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NMIH > SEC Filings for NMIH > Form 10-Q on 17-Dec-2013All Recent SEC Filings

Show all filings for NMI HOLDINGS, INC.

Form 10-Q for NMI HOLDINGS, INC.


Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following analysis should be read in conjunction with our unaudited consolidated financial statements and the notes thereto included in this report and our audited financial statements and notes thereto. In addition, investors should review the "Cautionary Note Regarding Forward Looking Statements" above and the "Risk Factors" detailed on page 15 of the Company's Prospectus filed with the Securities and Exchange Commission on December 9, 2013 as part of the Company's Registration Statement on Form S-1 (File No. 333-189507) and Item 1A of Part II of this report for a discussion of those risks and uncertainties that have the potential to affect our business, financial condition, results of operations, cash flows or prospects in a material and adverse manner. Our results of operations for interim periods are not necessarily indicative of results to be expected for the full year or for any other period.

NMI Holdings, Inc. ("NMIH" or the "Company") was formed in May 2011 and through its subsidiaries provides private mortgage insurance (which we refer to as "mortgage insurance" or "MI"). As used below, "we" and "our" refer to NMIH's consolidated operations. Following our formation, we focused our efforts on organizational development, capital raising and other start-up related activities. In November 2011, we entered into a definitive agreement to acquire MAC Financial Holding Corporation and its Wisconsin licensed insurance subsidiaries, Mortgage Assurance Corporation, Mortgage Assurance Reinsurance Inc One and Mortgage Assurance Reinsurance Inc Two, each a Wisconsin corporation, which were renamed National Mortgage Insurance Corporation ("NMIC"), National Mortgage Reinsurance Inc One ("NMRI One") and National Mortgage Reinsurance Inc Two ("NMRI Two"), respectively. In April 2012, we raised net proceeds of approximately $510 million in a private placement of our common stock (the "Private Placement") and completed the acquisition of MAC Financial and its insurance subsidiaries. The proceeds from the private placement were and will be primarily used to capitalize our insurance subsidiaries and fund our operating expenses until our insurance subsidiaries generate positive cash flows. On September 30, 2013, we merged MAC Financial Holding Corporation into NMIH, with NMIH surviving the merger, and we merged NMRI Two into NMIC, with NMIC surviving the merger.
On November 8, 2013, the Company filed a final prospectus announcing the sale of approximately 2.1 million shares of common stock through an initial public offering. The underwriters of the offering were granted a 30-day option to purchase up to an additional 315,000 shares of common stock from the Company at an initial public offering price, less underwriting discounts and commissions, to cover over-allotments. The principal reason for conducting the public offering was to expedite an increase in the number of holders of the Company's common stock to permit a listing of its common stock on the NASDAQ Global Market ("NASDAQ"). Obtaining a listing on the NASDAQ satisfied certain contractual obligations the Company has to its stockholders under a Registration Rights Agreement it entered into in connection with the Private Placement. On November 12, 2013, the underwriters exercised their option in full to purchase an additional 315,000 shares of common stock at a price of $13.00 per share, before underwriting discounts. The offering closed on November 14, 2013. Gross proceeds to the Company were $31.4 million. Net proceeds from the offering were approximately $29 million, after an approximate 6% underwriting fee and other offering expenses and reimbursements pursuant to the underwriting agreement.
Through our primary mortgage insurance subsidiary, NMIC, a mono-line MI company, and its affiliated reinsurance company, NMRI One, we provide residential MI in the United States. Mortgage insurance provides loss protection to mortgage lenders and investors in the event of borrower default on low down payment residential mortgage loans. By protecting lenders and investors from credit losses, we help facilitate the availability of mortgages to prospective, primarily first-time, U.S. home buyers, thus promoting homeownership and helping to revitalize our residential communities.
Our business strategy is primarily focused on commencing and growing our MI business by writing high-quality mortgage insurance in the United States. Since the Company's inception, our efforts to build our MI business have included, among other things, building an executive management team and hiring other key officers and directors and staff, building our operating processes, designing and developing our business and technology applications, environment and infrastructure, and securing state licensing and GSE approval. NMIC works to differentiate itself primarily on prompt and predictable underwriting, thereby aiming to provide lenders with a higher degree of confidence of coverage that such lenders are seeking. As a newly capitalized mortgage insurer, we have the ability to write new business without the burden of risky legacy exposures. Our financial results to date have been primarily driven by expenditures related to our business development activities, and to a lesser extent, by our investment activities. We commenced writing MI on a limited test basis during April 2013. In Management's Discussion and Analysis of Financial Condition and Results of Operation, we discuss the following in turn below:
• the significant conditions and factors that have affected our operating results, including the costs associated with the key start-up activities in which we are engaged and development of our investment portfolio;

• the factors we expect will impact our future results as our mortgage insurance business continues to grow, and certain issues impacting our holding company, NMIH;

• our sources and uses of liquidity and capital resources;

• our operating results, which were primarily driven by our start up activities; and

• critical accounting policies that require management to exercise significant judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

Factors Affecting Our Operating Results

Operating Expenses from Development Stage Activities Our expenses for the nine months ended September 30, 2013 and September 30, 2012, for the year ended December 31, 2012, and for the period from May 19, 2011 (inception) to September 30, 2013 were $45.5 million, $14.7 million, $27.8 million and $74.6 million, respectively, and consist largely of expenses associated with development stage activities, including payroll and related expenses, share-based compensation and professional fees. The costs that we have incurred to date do not represent the full operations of an operating MI company. We anticipate that, as our insurance writings grow and our sale activities increase, our underwriting expenses in future periods will be considerably higher than in the periods presented to date.
Although we expect our year-over-year expenses to increase significantly as we grow our business, we ultimately expect that the majority of our operating expenses will be relatively fixed in the long term. As our business matures and we deploy the majority of our capital, we are targeting our expense ratio (expenses to premiums written) to fall into a range of 20% to 25%. In our initial periods of operation, our expense ratio is expected to be significantly higher than this range given the low levels of premium written compared to our "fixed" costs customary to operating a mortgage insurance company. We believe that we will have an efficient expense structure providing us with greater flexibility. We do not expect to achieve operating profitability through 2014. Additionally, we are targeting an average unlevered ROE in the mid-teens over time.
We discuss below the significant development stage activities that have driven our results to date.
Start-up Operations
Since the closing of our private placement, we engaged in the following activities, which culminated in writing mortgage insurance business beginning in April 2013:
• we obtained certificates of authority for NMIC from state insurance regulators to write mortgage insurance in 49 states and D.C.;

• in January 2013, NMIC obtained approvals from the GSEs as a qualified mortgage insurer;

• we made substantial progress in the design, development and implementation of our information technology platform;

• we established customer relationships with mortgage originators; and

• we have attracted and retained our employee base and support systems.

State Licensing
To conduct MI business with many, or potentially all, large, national lenders, we believe NMIC will need to be licensed in all 50 states and D.C. NMIC applied for a certificate of authority in each of the 50 states and D.C. in June 2012. As of the date of this report, NMIC has obtained certificates of authority in 49 states and D.C. NMIC has not yet received a certificate of authority in Wyoming. NMIC's application for a certificate of authority has not yet been accepted by the Wyoming Insurance Department ("WY DOI") for formal review due to our inability to meet Wyoming's seasoning requirement. Like most of the states in which NMIC is licensed, Wyoming has a statutory seasoning requirement, which requires an applicant for admission to Wyoming to have transacted insurance for two years in its state of domicile prior to being admitted to Wyoming. The Wyoming Insurance Commissioner has the discretion to waive the requirement, however, if he finds that the applicant insures against special hazards to property or liability for which, in the Commissioner's opinion, adequate provision is not already made by insurers already authorized in the state. We requested a waiver under the foregoing provision; however, the Wyoming Insurance Commissioner did not agree to grant a waiver. We had requested, and had been granted, a hearing before a hearing officer to present evidence in support of our assertion that sufficient grounds exist under Wyoming law for the Wyoming Insurance Commissioner to grant our request for a waiver of Wyoming's seasoning requirement. We have agreed jointly with the WY DOI to postpone the hearing in order to discuss a settlement of the seasoning waiver issue. There can be no assurance that we will be able to settle the seasoning waiver issue with the WY DOI. If we do not reach a settlement on the seasoning waiver issue, we intend to request that the postponed hearing be rescheduled so that we may appeal the denial of our request for a waiver of the seasoning requirement. If a waiver is granted, we expect that the WY DOI will review NMIC's application for a certificate of authority in Wyoming. We intend to provide all information requested by the WY DOI but there can be no assurance that we will obtain a certificate of authority in Wyoming even if a seasoning waiver is granted. Many states also require approval of NMIC's insurance rates and/or policy forms before it may issue insurance policies in such states. Of the 49 states and D.C. in which NMIC has received certificates of authority, NMIC currently has effective rates in 48 states and D.C. and effective policy forms in 46 states and D.C. NMIC's application for approval of rates is pending in Washington

and its applications for approvals of policy forms are pending in Florida, Maryland and Alaska. NMIC must receive approvals of its respective applications in each of these states before it may write MI in such states.
As conditions of obtaining licenses in Alabama, Arizona, California, Florida, Missouri, New York, Ohio and Texas, NMIC entered into agreements with the Alabama Department of Insurance ("ALDOI"), the Arizona Department of Insurance ("AZDOI"), the California Insurance Department ("CADOI"), the Florida Office of Insurance Regulation ("FLDOI"), the Missouri Department of Insurance ("MODOI"), the New York State Department of Financial Services ("NYDOI"), the Ohio Department of Insurance ("OHDOI") and the Texas Commissioner of Insurance ("TXDOI"). The agreements with the CADOI, FLDOI, MODOI, NYDOI, OHDOI and TXDOI, provide, among other things, that:
• NMIC (i) refrain from paying any dividends; (ii) retain all profits; and
(iii) other than in Florida, maintain a risk-to-capital ratio not to exceed 20 to 1, for three years from the date of GSE Approval (i.e., until January 2016); and

• certain start-up compensation expenses and equity compensation in the form of stock options and restricted stock units shall not be allocated to or assumed as a cost or expense by NMIC.

In its agreements with the FLDOI and NYDOI, NMIC is required to obtain the FLDOI's and NYDOI's respective prior written approvals to significantly deviate from the plan of operations and/or financial projections that were submitted to the FLDOI and NYDOI in connection with NMIC's license applications in those states. In addition, if the lawsuit brought by PMIC's Receiver is determined adversely to any of our officers who are named as defendants in the lawsuit (including our Chief Executive Officer, Chief Financial Officer, Chief Sales Officer and Vice President of Sales Operations, Analytics & Planning), we may be required to remove and replace those officers under the terms of the agreements with the ALDOI, AZDOI, FLDOI, NYDOI and TXDOI, as a condition of NMIC obtaining certificates of authority in those states, as well as under an agreement with the Wisconsin OCI. In connection with NMIC's license applications in California, Missouri and New York, NMIH entered into agreements with the CADOI, MODOI and NYDOI requiring NMIH to contribute capital to NMIC as necessary to maintain NMIC's risk-to-capital ratio at or below 20 to 1 for three years from the date of GSE Approval. In the agreement with the FLDOI, NMIH agreed, consistent with conditions of the GSE Approval, to downstream additional capital from time to time, as needed, to maintain NMIC's risk-to-capital ratio at or below 15 to 1. In addition, our operation plan filed with the Wisconsin OCI and other state insurance departments in connection with NMIC's applications for licensure includes the expectation that we will downstream additional capital, if needed, so that NMIC does not exceed an 18 to 1 risk-to-capital ratio. NMRI One is also a party to the agreement with the CADOI. Additionally, and as part of the approval process with the GSEs, we are required for the first three years of operations (expiring December 31, 2015) to maintain our risk-to-capital ratio at no greater than 15 to 1 and at all times to maintain total statutory capital of at least $150 million. For further discussion of the GSE Approvals, see "-GSE Approvals," below.
Capital Position
In addition to the requirement that NMIC adhere to the above minimum capital requirements, in 16 states, NMIC is also subject to regulatory minimum capital requirements based on its insured risk-in-force. While formulations of this minimum capital may vary in each jurisdiction, the most common measure allows for a maximum permitted risk-to-capital ratio of 25 to 1. As a new entrant to the MI business, our insurance writings to date have been minimal compared to the volume of insurance we expect to write as our business grows in the near future. As of September 30, 2013, NMIC's primary risk-in-force was approximately $1.2 million on a total of 22 policies in force and pool risk-in-force was approximately $93.1 million on a total of approximately 22,000 loans. Based on NMIC's reported statutory capital of $190 million at September 30, 2013, NMIC is currently significantly below the contractual and regulatory maximum risk-to-capital thresholds. As our insurance writings grow and our risk-in-force increases, our risk-to-capital ratio will increase and NMIC's risk-to-capital metrics will become more important to an evaluation of its compliance with all of the capital requirements to which it is subject. State insurance regulators and the GSEs are currently examining their respective risk-to-capital ratio requirements to determine whether in light of the recent financial crisis, changes are needed to more accurately assess mortgage insurers' ability to withstand stressful economic conditions. On December 17, 2013, the FHFA, during a conference call with GSE-approved mortgage insurers, announced that the GSEs will issue new qualified mortgage insurer eligibility standards late in the first quarter or early in the second quarter of 2014. These proposed standards are expected to include new minimum capital requirements. During the conference call the FHFA stated that early in the first quarter of 2014 it will provide state insurance regulators a six week comment period in which to review the new standards on a confidential basis. As a result of these stakeholders' ongoing assessments, the capital metrics under which they assess and measure our financial strength will likely change in the future.

GSE Approvals
The GSEs are the principal purchasers of the mortgages insured by MI companies, primarily as a result of their governmental mandate to provide liquidity in the secondary mortgage market. Freddie Mac's and Fannie Mae's federal charters generally prohibit the GSEs from purchasing a low down payment loan, unless the loan is insured by a qualified mortgage insurer, the mortgage seller retains at least a 10% participation in the loan or the seller agrees to repurchase or replace the loan in the event of a default. As a result, the nature of the private mortgage insurance industry in the United States is driven in large part by the requirements and practices of the GSEs, which include:
• the level of MI coverage, subject to the requirements of the GSEs' charters (which may be changed by federal legislation) as to when MI is used as the required credit enhancement on low down payment mortgages;

•         the amount of loan level delivery fees (which result in higher costs to
          borrowers) that the GSEs assess on loans that require MI;

•         whether the GSEs influence the mortgage lender's selection of the
          mortgage insurer providing coverage and, if so, any transactions that
          are related to that selection;

•         the availability of different loan purchase programs from the GSEs that
          allow different levels of MI coverage. For example, the GSEs allow
          lenders to deliver loans with "standard coverage" from an MI company,
          or, in exchange for lenders paying higher fees, lower "charter minimum"
          coverage levels. Historically, the large majority of loans are insured
          at "standard coverage" levels. If the relationship between the cost of
          mortgage insurance and the fees charged by the GSEs for various

coverage levels changes, lenders may prefer to obtain "charter minimum" coverage levels on their loans;

•         the underwriting standards that determine what loans are eligible for
          purchase by the GSEs, which can affect the quality of the risk insured
          by the mortgage insurer and the availability of mortgage loans;

•         the terms on which MI coverage can be canceled by the borrower before
          reaching the cancellation thresholds established by law;

•         the terms that the GSEs require to be included in MI policies for loans
          that they purchase;

•         the programs established by the GSEs intended to avoid or mitigate loss
          on insured mortgages and the circumstances in which mortgage servicers
          must implement such programs; and

• the minimum capital levels required to be maintained by MI companies.

The GSEs' federal charters generally prohibit them from purchasing low down payment loans without certain forms of credit enhancement, one of which is MI from an entity that they determine to be a qualified mortgage insurer. Consequently, in addition to securing certificates of authority, the ability to successfully commence mortgage insurance operations in the U.S. is largely dependent on obtaining approvals from Fannie Mae and Freddie Mac as a qualified MI provider. Following the Company's private placement in April 2012, NMIC's key focus was to secure approvals from the GSEs. In January 2013, Fannie Mae and Freddie Mac each approved NMIC as a qualified mortgage insurer. We expect that the significant majority of insurance we will write will be for loans sold to the GSEs. With the GSE Approval, our customers who originate loans insured by NMIC may sell such loans to the GSEs (as of April 1, 2013 for Freddie Mac and as of June 1, 2013 for Fannie Mae).
In March 2013, the FHFA announced its 2013 performance goals as part of its Strategic Plan for Fiscal 2013 - 2017 for the GSEs, which includes the goal of contracting the GSEs' dominant presence in the marketplace while simplifying and shrinking certain lines of business. With respect to single family mortgages, the FHFA has set a target of $30 billion of unpaid principal balance in credit-risk sharing transactions in 2013 for both Fannie Mae and Freddie Mac. The FHFA has specified that each GSE must conduct multiple types of risk-sharing transactions to meet this target, which includes expanded MI, credit-linked securities, senior/subordinated securities and other structures. As discussed below in "-New Business Writings", NMIC has entered into a pool insurance agreement with Fannie Mae, pursuant to which NMIC insures approximately 22,000 residential mortgage loans with an aggregate unpaid principal balance of approximately $5.2 billion (as of September 1, 2013). As a new business opportunity for MI companies, we generally believe the FHFA's 2013 strategy for the GSEs will have a beneficial impact on our industry.As a GSE-qualified MI provider, NMIC is subject to continuing eligibility requirements imposed by the GSEs in both their January 2013 conditional approvals of NMIC, as well as their respective comprehensive mortgage insurer eligibility requirements.

Development of Our IT Platform
The success of our business is highly dependent on our ability to effectively and efficiently use technology to electronically conduct business with our customers. Accordingly, we have invested and will continue to invest resources to establish and maintain electronic connectivity with customers and, more generally, in e-commerce and technological advancements. In order to integrate electronically with mortgage lenders we must:
• Establish connectivity with the industry's largest providers of mortgage servicing systems, which automate loan servicing functions such as payment processing, escrow administration, default management, investor accounting, loan modifications, and year-end reporting. We have completed integration with the largest and leading servicing system providers, LPS MSP and Fiserv LoanServ™ , which combined process more mortgages in the United States by dollar volume than any other servicing system, creating significant opportunity to efficiently conduct business with large lenders and aggregators that require this integration; and

• Integrate with those lenders that maintain their own proprietary loan origination and servicing systems, which provide the functionality to automate the mortgage loan origination process, including point of sale support, processing, settlement services, document preparation and tracking, underwriting, closing and funding, recognizing that the time-lines for these integrations are heavily dependent upon the lenders' internal technology resource time-lines and availability. Many lenders require us to engage in their third party review processes before we can conduct integration testing with such lenders. While we are currently working through this process with some lenders, no direct lender connectivity has been completed as of the date of this report; and

• Establish connectivity with leading third party providers of loan origination systems. We have begun the process of integrating with the leading third-party loan origination systems and have completed integrations with Ellie Mae Encompass360® and RealEC® and are in process with FICS Loan Producer® and Mortgage Builder. By mid-2014, we believe we will be integrated with these and additional leading third-party loan origination systems.

Many of our customers will require us to have the above connectivity in place as a precursor to doing business with them.
In connection with the MAC Acquisition in April 2012, we purchased an insurance management system we refer to as "IMS". Given the time required to upgrade the underwriting module of IMS, we made the business decision during the second quarter of 2013 to pursue the development of two new modules to support (i) policy servicing and billing and (ii) delinquency and claims management within a new insurance management system. We refer to this new insurance management system as "AXIS", of which these new modules are a component. This change required us to provide these services to our customers using current IMS capabilities, interim applications and manual solutions until the new policy servicing and billing module and the delinquency and claims management module were deployed for production use in November 2013.
Additionally, during the fourth quarter of 2013, in order to reduce future operating costs, improve operational efficiencies and achieve a more flexible and enhanced user experience for loan originators, we decided to replace certain components of our underwriting module, which is currently a module of IMS. When complete, this new underwriting module will become part of AXIS. We are currently in the discovery and planning phase of this initiative and expect this new module to be deployed in 2014. When deployed, IMS will be fully retired. We have invested and will continue to invest significant resources to develop AXIS to support our MI operations. The success of our business will be dependent on our ability to resolve any issues identified with AXIS during development, testing and production and to timely make any necessary improvements. As a result of the above changes, we were required to reduce the useful life of IMS. Reducing the useful life of IMS has the effect of shortening the amortization period, causing us to record the same amount of amortization expense over a shorter period of time, which was implemented in the second quarter of 2013 and will continue to amortize over the coming quarters. We expect that IMS will be fully amortized by the end of 2014. Development of Our Customer Base
Our sales strategy is focused on attracting as customers those mortgage originators that fall into one of two distinct categories of national and regional lenders, which we refer to as "National Accounts" and "Regional Accounts". Before we can begin insuring loans originated by these lenders, they must agree to use NMIC as a mortgage insurance provider. Following an approval by the lender, NMIC issues its master policy to the lender, setting forth the terms and conditions of our MI coverage.
We consider National Accounts to be the 36 most significant residential mortgage originators as defined by volume of originations and volume of insured business. We plan to service this customer base with a small but specialized team of National Account sales people who have experience sourcing business from this segment. We expect that the National Accounts will purchase MI products from NMIC for loans originated directly through their retail channels, as well as to purchase loans from

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