Essent Group Ltd. (ESNT) Q1 2015 Earnings Report, Transcript and Summary

Good morning. My name is Angel, and I will be your conference operator today. At this time, I would like to welcome everyone to the First Quarter 2015 for Essent Group Limited 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, 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, and Larry McAlee, Chief Financial Officer. Our press release, which contains Essent's financial results for the first quarter of 2015 was issued earlier today and is available on our website 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 L. 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 February 27, 2015 and any other reports and registration statements filed with the SEC, which are also available on our website. Now, let me turn the call over to Mark.

Thanks Chris. Good morning everyone, and thank you for joining us. Earlier today, we reported our financial results of the first quarter of 2015. These strong results reflect our continued execution on building a high credit quality and profitable mortgage insurance portfolio. In addition, they represent our 10th consecutive quarter of profitability and delivering high-quality earnings to our shareholders. The outlook for our franchise and the MI sector remains positive based on improving fundamentals of the U.S. housing market and the economy. Given our solid market presence, we remain excited about our prospects in the core MI business. Furthermore, we continue to be cautiously optimistic about the Bermuda-based reinsurance opportunities. EssentRe create incremental value for our shareholders by expanding the use of our mortgage credit risk expertise and leveraging our Bermuda-based holding company structure. Also contributing to our positive outlook is the issuance of the final PMIERs. We believe that strong and transparent standards increase confidence in our industry. We also believe that they provide opportunities for a well-capitalized and investment grade company like Essent to play a larger role in housing finance. Based on our analysis, the final PMIERs line up well with our economic capital framework and the risk to capital that we have been managing our business to. As we previously reported, Essent had sufficient assets in its insurance companies to meet the PMIERs required asset amount as of March 31, 2015. We commend the FHFA and the GSEs for all their work in finalizing the PMIERs and are pleased to have these standards behind us. Now, let me discuss our strong results. For the first quarter, we earned net income of $34.8 million, representing a 132% increase from $15 million earned for the first quarter a year ago. On a per diluted share basis, we earned $0.38 for the quarter compared to $0.18 for the first quarter a year ago. Our results for the quarter were fueled by our growing insurance in force, which was $53.3 billion as of March 31, 2015. Compared to $34.8 billion at the end of the first quarter a year ago, we grew our insured portfolio 53%. As you know, growth in insurance in force drives top-line revenues and further operating leverage. For the first quarter, earned premium was $75 million, a 68% increase compared to $45 million for the first quarter a year ago. Including the strong credit performance of our insured portfolio for the first quarter, our combined ratio was 39.3%, down from 54.4% a year ago. For the first quarter, we generated $5.3 billion of NIW and grew our active customers to 1,025, representing a 30% increase compared to 787 as of the first quarter a year ago. We continue to be pleased with the expansion of our franchise, the number of active customers and our position in the marketplace. On the Bermuda front, we continue to make progress regarding our affiliate quota share and our third-party reinsurance business. During the first quarter, we seeded 25% of our GSE eligible NIW to EssentRe. Also during the quarter, EssentRe participated in two Freddie Mac ACIS transactions, where we were insured $21 million of risk. Including the two ACIS deals that we participated in during 2014, our total ACIS risk in force was $64 million as of March 31, 2015. Turning our attention to Washington, the other recent news pertains that FHFA's update on LLPAs. We believe that the removal of the 25 basis points adverse market fee is positive and slightly improves borrower execution on loans with private mortgage insurance. Overall, we share our industries view that G-Fee should reflect the appropriate level credit for private mortgage insurance and anticipate that our industry will continue to pursue this discussion with the FHFA and GSEs. Now, let me turn the call over to Larry to cover more of the financials.

Thanks Mark. Good morning, everyone. As Mark noted earlier for the quarter, we reported net income of $34.8 million or $0.38 per diluted share. This compares to $28.9 million or $0.33 per diluted share for the fourth quarter of 2014. Our effective tax rate for the first quarter of 2015 was 31% compared to 34.5% for the fourth quarter of 2014. As a reminder, we began writing business in EssentRe effective July 1, 2014. For the full-year 2015, we expect the contribution to consolidated earnings from EssentRe to increase over 2014, as a result of the revenues generated on the growing in force book. The accounting rules generally require that an estimated annual effective tax rate for the year be utilized to provide taxes for interim periods. This quarter's effective tax rate of 31% represents our current estimate of the annual effective tax rate for the company for the full-year 2015, based on the forecasted amount of earnings to be generated in the U.S. versus Bermuda. Our provision for losses and loss adjustment expenses for the first quarter was $2 million compared to $3 million in the fourth quarter of 2014 and $902,000 in the first quarter a year ago. Our provision for the quarter is in line with the number of defaults and aging of our inventory. Note, that for the first quarter, new default net of queers [ph] were 61 compared to 153 for the fourth quarter. This is in part due to the seasonal increase in queers [ph] historically experienced by the industry in the first quarter of the calendar year. Our default rate as of March 31, 2015, was 21 basis points as compared to 20 basis points last quarter and 12 basis points as of the end of the first quarter of 2014. Earned premium for the first quarter was $75 million, an 11% increase compared to $67.8 million for the fourth quarter and a 68% increase compared to $44.8 million for the first quarter of 2014. Our average premium rate for the first quarter of 2015 was 58 basis points compared to 56 basis points in the fourth quarter and 54 basis points for the first quarter a year ago. The increase in our premium rate was primarily due to an increase in single premium policies canceling during the quarter. Our expense ratio for the first quarter was 36.6%, a decrease from 37.8% last quarter and 52.4% for the first quarter a year ago. Other underwriting and operating expenses for the first quarter were $27.5 million up from $25.7 million in the fourth quarter and $23.5 million for the first quarter a year ago. For the full-year, we continue to believe that other underwriting in operating expenses will be in the $110 million to $115 million range. The consolidated balance of cash and investments at March 31, 2015, was $1.1 billion. The cash and investments balance at the holding company at March 31st, was approximately $124 million as compared to $126 million at December 31st. Note, that there were no capital contributions to our insurance units during the first quarter. The combined statutory capital of the U.S. mortgage insurance companies was $748 million, reflecting an increase of approximately $42 million compared to $706 million at December 31, 2014. This increase was driven by statutory earnings during the quarter. The combined risk to capital ratio of the U.S. mortgage insurance business was 15.81 at the end of the quarter. Finally as of March 31, 2015, Essent Group's total consolidated GAAP equity was $996 million. Also, as of March 31st, EssentRe had GAAP equity of $159 million and total risk in force of $1.1 billion as compared to $155 million of equity and $836 million of risk in force as of December 31, 2014. Now, let me turn the call back over to Mark.

Thanks, Larry. In closing, we had another strong quarter of operating performance and producing high-quality growing earnings for our shareholders. The underlying drivers of this performance continue to be solid and we remain pleased with the pro forma returns of our business. Our operating platform remained strong on all fronts and our team continues to deliver best-in-class service to our customers. Essent is well position within our industry and in housing finance and we remain optimistic about the future of our franchise. Now, let us turn the call over to your questions. Operator?

[Operator Instructions] Your first question comes from the line of Jack Micenko. Your line is open.

Hi. Good morning, guys.

Hi, Jack.

It's kind of an unanswerable question I guess, but plead off, your loss ratios obviously remain well below what would be historical numbers and some of your peers have begun to put out what some of their 2011-2012 loss ratio numbers look like. Just curious as an updated thought on where the 2.7 ultimately we think could get to on a normalized basis. I know it is hard to say, but the credit quality here I think surprised even the biggest skeptics so far to date.

Jack, I think we are going to sound like a broken record here, but in terms of our performance what we continue to be pleased with how the losses progressing. More importantly, really the underwriting quality that has been generated by our lender partners, the caution is our book is just relatively young, so it is still very early in the process but again I am pleased with the performance to-date, but really tough to pin kind of where we think they are going to end up longer-term.

Okay. Then just curious of your updated comments on some of the LPMI discussions that are going on. I think, the GSEs may be thinking about maybe dis-incentivizing that business or at least some of the pricing. I know you guys have not been as active there on the lender paid. Any updated thoughts on what we could potentially see around either capital requirements for anything on the lender paid stuff?

Yes. I do not have any real insight into kind of the capital requirements that the GSEs may add. I would just point to what we are doing, which is really just growing the portfolio. We are really happy with how the portfolio is shaping up in terms of our average premium rate and credit quality, so we are not participating as much. Again, it is more, it is we are really concerned with our portfolio how we are growing it, so no real insight to what the GSEs are doing.

Okay. Fair enough. I will get back in the queue. Thanks.

Your next question comes from the line of Mark DeVries. Your line is open.

Yes. Thanks. Mark, I was hoping you could comment at least qualitatively and possibly if you can, quantitatively about the success you continue to have both, adding accounts and also deepening wallet share with the existing accounts that may be a little bit newer.

Yes. Mark, it is we really break it up between activation and utilization. As a younger company, we continue to kind of build breadth and depth of our customer base and then as we get on over time your best case you want to kind of increased utilization. We are very pleased with the growth rate in active customers. We are still a big priority within the company and I think utilization is really reflected just how the portfolio is growing. I would not be more pleased with again how the portfolio is growing. I think it grew 53% year-over-year. That is the real output. Obviously it is the customers and the quality that goes into that, but we are very pleased on both of those fronts.

Okay. You are still seeing good progress getting the utilization up, even at some of the accounts that you have on for a couple of years now?

Yes. I mean, it is obviously different clients have different utilization rates, but it takes a while to go after the different branches depending if they are centralized or decentralized, but yes I think we are very pleased with how we continue to grow with our clients.

Okay. Then, Larry, I think you indicated you expect OpEx of about $110 million to $115 million for the year, which is actually your run rate this quarter. Is that an indication that you are nearing the end of having to invest in some of the fixed cost in the business and maybe we will see maybe even some acceleration in the improvement of the expense ratio relative to risk going forward?

Yes. Good question. I think, we have seen an improvement in the expense ratio over the period of time, but we will continue to look for opportunities to invest, so we think as we look at the year and the run rate we have that there is some opportunities to continue to invest where we see some opportunities.

Okay. Thanks.

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

Yes. Good morning. Actually I just wanted to go back and follow-up on the single premium question. I mean, this quarter it appears you grew share by a fair amount and you kept your share relatively stable, was that a conscious decision to sort of reduce your exposure there given profitability or just any color you can provide there?

Yes. Bose, I think, we are very pleased we have only said the range of market share will be like kind of 12% to 15% range. I think, with singles, yes, I think it was a conscious effort. We are very focused on returns and shaping our portfolio and that is here and this is where you see the output, so we have talked about it before, but again are focused on growing the portfolio, making sure it has appropriate premium and credit characteristics against which capital, we have to stacked against this. This is a long tail business and we think about it in a longer-term basis and I think from a certain pricing and certain lenders around that we are going to be cautious.

Okay, great. That makes a lot of sense. On the FHA price cut, do you think that has had much impact on MI industry volume this quarter or do you think it has really led to more streamlined FHA re-fis?

Yes. It is a good question, I think more on the streamlined FHA the re-fis we have not really seen an impact in the market where we could see in the first quarter.

Okay. Then actually just one more, just from your comments that you made earlier on the LLPAs, does it suggest that debate is not over that it's something that's going to be ongoing?

Yes. I think now the PMIERs are in place and we begin as an industry to show good returns on the capital. I think there is room for further discussion.

Okay. Great. Thank you.

Your next question comes from the line of Mackenzie Kelly. Your line is open.

Thanks. Good morning. Mark, can you provide some perspective on does your total views of NIW opportunity for the industry relative to the guidance that you laid out last quarter, just based on what you have seen thus far in the year on the FHA competition and just total purchase growth overall on? Is anything there that has caused you to change your views?

Yes. I think we said 175 to 185 on the last call. I would say it is probably towards the upper end of that now given some of the results of the first quarter, so we feel comfortable probably with the upper end of that range.

Okay, great. Then, secondly, on the high LTV is above 95%, the share of the NIW moves slightly higher this quarter as the GSEs new product took effect. I just wanted to get some color on, is it lenders that are filing now starting to offer those? What has been the response from lenders and what kind of borrowers are taking advantage of those? Going forward, how would you expect the demand there to go?

Yes. I still think that demand is pretty muted, Mackenzie and it is cross lenders there is no real specific lender. The execution still does not really work at that level versus FHA, so it was really small before but the GSEs took it away and brought it back, so I would say it is very again muted in terms of the growth, so always been a pretty small part of our originations and I would expected to remain small.

Okay. Thanks.

Thanks.

Your next question comes from the line of Doug Harter. Your line is open.

I am hoping you could talk about the returns on the ACISs risk in force that you have and maybe size that market opportunity?

Yes. Hi. Doug it is Mark. If the returns were consistent with the returns really in the rest of our portfolio, we say cautiously optimistic just because the future of the programs you really never now we have been pleased obviously we have seen them over the past really six quarters that the GSEs have been and after maybe a bit longer. Again, it is not like the primary business where we can gauge market size and share and get a sense of originations, so it is really difficult to quantify on that part, so stay tune quarter-by-quarter we are happy we are please with it because it allows it is really not a platform for us to kind of leverage our mortgage credit risk expertise. It is a below 80 business which is a nice growth, so in the future we could have nicer opportunities but we are still relatively cautious at this time.

I guess, just to be clear, so if you said you had $64 million of risk, I mean, I guess, how should we think about how much capital that sort of what how much capital you would hold against that risk?

Yes. I mean, it is a little harder because they are different structures. I would say, we used the same economic base capital methodology that we use on the primary business so it is hard to kind of give you a dollar for dollar or risk the capital because it is different but I would just say again, the capital allocated to that is relatively small at this point relative to the capital that we deploy in Essent currency but again if those have the opportunity longer-term to for us to allocate more capital to that business.

Great. Thanks Mark.

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

Hi. Thank you. Just wondering if you could help us quantify what the impact was of the elevated cancellation on the premium rate. Would it be that closer to the 56 basis points that we had in the fourth quarter?

Yes, Eric. That is a good raise, a couple of basis points.

Okay. Then as we are looking out at your affiliate quota share now that you have had a few quarters under your belt, how often do you expect revisit the percentage that you see to Bermuda?

There is no set timeline. I would say, we are up to 25%. We remain comfortable with it, so no plans for the foreseeable future.

Okay. Great. Thank you.

Thank you.

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

Hi. Just to follow-up on industry NIW expectations, the $175 billion to $185 billion, does that reflect an increase in private MI penetration?

Maybe a little bit. That is a good question. Maybe a touch higher on the penetration.

Okay. What is driving the other income line? It looks like it declined this quarter relative to the previous run rate by a pretty significant amount?

Yes. Amy, this is Larry McAlee, included in the outline or the results of our ACIS contracts, and as we had talked about previously, we account for them as derivatives and during the quarter we recorded a loss on those contracts as a result of an increase in the prepayment fees associated with the underlying mortgages.

Okay. Going forward, is it going to fall kind of in the middle of where it fell between this quarter and 2014 or how should we think about projecting that line?

Yes. Amy, again, it is still relatively small if you think about the $64 million of risk in force versus the entire portfolio, so it will be based a little bit on the market opportunity and additional transactions we may book. Also, as it relates to derivative accounting, you will see a little bit more volatility there just because of the nature of the accounting model.

Okay. Thank you.

Your next question comes from the line of Geoffrey Dunn. Your line is open.

Thank you. I actually wanted to follow-up on that question. When you say that there was a negative mark for accelerated prepayment, was that an actual impact or you are talking a mark-to-market impact?

Yes. It was a mark-to-market impact Geoff.

Is that something you might be willing to break out going forward, just so we can take out the noise of the market movements and just try to look at the fundamentals?

Sure. We can look at that. We do disclose it in our 10-Q, but we can look at that, Geoff, and see what make sense for purposes of the supplement as well.

All right. Great. Thank you.

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

Thanks. Mark. I wanted to get your thoughts, with PMIERs out of the way and regulatory risk, I think, largely behind the industry. Given that new product ROEs still seem fairly attractive, do you think we will see any new entrants or capital enter the space?

Well, Sean it is hard for me to say. It is a pretty crowded space at this time, so it is tough for me to predict that. It is a pretty long cycle to build the company, but the returns are attractive, so you never know capital those gets attracted to returns, but tough for me. I have no real insight into it.

Okay. To the point that it is crowded, do you think we will see any consolidation?

No. I mean, again, it is hard for me to predict that. It is crowded, but it was crowded when we started. We lost a few and a few more came, so it is still crowded. I think it is a good mix, but I have no real insight in the consolidation.

Okay. I am just wondering about if you could shed any light on the credit quality of the new stacker pools. I know they are below 80, but is there anything else you can give us, the credit quality of these pools versus your additional business?

It is very similar. I mean, almost. It is on the Freddie Mac websites, you can actually see they breakout the FICOs and all, but it is very similar to what you will see in our book just obviously lower LTVs.

Okay. Great. Thank you.

Yes.

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

Good morning. A question on capital, now that you guys had some time to digest the finalized PMIERs rules, could you update us on how you think about leverage levels, so we can I guess better understand whether additional equity under debt make sense over time as risk in force grows?

Yes. I mean, they are actually two separate questions. I think with the PMIERs behind us, remember we have always deployed our own models to set capital. We run a few different stress models and PMIERs actually lines up quite well with that. In terms of the capital, we feel pretty good in terms of the capital required for Essent Guaranty throughout the year and probably in the next year. The additional need for capital would really be growth capital, well - to EssentRe and opportunities that we see there. Should we require more capital down the road? We would obviously look at that debt and equity or whatever is better at that time depending on market conditions.

Just to clarify the EssentRe would be the sub. Is that the Bermuda sub? It would depend on the growth?

Yes. EssentRe is the Bermuda sub and Essent Guaranty is our U.S-based primary insurer.

Okay. I need to think about how much business you would be pushing into that sub over time to determine whether additional capital make sense?

As I said I think we are comfortable with our capital position as off we are today, really through 2015. Again, we will see it depends on - again as we said earlier in response to Doug's question, we do not have a lot of great kind of visibility in some of the opportunities and if we see a good opportunity that meets our return hurdles, we would probably deployed capital to take advantages of that.

Got it. Thank you.

Thank you.

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

Thank you, operator. We would like to thank everyone for participating in today's call and enjoy your weekend.

This concludes today's conference call. You may now disconnect.