Essent Group Ltd. (ESNT) Q3 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 Essent Group Limited Third Quarter 2015 Earnings 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 and Larry McAlee, Chief Financial Officer. Our press release, which contains Essent’s financial results for the third quarter of 2015, was issued earlier today and is available on our website at essentgroup.com in the Investors 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 another strong quarter as we continue building a high credit quality and profitable mortgage insurance portfolio. As managers of long-term mortgage risk, we are pleased with the growth and credit performance of our insured portfolio, as well as the returns that we are generating for our shareholders. The Essent franchise and our market presence are strong and our outlook for the MI sector and housing remains positive. Now, let me touch on our results. For the third quarter, we earned net income of $40.8 million, representing a 63% increase from $25.1 million earned for the third quarter a year ago. On a per diluted share basis, we earned $0.44 for the quarter compared to $0.29 for the third quarter a year ago. Our strong earnings continue to be driven by growth in our insured portfolio. During the quarter, we generated $7.6 billion of NIW and grew our insurance in force to $62.1 billion. Earned premium for the quarter was $83.7 million, a 39% increase from $60.3 million for the third quarter of 2014. Our insured portfolio’s premium yield for the quarter was 55 basis points while it’s credit metrics remained strong, ending the quarter with a weighted average FICO of 751 and a default rate of 29 basis points. Overall, our industry remains competitive, with 7 players operating and sourcing business from lenders throughout the U.S. While there has been increased scrutiny on MI pricing as a result of recent competitor actions, pricing in our view has always been competitive. Whether through rate cards or pricing engines, we believe the industry continues to migrate towards more granular risk-based pricing. This has been the trend since midway through the financial crisis and recent competitor actions are consistent with this. At Essent, we will continue to manage our business on a portfolio basis, targeting all-in premium yields and mid-teen returns. In fact, our insured portfolio today is risk-based, reflecting a mix of different pricing and credit attributes. In today’s competitive environment, we are well positioned from both a portfolio growth and return perspective, given our solid market presence and efficient operating platforms at both Essent Guaranty and EssentRe. Now turning our attention to Bermuda, we continue to be pleased with our affiliate quota share as well as our progress in participating in GSE risk share transactions. During the quarter, we participated in another Freddie Mac ACIS deal, while also participating for the first time in two Fannie Mae CIRT transactions. On the Washington front, Essent is supportive of U.S. MI’s efforts of having our industry play a larger role in transitioning U.S. mortgage risk from the taxpayer to private capital. We have always believed that our industry can efficiently help achieve this. Finally, on the recent rumors of another FHA price reduction, we are not aware of anything imminent. However, we believe that the private MI industry and FHA can coexist and play complementary roles in supporting a robust U.S. housing finance system. Even with the FHA price reduction earlier this year, there has been little impact on this year’s industry NIW level. Now, let me turn the call over to Larry.

Thanks, Mark and good morning, everyone. As Mark noted, for the third quarter, we reported net income of $40.8 million, or $0.44 per diluted share. This compares to $37.2 million, or $0.41 per diluted share for the second quarter of 2015 and $25.1 million, or $0.29 per diluted share for the third quarter a year ago. Earned premium for the third quarter was $83.7 million compared to $78.4 million for the second quarter and $60.3 million for the third quarter of 2014. The average premium yield for the third quarter was 55 basis points, down slightly compared to 57 basis points last quarter, primarily as a result of a lower level of single premium policy cancellations. The provision for losses and loss adjustment expenses for the third quarter was $3.4 million compared to $2.3 million in the second quarter of 2015 and $1.4 million in the third quarter a year ago. The provision for the quarter is in line with the increase in the number of defaults and aging of our inventory. The default rate as of September 30 was 29 basis points as compared to 23 basis points last quarter and 15 basis points at September 30, 2014. Our expense ratio for the third quarter was 34.3%, a slight decrease from 34.6% last quarter and a decrease from 40.6% for the third quarter of 2014. Other underwriting and operating expenses for the third quarter were $28.7 million compared to $27.1 million last quarter and $24.5 million for the third quarter a year ago. The combined statutory capital of the U.S. mortgage insurance companies at the end of the third quarter was $865 million, reflecting an increase of $48 million compared to June 30, 2015. This increase was driven by statutory earnings during the quarter. The combined risk to capital ratio of the U.S. mortgage insurance business was 15.4 to 1 at the end of the quarter. Looking forward, we expect statutory earnings will be sufficient to support the forecasted growth in the U.S. mortgage insurance companies. The consolidated balance of cash and investments at September 30, 2015 was $1.3 billion. The cash and investment balance at the holding company at September 30 was $69 million as compared to $108 million at June 30, 2015. The decrease during the third quarter was due to a $41 million capital contribution to EssentRe to support the affiliate quota share and GSE risk share activity. With this contribution, as well as the balance of cash and investments at the holding company as of September 30, we believe that we have sufficient capital to support our forecasted growth in EssentRe through the end of 2016. Finally, as of September 30, 2015, Essent Group’s total consolidated GAAP equity was $1.1 billion. Also as of September 30, EssentRe had GAAP equity of $212 million and total risk in force of $2 billion. Now, let me turn the call back over to Mark.

Thanks, Larry. In closing, we had another strong quarter of operating performance and the underlying drivers of our results continue to be solid. We are pleased with the credit performance of our growing insured portfolio and the returns that we are generating. While our industry remains competitive, as investors in long tail mortgage credit risk, we will continue to manage our business on a portfolio basis and target mid-teen returns. Essent is well-positioned within our industry and in housing finance and we remain optimistic about the future of our franchise. Now, let’s turn the call over to your questions. Operator?

[Operator Instructions] Your first question comes from the line of Mark DeVries. Your line is open.

Yes, thanks. Appreciate the comments. I think Mark you indicated you expect to see competition continue to drive the industry towards more discrete risk-based pricing. Could you talk about the implications for the industry’s overall share of high LTV lending in the scenario like that if the FHA doesn’t move pricing either up or down?

Well, when I say more discrete pricing, it doesn’t necessarily mean at all the FICO bands. I mean, just in terms of flat CARs, I wouldn’t necessarily jump to that conclusion. It’s really meaning pricing the risk for the appropriate return and also taking into consideration the overall size of the market. I think that’s one thing that we want investors to be clear around is that we want to make sure we are serving as big a market as we can. And so the comment was more people will fine tune it. But in general, we don’t see pricing changing that much in the industry at this time. At Essent, we are still focused on growing the portfolio and targeting certain premium yields that we do. So, I wouldn’t read too much into it.

Okay. But you are not necessarily seeing signs that competitors are lowering their return expectations for certain business as they get a little bit more – as they sharpen their pencil on some of their buckets, are they?

Yes. I think from our standpoint, given the current competitive environment and what we are seeing in pricing today, we feel very comfortable around our mid-teen return estimate.

Okay, that’s helpful. And I think we saw in the quarter, at least in the secondary market for credit risk transfer bonds, there was a decent amount of spread widening. Are you seeing an opportunity as you price new deals on the MI side to potentially push up your returns a little bit on that business?

You are talking about the core business or on the GSE risk share?

Yes, the GSE risk-sharing transactions?

Yes. And again, I think what we said before, I mean, we are pretty comfortable with the returns. Yes, it is market sensitive. So that is an opportunity for us as the market widens. Those deals get priced off the market, so that does enhance the returns for the insurers.

Okay, great. Thank you.

Sure.

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

Hi, this is actually Sam Cho filling in for Doug Harter. So, I know the focus has been on pricing pressures, but are there any other aspects of competition that are playing out in the industry that might have slipped to the wayside because of all these pricing moves?

Again, I think folks are reading too much into pricing rumors and pricing pressure. I think the market is competitive. It’s always been competitive. It was competitive the day we started the business with a few guys on the way out, did some things on pricing and its competitive today. Again, that’s one way and it’s not the only way that mortgage insurers compete. Obviously, it’s on turn times, servicing, how often you are calling your clients. There is a lot more hard work and kind of shoe leather sweat equity in the business that folks don’t always appreciate. And I think our sales force has done a tremendous job out there really starting the business from scratch and getting these lender relationships over the last five years and a lot of it is because of service and how well you call on clients. Is price important? Of course, it is. But at the end of the day, we built the business and built our portfolio in a competitive environment. And we have no doubt that we will continue to build the business in today’s environment and tomorrow’s environment, because we are focused on growing the portfolio, remaining disciplined not just around pricing, around credit, around expenses, all the things that make that lead to a well run insurance company.

Got it. Now, shifting gears, in the other revenue line there was the positive fair value change in the insurance policies by EssentRe, what was the driver of the $1.3 million?

Yes, this is Larry McAlee. I will respond to that question. And we have talked about this in prior quarters, but the initial contracts that we wrote in Bermuda, the ACIS contracts with Freddie Mac are accounted for as derivatives. So, in the second quarter, we recorded a loss of $391,000 and that related to a speed up in prepayment speeds. In the third quarter, prepayment speed slowed and the valuation adjustment was favorable of about $1.3 million.

Got it. Thank you.

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

Hey, guys. This is Chas Tyson on for Bose. I was just wondering back to the pricing as we see the industry maybe move more towards risk-based pricing, if you consider some of the programs that competitors have introduced to be price cuts or just price restructuring and kind of a different method of pricing and if risk-based pricing presents kind of an attractive opportunity for Essent to introduce at some point?

Well, Chas, as I said in my comments, the industry is being risk priced and really starting right post-crisis when the FICO bands got expanded. So, that will continue to happen. Again, don’t read too much into it. These are subtle changes. In terms of certain competitors with new offerings, we don’t react to that so much. I mean, this is a business where we are really focusing on growing the portfolio, making sure we have appropriate premiums around that portfolio. So again, from a pricing perspective, yes, there could be some fine-tuning, but overall we don’t see the overall premium yields in the business changing relative to the capital that’s supporting the business.

Got it. So, you guys are comfortable with kind of the way you are currently pricing the business as opposed to more of a Black Box model that some competitors are either using right now or introducing in the future?

Well, again, don’t get confused with the delivery of pricing, whether it’s through rate cards or electronically. Those are just two different forms of pricing. We have the ability and with a couple of clients have delivered pricing electronically. And I am sure most of the industry could do the same thing. It’s really about, again what’s the all-in premium yields in the portfolio? What are the actual returns that businesses are generating? We went through this with PMIERs, where folks focused on capital within certain cells. And I think we focused folks back on the portfolio and we will do the same thing today. I wouldn’t look at any one competitor’s pilot rate program or other type of introduction to pricing as something that’s going to take hold of the industry. I think, again from our focus, we feel well positioned given our structure and given how pricing is today, what we are currently seeing in the market that will continue to drive strong returns.

Okay, it makes sense. And then you noted that you are pretty comfortable with your capital position at EssentRe through the end of 2016. I am just wondering how we should think about the capital requirements for that business going forward and what kind of capital will be required post-2016 maybe?

Yes. I mean, again, we are not going to read too much into that. I think given – I think it’s a pretty solid statement to say we are comfortable with capital through 2016. We will obviously update the market as we get through next year, but as of right now, we feel comfortable with the capital situation at the company.

Okay. Should we be thinking about that kind of on a PMIERs-like risk to capital type metric? I think we have usually heard kind of around 14 to 15 times risk to capital quoted as PMIERs compliant?

Well, again, our economic capital and PMIERs are relatively the same. I wouldn’t jump to 14 to 15. Again, remember a lot of this is done on the portfolio basis versus new originations. I think, given where we are in a risk to capital standpoint today, we feel again very comfortable.

Sure. And then last one just on the 25% seed to EssentRe, how do you think about reassessing or requesting higher seed? I mean, what do you think about it in your conversations with regulators or as you look at the mix of the business? And what timeline do you think if you were going to request something like that it would happen over?

Yes. I mean, I would say right now we are very comfortable with the 25% quota share going forward.

Okay, thank you.

Our next question comes from the line of MacKenzie Kelly. Your line is now open.

Thanks. Good morning. Mark, just first wanted to get some updated thoughts from you about TRID and what you have been hearing from your customers in terms of how this just the first month of implementation has been going and any expectations for implications for MI that you might see? And just lastly whether you are anticipating any potential delays next quarter or in the first quarter related to those applications?

Yes. I mean, the first applications that were taken in early October, a few – I mean, some have already turned into loans. They actually started turning into loans in the third week of October. So, based on a lot of my conversations with lenders, it’s gone very well, very smooth, again, a good testament to our lender partners. I mean, these guys have been working on it – this crew has been working on it for a year. The MBA did a great job of helping coordinate a lot of that stuff, but the lenders did a great job. So, what we are hearing to-date is it’s going very well and I would expect it. Mortgage bankers are very adaptable and have always – our clients have dealt with regulations since I have been in the business for 20 plus years and have always managed to handle it extremely well.

Okay, good to hear. And just secondly, on the deep cover proposal that was released a couple of weeks ago, just wanted to kind of get your bigger picture thoughts on what your initial take of that was. And is it in line with what you were hoping to see from the trade group and what are the next steps at this point in terms of moving along that process with the FHA and the GSEs?

Yes. I mean, I thought the trade group did an excellent job with it, it’s a first step, right. I know it’s a first step in a path forward in terms of using more – having the GSEs use more permanent capital as solutions versus just – right now these are probably up 70% of the risk share is through the capital markets and 30% is through the multi lines and not a lot through private mortgage insurance at all on the lower LTV. And we see a more – I see a more balanced path going forward. Capital market execution is great, but it’s levered and it’s obviously market dependent where you want more through the cycle type capital and permanent capital. And so I think – this is the first step, I think in terms of working with the GSEs and FHFA. And I am positive going forward. It’s hard to put a timeline on it. But I think it’s a – I thought it was a very solid first step.

Okay, great. Thanks.

Our next question comes from the line of Jack Micenko. Your line is now open.

Hey, good morning. Mark, I wanted to talk a bit about persistency, I think lost in some of the pricing concerns out there. In the model, it seems like persistency improvement would more than off shadow any sort of – some degree of modest compression on pricing if it were to happen. You guys were running high 80s about a year ago and I know the portfolio is still in its infancy, but down to an 80% now, I mean where do you think persistency can go in the industry if we sort of see this slow grind higher consistently on rates through ‘16 and ’17, just curious there?

Yes. I mean, it’s hard to call it Jack, I mean it’s really so interest rate dependent. I would say just right now, I mean short term we are comfortable with the 80% number. It’s dependent on NIW, I mean it’s dependent like I said on rate. So if rates tick up, you will see persistency tick up and you will see there is a correlation with NIW. All-in, I would really just focus on the growth in the insurance portfolio, that’s where it call comes out in the wash. So again, I think we feel pretty comfortable with how we are growing the portfolio with the combination of NIW persistency. Really the insurance in force growth for us has been very strong I think 8% quarter-over-quarter and 35% year-over-year. So that’s all factored in. But I think over the next couple quarters 80% is a decent number.

Okay. And then thinking through some of the products that are coming out now and more of an opaque model and I know one of the larger competitors has been doing it for some time. But just thinking through that, I am curious what your thoughts are around some of the larger banks and that kind of product. I mean the risk tolerance at some of the banks seems to be quite high, they have – actually some of them moved away from FHA, with some of the legacy issues that they have experienced in the downturn, it just seems like with some of the disclosures and compliance issues that maybe a black box model may be a challenge for the banks, so I am just curious what your take is on that?

I think it depends on the lender. I think we have shown the ability to tailor our offerings, whether it’s pricing, underwriting, training to the needs of the lender. Some lenders have the systems to deploy different forms of pricing delivery and some don’t. So again, I wouldn’t read too much into it. If the industry goes more towards where lender systems can handle electronic delivery and the ability to fine tune pricing down to the loan level, then I would think the whole industry could – we know certainly at Essent we could do it, that others could certainly comply. So again, really focus, get back on to the – what are the premium yields on the portfolio and not try to pick through kind of certain cells. I think you will lead yourself to a false conclusion back. All-in premiums on our portfolio remain strong. And again, this is – Jack, this has been through an industry where someone’s had a black box since the day we started and we still manage to grow the business. A lot of lenders and a lot of loan officers like transparency. And if you have a 250 branch system you like the transparency of a rate card. Someone else who centralized may like light handling, have it more electronic delivery. Our view and what we will do is continue to understand the needs of our lenders, do what we need to do to help them grow their business the right way. And in turn, when we do that and we have done that, helps us grow our business.

Okay, great. Thank you.

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

Thank you and good morning. I have a question about the average premium yield. It came in two basis points sequentially and did I hear somebody say that that was because that there was a lower level of single premium cancellation in the quarter?

Hey, Sean, it’s Larry. That’s correct. Some of the tick up earlier in the year was due to an increase in single premium policy cancellations. And we have the corresponding offsetting effect this quarter.

Okay. So assuming that there is not an all out pricing war and pricing more or less stays where it is, where would the portfolio premium yields migrate in the near-term?

Yes. I mean I think it’s – there is no real change to it. And I kind of – we have always said it’s been around this level. And it kind of ticked up because of the cancellation. But, kind of that low to mid-50s is a good number.

Okay. And then, just in terms of required capital…

And Sean, just to comment on your price war, there is no price war out there. I mean pricing has always been competitive. And I wouldn’t necessarily look at history to look at the future. I think there’s a – it’s a return driven mindset with PMIERs. I think the discipline in the industry over the last few years has actually been excellent. So, I wouldn’t look at a move of certain players as to how the whole industry is going to react. The portfolio remains strong in terms of portfolio yields and returns and we expect it to remain strong. I mean there was LPMI pricing discussion just two quarters ago. And I think at Essent we will maintain our discipline and continue to help our lenders grow their business the right way while we are focusing on growing the portfolio.

Alright. Thank you. Thinking about statutory capital, so you said that you have enough stat capital at Essent Re to continue to write new business through the end of 2016, did I hear that at Essent Guaranty you are generating enough stat capital to support new business for a period longer than that?

Yes. Sean, it’s Larry again. Right now, based on our forecast, we expect that the statutory earnings of Essent Guaranty will be able to support the growth of the business.

Okay. So, that’s as far as you can see?

Yes.

Based on current forecasts.

Yes. Thank you.

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

Hi, guys. Thanks for taking my question. So in some ways we are probably a little bit approaching a transition in the business model and that the last 2 years or 3 years have really been about the trajectory on operating leverage. And that’s well established and that’s going to continue, but the rate of improvement is going to slow. And I think the next 2 years or 3 years are really going to be about the trajectory of credit and provision expense. And we are starting to see that come through and I think over the next 12 months to 24 months that’s going to be the metric that moves around the most. And I think understanding how that plays out is critical. When we look at our model, one of the things that we are noticing is delinquencies are coming through pretty much as we have assumed, but the actual payments on losses are lower than we would have expected. And I am wondering what’s driving that, if that’s consistent with what you are seeing and I am wondering – I could attribute it, I think to three potential factors. One would be a higher percentage of cures, the second would be lower loss severities and the third would be – and this might be the most interesting, if there are just delays in the foreclosure process and so the payments on losses are just getting dragged out, I would love to get your thought on those different variables?

Yes. I mean Rick, thanks for asking the question. It’s a good question. I wouldn’t read too much into us at all. I think our default levels are actually very low. And we are seeing probably a normal course from our defaults in claim payments. I think what’s driving our low losses is we are – our level of delinquencies is actually very low. And I think again, that’s – we have talked about this on past calls. Although our book is still relatively new in terms of the seasoning, the quality of what we are underwriting and the losses to-date, have been better than expectations. And I think for 2016 we are thinking through increased disclosures around incurred loss ratios. And by then another three months, six months, the book will be – especially our earlier books will be seasoned enough to let you guys – let the investor community see where we are in terms of loss ratios, what I think will help you guys build your models out a little bit better.

Terrific. And I think what you are suggesting there and I would – if you are I would really encourage it. Are you saying that you might provide that on a vintage basis so that way we can really sort of parse it out?

Absolutely.

Excellent. Thank you.

[Operator Instructions] And your next question comes from the line of Amy DeBone. Your line is now open.

Hi. Just to circle back real quick to the risk share deals, are the economics of Fannie CIRT programs similar to the ACIS program? And then would you expect the economics to potentially improve if first year targets increase significantly for 2016?

That’s a good question, Amy. I would say, yes. To answer your first question, the returns are very similar across both types of transactions. In terms of pricing, if they were to increase the amount, I think it depends on the sources of capital and how much is out there. I think from our standpoint and our view really has been – our strategy is how do we position ourselves when the market gets a lot bigger, very similar to how we built the business in the U.S. If you remember, we built the U.S. business when the NIW market was very small, but built out the infrastructure and the capability to take advantage of a larger market, which has happened over the last few years. We see similar thing playing out in Bermuda. We have the infrastructure. We continue to build it out. We are doing deals. So, if the market was to get larger and the returns stay in line with our expectations, we feel like there is a nice opportunity for us to continue to grow that business.

Okay. And then speaking of market share, it looks like market share remained pretty flat quarter-over-quarter around 12%. Is your expectation – I think you mentioned last quarter just to kind of maintain the current level. Is that still the expectation for the foreseeable future?

I think our expectation is to continue to grow our portfolio making sure we have appropriate premium yields and return targets for our shareholders. So, we are not going to manage market share around – as you will see, in terms of some of the other competitors where market share has come down a lot and others going up, you can manipulate that based on different pricing schemes, especially around LPMI. This is a long-term business. We are going to continue to manage it for the long-term. Market share is an important metric, but it’s really the result of calling on good lenders, having good premiums and good credit characteristics. We are not going to let that metric drive the business or drive the strategy of the company. We are in this for the long haul. This is long-term mortgage credit risk. It’s a business where you don’t know what your cost of goods sold is for three years. So, you have to be careful around how you price it and make sure, from our standpoint, the support of our core shareholders, full expectation to continue to grow the business the way we have done it in the past.

Okay, thank you.

[Operator Instructions] There are no further questions at this time. I turn the call back to the presenters.

Okay, thank you, operator. We would like to thank everyone for participating in today’s call and enjoy the rest of your week.

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