the quarter was unchanged at 26 basis points, and a core yield of 34 basis points, which excludes the cost of reinsurance coverage and the contribution from cancellation earnings.

The company and industry have begun raising prices to account for the increasingly challenging macro-outlook, which ultimately should start to slowly work its way through the portfolio. In addition, the company is continuously refining its mix of business by risk cohort and geography. One big change in the industry has been excess-of-loss reinsurance deals. This reinsurance will protect capital in a major recession, as loss triggers are met. This should allow the Mis to continue writing profitable new business and meet capital requirements even in the worst of times. NMIH entered into a new deal that covers policies originated in Q4 2022, as well as those originated on a forward flow basis in the first two quarters of 2023. 99% of the insured portfolio is covered by a comprehensive reinsurance solution. With this strategy, major recessions should be earnings events mostly for the Mis, as opposed to a possible kiss of death, like it was in 2008 for several companies. Investment income was $14.9MM in Q1, up from $13.3MM in Q4, as new cash flows are reinvested at more favorable rates. The company is doing a good job managing its expenses with underwriting and operating expenses declining by $.9MM QoQ to $25.8MM, resulting in a record-low 21.2% expense ratio, highlighting the substantial operating leverage inherent in a growing insured portfolio.

Credit continues to perform better than expected, as the company has 4,475 defaults in the primary portfolio at the end of Q1, up very slightly from 4,449 on December 31^st. The default rate was constant at 75 basis points, while claims expense of $6.7MM was up from $3.4MM sequentially. Cure activity has been really favorable, and the company was able to release a portion for the reserves it conservatively built to deal with claims outcomes from the Covid default population. The company established case reserves of $22.3MM for the 1558 new defaults that came through in Q1, along with an additional $4.9MM for a potentially declining macroeconomic environment.

Shareholders’ equity ended Q1 at $1.7B and book value per share stood at $20.49. BVPS, excluding the impact of net unrealized gains and losses on the investment portfolio was $22.56, up 4% sequentially, and 19% YoY. The company has a very strong balance sheet with a $2.3B investment portfolio, which it took advantage of to repurchase 667,000 shares at an average price of $22.19. Since commencing its first buyback authorization last year, NMIH has repurchased a total of $71MM of stock under its original $125MM authorization, retiring 3.6MM shares at an average price of $19.87. The company has $54MM remaining, which I hope it puts to good use on any meaningful dips in share price. NMIH’s $2.5B of total available assets under PMIERS puts it at an excess of $1.2B, highlighting the strength of the balance sheet.

At a recent price of $22.71, NMIH trades at just over 6x forward earnings and 1.11x book value. This is really cheap for a company that is generating an ROE of near 20%. Surely, there is risk to the downside with the economy, but it does seem that the worst prognostications for residential housing are not coming true. Supply constraints will make depreciation like we saw during the Great Recession extremely unlikely. I believe the future is quite bright for NMIH and the MI industry and the valuations are favorable. I believe this could be a $28 stock within 12-18 months, assuming housing doesn’t deteriorate too badly. Long-term investors would be wise to accumulate the stock on dips from current prices.