Essent Group Ltd. (ESNT) Q1 2016 Earnings Report, Transcript and Summary

Good morning. My name is Lindsey and I will be your conference operator today. At this time, I would like to welcome everyone to the Essent Group Ltd First Quarter 2016 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. Mr. Chris Curran, Vice President of Investor Relations, you may begin your conference.

Thank you, Lindsey. 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 2016 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 29, 2016, 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. I am pleased to report that Essent had another strong quarter of financial performance as we continue building a high credit quality and profitable mortgage insurance portfolio. As investors in long-term mortgage credit risk, Essent is well positioned in both the US and Bermuda to continue growing our portfolio. Given our strong premium levels, efficient expense base, and Bermuda-based structure, we believe that Essent can continue producing high quality earnings and generating strong returns. Combining this with our positive view on housing, including favorable affordability and low interest rates, we remain optimistic about Essent's prospects. Now, let me touch on our results. For the first quarter, we increased net income 38% to $48 million from $35 million for the first quarter of 2015. On a per diluted share basis for the first quarter, we earned $0.52 compared to $0.38 for the first quarter a year ago. Our earnings growth continues to be driven by our insurance in force, which grew 27% to $68 billion from March 31 a year ago. Additionally, our strong performance for the quarter resulted in a 17% return on average equity for our shareholders. We continue to be pleased with our portfolio's credit performance, ending the quarter with 1,060 loans in default out of 309,000 policies in force. We believe guardrails such as QM and improved quality assurance by the GSEs, lenders, and MIs have strengthened loan underwriting processes. These changes combined with strong borrower profiles have improved the quality of loans being originated today which benefits our policyholders and shareholders. Our balance sheet remains strong with $1.6 billion in total assets and $1.2 billion of equity at March 31. Also, we grew adjusted book value per share 16% on an annualized basis to $12.49 compared to $12.01 at the end of 2015. Shifting our attention to the marketplace, we are encouraged to see the impact that PMIERs are having on the competitive pricing landscape. With the PMIERs now in place, industry pricing is naturally evolving towards a more risk based framework. Unlike historical price changes, where rates were reduced across the board recent industry changes have been focused on maintaining return levels across the entire risk spectrum. We believe that this should lead toward a more stable pricing environment and is why we have strongly supported PMIERs as a long-term positive for our industry. They shine a light on pricing and increase transparency around returns and capital management. As previously announced, we have closed on a $200 million revolving credit facility which enhances our financial flexibility and expands our access to growth capital. We are very pleased with the terms of the facility, which we believe are reflective of our strong financial profile. The facility will enable us to take advantage of incremental opportunities that may arise for Essent Re to invest in mortgage risk. As a reminder, Essent Re provides us a unique opportunity to reinsure loans with LTVs of 80 and below to the ACIS and CIRT transactions. This business is incremental to our already strong above-80 LTV franchise. Finally, on the Washington front things are relatively quiet now that PMIERs are effective and housing finance reform seems to have taken a back seat to the presidential election. While our industry remains engaged with the FHFA and GSEs on front end and deep MI opportunities, there are no new developments to report at this time. However, we continue to believe that Essent is well positioned to participate in these opportunities. Now, let me turn the call over to Larry.

Thanks, Mark, and good morning, everyone. For the first quarter, we reported net income of $48 million, or $0.52 per diluted share. Net income for the quarter is up 8% over the fourth quarter of 2015 and 38% over the first quarter a year ago. Earned premium for the first quarter was $94 million, an increase from $89 million, or 6% over the fourth quarter and an increase from $75 million, or 26% over the first quarter of 2015. The average premium rate for the first quarter was 56 basis points compared to 55 basis points in the fourth quarter of 2015 and 58 basis points for the first quarter a year ago. The increase in our premium rate this quarter over the fourth quarter is principally due to an increase in the level of single premium policy cancellation income. The provision for losses and loss adjustment expenses for the first quarter was $3.7 million, a decrease from $4.2 million in the fourth quarter of 2015 and an increase from $2 million in the first quarter a year ago. The decrease in the provision this quarter versus the fourth quarter was driven by a modest net increase in our default inventory offset by an increase in the aging of our defaults. While our insured portfolio is still young with a weighted average age of 19 months, we continue to be pleased with its credit performance, ending the first quarter with a default ratio of 34 basis points. Our expense ratio for the first quarter was 33.2%, essentially flat compared to the fourth quarter of 2015 and a decrease from 36.6% from the first quarter of 2015. Our effective tax rate for the first quarter was 28.8%, which represents our current estimate of the annual effective tax rate for the full year 2016. This compares to an effective tax rate of 31.1% for the full year 2015. The reduction in our effective tax rate in 2016 is due to the increase in the proportion of our consolidated earnings estimated to be generated in Bermuda versus the United States. The consolidated balance of cash and investments at March 31, 2016 was $1.4 billion. The cash investment balance at the holding company was $71 million at both March 31, 2016, and December 31, 2015. The holding company did not make any capital contributions to our insurance or reinsurance subsidiaries during the first quarter. Finally, the combined risk to capital ratio of the US mortgage insurance business was 14.8 to 1 at the end of the first quarter compared to 15.2 to 1 at December 31, 2015. Now, let me turn the call back over to Mark.

Thanks, Larry. In closing, Essent had another strong quarter of operating performance in providing mortgage insurance and reinsurance solutions. And we continue to be pleased with our earnings growth and mid-teen returns that we are generating for our shareholders. Our business development team along with the rest of the Essent team members in Winston, Radnor, and Irvine do an excellent job in providing best-in-class service to our customers. The Essent franchise and market position are strong and we remain positive about mortgage insurance, our industry, and housing. Now, let's turn the call over to your questions. Operator?

[Operator Instructions] And your first question comes from the line of Eric Beardsley from Goldman Sachs. Your line is now open.

Hi, thank you; and nice quarter. Just wonder if you could give me a little bit of color I guess just on what kind of trends we should expect to see in the other income line. And if there's any thoughts on whether in the derivative accounting, how the reinsurance might shift any time soon.

In terms of trend, Eric, what you've seen over the last couple of quarters is really the change in the fair value of derivatives has driven really all of the changes in other income. So we don't expect to see any significant change in that absent the derivative accounting. We continue to look at that and to talk with our counterparty relative to the derivative accounting and we'll let you know once we make any changes in that accounting.

Got it. And I guess if you could just expand a little bit on what type of opportunities you're seeing in the reinsurance space outside of the agency re-sharing transactions?

Yes. Right now, Eric, we're pretty focused just on the ACIS and CIRT transactions. We've looked at other things but I would say primarily our focus is on the US-based business, which we understand well.

Got it. And then just lastly I guess on the OpEx trend. How should we think about that developing over the rest of the year? Is this current year-over-year growth around 14% the right level, or are we going to see that closer to 10%?

Yes, it's probably somewhere in the middle I think is a good gauge for kind of year over year.

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

Yes, thanks. My first question's around plan use of the new revolving credit facility. I think when -- on the last quarter call you guys indicated at this point you're pretty much self funding. But it looks like if I understand it right, there's a cost to not using the capacity in this facility. So I guess the implication is you will use it. Can you give us a sense of what you plan to do with that? Do you see kind of outsized opportunities to grow through some of the risk sharing transactions? Could you potentially use money to buy back stock here which to us looks pretty cheap? Just interested in your thoughts there.

Hey Mark, it's Mark. I think in the last quarter we said -- I think we said on a couple of quarters -- we feel like we're self generating, self-funding within Essent Guarantee. Any new capital that we would source would be used to take advantage of incremental opportunities around Essent Re. And that's pretty much what we see. We don't have any immediate plans to draw it, but again, as we said in the past, capital begets opportunities. And we are encouraged around what we're seeing around the ACIS and CIRT transactions in terms of kind of the visibility of those programs. It was close to $4 billion of risk transferred last year; it's closer to $6 billion this year, according to AON, which is the broker on those types of transactions. And again, not saying we're going to use it, but I think it's nice to have the capital. And we would certainly use it to invest in the business. I think buying back shares at this point in our lifecycle is really not something that's on the horizon. We're really a growth company; we continue to grow the portfolio in the US. We're really at the very early stages of growing the portfolio within Essent Re, but any capital we would source at this time would be for growth.

Okay, that's helpful. And just a question on the expense ratio. We're seeing a little bit less operating weathers than we would have expected there. I think expenses were up year-over-year, underwriting expenses I think while NIW was down -- is there anything to call out there? Is there any more room to see that improve?

Yes, I think the thing to call out, Mark, is the low level of nominal expenses that we have relative to others in the industry. If you took just our dollars of expenses divided by our NIW, you would think and you would calculate we're probably the lowest cost in the industry to originate a dollar of NIW. So the expense ratio is really just a function of how we grow the portfolio. And we've guided people in the past -- I would really look at combined ratio. I think we've guided people kind of to that high 30s, low 40s number over time. The loss ratio obviously going up, the expense ratio going down somewhat. So again long-term trends combined ratio low 30s, low 40s is actually we think is really good. So we don't get too caught up kind of in the quarter-to-quarter changes. It's really focusing on the nominal expenses. And we've said this before, the best risk companies are the best cost managers. So we focus on that number. And again, if we seen an opportunity to invest in expenses and invest in the business, we're certainly going to take advantage of it. But I think at this part of our lifecycle we're very pleased with the expense leverage we're getting, and we would expect it to continue.

Okay. Got it. And then just finally on pricing, appreciate your comments on expectation for a more stable pricing environment kind of post PMIERs and we would agree with that. Though one of the concerns we hear from investors is that we're going to see continued pressure on pricing. Are you seeing any signs that you can call out to kind of show that maybe we're finally reaching equilibrium here? That you're seeing competitors now finally starting to stabilize around a similar set of prices with a similar set of return expectations?

Yes, I think they have stabilized, Mark. And in fact they really haven't changed much over the past year. I think there's been a lot of kind of misunderstanding in the market. With PMIERs, the pricing really got reconfigured. And again, there was a little noise, and it played out in the public markets, which was just the way it is. But really, higher FICO loans are getting lower rates and lower FICO loans are getting higher rates. The all in average premium really hasn't changed much. And in fact, the average premium on the portfolio even one of our sizes is somewhat negligible. So I think this concern -- this is our view -- the concern around pricing is somewhat overblown and you really have to look from an Essent perspective. Really the average premium we disclose it every quarter earned premium yield on the portfolio, which is in the mid-50s, again, we continue to grow the portfolio. Pricing from a historical basis is very strong especially relative to the type of borrower we're putting into the portfolio today. You're looking at an average FICO of anywhere between 745 to 750 much higher than it was pre crisis, which was probably closer to 710, 715. Very clear and transparent capital standards now around the industry. You could see -- we feel comfortable on kind of what we're pricing today, unit economics, in that mid-teen return level, unlevered for us. And then just look at the returns we're printing. I mean 17% in the first quarter. So again I think when you look at the facts and look at the growth of the portfolio and look where pricing is just in facts and not kind of look at a certain rate sheet or a certain bid that you guys see in the market, I think you'll see the pricing environment's actually quite favorable.

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

Thank you. To get back to OpEx and combined ratio, I think at some point in the past it was suggested that if the loss ratio came in lower perhaps the expense ratio would be a bit higher to get to the high 30%, low 40%. But those two -- the loss ratio and the expense ratio -- should move independently, correct?

Correct.

Okay. And then just -- you had very low loss experience, but I'm wondering if you could tell us about the geographic dispersion of the delinquencies that you are getting. And if anything's changed.

Yes. I mean, again, it's a very low level of defaults. But to date, the geographic dispersion of the delinquencies follows the geographic dispersion of where the risk is.

Our next question comes from the line Vic Agarwal from Wells Fargo Securities. Your line is now open.

Thanks and good morning. Nice quarter. I just wanted to know what you were thinking about as we see the trends and the 95% LTV bucket higher as that grows. Is there a certain level that you'd like to take that to over time?

Not particularly. I think the level's relatively low. It was probably in the close to 4% to 5% range before the GSEs backed out of 97s, and now that they're back into the market we've seen a tick up. But I would say given where the pricing is in that market, in that part of the price card and the capital we have to hold against it, we're fine. And we wouldn't expect it to be a very big number, Vic, just because it's really tough from a pricing standpoint with FHA at that level. So we're seeing relatively good credits, but I would never expect it to be a large part of the portfolio.

Okay. And then on your ACIS and CIRT transactions, I think you said that you see your AONs at roughly $6 billion. How do you see your proportion of the risk increasing? Do you think that it grows up by the same level of 4 to 6 for this year and into next year?

Again, we look at it a little bit longer term. It's not the quarter-by-quarter watch that we have on the US business with NIW. I think some of it becomes what the opportunities are, and we could always have an outsize quarter and then a quarter where it's a little bit lower. So I would say -- we wrote $121 million of risk last year; we would expect that to grow this year. We're not going to disclose the number. And again, some of it's dependent on the actual -- making sure that $6 billion actually happens. That could be higher, that could be lower. And there's timing when the GSEs do this stuff. But again, I think longer-term we like the trends. We really like the trends in the market. It's more of a pragmatic nature. There's a program there with both GSEs that's becoming almost another market, and I think the multi-lines have been a participant and we're obviously a participant in, too. But again, bigger picture with risk share I think the GSEs have done a great job. They really have just kind of starting these programs, managing these programs. They have counterparty standards for the multi-line, just like they're doing with the PMIERs on the US basis. We really have a lot of confidence in how they're managing the program and we're confident that we can continue to be a good participant and a good counterparty for them.

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

Hi. Good morning, everybody. Mark looking at your NIW trends year-to-year, you definitely held up better versus the peers that were down double digits. When you started out, I think it was more customer growth and I think that's sort of pivoting but can you help us year-to- year, clearly that implies some share take. Is it more customers or is it more with the customers you have at this point?

Yes, Jack. The answer's a little bit of both. We continue to add customers and again we don't disclose that anymore just because we feel we're at a critical mass. But we obviously continue to add customers. We gain share with existing customers; we lose share with some customers. I mean I think it's a little bit of both. I think we're really focused, though, on growing the portfolio and really making sure that portfolio has obviously good premium and credit characteristics, but also good lender characteristics. There are certain lenders that we will shy away from and we feel comfortable doing that. And remember, we're the only mortgage insurer out of the seven that does not pay a sales commission to our sales force. So they really are incented longer term to think like equity holders and like us, which is to grow the portfolio in a prudent fashion. Not to say that others don't, but I think that's sometimes that may hurt us in the short run in terms of share, but we think long term, I think it'll pay off in spades in terms of building a well kind of balanced portfolio. And we're obviously growing it at a good pace, anyway. So we're very comfortable with our market position. And again every day we're really focused on helping the lenders. If we can help our lender customers and whether that's through training, being visible in their offices, helping them find underwriters, all those sort of things that gets lost sometimes when people focus too much on pricing. Our view is if we help our lenders grow, we're going to grow. And that's been the philosophy we've had since we started the Company and that's the one we'll continue to have. I'm still very visible out at customers. And it's a little bit of a different approach. Others have good approaches, too; this is the Essent approach and we feel very comfortable and will continue to grow the business.

All right, great. And then investment income number came in a little bit better than we were looking for so trying to understand if that's maybe more the settlement in December flowing through the book or is it -- are you re-mixing the composition of the portfolio instead? I guess the real question there is, is this the right run rate on yield going forward?

Hey, yes, Jack, it's Larry, responding to that question. There's really nothing new in the portfolio. Most of the increase would be driven by an increase in the average balance. The yield on the portfolio was 196 basis points in the fourth quarter, a little bit over 2% in the first quarter. And again, in terms of run rate I think that's a relatively reasonable run rate for the intermediate term.

Okay. Just one more for you, Mark. The first quarter of every year you've kind of given us your crystal ball on NIW for the year; you've been closer to right than not. Where are you thinking NIW for the industry comes out with one quarter under your belt here in 2016?

Let me look into my crystal ball.

Dust it off.

We think it's going to be pretty similar to last year, relatively flat. Which to me flat is a great thing. I mean we're back to historical norms in terms of the size of the market kind of that $200 billion plus. Which by the way is the average NIW for the industry back to early 1990s? So we're very comfortable at those levels. And as a reminder, we really, as an industry, follow housing. And I know, Jack, you follow it very closely with the homebuilders. So what we're seeing kind of in the housing environment -- and we mentioned this briefly in the script is that we continue to be positive. I see it when I'm out on the road talking to customers and in different locations, continual more supply coming into the market, which has been an issue, obviously over the past couple of years. We see the demand continuing to grow. So again, we follow the fortunes of housing and the economy in general which again that's -- those are obviously big picture things but we follow those fortunes well. And I think looking at those fortunes really will lead you to kind of the future of Essent and why we continue to be positive. So again, industry size I think is very strong and we expect it to stay at that level.

Our next question comes from the line of Douglas Harter from Credit Suisse. Your line is now open.

Thanks. Can you just talk about kind of the singles versus monthly and any sort of change in composition you expect there? How the relative competition is within those two segments?

Yes. We're probably in that kind of mid-20s range. Our calculation is the industry's probably over 30%. And that's been pretty stable, Doug, over the past few years -- kind of in that 30%. Singles were a touch lower; that could always change over time. It is somewhat dependent on client mix. We're very comfortable with kind of the mix of singles we have in the portfolio now. And again as long as we can continue to grow the portfolio at the right average premium level, which we clearly are at that mid-50s earned premium level, we feel pretty comfortable where we are in the market. We don't see a lot of changes, though, in the mix; we really don't. Again, the industry did change LPMI pricing, and again, ironically with the lower BPMI pricing, at least in the upper FICO ranges, that's actually more competitive with LPMI. So I think you're going to probably see over time that LPMI level could actually come down a bit.

Our next question comes from the line of Mackenzie Aron from Zelman and Associates. Your line is open.

Thanks, good morning. Mark, just first on the bulk product that was done this quarter; can you provide a little more color around that deal? Just curious if it's the same customer that originated the deals last year and how aged the loans were and whether you think those deals could become more of a normal source of incremental volume going forward.

Yes; hey, Mackenzie. We don't disclose customer information so we're not going to do that. I would say it really is that kind of professional loan program. Its regional banks that keep it on their balance sheet. I would say it's spotty. I wouldn't look at it to be something you can rely on. But again, it's relatively newer production. The reason we classify it in bulk is because it's not all technically 2016 originations, but it's relatively new. And it adds to the portfolio, so I think that gets missed sometimes. So yes, it happens -- we have some quarters where we do it, some where we don't. I think the largest bulk we did was the Fanny deal back in 2014, and that was actually very large and meaningful to the portfolio.

Great. And if this kind of loss is incurred, there's been a small favorable benefit, I think almost every quarter going back to 2013 except for one. Just kind of wondering where's the upside been on credit trends that has driven those adjustments.

Again, I would just say its two things right its a few things. It's the economy continues to improve; home prices have increased a little bit. And it just speaks well to the overall kind of FICO level that we see in the bulk, and the manufacturing quality. We mentioned this a little bit on the call before and I talked a little bit about it on the script. But I do think there's a little bit of a secular change going on in underwriting given kind of the guard -- we talked about PMIERs as being kind of pricing guardrails. Our view is QM, the enhanced level of QA that the GSEs are doing, and they do a great job with that. I think the MIs have done a great job with QA. So what you're seeing is probably just that combined with the strong borrower profiles, you're going to see probably just strong performance out of the portfolio that we have. We've seen it to date and obviously it's economically dependent; that always can weigh on the portfolio. But right now what we're seeing, we would expect the trends to continue.

And our next question comes from the line of Amy Debone from Compass Point. Your line is now open.

Good morning; thanks for taking my questions. Can you provide an update on the minimum required asset amount and capital cushion according to PMIERs?

That's not something we disclose, Amy.

Okay. And then, given the MI7's retaining enough capital on its own, does the new credit facility change the time line for up-streaming capital to the holdco?

No, it does not. Again I mentioned a little bit earlier is the capital from the line of credit or the source of capital is really for growth. And the up-streaming of capital to the holdco is really dependent on contingency reserves and the timing. We mentioned in the fourth quarter call that we generated a lot of cash within Essent Guaranty in 2015 above what we would have for net income. That trend will continue in 2016. So over time, we'll be a strong generator of excess cash. But we're still not quite there yet. And again, there's a little bit of an imbalance so we're cash-generator, excess capital-generator within Essent Guaranty, and we're still capital consumption within Essent Re. So over time, obviously net-net there'll be available cash to up-stream to the holdco, but we're not at that level right now.

Okay, that makes sense. And then the tax rate appears to have ticked down just slightly again to 29%. Where do you see it bottoming out based on the current mix of business?

Yes. Again, it's dependent on the timing of the mix of business. But since it's a 25% quota share, you could assume that it'll bottom out close to 25% lower than the standard 35% rate. It's going to take some time to get there, but that's a good gauge as to where it'll bottom out at.

Okay. And then just my last question, what was the impact on the average premium rate from cancellations? And then is the underlying trend flat? And is like 55 basis points kind of a reasonable level for the rest of the year?

Yes. Amy, this is Larry. The one basis point tick up in the first quarter versus the fourth quarter is pretty much due to this increase in singles cancellation income over the fourth quarter level. And in terms of run rate, as Mark mentioned earlier, we're pretty comfortable with a premium rate in the mid-50 range.

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

This is actually Brian Jones on for Bose. I had a couple of questions about kind of the marketplace. So with some of the competitors coming out looking to take market share, how do you guys plan to kind of defend your market share in the industry right now?

Yes, we don't plan to defend anything. I think our plan is to continue to grow the portfolio with a good mix of lenders that we like to do business with, making sure we have strong kind of premium and credit characteristics. And again, long as we serve our lenders well and help them grow their business, we feel like we'll continue to grow the business. So again, we don't -- our competitors and we have some very good competitors that work hard everyday and try to do the same things we do. At Essent, we really just worry about Essent and our customers and our view is, we do that, we'll continue to do well. When we started the business there were seven or eight companies and then there was five and now there's seven again. And through all that -- and there was bulk LPMI programs and special rate cards here and there, through all of that, we've continued to grow the business and add customers. And we feel like we'll continue to do that. So as long as we do that, we're going to be fine. So again, not worried about what others are doing.

Okay, that sounds good. And another one, have you seen any market share shift to FHA because of the new rate cards that have come out recently?

No, it's pretty early on the new rate cards to see any shift. We saw a little bit of shift last year with FHA when they lowered their price. But again, I would focus you really on the size of the NIW market both in 2015 and 2016. As long as housing continues to grow, and it's really -- our view is housing's in probably more of the earlier stages than people might think. As long as housing continues to grow, and mortgage insurance penetration stays at these types of levels, I think you'll see the industry in force -- or, the industry pie continue to grow. And as long as that happens and we don't get too caught up in share among competitors or share amongst FHA -- this is really kind of a big-picture three- to five-year outlook. And as I said earlier I think in a three- to five-year outlook -- Jack mentioned earlier my crystal ball. It doesn't work well within quarters or years, but three to five years, we feel like the industry has a lot of wind at its back.

There are no further questions at this time. I'll turn the call over to Mark Casale for closing comments.

Okay. Thank you, Operator. We'd like to thank everyone for participating in today's call, and enjoy the rest of your week.