Chit Chat Stocks - A Secret Housing Stock: 20% Earnings Growth, P/E of 8 With Capital Mindset (Ticker: NMIH)

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Starting point is 00:00:47 welcome to chitchat stocks on this show host ryan henderson and brett shaffer analyze businesses and riff on the world of investing as a quick reminder chitchat stocks is a ccm media group podcast anything discussed on chitchat stocks by ryan brett or any other podcast guest is not formal advice or recommendation now please enjoy this episode welcome in to another edition of chit chat stocks a podcast talking about all things investing we have a fantastic wednesday episode for you guys we have an interview with fabio from capital mindset a great youtube channel talking quality investing fundamental investing it's on youtube there's a lot of uh as we might say people that don't necessarily do much work i would say capital

Starting point is 00:01:48 mindset is the opposite we try to strive to be like them as well trying to do quality work and if you like our episodes we think you'll enjoy it as well but fabio is back on the show and we're discussing uh the ticker is nmih and i think i want to get the exact name right nash nmi holdings almost national mortgage insurance company would maybe be their underlying name. But Fabio, welcome to the show. Why NMI Holdings? Well, thank you for the generous introduction. And well, NMI Holdings is part of the PMI insurance space. So first, let's, I guess, break down the industry as a whole, and then we'll get into why NMI in particular. But property mortgage insurance, or PMI, it's a very underfollowed

Starting point is 00:02:37 space, I would say, on FinTwit or other spaces where people talk equities. The space has evolved a lot over the last, I'd say, 20 or so years, given the context of the great financial crisis, real estate crisis. Today, we're dealing with a whole other animal. Now, with the regulations that have come into play, the space is, I'd say, it looks very different than it once did. Property mortgage insurance, or I'm sorry, PMI insurance, we'll just say from here on out, it's mainly focused on the portion of the loan, if there is a default, that is not covered by the equity of the property. So for those of everyone else who's maybe not in the United States or in a country that doesn't have this exact same system, but many Western countries

Starting point is 00:03:30 do have something that resembles this. If you have, let's say you buy a house, something happens and you're not able to make the payments, right? Then at which point the lender is going to foreclose on the property. But depending on how much equity you've built up in the property, let's say the house has gone up a little bit, whatever is not covered upon that foreclosure sale, the mortgage insurance will pick up the tab, so to speak. And so that's the risk that these companies are taking. Why are they there? They enable these transactions in the first place, in many cases. A lot of these products that we deal with in the modern world, they're securitized. We have a whole slew of investors, pension funds, endowment funds,

Starting point is 00:04:20 et cetera, on the other side of these things. And so we as a society or as the market has wanted, we want these transactions to occur. We want people to be able to purchase a property, purchase a home. And so this is one way, just like as insurance does, enables some sort of transaction, some sort of activity to occur because we're spreading out the risk of said product. Now, PMI after 2008 has radically changed, and you can see this in the combined ratios. So for insurance, let's take a step back. When you're looking at an insurance company, you'll typically look at the combined ratio as a measure of profitability.

Starting point is 00:05:01 To simplify the term, it's the amount of money they keep after everything. And so you look at something like a progressive, progressive, very large, very well-known property casualty insurer has a combined ratio in the 90%, which is considered good. If you see a combined ratio above 100, and usually people think higher the number sounds better. No. In insurance, we take the opposite approach. The higher the number, the worse it is. So if you look at an insurer and the combined ratio is above 100%, you're going to be dealing with an entity that is going to rely more so on the investment income than the underlying operations. And so we're taking on a little bit more risk. Maybe it's also an inferior operator in the sector. And you can

Starting point is 00:05:46 also look at different types of insurances tend to have different combined ratios. Now, when we're looking at PMI, we are actually looking at extremely low combined ratios. So that should stand out and people say, what's going on here? Well, this is all, now we're delving into the realm of my opinion. Well, we've always been in there, but we'll talk a little bit about the I guess the changes that occurred. But now we're dealing with a sector where you have combined ratios in the low 30s. And so you're saying, how can this be? Well, due to the 2008 financial crisis, and all the requirements have been put in place since then, you're now potentially, if you can kind of use an example, the government has put its hand on the scale.

Starting point is 00:06:32 And so where maybe before or maybe in other markets, you have more discovery, price discovery or more free markets, let's say. Here we have an enforcement mechanism that requires these products when maybe they wouldn't be otherwise required. So because the risk isn't actually there. But you're forcing them to be insured regardless because you really don't want something to happen ever again, which is something like a 2008. So, yes. I was going to say, was before 2008, was mortgage insurance not required? And now is it more like car insurance where everyone has to get it? It was something that was needed to facilitate the transactions for securitization.

Starting point is 00:07:21 but now more so than ever, the requirements or the strictness on each loan needing it has gone up. And there's even been talks, although this is so far out and potentially not going to happen, but certain politicians have even been talking about increasing the requirements for mortgage insurance, going up to 30% equity before you can get rid of it. That would be extraordinarily hyper bullish for this company, but don't plan on that ever happening. But regulators seem to look at ways to increase the safeguards, so to speak, against a 2008 event rather than take them away. And that's been something that's been in place or been progressing since 2008. Gotcha. Anything else on the mortgage insurance part before we get to NMI

Starting point is 00:08:10 specifically? The credit profile of mortgages in general in the United States have never been healthier. The requirements have never been stricter. In fact, some argue that we've gone on the other side, the opposite side of the spectrum. We went from really loose, from normal, let's call it normal historical average, to really loose, to extremely conservative. And so that shift arguably has enabled the risk profile of these products to go down quite tremendously. Now, if we get to a point where that gets loosened, maybe back to that historical average. Some might say, hey, that could be bearish. Not necessarily. That actually could expand the amount that they could insure. And so it expands the market. So it's not necessarily

Starting point is 00:08:56 what we do not want. We'll get to that more in the risk part of the discussion is right before 2008 to ever happen again. Yeah, I think anything mortgage or housing related, you definitely don't want 2006 2005 type environments to be happening but let's hit on nmi specifically what products do they offer and why do they as an upstart i would say mortgage insurer need to exist so they started post 2008 and so their their story you had a bunch of other players some of them went are no longer with us uh some of them almost are no longer were were taken out but nmi started as an opportunity to kind of address or attack this vacuum this power vacuum that was enabled and it was them and off memory i have it in my notes essence group those two are the the newer

Starting point is 00:09:51 ones and then the other ones being radian group and um mtg was the ticker of the other one they and i think their name is mtig they have uh you know been around for quite some time so when we look at what NMI focuses on, they tend to focus on the loans that are not FHA, conventional loans. So why is that important? Well, conventional loans tend to be of a higher burden or higher strictness than FHA. So when we look at what is the purpose of FHA, an FHA loan is for that first time home buyer. It's for that person that does not have maybe, let's say, the ability to get the conventional loan. The conventional loan, you'll go to a bank and they sometimes require even a lower down payment. You can see 3% down payment versus the 3.5 minimum for an FHA loan.

Starting point is 00:10:45 And then the credit requirements for conventional tend to be a little bit stricter than that of an FHA. So when you look at the average credit profile of an MIH, it tends to be higher than its peer group. But again, we're kind of going off of an era where the credit profile for all of them is pretty high. The credit quality is pretty high and the default rates are quite low. So even in that cohort where it's already looking really good, they're just a little bit better. And then additionally, this is more subject to, let's say, debate. But if you spoke to NMIH's management, their claim to fame, so to speak, or the claim to success has been their focus and emphasis on technology.

Starting point is 00:11:28 Technology and deep-rooted customer relationships that once you kind of establish, it's very difficult or not, you're unlikely to change. If you have that reputation, you grow the reputation with your client base, you're more likely to not get switched out. And in fact,

Starting point is 00:11:42 they've actually been growing their market share over time in that space. And again, focusing on that conventional niche rather than, let's say, the FHA or VA loans. And VA loans, you know, you can get up to 0% down. That's not always, you know, But in terms of risk profile. And so even within this space, they've carved out, I would argue, a very attractive risk reward section of the market. And them being the newer player on the block allowed them to kind of start from the ground up or build from the ground up and have this, what the management would say is their technology focused approach.

Starting point is 00:12:20 so they don't have any of the old legacy baggage that might have kind of held down some of their competitors that had to perform a transition maneuver to some more modern tools and techniques okay so i know insurance can be a little confusing it's it's a confusing section to begin with this is like almost another derivative so it might be a little more confusing but just Just to summarize, basically NMI holdings and really the mortgage insurers in general exist essentially to be a safety valve for any sort of mortgage lenders up until a certain point until the mortgage – until, sorry, the home buyer hits a certain percentage of home equity.

Starting point is 00:13:08 Hope I'm summarizing that all correctly. Now, I've got a second question here. You mentioned 2008. You mentioned that a lot of the mortgage insurers had a very difficult time and maybe just went under altogether. Do you have to have a view on the housing market in order to justify owning shares in NMI? I'd say to some extent, yes. Although, again, the risk here also because of what happened in 2008, they are really well reinsured. each and every single one of them. And when I told you about the combined ratios before being in the

Starting point is 00:13:48 30%, if we were to get a 2008 style of recession, again, which is, again, an anomaly, right, for the United States, that's an anomaly. People would like to point to that as being like, you know, what they think of when they think of recession. People just don't appreciate how abnormal that really was. We would probably see combined ratios for each of these players in the 90s, which is kind of insane to think about because we're going from 30 to 90s and 90s isn't even considered bad. That's because that's where the reinsurance really kicks in. And a lot of them, when you look at their capitalization, they're well and above overcapitalized than what they really should be. We'll get into some details maybe later with NMIH for their numbers.

Starting point is 00:14:30 But in opinion on the housing market, I don't think you have to have an exact measure. You kind of just have to think, will housing prices go up into the future? If the answer is yes, then will mortgages or the value of the mortgage go up into the future? The answer is probably yes as well. And so the premiums will go up into the future. The answer is probably something like that. And then you also have to ask yourself, will the credit profile of the average home buyer in the United States deteriorate meaningfully at any point in time? If the answer is no, then you're looking at fairly, again, attractive business. But prior to 2008, These actually used to trade a lot more expensive than they are now.

Starting point is 00:15:10 And I like to use the term, I don't know if it's spreading a lot or if a lot of other people use it, I have no idea. But I like to say the word industry scarring to describe when I'm finding a sector, an industry that they had some sort of multiple before, something happened, and then they're just discarded and trading at what seems to be permanently lower multiples. But again, we like to sometimes as humans, our time horizon is really short. And just, you know, funny enough, a decade, even a decade and a half is still a short time frame in the grand scheme of things. But yes. It is funny how many people – and I think maybe this is the housing sector or industry broadly – people get wary because they think of 2008.

Starting point is 00:15:54 But like you said, it was a very abnormal recession and it was driven by really loose lending standards, which doesn't seem to be the case anymore, as you mentioned. And I guess follow-up here, it sounds a bit like a commodity in that any mortgage insurer can offer the products to any borrowers or lenders, I guess, in this case. Why has NMI been able to differentiate itself? It looks like they've grown market share really quickly because, like you said, it started after 2008. they wrote the first policy in 2013, and all of a sudden they've become a big part of this market. What's allowed them to do that? So if you spoke to the management team, they would argue, again, that they focus primarily on technological innovation to make them actually be more competitive in the pricing. So if you look at their margins, they're relatively the same,

Starting point is 00:16:56 look at the combined races, et cetera. They're relatively comparable to their peer group with slight variations slight deviations from that and this is going to sound funny but with with all these guys there is a there is a lack of desire to grow too much and i know that sounds crazy because you're talking about most companies in the world they're like no no grow grow grow grow grow uh with with these guys because the the more they grow if they grow too rapidly then they're going to have to put more capital away and i'm going to use the most layman terms I can think of to simplify this, but they have to put more money to the side and prepare for that eventual rainy day. Again, a lot of regulation involved here.

Starting point is 00:17:37 And if you grow too quickly, there's too much capital you got to put away. You might not want that, but you want to reward your shareholders in some way. And so when you have an insurance company, it's very standard across the whole industry regardless of insurance. If you have the holding company, then you have, let's call them operating co. Operating co has the policies and then the subsequent liabilities tied to the asset. And then depending on how much money it makes or has a surplus of assets to liabilities, that operating company pays a dividend. You'll hear them say that all the time in their earnings calls. I'm trying to simplify it here, but they pay a dividend from the operating company to the holding company. You own shares of the holding

Starting point is 00:18:17 company. It's not like the operating company you don't own, you own that too, but they're technically like they're spoken of and they technically are separate entities then they can grab that dividend that they received and then return it to you in the form of buybacks dividends etc and that's the money that as a shareholder you actually can have access to so growing too quickly can defer delay that amount and they could probably even take on more risk than they want so when you look at some of the other players it's almost as if they have an attitude of not wanting to grow too much. They're fine with their current state of things. And the market itself is extremely, you probably can't find a more mature market. The market's

Starting point is 00:18:59 just growing in line with GDP, essentially. So I find it very difficult to really think of off the top of my head as a more mature market than the mortgage insurance space. But they're pretty much just growing in line with those factors I mentioned before, which is our housing prices going up into the future, our mortgage value is going up into the future. That's pretty much the growth of the pie, so to speak. But yeah, with regards to the specifics, there's been a rise in conventional, as you guys might know, over FHA. Lenders like the proposition of conventional. And with a lot of people having that ability and desire, actually qualifying for conventional loans, you have had NMIH, which then focuses on that specific niche of conventional doing decently

Starting point is 00:19:47 well. And we're not talking about crazy growth rates, but yes, above normal growth compared to their peers. Do you think there's any reason these market share gains won't continue as they have for the last 10 years for NMI over the next 10 years? Oh, yes. No, there stands to reason that at some point in time, this is going to slow down. And I argue that once that point in time occurs, you basically have a story of a business that's just going to return everything to you. This growth is going to stagnate. Everything's going to start to normalize. And then the amount they're going to be able to return to you will start to take up higher and higher. And it's going to be more like a story such as their their their competitors like uh um mtic uh so that or

Starting point is 00:20:39 or radion or any of the other ones um these guys they're they're already at that phase where they're pretty much just grabbing all the excess cash flows and then just throwing it back to shareholders form of dividend or buyback and they don't really need to put much more into the business to grow it some argue that you know they really love those kinds of businesses uh out there Think of a completely different sector, but like Otis, doesn't really need much to put back into the business. It's just cash counting to shareholders, to cigarette companies, stuff like that. Gotcha. Now, one thing that I've seen talked about with NMI and the entire mortgage insurance market is the quote unquote persistency rate of mortgages where if people aren't moving and we've

Starting point is 00:21:27 seen that freezing of the housing market. You don't get the turnover of, I think the example someone used was 50% turnover versus a much lower number of closer to maybe 10% or 15% on the existing mortgages because no one is refinancing. How long do you think this can continue? And maybe specifically with NMI, if it normalizes, do they get hurt? Is that a risk to a business the business it's not that big of a risk although we just went through something that also is pretty uh strange so when we look back at and we we're all living through history that's the that's the wonderful thing it's it's kind of crazy when you look back and you're like wow that that's that was never happened before like that and you just live through it um so what we just saw in

Starting point is 00:22:15 2021 right is uh crazy low interest rates crazy low interest we've never seen that in the united States. We're unfamiliar with that. And so the amount of people, and probably anecdotally in your own lives, you probably know some people that secured a really low mortgage rate. And then they often, if you talk to them, they often use the same lingo. And it's like, oh, I'm never getting rid of this mortgage. Oh, I'm staying in this house for a long, long time. So yeah, that gets into that, what you were just describing as that stagnation that's occurred. And that has in fact benefited the portfolio vintages of all of these players in the sense that some of these ones that originated in or started the policies in 2021, for example, those probably are going to go all

Starting point is 00:22:56 the way right. They're going to creep up right to that 20% equity mark. And there's not going to be that refinancing. I don't see the longer term as just being an issue per se, just because in general, I do think that what I'm going to be mainly paying attention to, what I think is the most important is that over time, there's just going to be more volume, dollar volume of transaction to mortgages. That's pretty much the most important KPI. As long as that happens, and then the players in the space are generally speaking, keeping roughly the same quantity or amount of their market share, which they pretty much all are, they'll all be fine. They'll all continue to grow. They'll all continue buybacks, dividends, et cetera. And again, those other

Starting point is 00:23:43 factors as well about credit risk profile remain true. So just to reiterate that for listeners, the most important KPI is, say, the total dollar volume in the United States of mortgage originations over, say, a quarter, year, multi-year period. Yeah. For growth. We're talking about risk, et cetera. There's other KPIs I'd be paying attention to. Hey, that leads right into my follow-up. Investors are going to look at this. The listener is going to look at this and say, it's insurance. There are risks. The definition of insurance is literally managing risks. What insurance risk can hurt NMIH? How do you track them? I guess historically, we saw some of these stocks go down 97% during the great financial

Starting point is 00:24:29 crisis. Clearly, other people are concerned that's going to could happen again, although you already mentioned that scarring thing. So what are you tracking for them? And what should listeners track if they own the stock as well. This episode is brought to you by our friends at Yellow Brick Investing. Yellow Brick is an aggregator of the best stock pitches across the internet. By tracking thousands of blogs, newsletters, fund letters, podcasts, and more, they collect and summarize the best stock pitches and bring them to you in a single place. If you're a regular listener, you know that we use Yellow Brick every single week here on the podcast to discover new investments or just find reports on companies we've already heard of. Try it for

Starting point is 00:25:09 yourself, simply go to joinyellowbrick.com slash chitchat and search a company or ticker you are interested in. You are bound to find a great report on just about any company. That's joinyellowbrick.com slash chitchat. Heads up folks, interest rates are falling, but you can still lock in a 6% or higher yield with a diversified portfolio of high yield and investment grade corporate bonds on public.com. You might want to act fast because your yield isn't locked in until the time of purchase. Lock in a 6% or higher yield with a bond account only at public.com forward slash chitchat stocks. Okay. So number one probably is unemployment rate, right? So it's going to be, I'd say a couple of factors. Unemployment rate is, you know,

Starting point is 00:26:00 we all look at it every day. It's a headline number that we are like, oh, unemployment rate take top of, et cetera. Obviously, during a recession, it becomes a bit more troubling to be a mortgage insurer. Why? Because if people have less money, they start to default on their loans. Arguably, the one of the lowest or the last one someone will default on, and this was funny enough, the same argument people used right before the housing crisis of 2008. But up until that point, we have never seen something like that. And so a lot of people, famous last words were like no one would default on their home uh it was a really common phrase back then just like the big short movie right yeah no no one would default on their home uh people would

Starting point is 00:26:44 default on their cars way before they they decide to default on their homes that that that makes sense but of course if you don't have the money you don't have the money there's no around way around it but people tend to be a little bit more scrappy to figure out how they pay their home but they'll definitely stop paying their car before they stop paying their home. And then you also have the consideration of credit standards. So this is going to be more complicated to keep an eye out because now you're getting involved in maybe even listening to regulators. And this is the most boring calls you'll ever listen to in your life. And you'll have journalists who tell you summaries of them that are not quite accurate. I'm dealing with

Starting point is 00:27:23 that with one of the energy companies I'm involved with. Journalists are giving summaries and then it causes stock price to collapse. And then the very next day, once people actually read the transcript, stock price moons like 15%. That is potentially what you can expect sometimes here if there is any regulator noise. What I've alluded to earlier is that the only regulator noise I've ever heard in this space is actually making it more strict, not less strict. But I don't plan on that happening. But if again, if it did, that would probably be one of the most bullish things I could ever imagine. You know, raising the requirement from 20 to 30% would be ridiculous. But yes, you do want to pay attention to standards not collapsing, standards not going

Starting point is 00:28:11 down. If that happens, then you know, start start to get a little worried. But that's a little bit more complicated to keep track of. Like I said, unemployment is there. And then also the third one, which is property prices or housing prices. You don't want a collapse. You do not want that. If that happens, the two KPIs that you want to pay attention to is primary insurance in force and risk-in-force. Fancy terms. What does it mean? Primary insurance-in-force, that is the total amount of money. And so I'll give you specific numbers. Primary insurance-in-force, otherwise known as IIF, stood at $207.5 billion for NMIH. That is all the mortgages that they're insuring? 207.5 billion. Property prices collapse. Let's say Armageddon happens. They're down 50%.

Starting point is 00:29:15 And you have high unemployment, right? And people are defaulting. Well, now they're going to come for you. Of course, you have reinsurance. But we get to that extreme scenario where the combined ratio, earnings will collapse. The combined ratio will jump to somewhere in the 90 percentages and maybe teetering close to 100%. The company will very unlikely go bankrupt even in that scenario, again, because the requirements for reinsurance are just so burdensome in this space.

Starting point is 00:29:45 And by the way, that would actually mean that their margins would be better if they weren't required to reinsure pretty much everything. But yeah, when we're looking at the amount, you do want to be cautious of a housing collapse. So if you think in your thesis and your broader thesis, you think there is a housing collapse coming, it wouldn't make too

Starting point is 00:30:06 much sense to invest too heavily into something like this because the sentiment would be down. Not that the business will do poorly. In fact, in my case, I'd be a little bit happier because they could buy back stock at cheaper prices because I just don't think it changes the longer-term dynamics of this. And then there's also the second acronym is risk-in-force. This is the amount that they're, the unpaid principal that they're supposed to cover. So it's like the risk on top of it from what the equity covers and then what's remaining. So you want to be paying attention to those two, making sure that the risk enforced is not growing too quickly.

Starting point is 00:30:44 You would see that in some sort of crisis scenario. But again, I'm obviously of the opinion, like I said earlier, that 2008 is rare case. We won't see something like that probably again in our entire lifetimes. And typically, you do see, for better or for worse, political policy around the country that favors the prop of housing prices. A lot of people complain about this. They say, well, we're not building enough in certain areas of the country. And then people say, well, it's because the voter base doesn't want, not in my backyard.

Starting point is 00:31:16 I don't want more housing because it keeps my property prices high. So the apparatus in the United States is established in a sense that it does tend to keep them up. And I've heard some opinions saying that they don't expect a housing crash, so to speak, but not really a huge tick up in values, maybe for quite some time. Because that was also an anomaly that we saw. We already mentioned like five anomalies. We're going to live through yet another one. watch but yeah so let me let me give you a scenario and you tell me how nmi would be impacted so we've talked about housing a number of times on this show and really you can talk in

Starting point is 00:31:59 circles and pretty much get nowhere because there's so many moving parts and no one really knows where it's going but scenario rates come down a little bit all those people that are in ultra low uh refinanced mortgages start to say oh you know what maybe it is time to move And so some of that supply, that really constrained supply that everyone talks about that's kind of helped home prices stay high, some of that supply unlocks and then all of a sudden you've got transaction – like the number of people moving going up. Maybe homes are more affordable in that scenario, so the average FICO on new home buyers comes down a little bit. If you do get a supply unlock, you get a lot more transactions, but potentially a slightly higher foreclosure rate. Is that beneficial for NMI, or are they trying to limit the volume of new loans so they'd see the elevated risk instead? Any elevation in foreclosure rates is going to be troublesome for the company.

Starting point is 00:33:06 They recently, as of the last earnings report, they increased the loss ratio or their loss expectations. So they basically, you know, to simplify that, insurance companies, when they estimate that there's going to be a loss that's coming up, they add it to this loss account, right? Simple accounting, they're saying, we're going to lose X amount of money. We're expecting to lose this amount of money. So we're putting it down. And so it's a write down in the now, and then later down the line, if that loss doesn't

Starting point is 00:33:35 manifest, that goes right back to earnings. So they just recognize it as earnings. Recently, them and their competitor that I have here in my notes, Essent Group, ticker symbol for your audience, ESNT, reported earnings a week before. And I was actually really excited to do the show with you guys because when Essent reported, it dragged the whole sector down. And once we get into numbers and valuation, you'll see why, because we got into a more interesting price, essentially. But Essent Group reported the same thing. They increased their provision for losses. And this is not that abnormal. They do this quite a bit. They even talk about in the earnings call about the seasonality and expectations of foreclosures.

Starting point is 00:34:17 Believe it or not, everyone listening, that foreclosures are also seasonal. They're quite seasonal. It has a lot to do with when tax time is, tax refunds, et cetera. So there is an uptick. But again, when we're talking numbers, it's fairly small. I think with NMIH, it was roughly 10 million. We just talked to the portfolio being quite large and 10 million. You probably can grab 20 households and you're like, yep, that's the 20 people that foreclosed in their whole portfolio. it. So realistically, any uptick in foreclosures, just not good, at least for sentiment. Survivability of the company, profitability longer term, not really an issue unless, again, we get to 2008. If we don't see 2008, which that's a huge pillar of the thesis, by the way, that's a huge pillar of the thesis. 2008 is an anomaly. We're making that claim. So I, as an investor, am making that claim, that belief. Operating around that belief,

Starting point is 00:35:14 If I don't think that's going to be something that occurs again, then I'm looking at a company that trades at historically cheap valuations as a sector, cheap valuations, for, in my view, due to an event that I don't think we'll ever see again. But yes, any foreclosure update, not good. Okay. Not ideal. Makes sense. What are your thoughts on the management team? So management team's pretty good. I can't actually say anything bad about any of the company's management teams, any of the ones in this space. None of them are bad. They're all fairly well experienced, especially coming out of 2008. A lot of them quite seasoned as far as what they've seen, what they kind of take into approach as far as risks go.

Starting point is 00:36:01 you might argue that industry scarring is also relative to management teams, as in they've seen something really bad and then they almost lower their risk tolerance a lot as far as what their portfolio is invested in. And for the audience's context, I have the numbers for you guys as far as yields go. They update that pretty periodically. So the yield in NMIH's portfolio is about 3%. If you think about that, that means that the instruments that they're invested in the portfolio is roughly about $2.7 billion in the general account. So let me also break that apart real quick before we continue. So I'll put a pin in what I just said. The general account in insurance, when we talked about the holding company and the operating company, the operating

Starting point is 00:36:44 company separate, within the holding company that you own shares in directly, not the subsidiary, they have, typically in the insurance space, they have what's called the general account. So there's this portfolio that's there, and they can invest it in practically whatever they want. And then any excess of what they're required as far as capital requirements goes, they can just give right back to you. The capital requirements for NMIH is $1.7 billion for just giving out the numbers. They need to have $1.7 billion as of now. They have $2.7 billion, roughly. That means anything above $1.7 billion, they are at liberty to give back to you as a shareholder. They may not want to because they might want to keep a bigger buffer than what is otherwise required.

Starting point is 00:37:28 And you typically want this. That does show you some conservatism. And for context, this is, again, the faster growing player. At their report, and I have the number here because I have their filing, from December 31st, 2023, the general account, which is their portfolio, went from $2.3 billion to the figure I just cited, which is $2.7 billion as of September. So it is growing. You can see the growth in a multitude of ways, including in their own portfolio. You see their portfolio growing. They did make a comment. Now, coming back to the comment on the yield and the risk, they are not taking on much risk here with their investments. They're not Berkshire Hathaway. They're not buying common stock of publicly traded companies. They're not making that claim that they

Starting point is 00:38:15 know how to allocate capital that way. Of course, we would love that. We would love a Buffett, you know, in this company. And then we'd all be very rich people and not too distant future. But with where these entities are at and how regulated they are, they typically have very conservative portfolios. This is not uncommon, what we're looking at with NMIH. The other players, same thing. The other part that we want to, you know, kind of take into account is what the new capital is being deployed into. And they made that, they gave us that figure, which was 5%. That's just the consequence of where yields are at. Their average is 3%. And then now they're investing in new investments at 5%. That helps us because I get that question all the time,

Starting point is 00:39:01 yields. And I imagine you guys have that question too. So I'm anticipating this question. What about yields and insurance and what you invest in? Because bond yields, they come down. So then your investment income goes down too. I argue that that is way less impactful than just the premiums earned. The premiums earned in their combined ratio, what they're getting as far as how much their payouts are, that's what you want to be paying them. The other stuff is icing on the cake. It's noise. It's not what I would be paying attention to really at all. They'll do just as fine in a very low rate environment as they will in high rate environment. When I started this conversation with you guys and I talked about the combined

Starting point is 00:39:36 ratio and we talked about some operators having above 100%, those guys you have to be very worried about when rates come down fun fact for insurance space if you see an insurance provider that has a combined ratio above 100 oh yes i'm not telling you to short it but i definitely would be very nervous owning that operator so and that's because their their business model is to earn money on the float and then have razor thin margins or negative margins on the insurance operation yeah yeah They're a charity at that point. They're almost a charity. They're paying out more than they're collecting.

Starting point is 00:40:14 So they're not doing a good job of risk management. Ryan, you want to ask this next one? Yeah, question for you. Is there any sort of, I guess the name is, I believe it's National Mortgage Insurance Holding. So I would assume it's national. But is there any sort of geographic concentration here? Like, do they focus on certain states?

Starting point is 00:40:36 so like if foreclosures went up in florida relative to foreclosures in washington is there any sort of big geographic exposure for them for for a lot of them they have their different niches with nmh uh i know it sounds like whoa but they tend to follow the concentration of the population in the united states it's very fairly bland in that that sense it's um more people live here that's they have a higher concentration there than than in other states so not not really um a specific market that they're saying we don't want to service. They did talk or have a conversation about Florida because Florida is a huge state in terms of population. And so Florida is also having, and this probably contributed to them allocating more capital to their lost

Starting point is 00:41:21 provisions. Because I don't know if we, well, you definitely have some Floridian listeners, Floridian listeners who are watching, look around you, you probably have noticed that your Housing prices have gone down. You might view this as good, but housing prices have come down maybe 20% depending on where you live. But we also had an anomalous period where in some places in Florida, property prices doubled within five years, 40% in five years, 30%. That's not normal. And so things are just normalizing a bit. And so they brought it up because obviously there's a huge chunk of their policies in Florida, which again, if you're just doing it by percentage of population of the United States, it's obviously going to have a lot. Texas

Starting point is 00:42:07 as well, California, those are going to be obviously their main focus points. All right, folks, if you're a regular listener to Chit Chat Stocks, then you know that we use FinChat.io daily. FinChat is the complete stock research platform for fundamental investors. They have robust financial data on more than 100,000 stocks globally, including company-specific segment and KPI data. Want to see Google's cloud's quarterly revenue growth? FinChat's got it. Like to track PayPal's take rate? They've got that too.

Starting point is 00:42:36 And they recently added sell-side conferences and insider transactions to the platform. Best part is it's completely free to sign up. However, if you want to get unlimited data, you can use our link finchat.io slash chitchat to get 15% off any paid plans. The link will be in the show notes. Yeah, I was going to say normalization does seem like the word that is happening. We always hope that normalization doesn't turn into the soft landing turning into a hard landing. As I think the famous quote is, every hard landing starts out looking like a soft landing, but that's more of a macroeconomic thing. I want to talk one more time about the capital returns program. I think this is when they started

Starting point is 00:43:18 the buyback, maybe at the end of 2021. Shares outstanding by my math on FinChat. Go check out our sponsor if anyone's listening. Down at a 2.8% rate per year. Do you think this can be a long-term share cannibal, and is that a big part of the thesis? That is a big part of the thesis, And yes, it will be. I say that with confidence. So why you're seeing is for quite some time, they were mainly focused on growth, right? And they were in that growth phase. They're still in that growth phase.

Starting point is 00:43:54 It's not like they're out of it. I made it sound like they're out of it. But they're still in that growth phase. And we recall what I said earlier is that they're almost out of their competitors or their peer group. It's almost like at a controlled growth. They want controlled growth because the more they grow, if they grow really quickly, they have to put more money away.

Starting point is 00:44:10 They can't give you as much. So they have basically achieved a, let's say, not a crossroads, but an inflection point. So this inflection point is now that their growth is good, but it's fairly sustainable from a viewpoint of returning capital to shareholders. They can still grow and still return capital to shareholders. And so what I mentioned earlier is the capital that they're required to keep on the books, $1.7 billion. That's their requirement. They have $2.7 billion.

Starting point is 00:44:46 And again, when we're talking the numbers, this is not too shabby in terms of growth. $2.3 billion from December 31st of last year, 2023. And now in the September quarter, we're not even done with the year yet, the September quarter, $2.7 billion. And so you keep on doing that. And they're getting to a pretty healthy separation between what's required and what they have. And then all the excess, they can just basically, if they so want to, return it. So I would probably bet on the capital return accelerating from here, even as a percentage

Starting point is 00:45:20 and in nominal terms. If you look at their peer group, I would probably say longer term, that's what you can expect. I've spoken to some other people who are bullish on this company, have been following the company for a while. they thought that they would actually start paying a dividend at the end of this year. I was hoping more than anything they wouldn't because I would prefer for the time being straight buybacks, just increased buybacks. And then if I like to follow a general rule of thumb that if the immediate return to shareholders is in excess of 11%, 10%, 12%, that range,

Starting point is 00:45:59 If you're above 10%, I think that doing a buyback approach and excluding growth, this is in the now, so excluding the growth and kind of trying to form some valuation from projected forward growth, no, just like immediate growth, I would prefer the buyback approach. If that multiple starts to creep up, I would favor more dividends than I would, let's say, a buyback. So right now where they are, they're in that sweet spot where the buybacks are decently accretive, decently at value add to shareholders. And as long as they're still maintaining their growth, you could probably just expect that buyback to creep up.

Starting point is 00:46:39 Makes sense. Now, we had some questions from Twitter. We'll see if you have any big thoughts on these. They wanted to know your opinion on the latest earnings. They said loss ratio jumps to 7.2%. That's all they said. So maybe we can just say, what is your opinion on the latest earnings? material from that or was it just business as usual? A lot of business as usual, but I'll say that the loss provision of increasing to 7.2%, not abnormal. Again, they discussed it. If you look back, seasonality has a lot to do with it. And they've done this before where they add to the provisions of losses, but then don't have the losses they think they did. And then so that just goes right back to earning. That is where I kind of lean on. It's more business as usual. It's not

Starting point is 00:47:27 nothing to these are very boring businesses these are i would challenge all the audience to go find there probably are but this is probably in the uh top quartile of most boring businesses if the measure is boring so very boring earnings very boring it's pretty pretty much every quarter that you know i've listened to i can summarize in a humorous way as the following we collected premiums and we didn't pay out yeah not a bad insurance operation right there not a bad one although i do know some other insurance operators with less uh i guess healthy financial statements that like to provide lots of commentary and 50 page shareholder letters that are quite colorful uh speaking of i guess boring and housing there are a lot of different ways to play the housing

Starting point is 00:48:18 sector. You buy homebuilders, for example. Those are big ones. There's a lot of different homebuilding stocks out there. Why invest in NMIH over other housing-related stocks? I'd argue you're playing a different arena in housing. You're playing something that, going back to the old phrase of risk-reward, in my opinion, NMIH offers a fairly attractive risk reward profile, way less cyclicality. Of course, absolutely true that if you can perfectly buy or if you can understand where we are in the cycle, there's probably more upside to be had in the home builder per se. Because the home builder has, in terms of sensitivity to its TAM, it's going to be more sensitive. It's going to be able to actually pull on levers of growth

Starting point is 00:49:09 during a boom cycle, but then during the down cycle, if there is one, again, this all perspective, different opinions on investors, then you'll see that as well. With this company and its peers, you're going to have more stability. You have more, let's say, surety, I'd say, if we want to call it that. So the other ones, yeah, like I said, absolutely. They probably offer at the bottom of a cycle the greater uh total return profile but with more risk so here it's very boring steady business as usual quarter in quarter out quarter in quarter out quarter in quarter out you eventually get some maybe well i i don't think it's gonna happen but you get something exciting like 2008 or 2020 covid lockdown but other than that it's it's extremely boring

Starting point is 00:49:59 in a good way i think that's good yeah hey their growth rates their stock chart that seems like it's been boring in a good way you you know my takeaway from this episode is you think the stock is cheap so i was getting my question was do you think it's cheap but i think i'm going to phrase it to why is the stock cheap today maybe go through some of your valuation work yeah yeah of course so i think the stock is cheap today i actually came up with a valuation on the stock a bit ago and I have to update these numbers a little bit more, but what I've kind of gathered is before it was a good and interesting buy at 42. And when we were discussing about having this episode, we got a little bit lucky because it was basically trading at that 42 price.

Starting point is 00:50:44 And then we had the earnings from their peer and it kind of fell back down. So then I was really excited to do this episode because now for the audience listening, we're basically back at that range where I think it's a decent buy. It's a pretty good buy. The updated figures, I haven't fine-tuned it yet, but it hasn't changed too much. It looks really attractive under around $44-ish a share, $44.43. But it's looking like that's where I'm going to end up concluding as my flagpole until when I want to slow down my buying. Why is it cheap? Well, Well, I think that what we're going to see in the next several years or so is, again, those buybacks are really going to start to creep up and are going to do continual damage

Starting point is 00:51:29 to the share count. And this is the part where I say this is like your extra catalyst. At any point in the future, there is a re-rate because the industry scarring kind of eases, which in my view, again, this whole industry, this whole sector, it's scarred. the appreciation for just like the margin profile, the security of these cash flows may come back at some point, but I don't want to assume that. But if that does, you could expect even more returns than what I would argue is what I'm expecting. And I'm expecting just above market average rate of return for a lower risk profile. So with the buybacks kind of accelerating into

Starting point is 00:52:11 2025, 2026, which if you look at insurance companies, one way to kind of measure the potential total return rate or average return rate that you can expect on the book, so to speak, is a return on equity. That's one popular way of looking at it. These guys achieved 17.5% return on equity with guidance of maintaining 17.5% or 18% for the following years. So if they can continue to compound at those rates, grow the portfolio, buy back stock at cheap valuations, cheap multiples. I don't really see how in 10 years' time I'm going to be upset holding this company.

Starting point is 00:52:50 All right, that's a good summary. Ryan, anything else before we close things out? No, I think that covers pretty much everything on it. So thank you, Fabio, for joining us again. And tell the listeners that are interested in this work, if you've listened to this full interview, I'm sure you are because that was some nitty gritty on, as you said yourself,

Starting point is 00:53:09 what some might describe as a boring sector, but I will say something that has, if you look at their stock chart, been some pretty phenomenal returns with what looks like a decently good earnings yield today, especially if you look at that compared to some of the growth stocks. But I'm rambling. Where can investors find you? What do you guys cover at Capital Mindset? So at Capital Mindset, we cover a whole variety of sectors. So there's me and myself and a few other analysts uh we all have our different specialties uh in terms of what we cover but we like to say that we're you know broadly generalists um in what we invest in and uh yeah you can find us at capital mindset youtube channel and we run an investing club that's hosted

Starting point is 00:53:52 on discord where we post write-ups have lots of uh private episodes and uh discussions there so all right and i think we yeah we did go on the show i think maybe it was together yes we talked about old Sprouts farmers. Oh, yes. That turned into the best investment, way better of investment than I could have ever, ever imagined during that episode. Oh, yes. That was a good one. That was a, that, that one ended up being a fun one, but yeah, go check out any of their stuff. They got plenty of other stuff besides our one episode. Let me hit the disclosure before we get out of here. We are not financial advisors. Anything we say on the show is not formal advice or recommendation. Ryan, I, or any podcast guests may hold securities discussed in this

Starting point is 00:54:31 podcast, may have held them in the past, and may buy, sell, or hold them in the future. Thank you once again, Fabio, and we'll see everyone next time.

Chit Chat Stocks - A Secret Housing Stock: 20% Earnings Growth, P/E of 8 With Capital Mindset (Ticker: NMIH)

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