Essent Group Ltd. (ESNT) Q4 2014 Earnings Report, Transcript and Summary

Good morning. My name is Kelly, and I will be your conference operator today. At this time, I would like to welcome everyone to the Essent Group Limited Fourth Quarter 2014 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. [Operator Instructions] Thank you. Chris Curran, Senior Vice President of Investor Relations, you may begin your conference.

Thank you, operator. Good morning, everyone and welcome to our call. Joining me today are Mark Casale, Chairman and CEO; Adolfo Marzol, Executive Vice President; and Larry McAlee, Chief Financial Officer. Our press release, which contains Essent's financial results for the fourth quarter and full year of 2014 was issued earlier today and is available on our Web site at essentgroup.com in the Investor section. Our press release also includes non-GAAP financial measures that may be discussed during today's call. The complete description of these measures and the reconciliation to GAAP may be found in our press release in Exhibit M. Prior to getting started, I would like to remind participants that today's discussions are being recorded and will include the use of forward-looking statements. These statements are based on current expectations, estimates, projections and assumptions that are subject to risks and uncertainties, which may cause actual results to differ materially. For a discussion of these risks, please review the cautionary language regarding forward-looking statements in today's press release, the risk factors included in our Form 10-K filed with the SEC on March 10, 2014 and any other reports and registration statements filed with the SEC, which are also available on our Web site. Now, let me turn the call over to Mark.

Thanks Chris. Good morning everyone, and thank you for joining us today. In our first full year as a public company Essent had a very successful 2014. During the year, we continued expanding our franchise, growing our insurance in force and delivering high-quality earnings growth to our shareholders. As I have stated before, our goal is simple and that is to build a high credit quality and profitable mortgage insurance portfolio. We are optimistic heading into 2015. Our outlook for the MI sector remains positive based on the improving fundamentals of the U.S. housing market and the economy. Given a solid market presence that we have established over the past five years, we are excited about our prospects in the core MI business. In addition, we continue to view GSE risk share and Bermuda as long-term opportunities for us. During 2014, we participated in risk share transactions at both Essent Guaranty and our Bermuda based reinsurer EssentRe. Activating EssentRe in 2014 expands the use of a mortgage credit risk expertise and helps to leverage our Bermuda Holding Company structure there by creating incremental value for our shareholders. Our capital levels are strong ending the year with $956 million of GAAP equity and no financial leverage. In November, we issued 6 million shares and successfully raised $127 million of primary capital that is targeted to support future growth. In addition, our solid market presence, growing profitability and strong capital levels are reflected in our investment grade financial strength ratings of BBB+ with S&P and BBB flat with Moody's. We take a long-term view of our business of investing in mortgage credit risk and firmly believe that strong capital levels beget more opportunities in the marketplace. Now, let me touch on some of our strong financial results. For the full year, we earned $88.5 million or $1.03 per diluted share, while for the fourth quarter; we earned $28.9 million or $0.33 per diluted share. We ended the quarter with insurance in force of $50.8 billion a 9% increase from the third quarter and a 58% increase from the fourth quarter a year ago. Our insurance in force continues to drive our top-line revenue growth. Net premium earned for the quarter was $67.8 million, a 12% increase from the third quarter and a 68% increase from the fourth quarter a year ago. Finally, our combined ratio for the quarter was 42%, a decrease from 43% last quarter and 57% from the fourth quarter a year ago. During the quarter, we generated $6.5 billion of NIW, while for the full year we generated $24.8 billion. In addition, for all 2014, we increased our active customers to 1000, a 39% increase from 721 active customers in 2013. Although competition in our industry is strong, we remain comfortable with our solid market position. In addition, we manage our insured risk on a portfolio basis focusing on premium yield, expected losses, expenses and returns. For the fourth quarter, our premium yield was 56 basis points and we continue to be pleased with the unit economics and pro forma returns on our insured portfolio. For 2015, we are estimating industry NIW to be approximately $175 billion to $185 billion. This estimate reflects a combination of scenarios and estimates around the size of the origination market and private MI penetration rates. However, I should note that these estimates could be impacted by a number of factors including the new FHA pricing, any changes in G-Fees and the final PMIERs. Turning our attention to Washington, we expect final PMIERs by the end of this quarter or shortly there after. As for FHA's price decrease, while the new pricing is more competitive for certain FICO and LTVs, the substantial majority of NIW being generated by us is outside of the impacted ranges. In addition, while it is uncertain as to whether G-Fees will be lowered to the extent that they are private MI becomes much more competitive in many of these ranges. Ultimately we believe that G-Fee should reflect the appropriate level of credit for private mortgage insurance. Finally, the FHFA recently issued its 2015 scorecard. Goals this year include increasing the amount of GSE risk share to $270 billion from $180 billion in 2014 directionally we think this is positive for private capital investment and an area that Essent targets as an opportunity in expanding our franchise and increasing shareholder value. Now, let me turn the call over to Larry to cover more of the financials.

Thanks Mark, and good morning, everyone. In addition to the strong financial results Mark discussed at the beginning of our call, I wanted to touch on some additional items. For the quarter, we reported net income of $28.9 million or $0.33 per diluted share. This compares to $25.1 million or $0.29 per diluted share for the third quarter. Our effective tax rate for the fourth quarter was approximately 35%. As a reminder, we began writing business in EssentRe effective July 1, 2014. The average risk in force and contribution to consolidated income from EssentRe in 2014 was small. In 2015, the contribution of earnings from EssentRe will increase as a result of the revenues generated on the current in force book as well as new business written for the full year. Accordingly, we expect our effective tax rate to decline in 2015 as compared to 2014. The actual effective tax rate for 2015 will be depending on the mix of earnings from our U.S. mortgage insurance business as compared to our Bermuda business. Based on our current forecast, we expect our effective tax rate for 2015 to decline to the low 30% range. Our provision for losses and loss adjustment expenses for the fourth quarter was $3 million compared to $1.4 million in the third quarter and $692,000 in the fourth quarter a year ago. Our provision for the quarter is inline with the increase in our default rate to 20 basis points from 15 basis points last quarter and 11 basis points at the end of 2013. Our expense ratio for the fourth quarter was 37.8%, a decrease from 40.6% last quarter and 55.3% for the fourth quarter a year ago. Other underwriting and operating expenses for the fourth quarter were $25.6 million slightly higher than our forecast, slightly higher than our expenses in the third quarter of $24.5 million and $3.4 million higher from the fourth quarter a year ago. Looking forward, we believe that for the full year 2015 other underwriting and operating expenses will be in the $110 million to $115 million range. The consolidated balance of cash and investments at December 31 was $1.1 billion as compared to $915 million as of September 30. The increase during the quarter was due to the net proceeds of $127 million from the equity offering in November and the operating cash flows generated by the business. The cash and investment balance of the holding company at December 31 was $126 million as compared to $47 million at September 30. The primary reason for the increase was due to the capital raised previously discussed partially offset by $50 million capital contribution to EssentRe. This contribution was made in the fourth quarter to support the expected growth of the business in the first quarter of 2015, the second Freddie Mac ACIS deal executed in the fourth quarter and the ongoing 25% quota share with Essent Guaranty. Note, there was no capital contribution needed from the holding company to Essent Guaranty during the fourth quarter. The combined statutory capital of the U.S. mortgage insurance companies was $706 million reflecting an increase of approximately $42 million compared to September 30, 2014. This increase was primarily driven by statutory earnings. The combined risk to capital ratio of the U.S. mortgage insurance business was 16.2 to 1 at the end of the quarter. As of December 31, 2014, total consolidated GAAP equity was $956 million. Also, as of December 31, EssentRe had GAAP equity of $155 million and total risk in force of $836 million as compared to $102 million and $462 million, respectively as of the end of the third quarter. Now, let me turn the call back over to Mark.

Thanks Larry. Before getting into my closing remarks, I would like to take moment to thank my colleague, Adolfo Marzol for all of his valued contributions over the past six years. In November, we announced Adolfo's retirement effective March 31 of this year. Adolfo played an integral role in our success from start-up through today, a solid reputation and deep knowledge of the U.S. mortgage industry helped Essent establish strong relationships in Washington. Adolfo has been tireless in promoting the benefits of Essent and private mortgage insurance and housing finance and he played a leading role in starting our industry trade group USMI. Adolfo on behalf of all of our employees and the Board, thank you for your dedication and service to Essent and we wish you the very best. In closing, we had a great quarter as well as an excellent 2014. During the year, we grew and strengthened our franchise while producing strong and growing earnings for our shareholders. The entire Essent team made great progress in expanding the Essent franchise throughout the U.S. as well as an activating EssentRe. Our operating platform will remain strong on all fronts. And our team continues to deliver best in class service to our customers. Essent is well-positioned heading into 2015 and we are optimistic about the future of Essent and the value of private mortgage insurance in housing finance. Now, let's turn the call over to your questions. Operator?

[Operator Instructions] Your first question comes from the line of Douglas Harter of Credit Suisse. Your line is open.

Thanks. Mark, when you take a look at the new vintages being written, how do you think that the credit quality of that compares to the prior couple of years?

Doug, it's a good question. I think it's very similar. I know that the FICOs are a little bit lower and the LTVs have touched higher that's generally because of the switch from purchase from refinance to the purchase business. But in general, we have been very pleased with – not only the quality of the originations, but the consistency since we started writing back in 2010.

So I mean, I guess what is your expectation that these – that the newer vintages kind of sort of could follow the loss, sort of the yearly loss curves that we have seen, which I think you would probably agree have been sort of better than your expected over the past of couple years?

Yes. Again, our book is relatively young and I still like to caution everyone around that. We have done this before. I will point you to the late 90s where that's obviously book was baked and saw the losses, they are kind of that 1% to 3% claim rate and we still think it's in that range probably a touch – in the 2% to 3% range. But, you can read that in the 2010 and later, but again, for us the book is still young, but obviously, pleased with the performance to-date.

All right. Thank you, Mark.

Sure.

Your next question comes from the line of Eric Beardsley of Goldman Sachs. Your line is open.

Hi. Thank you. Just on your NIW outlook for 2015 for the industry, how much of an impact from the FHA premium cut are you baking into that?

Hey, Eric. It's Mark. I would say kind of mid-single digits given the analysis that we have done on our portfolio and kind of combining the quantitative effects of the FHA pricing along with some of the qualitative factors. That being said, I actually – we are quite positive even on the pricing. And just from an industry outlook, our view is lower FHA pricing helps – could help spur more economic and housing activity which helps our lender partners. And as a lender partners, if their business improves, our business improves. So we take a little bit of a different look at it than in some of the others.

Got it. And then just on the OpEx guidance for 2015, touch higher than where you are thinking maybe around 7% to 10% growth rate moving forward. I guess is that because you are seeing more opportunities whether it be in Bermuda or other areas?

Maybe I will touch more on the opportunities. I do think that guidance was more over kind of 3 to 5 year range in general. So it could be different in certain years. But, certainly we are seeing – we are spending a little bit more around Bermuda because some of the opportunities, but we feel pretty comfortable still, just taken a step back just a nominal expenses that we have relative to some others in the industry we feel very comfortable. When we think longer term it's an advantage for us.

Got it. And then just lastly, if we've heard quite a bit of noise in the competitive environment in terms of some folks getting more aggressive on the single premium and potentially that volume increasing in 2015. Are you feeling similar pressures or are you observing those same trends?

Yes. Eric, I think again, taking a step back, we said before, we really look at the impact on our portfolio. We are a portfolio growth story. Our portfolio continue to grow, I think 68% -- 58% of our portfolio grew, our premiums grew 68%. So we have seen pricing pressure in different pockets since we started the company. We saw it in the BPMI singles. I think some of that has shifted because of a QM to LPMI, so you are seeing a little bit more activity in that business. But all-in-all, from an Essent perspective, I think we are pretty pleased with the make-up of our portfolio and the profitability of the portfolio.

Okay, great. Thank you.

Your next question comes from Jack Micenko of SIG. Your line is open.

Hi. Good morning. Just curious on one of the areas, you are a little bit different is some of the last year's stuff and 50% increase expected in the risk share business out of the year-end report. I think you kind of highlight a little more in your comments today. I mean how do we think about that as a growth driver for Essent, I mean should we think about sort of like 50% increase in your business there on a NIW basis. How do we – how should we think about that for 2015?

Jack, its Mark. I still think longer – we think it's a longer term opportunity I would repeat what we said in the third quarter that we are cautiously optimistic about some of the prospects. The issue is just really have a quantify that. GSE risk share still relatively new, we have been pleased with the activity to-date. Again, longer term although we can't quantify, it really is becoming another platform for us to invest in mortgage risk. And I think that's what excites us about it. But for us to give a – give you kind of like real guidance around kind of quarterly flow and so forth, I think it's just too early.

Okay. That's fair enough. One other question, I guess obviously Florida and Texas are huge housing states and they are also big MI states. It looks like Florida and Texas for you has continued to grow as a slice of the pie, I'm wondering if that's intentional and targeted or if that's just you growing into what a normal housing footprint looks like? Thanks.

Yes. I think it's more the latter. As we grow customers and get more geographically diverse with our customer base, you are seeing our portfolio match the population on the U.S.

All right. Thank you.

Your next question comes from the line of Bose George from KBW. Your line is open.

Hi, guys. Good morning. Just – first a question on the premiums, just curious what's driving the increase in the premium it was 54 basis points, earlier in the year 56. Is it sort of the purchase volume trend that you noted earlier?

Yes. Pretty much Bose, that's kind of working its way through the portfolio. Again, it's obviously, higher price given touch lower in the FICOs, touch higher on the LTV, so that – as that works its way through the portfolio you are seeing a little slight up tick. But, it's generally relatively again taking a step back is relatively flat over the past year.

Okay, great. And then it's just the comment you made about the single-digit impact from the lower FHA pricing, does that assume no changes in the LLPAs?

Yes.

So to the extent that there are – could end up being a very potentially no impact at all if there are meaningful – cuts there?

Yes. Obviously, well, it depends obviously with the changes, if there are any changes – the magnitude of the market, surely that could – that would change our view.

So okay, great. And then just one last thing just on the Freddie Mac ACIS deal, where do those premiums flow through your income statement?

Hey, Bose, it's Larry responding. That is in other income. We concluded that the accounting for at least the initial contracts are derivatives. So we are flowing that through other income. The impact in the fourth quarter and really entire year 2014 is very small.

Okay, great. Thanks a lot.

Your next question comes from the line of Sean Dargan of Macquarie. Your line is open.

Thanks. Good morning. I have a question about your NIW estimate. You quantified what you think the impact from FHA pricing move would be, does that estimate assume that LLPAs and G-Fees stay where they are now?

Yes. It does Sean.

Okay. So there is some potential upside from that. And then we are seeing some rationalization in the larger Bermuda reinsurance market with some M&A activity there, just wondering if you think there is any opportunity to reinsure other primary arrears business?

Well, there is always opportunities.

The legacy [M&A] [ph].

Yes. There is always opportunity. But I think we are more focused on the GSE ratio at this time. We like it. It's a little bit more of diversification around the risk profile for the company.

Okay. Thank you.

Your next question comes from the line of Rick Shane from JPMorgan. Your line is open.

Thanks guys. Good morning. And appreciate you taking my questions. Just one quick question, you answered the question about geographic diversity, I'm curious if within the portfolio you are starting to see any divergence in credit performance related to what we are seeing economically in the oil patch days?

Hey, Rick. It's Mark. No. The short answer is no. We haven't seen any impact. I think the precipitous drop in oil prices kind of caught everyone by surprise, but it's still too early to tell certainly something that we are looking at and will continue to look at and report in the future quarters, but right now it's early. And we are not seeing any change whatsoever.

Got it. And Mark, given your relationships with the lenders, do you have much ability to tweak your underwriting in those states if it becomes a concern and you pull back or do you from a relationship perspective need to continue to take a volume there?

I think it's a risk organization we would always – we would always align our underwriting guidelines with potential risk. Yes, we have strong relationships with lenders. And think we would compare information with lenders, so I think that's part of what we and what we do with some of the partnerships with our lenders who share that type of information and work together to make sure we are both managing our risk appropriately.

Got it. Great, thank you.

You are welcome.

Your next question comes from the line of Amy DeBone of Compass Point. Your line is open.

Hi. Good morning. Thank you for taking my questions. Most of them have actually – already been asked, do you explore the opportunity provided by the non-agency mortgage market, Arch recently announced the launch of AMG just a few weeks ago and given us investment grade rating and improving capital position, it seems like it could be an opportunity diversifying your business away from the agencies?

Hi. Amy, its Mark. I think our view on the non-agency, I think it's still somewhat range bound. And I think it will continue to be range bound until yields are increased the rates rise to attract the investors into that market. But it's certainly something that we look at and we are following. But again, I mean we are more focused right now on opportunities with the GSEs both within Essent Guaranty and obviously within EssentRe.

Okay. Thank you.

Your next question comes from the line of Chris Gamaitoni from Autonomous. Your line is open.

Good morning guys. Thanks for taking my call.

Sure.

Sorry, I missed the guidance on OpEx, would you mind repeating that for me?

$110 million to $115 million.

And then on the new client, can you just talk about what the profile of this client you are moving down, is it more winds on the smaller more purchase centric originators, just how that customer acquisition is going, you need more staffing those types of new color on that. And how many more clients that you need to be fully – [add to] [ph] your goal?

We said before, I think our longer term goal is 1500, which would put us pretty much inline with most of the industry a few years away from getting there. I think we are very pleased with the staffing. I think – I don't say we are fully staffed; we are always looking for opportunities for smart people in territories. It's an iterative process in terms of where we see the opportunities and where we add people. I think with the clients, let's say it's mostly on a smaller ends and again it kind of gets to the tail on some of the stuff, so the impact on the overall market or the overall market size in terms of how much we penetrate gets to be a lot smaller or the increases are smaller as you add lenders. But, again we still are a big believer in breadth and depth of our client base. And we are obviously very pleased with how we grew that in 2014 and something we'll continue to focus on over the next few years.

And do you have any color on the tax adjusted return differentials lay between the flow business and the risk sharing transactions you are doing it from your Re?

As we said before, we don't really comment on individual type transactions, I would just say the returns of the business are pretty consistent in those entities.

All right, perfect. Thank you.

You are welcome.

[Operator Instructions] Your next question comes from the line of Mike Zaremski of BAM Funds. Your line is open.

Hey, good morning. Mark, you sounded kind of cautiously optimistic or uncertain about the long-term opportunity for the non-traditional GSE risk sharing market to expand further. I'm curious, is it more of a lack of demand from the private market, I mean obviously, you guys are interested in it, but maybe others aren't, or is it lack of supply and reform clarity from FHA or maybe its both?

Well, I mean one would emphasize the optimistic part – of the cautiously optimistic, I think we are just – I think we are – I think we continue to see flow, I think the caution comes from it's still relatively new, the GSE has only been doing risk share for a year-and-a-half and given that where they are in conservatorship, it's something that could change. I think that's what we want to just hedge our best there in terms of speaking the folks about it. But again, I think, we have been pleased with how we have established EssentRe the activity in 2014 and some of the opportunities we are saying but it's not like the U.S, business where it's a charter and they have to use mortgage insurance. So that's at all. I wouldn't read too much more into it.

Okay. So you do think there is enough demand from other companies other than Essent and some other asset managers out there that – like these transactions?

I think there has been demand both on the insurance side and on the funded side. I think you can speak to the GSEs about that. I think the programs have been very successful; they have done a great job with this initiative, both of the GSEs.

Okay. Got it. And lastly, if I missed it in the prepared remarks you can just tell me but persistency looks like it declined a bit this quarter, if you can talk about the drivers and how you are thinking about persistency in the new year?

Yes. I think it obviously dropped a little bit. But, I think that was due to – the primary driver is really the refinance activity ticked up a little bit towards the end of the year and our guess just lenders it will tick up a little bit in the first quarter of this year. But then should flatten out a little.

Makes sense. Thank you.

Yes.

There are no further questions at this time. I would now turn the call back over to the presenters.

Thank you, operator. We would like to thank everyone for participating in today's call. And have a great weekend.