Still Unprofitable Insurer NMI Holdings Seeks to File IPO

October 18, 2013 by Zachary Tracer

NMI Holdings Inc., the mortgage guarantor backed by Kyle Bass, Carlyle Group LP and BlueMountain Capital Management LLC, is seeking to be the first U.S. insurer since 2009 to file an initial public offering without posting a profit, as demand climbs for housing-related investments.

The firm had sold coverage on 22 individual loans at the end of September, is working to get its computer system running and will be unprofitable at least through next year, according to the IPO filing. NMI also competes with Essent Group Ltd., a profitable company whose investors include George Soros and Goldman Sachs Group Inc., that’s pitching its own IPO.

Investor appetite for home-loan guarantors is climbing as the U.S. property market rebounds at the fastest pace in seven years and the government retreats from backing mortgages. Still, NMI’s IPO filing carries warnings more often found in Internet and biotechnology offerings, said Josef Schuster, founder of a firm that tracks public offerings.

“In financials, it’s a rare occasion that you see such unseasoned deals,” Schuster said.

In the Oct. 8 document, Emeryville, California-based NMI described itself as a development stage corporation started in 2011. “We have a history of losses and expect to continue to report annual net losses in the near term,” the company said. “Our ability to achieve profitability, if at all, is uncertain.”

Mary McGarity, a spokeswoman for NMI at Strategic Vantage, declined to comment before the share sale. NMI is pursuing the IPO because it’s the fastest way to increase the number of holders and secure a stock-exchange listing, satisfying obligations to investors, according to the filing.

Vulnerable Insurers

It’s been almost five years since an insurer filed to go public with a net loss in its most recent reporting period, according to data compiled by Bloomberg. That firm, Penn Millers Holding Corp., was a property-casualty insurer, which traced its history to 1887. Penn Millers was acquired by Ace Ltd. for $107 million in 2011.

NMI was created when rivals were vulnerable because of the housing crash and there was less capacity in the market for mortgage insurance, which covers losses when borrowers default and foreclosures fail to recoup costs. Coverage is typically required when borrowers pay less than 20 percent of the cost of their home up front.

“The further we get from the crisis, the more uphill battle it is to gain customers,” Jack Micenko, an analyst at Susquehanna International Group LLP, said by phone. “If you’re an issuing bank, your sense of urgency of adding yet another counterparty is much, much lower.”

FBR Raise

Led by Chief Executive Officer Bradley Shuster, NMI raised $510 million from investors in a 2012 private share sale led by FBR & Co., which is also managing the IPO. It got regulatory approval this year from Fannie Mae and Freddie Mac, and began selling coverage in April.

Claren Road Asset Management LLC, the hedge fund majority- owned by Carlyle, is NMI’s largest backer, with a 12.6 percent stake. Bass’s Hayman Capital Management LP has 9.9 percent and BlueMountain owns 9.8 percent.

Spokesmen for the investment firms declined to comment.

From its May 2011 founding through June, NMI has lost $57.1 million, according to the regulatory filing. Shareholder equity, a measure of assets minus liabilities, was $465.5 million.

In comparison, Essent has posted operating profit for three straight quarters after getting approvals from Fannie Mae and Freddie Mac in 2010, and now controls 12 percent of the traditional private mortgage insurance market. Its investors include JPMorgan Chase & Co., the No. 2 mortgage originator, which has an 8.9 percent stake. Pine Brook Road Partners is the insurer’s biggest investor and holds 22.7 percent. Goldman Sachs owns 11.3 percent.

Rebuilding Capital

NMI or Essent would be the first U.S. home-loan guarantor in almost two decades to go public. The IPOs would be the latest way for investors to bet on an industry that’s been drawing capital this year, after the financial crisis forced almost half the companies out of the business. Radian Group Inc. and MGIC Investment Corp. raised fresh cash this year, helping rebuild capital drained when housing crashed.

After declining for six straight years, home prices climbed about 7 percent in 2012, and are up another 11 percent this year through July, aided by mortgage rates that have been pushed near record lows by the Federal Reserve’s stimulus program.

Mortgage originations to purchase one- to four-family homes are projected to rise 22 percent this year to $616 billion, and another 14 percent in 2014, according to a Mortgage Bankers Association forecast. The figure was $1.5 trillion in 2005.

Leveraged Play

“There’s pretty good pent-up demand,” said Rick Lane, who helps manage the $867 million FMI Focus Fund as president of Broadview Advisors LLC. “You just won’t find a more leveraged play on housing” than mortgage insurers.

The Federal Housing Administration, which took on a bigger role in backing home loans in the crisis, is also ceding business to private insurers by raising prices for its coverage.

Crisis-era losses pushed three mortgage insurers from the market and weighed on the financial-strength ratings of MGIC, Radian and Genworth Financial Inc. That’s helped convince lenders it’s a bad idea to rely on just one home-loan guarantor, said Sean Dilweg, president of CUNA Mutual Group’s mortgage insurer.

“It opens the door for new entrants to make their case,” Dilweg said by phone.

Still, companies need to make sure they’re easy to work with to win business, he said. NMI is still working to integrate its computer system with some programs used by originators, according to its filing.

Hand-to-Hand Combat

“It’s really hand-to-hand combat,” Dilweg said. “It’s pricing, it’s your service, underwriting, how quickly you can respond to a loan.”

NMI reached a deal in July with Fannie Mae to cover a pool of about $5 billion of mortgages. The premiums on that deal, which started in September, are lower than typical costs for loan-by-loan coverage.

“You’re trading off margins for volume within that type of deal,” said Rob Haines, an analyst at CreditSights Inc. “But it allows you to deploy the capital immediately.”

Essent has relationships with about 800 customers, including 20 of the 25 largest U.S. mortgage originators, according to a regulatory filing. Wells Fargo & Co., the biggest U.S. home lender, accounted for 17 percent of Essent’s sales in the first six months of this year.

Meaningful Strides

NMI says it’s “made meaningful strides establishing relationships” with 36 of the biggest mortgage lenders. Half have agreed to use the company as an insurer.

The firm may be able to persuade lenders to buy its policies by highlighting the quality of its balance sheet and customer service. Disputes over coverage between insurers and investors might help NMI win business, said Brian O’Reilly, president of Collingwood Group LLC and a former mortgage industry executive.

“You’re probably not going to ever accuse your competitor of denying claims unduly,” he said “What you might say is that your customer service exceeds theirs.”

MGIC and Radian were unprofitable for most of the past six years. MGIC, based in Milwaukee, has reported two straight quarterly profits this year, its first since 2010, while Radian had a loss tied to investments in the second quarter and hasn’t yet reported third-quarter results. Genworth’s U.S. mortgage insurer was profitable in the six months ended June 30, its first half-year profit since 2007.

Mortgage insurance written since the crisis has proven more profitable as banks and insurers tightened their standards. That’s driven return on equity to at least 20 percent on new policies, Micenko said.

“The good news is, the new business is 20s ROE,” he said. “The bad news is, NMI has got to go get some of it.”

–Editors: Pierre Paulden, Rob Urban