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NMIH > SEC Filings for NMIH > Form 10-K on 12-Mar-2014All Recent SEC Filings

Show all filings for NMI HOLDINGS, INC.

Form 10-K for NMI HOLDINGS, INC.


Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and notes thereto included below in Item 8 of this report and the Risk Factors included above in Part I, Item 1A of this report. In addition, investors should review the "Cautionary Note Regarding Forward Looking Statements" above. Overview
NMI Holdings, Inc. ("NMIH" or the "Company") was formed in May 2011 and, through its subsidiaries, provides private mortgage guaranty insurance (which we refer to as "mortgage insurance" or "MI"). As used below, "we" and "our" refer to NMIH's consolidated operations. MI protects mortgage lenders from all or a portion of default-related losses on residential mortgage loans made to home buyers who generally make down payments of less than 20% of the home's purchase price. 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. MI also facilitates the sale of these mortgage loans in the secondary mortgage market, most of which are sold to Fannie Mae and Freddie Mac. Our business strategy is to become a leading national MI company with our principal focus on writing insurance on high quality, low down payment residential mortgages in the United States. 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 we renamed National Mortgage Insurance Corporation ("NMIC"), National Mortgage Reinsurance Inc One ("Re One") and National Mortgage Reinsurance Inc Two ("Re Two"), respectively. In April 2012, we raised net proceeds of approximately $510 million from a private placement of our common stock (the "Private Placement") and completed the acquisition of MAC Financial Holding Corporation 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 Re Two into NMIC, with NMIC surviving the merger.
In January 2013, Fannie Mae and Freddie Mac (collectively the "GSEs") approved NMIC as a qualified MI provider on loans purchased by the GSEs. With our 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). Our primary insurance subsidiary, NMIC, requires a certificate of authority, or insurance license, in each state or jurisdiction where we issue insurance policies. We applied for a certificate of authority in each of the 50 states and D.C. in June 2012. We are currently licensed in 49 states and D.C. On November 8, 2013, we filed a final prospectus announcing the sale of approximately 2.1 million shares of common stock through our IPO. The principal reason for conducting the IPO was to expedite an increase in the number of holders of our common stock to permit a listing of our common stock on the NASDAQ. Obtaining a listing on the NASDAQ satisfied certain contractual obligations we had to our stockholders under a Registration Rights Agreement we 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 us were $31.4 million. Net proceeds from the offering were approximately $28 million, after an approximate 6% underwriting fee and other offering expenses and reimbursements pursuant to the underwriting agreement.
Following our IPO, and to meet our obligations under the Registration Rights Agreement, we filed a final prospectus on December 9, 2013 registering 51,101,434 Class A common shares. These shares had previously been issued during our Private Placement.
Through our primary mortgage insurance subsidiary, NMIC, a monoline MI company, and its affiliated reinsurance company, Re One, we provide residential MI in the United States. We are one of seven companies in the U.S. who offer such insurance.
We believe the MI industry has significant barriers to entry due to the substantial capital necessary to fund operations and satisfy GSE requirements, the need for a customer-integrated operating platform capable of issuing and servicing mortgage insurance policies, the competitive positions and established customer relationships of existing mortgage insurance providers, and in order to conduct MI business nationwide, the need to obtain and maintain insurance licenses in all 50 states and D.C. Additionally, the resource commitment required by customers, and larger lenders in particular, to connect to a new mortgage insurance platform, such as ours, is significant, and absent a critical need, such as the capital constraints in the MI industry during the financial crisis, they have historically, in our view, been reluctant to make such an investment. We were formed at a time when the severe dislocation in the private mortgage insurance industry caused by the financial crisis created a need for newly capitalized mortgage insurers and this has facilitated our efforts to establish relationships with lenders.

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 obtaining state licenses and GSE approval. NMIC works to differentiate itself primarily by prompt and predictable underwriting, thereby aiming to provide our customers with a higher degree of confidence of coverage than our competitors provide. We have established risk management controls throughout our organization that we believe will support our continued financial strength. As a newly capitalized mortgage insurer, we have the ability to write new business without the burden of risky legacy exposures and believe our current capital supports our current business writing strategy while staying within the regulatory guidelines imposed by state insurance departments and the GSEs.
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. Since we commenced writing MI on a limited test basis in April 2013, we have become a fully operational MI company, with $161.7 million of primary insurance-in-force and $5.1 billion of pool insurance in force as of December 31, 2013. For the year ended December 31, 2013, the Company had primary risk-in-force of $36.5 million compared to primary risk-in-force of $1.2 million at September 30, 2013. Pool risk-in-force for the year ended December 31, 2013 was $93.1 million.
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 were 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 the composition of our NIW and IIF; and

critical accounting estimates 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.

Operating Expenses from Start Up Activities Our expenses for the years ended December 31, 2013, 2012 and 2011, were $60.7 million, $27.8 million and $1.3 million, respectively, and consist largely of expenses associated with start up activities, including payroll and related expenses, share-based compensation and professional fees. The costs that we have incurred to date represent the culmination of our start-up activities. As such, they do not reflect the same types of expenses that an MI company with an established insurance portfolio after many years of operations would be expected to incur. 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 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%. During the first few years 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 at least 2014. Additionally, we are targeting an average unlevered return on equity in the mid-teens over time.
We discuss below the significant start up 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 and are actively using the applications today to transact business with customers;

we established customer relationships with mortgage originators; and

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

State Licensing
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. On March 7, 2014, we received a letter from the Wyoming Insurance Department ("WY DOI") notifying us that our application for a certificate of authority in Wyoming has been recommended for approval subject to NMIC posting a statutory deposit with the Wyoming Insurance Commissioner, which is customary for mortgage insurance companies. See Part I, Item 1A, "Risk Factors - We may not receive, or be able to retain, licenses in all states, which would hamper our ability to issue MI on a nationwide basis." Many states also require approval of NMIC's insurance rates and/or policy forms before it may issue insurance policies in such states. NMIC currently has effective rates and effective policy forms in each of the 49 states and D.C. in which NMIC has received certificates of authority.
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 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 ("RSUs") 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, FLDOI, NYDOI and TXDOI, as a condition of NMIC obtaining certificates of authority in those states.
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 NMIH will downstream additional capital, if needed, so that NMIC does not exceed an 18 to 1 risk-to-capital ratio. Re 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 NMIC's risk-to-capital ratio at no greater than 15 to 1 and at all times to maintain NMIC's 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 December 31, 2013, NMIC's primary risk-in-force was approximately $36.5 million on a total of 653 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 total statutory capital of $182 million at December 31, 2013, NMIC's risk-to-capital ratio was 0.6:1, 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.
The NAIC has formed a working group to explore, among other things, whether the risk-to-capital requirements applicable to mortgage insurers should be overhauled. We, along with other MI companies are working with the Mortgage Guaranty Insurance Working Group of the Financial Condition (E) Committee of the NAIC. The Working Group will determine and make a recommendation to the Financial Condition (E) Committee of the NAIC as to what changes, if any, the Working Group believes are necessary to the solvency regulation for MI companies, including changes to the Mortgage Guaranty Insurers Model Act (Model #630). We have participated in the Working Group since early 2013 and continue to advocate for a strong capital model, as the industry migrates from a risk-to-capital metric to a more traditional risk-based capital approach. The discussions are ongoing and the ultimate outcome of these discussions and any potential actions taken by the NAIC cannot be predicted at this time. However, given our current strong capital position and having no exposure to risk written in the 2005 through 2008 book years (which we consider to be some of the poorest performing books of business ever written by the MI industry), we believe that NMIC will be able to fully comply with any new capital requirements at the time they are enacted.
In late 2013, the FHFA informed the MI industry that the GSEs have jointly developed new qualified mortgage insurer eligibility standards that will be issued in draft form for public comment in 2014. However, in January, 2014, the FHFA informed the MI industry that issuance of the new MI eligibility standards in draft form had been delayed by FHFA's Director Mel Watt in order to permit Director Watt to review the draft standards. FHFA has not announced when the draft standards will be issued.
GSE Approvals
The GSEs are the principal purchasers of mortgages insured by MI companies, primarily as a result of their legislative mandate to provide liquidity in the secondary mortgage market. Consequently, 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). For additional discussion of the conditions we agreed to in connection with obtaining GSE Approval, see Part I, Item 1, "Business - Regulation - GSE Qualified Mortgage Insurer Requirements." Development of Our Insurance Management System ("AXIS") and Integration with Loan Origination Systems
We are currently underwriting and servicing loans within our AXIS platform. Having a fully functional, cost efficient and scalable insurance management system is critical to our ability to conduct business with customers that control the majority of the mortgage insurance market. We continue to develop AXIS, which is primarily comprised of two modules: (i) underwriting and (ii) billing, servicing, and default and claims management.
The underwriting module currently in production was acquired in connection with the MAC Acquisition in April 2012. We have made investments in this module and have upgraded it from the time of the acquisition and believe it is capable of supporting our anticipated mortgage insurance volume through at least the end of 2014. 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 further enhance our underwriting module. The new design and development of this underwriting module started in late 2013 with deployment expected to occur in the fourth quarter of 2014. We continue to accept MI commitments from all of our customers and expect the new module to be viewed as an enhanced user experience by our customers. This upgrade does not impact our ability to service existing or new customers. The currently deployed billing, servicing, default and claims module was designed and developed during 2013 and successfully deployed in late 2013 and early 2014. The module generates and processes premium bills and statements, processes monthly premium payments, and performs service transfers, principal balance updates and cancellations, among other functions. AXIS is integrated with the two largest servicing system providers, facilitating an automated and efficient process between us and

our customers related to all aspects of billing and servicing our policies. Integrating with the two largest servicing system providers was integral to many of our customers who require this automation prior to doing business with us. AXIS also accepts and processes NODs, allowing us to automatically track claim time-lines for adherence to the terms and conditions of our insurance policies and provide timely feedback and metrics to internal groups, among other functions.
Both modules replaced similar modules acquired as part of the MAC Acquisition. This was done to reduce future operating costs, improve operational efficiencies and achieve a more flexible and enhanced user experience for customers. We expect the software portion of the MAC Acquisition will be fully amortized by the end of 2014 when the new underwriting module is deployed. Loan Origination Systems
Our fully operational, cost efficient and scalable AXIS platform is critical to our ability to integrate with third party and proprietary loan origination systems and to our ability to address the majority of the mortgage insurance market. Loan origination systems 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. We continue to work through the integration process with additional lenders and third party loan origination systems. Customer Development
As discussed above in Part I, Item 1, "Business - Sales and Marketing and Competition - Sales and Marketing," we organize our sales and marketing efforts based on our national and regional customer segmentation. Our sales strategy is focused on attracting as customers mortgage originators in the United States that fall into two distinct categories, which we refer to as "National Accounts" and "Regional Accounts".
We define National Accounts as the 37 most significant residential mortgage originators as determined by volume of their own originations as well as volume of insured business they may acquire from other originators. These National Accounts generally originate loans through their retail channels as well as purchase loans originated by other entities, primarily mortgage originators who we would classify as Regional Accounts, as described below. National Account lenders may sell their loans to the GSEs or private label secondary markets or securitize the loans themselves. We plan to service these customers with a specialized team of National Account sales people who have experience sourcing business from this segment. To date, approximately 20 of the National Accounts have indicated that they intend to do business with us, and we continue to work towards completing our customer boarding processes. We believe we have favorable relationships with the approximately 20 National Accounts who have indicated they will purchase MI from NMIC. As of the date of this report, we have received a limited amount of business from four of these national account providers and have continued to work with the other National Accounts to engage them as customers. We expect to begin insuring loans in the correspondent channels of two large National Accounts in the near term future.
The Regional Accounts originate mortgage loans on a local or regional level throughout the country. Some of these Regional Accounts have origination platforms that span across multiple regions; however, their primary lending focus is local. They sell the majority of their originations to National Accounts, but Regional Accounts may also retain loans in their portfolios or sell portions of their production directly to the GSEs. Our nationwide and regional sales teams address the Regional Accounts segment of the market, and with the early efforts of these teams, we have been able to attract lenders in this segment who have agreed to purchase MI from NMIC. Our future efforts will be focused on growing this segment of our customer base. Our ability to make progress penetrating Regional Accounts is primarily dependent on the following three factors:
Obtaining approval from National Account lenders to be an authorized MI provider enables Regional Accounts to sell loans with insurance from NMIC to those National Accounts. Consequently, these approvals are critical to making inroads with Regional Accounts. As discussed above, approximately 20 of the 37 National Accounts have indicated that they intend to do business with us.

Achieving connectivity with the largest loan servicing systems. Many loan servicers, including large lenders and those in the industry who service loans originated by Regional Accounts, that do not maintain proprietary servicing systems rely primarily on the two most significant servicing systems, LPS MSP and Fiserv LoanServTM, to service their loans. In 2013, we completed integration with LPS MSP and Fiserv LoanServTM. Attaining connectivity with these servicing systems is one of the important steps with respect to both National and Regional Accounts purchasing MI from NMIC.

Achieving connectivity with leading third-party loan origination systems utilized by Regional Accounts, including Ellie Mae Encompass360. The Regional Accounts who originate loans using these third-party loan origination systems will be able to automatically select NMIC as an MI provider within those systems. The progress we have made to date connecting with these loan origination systems is another significant achievement with respect to our readiness to engage with Regional Accounts.

The MI industry is highly competitive and includes other private mortgage insurers, governmental agencies that sponsor government-backed mortgage insurance programs and alternatives to credit enhancement products, such as piggy-back loans. See Part I, Item 1, "Business - Sales and Marketing and Competition - Competition," for additional discussion of our competitors. The MI industry has recently been in a state of flux, with some existing companies exiting and new companies entering the space. In addition to ourselves, in 2010 another new MI company was formed and started writing MI. One existing company that had been serving credit unions only was acquired and announced its intent to expand operations to serve the entire mortgage market. In addition, an existing MI company that had previously stopped writing MI . . .

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