Description

National MI VIC Feb. 26, 2022

National MI is the smallest but fastest growing mortgage insurance company among the six peers that are publically listed on the stock market.  The company can grow EPS at a 35% CAGR the next three years and is valued at a 7x P/E on 2022 EPS.

So What Is Mortgage Insurance:

Banks require consumers that apply for a residential mortgage to pay for 20% of the home with cash. Fifteen percent of new home buyers do not have enough cash for this 20% down payment.  In order to qualify for a mortgage, banks require these consumers to purchase mortgage insurance. This insurance will reimburse the bank if the borrower defaults on the mortgage payments. Thus the consumer needs to pay the standard mortgage payments plus  a $1,000 annual insurance  premium for a $300,000 mortgage. 

An Appendix of Terms Is Listed At The End Of This Report:

For readers less familiar with the mortgage insurance industry, there is an appendix at the end of this note that explains some of the terms used in this report. 

Macro Economic Trends Are Positive:

The three most important macroeconomic factors that help National MI are rising 30 year mortgage rates, a low unemployment rate and home price appreciation.  All three factors are moving in the right direction today for National MI. 

The best mortgage insurance policy stays in force for years and the home owner never defaults on their mortgage payments. As of December 2021 National MI has entered one of these periods which are considered the best of times.  The past few years National MI would have 50% of their insurance customers terminate their policies annually as they refinanced their residential mortgage at lower interest rates. It is tough to grow your business when you lose half of your customers every year. In the past 2 months, interest  rates for a fixed 30 year mortgage have risen from 3% to 4%. Most consumers now can no longer refinance their mortgages at lower mortgage rates to save money. As a result the “persistency rate” for National MI’s customers will likely rise from 50% to 85%. It is much easier to grow insurance in force when 85% of policies renew every year instead of  50%.

The number one reason that consumers default on their mortgage payments is a result of losing their job. Today the USA unemployment rate is under 4% which means that very few consumers are failing to pay their monthly mortgage payments.  

Home prices rose by +15% in 2021. This helps National MI since a home at a higher value allows  a bank to sell the house and get its mortgage repaid without needing to file an insurance claim with National MI.  This home price appreciation has resulted in underwriting losses at National MI being  at record lows. 

Competitive Advantages Drive Higher Market Share. 

National MI wrote its first mortgage insurance policy in 2013. The company has growth rapidly and in  eight years has captured 10% market share by 2021.  There is good reason to believe that National MI is headed for 20% industry market share.  

The company has gained market share for three reasons: 

1. Certainty 2) Customer Service and 3) Lower cost.

Unlike its mortgage insurance competitors, National MI guarantees that it will honor all policies written and not try to find loop holes to avoid paying a lenders insurance claim. This is an important guarantee for bank lenders. In the last housing crisis about 50% of mortgage insurance claims filed by banks were denied by the insurance companies. 

The company has a more effective sales-force that has been able to continually gain market share within existing accounts. National MI has a modern technology stack that was able to easily shift to remote work during COVID while competitors had problems. The company also proved during COVID that their IT platform was faster and lower cost for lenders to use as well.  

The Two Biggest Drivers For National MI EPS Exceeding Consensus Estimates Are:

1. A higher persistency rate for the mortgage insurance in force and 

2.  further gains in market share

These two factors will help National MI to earn $4.70 EPS in 2023 which is 22% above the consensus.

Below is a summary of First Call consensus EPS estimates and the VIC forecast. 

2022 $3.15 EPS estimate from First Call.    7% Higher $3.37 EPS by the VIC author

2023 $3.88 EPS estimate from First Call.  22% Higher $4.70 EPS by the VIC author

The driver for the EPS estimates above consensus is mostly a result of a higher persistency ratio.

Every 10% increase in the annual persistency rate will increase annual EPS by $0.35 or 13%.

The long-term average for the persistency ratio has been 80%, but 2021 started at 52%.  The recent rise for 30 year fixed rate mortgages to 4% is going to lock in the vast majority of National MI policy holders. Since refinancing a mortgage at a lower interest rate will not be possible, you can see how the persistency rate will rapidly reach 80% or higher. So a 20% boost in the persistency rate will add $0.70 EPS a year.

Below is an explanation for how to calculate the EPS boost from a 10% increase in the persistency ratio.

As of Dec 2021 NMIH has $152 Billion of insurance in force.

We assume 30 basis points of fees or $455 Million of premium is earned a year on the policies in force.

A 10% increase in persistency adds $45 Million of premium a year.

The pretax margin on this retained mortgage insurance is 85%.

Thus pretax income is $38.7 Million.

This results in $0.35 EPS/year with a 22% tax rate and 87 Million shares outstanding. 

Every 1% gain in market share for New Insurance Written (NIW) adds $0.10 EPS a year for NMIH.

National MI has gained one or two percent of market share a year over the past two years. They have existing relationships with nearly all of the major residential mortgage lenders. They are just in the process of gaining share within the customer base. My EPS estimates assume a 1% gain in market share by 2023, but the gains could be larger. 

Below is an explanation for how to calculate EPS from a 1% increase in mortgage insurance market share. 

The starting assumption is that $550 Billion of mortgage insurance is written in 2022 by the industry which is below the levels written in 2021. Since home prices increased by 15% in 2021, you can make the case that a larger percent of first time home buyers will need mortgage insurance in 2022. To be conservative I do not assume an increase in demand for mortgage insurance.

A 1% share of net insurance written is $5.5 Billion.

This insurance priced at 30 basis points a year will generate $16.5 Million in annual premiums

The pre-tax margin is 65% after incurring underwriting and operating expenses.

This results in $0.10 EPS/year with a 22% tax rate and 87 Million shares outstanding. 

The P/E Ratio for NMIH Can Also Rise:

In 4 of the past 5 years National MI’s next twelve month’s P/E ratio has exceeded  11x.

It is only over the past year that the P/E  ratio has compressed to 7x.

National MI has continued to rapidly grow EPS, but the stock price has moved sideways. 

Once more investors recognize that National MI is a direct beneficiary of rising interest rates, I believe that the P/E ratio can return to the 11x level. 

Competition:

Below is a list of the other public mortgage insurance firms:

(ACGL) Arch Capital

(ACT)  Enact Holdings

(ESNT) Essent Group

(MTG) MGIC  Investment

(RDN) Radian Group

(ORI) Old Republic

RISKS:

Home Price Declines Can Cause a Shareholder Disaster:

National MI has an average 92% loan to value ratio (LTV) for the home mortgages that it insures. If the average value of homes in the United States declined by 15%, home owners that are customers of National MI would have no equity in their homes.  If these home owners  stopped paying their monthly mortgage payments, banks could foreclose on the house. Consumers would  have to move, but they would not lose any equity value in their homes.  The  banks would sell the home and any loss on the sale would need to be paid by National MI. 

This disaster scenario did take place during the 2006-2011 time period when the value of the average home in the United States declined by 22% over 4-5 years.  Public mortgage insurance firms such as MGIC lost money for seven consecutive years and their stock prices fell by 97%. The entire mortgage insurance industry lost money each year during (2007-2012). During this time-frame numerous MI firms such as Republic and Triad shut down.

Large Increase In the Unemployment Rate Caused By A Recession:

Home owners often allocate one-third of their wages to paying monthly mortgage payments. 

If people are unemployed they cannot afford to pay their mortgage payments. That is why rising unemployment is a big risk for mortgage insurance companies and banks. A recession is the biggest threat because in those situations unemployment can rise sharply on a national basis. 

Poor Risk Assessment  During the Underwriting Process:

The best insurance companies are able to more effectively use data to write insurance policies for customers that will not default.  National MI told investors that they had as superior underwriting process, but this assertion had never been tested in a recession or other negative economic environment. The first test of the companies underwriting skill took place during the rapid rise in unemployment caused by COVID starting in March 2020. By September 2021 it was clear that National MI was a superb underwriter. The company sustained cumulative losses of 10% over 18 months relative to premiums earned. These losses were 63% lower than the average losses for the entire MI industry. National MI actually had the lowest loss ratio among all six mortgage insurance companies that are public. 

If Most Investors Believe There Is A High Risk Of A Recession – Mortgage Insurance Stocks Will Underperform. 

In a recession the unemployment rate rises and fewer homeowners are able to pay their monthly mortgage payments.  The fear of more underwriting losses will cause the valuations for the mortgage insurance stocks to compress. 

Appendix of Key Terms For The Mortgage Insurance Industry:

Annual Persistency – The percent of mortgage insurance policies that remain in force 12 months later. 

(IIF) Insurance In Force – The dollar value of all mortgage insurance policies in force.

Historically the industry has earned insurance premiums of 30 – 40 basis points annually on the dollar value of policies in force. 

(NIW) New Insurance Written – This is the dollar value of new mortgage insurance written.

In order to grow the industry needs to write new insurance as existing policies end when the home owner sells their home or refinances the mortgage at a lower interest rate. 

Catalyst

1 - National MI should exceed First Call quarterly EPS estimates of $0.74 in the March 2022 quarter as rising persistancy rates boost profits. 

2 - As the Federal Reserve raises the Fed Funds rate more investors will search for companies that benefit from rising interest rates. National MI (NMIH) is one of those beneficieries.