Good morning, ladies and gentlemen, and welcome to the Essent Group Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. And please be advised that this call is being recorded. After the speakers’ prepared remarks, there will be a question-and-answer session. [Operator Instructions] I'd now like to turn the call over to Phil Stefano, Vice President, Investor Relations. Please go ahead.

Thank you, Bill. Good morning, everyone, and welcome to our call. Joining me today are Mark Casale, Chairman and CEO; and David Weinstock, Interim Chief Financial Officer. Also on hand for the Q&A portion of the call is Chris Curran, President of Essent Guaranty. Our press release, which contains Essent's financial results for the third quarter of 2022, was issued earlier today and is available on our website at essentgroup.com. 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 the risks and uncertainties, which may cause actual results to differ materially. For a discussion of these risks and uncertainties, 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 16, 2022, 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, Phil, and good morning, everyone. Today, we released our quarterly financial results, which continue to reflect the strong operating performance of our business. For the third quarter of 2022, we reported net income of $178 million as compared to $205 million a year ago. On a diluted per share basis, we earned $1.66 for the third quarter, compared to $1.84 a year ago and our annualized return on average equity was 17%. Our long-term outlook for housing remains constructive despite near-term headwinds. Sharply higher rates and elevated home price appreciation have pressured affordability, resulting in a slowdown of housing activity. However, housing inventory remains low at approximately three months, partially due to reductions in supply from the lock-in effect of existing homeowners and low rate mortgages. Also, favorable demographic trends should continue to provide foundational support to housing demand. As of September 30, our insurance in-force was $223 billion, a 7% increase compared to a year ago. Our three-month annualized persistency on September 30 was 84%, while the weighted average note rate of our book is approximately 3.7%. As a result, the rising rates should continue to translate to higher persistency for our in-force portfolio, which remains well positioned from both an expected duration and embedded home equity perspective. The credit quality of our insurance in-force remains strong, with a weighted average FICO of 746 and a weighted average original LTV of 92%. While the strong labor market has bolstered credit performance, forward results remain levered to unemployment trends. In the third quarter, we closed our eighth Radnor Re ILN transaction, obtaining $238 million of fully collateralized excess of loss reinsurance coverage on our NIW from October 2021 through July 2022. This follows our quota share and excess of loss transactions placed earlier in the year, covering 40% of…

Thanks, Mark and good morning, everyone. Let me review our results for the quarter in a little more detail. For the third quarter we earned $1.66 per diluted share compared to $2.16 last quarter and $1.84 in the third quarter a year ago. Net premium earned for the third quarter was $208 million and included $13.7 million of premiums earned by Essent Re on our third-party business. The net average premium rate for the U.S. Mortgage Insurance business in the third quarter was 35 basis points, a decrease of 3 basis points from the second quarter, driven primarily by higher reinsurance costs. Net investment income increased $3.3 million or 11% in the third quarter of 2022 compared to last quarter, due primarily to higher yields on new investments and floating rate securities resetting the higher rates. Other income in the third quarter was $11.4 million, which includes a $5.2 million gain due to an increase in the fair value of embedded derivatives in certain of our third-party reinsurance agreements. This compares to $1.6 million last quarter, which included a $5.5 million loss due to a decrease in the fair value of these embedded derivatives. The provision for loss and loss adjustment expenses was $4.3 million in the third quarter of 2022 compared to a benefit of $76.2 million in the second quarter and a benefit of $7.5 million in the third quarter a year ago. This quarter’s provision reflects an increase in the average reserve per default based on the composition of the default inventory and the current economic environment. Our reserve estimate on late stage delinquencies increased primarily due to continued low levels of foreclosure and claim activity. As a reminder, the provision for losses in the second quarter included a benefit of $62.9 million related to a change…

Thanks, Dave. During the third quarter, our business continued to generate high quality earnings and robust returns where our balance sheet and liquidity remains strong. We believe that our measured approach around excess capital is in the best long-term interest of our franchise and stakeholders, providing us both offensive and defensive optionality. As a result, we remain confident in the strength of our buy, manage and distribute operating model and view Essent is well positioned in supporting affordable and sustainable home ownership. Now, let’s get to your questions. Operator?

Thank you, sir. [Operator Instructions] We’ll take our first question this morning for Mark DeVries at Barclays.

Yes. Thank you. Mark, could you just discuss kind of what you’re doing around pricing here with some of the growing uncertainties in the market? And what you’re observing from competitors?

Sure. I mean, I think it starts with the environment Mark. As we said in the script, we’re clearly levered to unemployment. So it is a slowing economy as far as we’re seeing. You’re starting to see some weakness in the lower end consumer, particularly driven by inflation versus unemployment. Inflation is a very difficult for the unsecured borrower down kind of below 680, that’s our renter. A lot of that shelter inflation is hitting those guys hard and obviously not with us. But it’s certainly something we have our eye on. FHA delinquencies are up a bit and you’re starting to see some defaults in the single-family rental or at least delinquencies. And the single-family rental business, some of the larger ones that we follow their average FICO is kind of in that 660 to 680. So again, the environment’s there, you’re not really seeing it in unemployment. That’s pretty much a lagging indicator. But you’re starting to see other signs, particularly even around the technology sector. So, because of that and also I think just the capital markets are a bit volatile. We saw that with our eye on execution, you’re starting to see the Property and Casualty business harden, the pricing really hardened in that side of the business, which will probably draw capacity from the mortgage insurers. So when you – so the cost of reinsurance is going up to, so when you talk about cost to capital going up, slowing economy, elevated HPA and probably, Mark, more of a normalized credit environment. If we’re going to hold to 12% to 15%, longer-term returns, pricing just needs to come up. It’s kind of simple math. We are – we do have some support with higher investment yields. But our view, pricing has to come up. We…

Okay. That’s really helpful. And then just turning to capital deployment. I mean, you did raise the dividend, but you’ve been pretty conservative, I think that your premier’s sufficiency ticked up a decent amount of Q-over-Q. Can you just talk about how you’re thinking about deploying excess capital in this environment?

Yes. I mean, I think, again, we think the dividend, we are deploying it and we’re turning at the shareholders in the form of dividend. But again, I think when you see just where the environment is and we don’t have a crystal ball, Mark. We don’t really know where unemployment’s going to go and what the impact is. I think when you think about the procyclicality nature of PMRs it probably argues to be a little bit more conservative around excess liquidity. I mean, as we run through various stress amounts, you want to make sure you’re bolster there. So I think we’ll take a measured approach to it, as you’ve heard me say in the past. And I think the next, I don’t know, 12, 18 months, I think it’s all going to be all about the balance sheet. I really do. I don’t think it’s about growth, our insurance and force, pricing is clearly one aspect of it. But I would say that’s more of a defensive nature. I think when – again, when this is all through, I think a strong – I think we’re going to be in better shape, and I think our shareholders will be in better shape for us to have this type of balance sheet. And I think that’s something we believed in. It’s a long game. And the other part to think about it, Mark, is when you get into these environments sometimes those are the best times to invest. So you have to think of it that way. That’s the offensive nature of it. And when we look at investments, it could be as simple as additional data, strengthening additional employees, the foundation of the business in terms of our infrastructure. It could be potentially in new businesses. Essent was born at a dislocation, so we’re – we’ve seen kind of the movie before and I think sometimes longer-term, you’ve heard me say this. Longer-term for Essent, I can’t speak for others in the business, but for Essent to continue to maintain its growth, it’s going to have to find other sources of revenue. I mean, the mortgage insurance industry is a fantastic industry, but it’s only so big. So you have to keep that in mind. And again, the toughest times on the balance sheet and whether there’s stress are also sometimes the best times to invest. So we just want to make sure that we’re well balanced and we’re not kind of caught short and not able to take advantage of those opportunities.

Okay. Make sense. Thanks for all the comments.

Thank you. We go next now to Rick Shane of JPMorgan.

Thanks. Thanks guys for taking my question and good morning. I want to follow up a little bit Mark on your comments about pricing. And one of the things that we’re thinking about is that there are some pretty significant differences this cycle. One is that obviously we’re sort of in slow motion watching what everybody perceives to be an economic downturn and very specific views on certain geographies and certain things that are going to manifest. Also the industries move to much more granular dynamic pricing. I’m curious if you are seeing because of those two dynamics, greater disparity in terms of pricing dynamics than you’ve seen in the past? And does that make it more difficult? Because you might see overall trends in terms of pricing moving up, but pockets of risk that you like more increasingly competitive?

We don’t see any really discerning. I mean, I think there’s, clearly we see differences amongst the industry around MSAs, right? Certain players are picking MSAs that they don’t like and they’re kind of heavily emphasizing other MSAs that they do like. I think we’re a little bit there in the middle of the pack. I mean, again, we’re more of a frequency game. And our view is just to give you our top level view, Rick, in terms of HPA is we probably see it flattish for three to four years. And again, that’s part of the HPA rise really was driven by excess demand, right, from kind of that COVID excess demand on top of low rates, on top of a shortage of supply. So it’s kind of simple supply and demand. So we think that flattens out. It doesn’t mean there’s not going to be pockets or certain areas that have overbuilt that will see declines. That’s certainly – that’s going to happen. There’s no doubt that that’s going to happen. And you can price for some of that, but at the end of the day, you’re not going to price your way out of that. So I wouldn’t get – we don’t get – sometimes you can be a little bit, what is the old saying generally right or precisely wrong. So we have to be careful with the engine. So I think we have a broader perspective around the portfolio. I think it’s more around kind of the base rates versus picking and choosing on MSAs. I really think that that will be the driver longer-term.

Got it. I actually have not heard that expression before, but I like it and I appreciate the answer as well.

Thank you. We go next now to Doug Harter of Credit Suisse.

Hi, this is John Kilichowski on for Doug. Just look at the provision for losses here in this quarter. You can see the prior period reserve is down quarter-over-quarter and versus peers. I’m just kind of curious, is that conservatism on your part or is that just you’ve made the adjustment for the COVID vantages that you need to? Just would like some more color around that.

Yes, I’ll start and then Dave can add. Yes, I do think – I’m not sure about, again, we don’t really are familiar with what the competitors are doing there. But I think in terms of us, to remind everyone, we really highlight it, the COVID quarters second and third quarter kind of frozen. And then in the fourth quarter of 2020 went back to our normalized actuarial model. So a lot of the performance past that kind of ran through the model, so you saw a lot of pluses and minuses. And then in the last two quarters is where we really adjusted for the COVID to the point where I’m not sure we’re quite done with it, but we’re pretty much done with it. So I think that’s it. And then I think there was some additional changes to the reserves around some of the later stage buckets that I’ll let Dave comment on.

Yes. And John, as we’ve talked about in the script, we are seeing really not a return to normalcy for foreclosures and for claims. So foreclosure moratoriums kind of ended at the end of the first quarter. And not surprisingly we hadn’t seen a lot of foreclosure activity in the second quarter, but we thought that might start picking up in the third quarter and really did not significantly change much from the second quarter. Same thing really with claims activity. So we are – as we said, we’re seeing a kind of a build-up of some late stage delinquencies. And so that along with what’s happening in the environment with what you’re seeing with interest rates and maybe how that may affect borrowers and their options, especially severely delinquent borrowers. It just – it was something where we felt that clearly risk is building on these later stage delinquencies. And so that really drove an increase in the average reserve for default in the quarter. We still did have prior period – prior year favorable development. It was probably more muted than we’ve had in the prior quarters. And some of that’s going to be some of the timing things I think that Mark referred to.

Got it. Thank you very much for the color.

Thank you. We’ll go next now to Bose George at KBW.

Hi. This is actually Alex Bond on for Bose. This is more of a modeling question. But I was wondering if you could break out what goes into that other income line item. I know that you mentioned the change in the quarter was due to the change in fair value of the embedded derivatives. But yes, any color there on what else is included in that line item? And then also what would be a good run rate for other income going forward?

Yes. So other income is really a combination of a handful of things. We do have our MGA business. So we're providing consulting services to other reinsurers and that goes in there. We also are providing some services. We're still providing services to triad and our triad service fee goes in there. Those are probably – and then our contract underwriting business is also in there. So there's a handful of things in there. The thing that's going to move that around a lot is really going to be those embedded derivatives. And so that's why you see it fluctuate and that's something that is really going to be based on what happens in the market and really hard to predict. So I think that's one of the reasons we try to give those numbers so that you guys can kind of get an understanding why other income is moving around and kind of adjust for those variations.

Yes. For longer term, I wouldn't expect – and there's not like a run rate for it. Again, I think it's relatively – the MGA is probably the most, I would say, sustainable part of that income line. And that actually – that spikes in certain quarters because some of the – we have some profit commissions in some of the earlier agreements that we structure that are kind of paying off in the next couple of years but kind of stayed away in the outer years as it's gone more from just to a straight fee-for-service.

Okay. Great. That's helpful there. Appreciate the color. And then also just wondering if you guys could provide any guidance or outlook for operating expenses for next year.

Yes. Probably a little early. We generally give that guidance on the February call. So stay tuned there.

Okay, great. Makes sense. Thanks for taking the questions.

Thank you. We'll go next now to Mihir Bhatia of Bank of America. And Mr. Bhatia, your line is open. Would you have a question, sir?

Sorry, I was on mute. Good morning, thank you for taking my question. Wanted to start by asking about EssentEDGE. As we enter – or it looks like we're entering a time of economic volatility here with unemployment rising, and consumer finances becoming more stressed. I was curious about how that model is working and going to your comment about being generally right and precisely wrong. Are you finding yourselves needing to put any kind of qualitative overlays on top of what like, the pure quantitative model would split out or anything like that?

No. I mean, I would say there's two components to it. One, it's really the frequency part of the model and that really is driven from the raw – the soft credit pull and a lot of the variables that go into it. So it is a little bit more real-time and we believe more effective than FICO. And it should be. It's looking at more variables. It's particularly good as we move down the credit spectrum because there's obviously more of a discrepancy or diversion amongst really good credits versus not so good credit. So we like it from that aspect. I think the overlay – we have the technology around the HPA, but that is more of an overlay in terms of how we price the market. So keep – in fact – and again, the EDGE is really a – is a score. So it spits out pretty much an expected claim rate. And then as we always talk about unit economics, you kind of back solve for rate based on kind of return goals. In terms of just pricing in general, the other qualitative aspect could be you just expect to hire – you have a higher discount rate. So you expect a higher return given some of the uncertainty. But we do think in this environment, EDGE, it should provide a little bit of an advantage on the margin.

Great. And maybe just to follow up on that. The advantage on the margin, is that going to lead to in a little bit more stressed economic time? Does that lead to just better credit performance? Or is that also an opportunity to write more business in some of those bands where you're seeing the differentiated performance than some of your peers, maybe just because you have more confidence in your model?

Well, I think it depends, right. I mean it depends on how the size of the market. So the market historically below 700, hasn't been a very large market, which is both a blessing and a curse. I would say, if you don't have the technology, which the industry really didn't, with cards, it's probably more of a blessing. Hence, the strong high FICOs that we have in our portfolios, it's hard to price that. There's so much volatility around your mean expected losses when you get below 680. Hence, why you hold more capital, but it's certainly riskier for a reason. And it's not always priced appropriately. So I think when we talked about what we have heard in the industry about FHFA's change, that has the potential to significantly open up that market. Our view is at the top of the house is it's FHA probably changes their premiums also. So we have a bit of offsetting penalties. However, if that were to be an open market, I mean, you have to proceed with caution. We do think EDGE can help pick and choose a little bit better than FICO, but it may actually be the opposite. It keeps you away from those businesses. So you're pricing in a way because of the risky nature of it that you don't do as much in that market. And over time – I've been in the business for a while is – when consumer lenders, whether it's mortgage finance companies, autos, credit cards, when they go below kind of 680, they tend to lead with their chin, and they get attracted by the price and don't have a true appreciation for the volatility of the loss over an extended period of time, right. You can go below 680 and make a ton of money for a period of time. But in generally, over the course of it, it always catches up with you. So we're pretty cautious around that. I think you pick and choose for your opportunities, but I certainly wouldn't look at it as a way – I certainly wouldn't look at it as a growth opportunity. We like kind of where we are in the credit spectrum and the type of borrower we have now.

Okay, thank you.

Thank you. We’ll go next now to Rowland Mayor of RBC Capital Markets.

Hi, good morning. First one is a simple question. Is there any sort of interest rate cap on the revolving or the term loans? I'm trying to understand how that might drive your fall going forward.

Yes. There's no cap on it. It's just tied to a short-term index. So it's based on trailing market rates.

So certainly, we're sensitive to the rising rates there. The mitigant to that, Rowland, is twofold. One, it's not relatively. It's not that big of a number. And second is just the adjustable portion of our investment portfolio more than – is probably triple the size, if not more. So it certainly makes up for that.

Okay. And then last week, I think the FHFA announced the FICO and 10T would be able to use in the future. Does that have any effect on how EssentEDGE actually runs or part of your credit selection?

Hey, good morning. It's Chris. As far as the announcement on the alternate credit scores, I think from our perspective, certainly, the time line remains outstanding and as far as what the finality of it will look like. I think generally speaking, we're comfortable. We work with data, ongoing. So from our standpoint, as it relates to EDGE, I think we're going to be pretty comfortable in transitioning to the alternative credit scores.

Okay, perfect. Thank you for the answers.

Thank you. We’ll go next now to Eric Hagen of BTIG.

Hi, thanks. Good morning. Thanks for taking my question. I think I just have two. Following up on the conversation around unemployment, is there on the sensitivity analysis that you can maybe share around the PMIERs cushion on the reserve, the incremental changes in unemployment? Or do you feel like it's just too much of a lagging indicator that there's other factors at the loan level that you can really point to sort of sensitivity? And then how are we thinking about bringing new ILN transactions with costs at their current level? Like how much flexibility do you think you have to tweak the structure like the attachment or detachment? Or is there just not that much flexibility there? And just how we're thinking about that in general. Thank you.

Sure. I'll take the first one. I think you can kind of look at COVID, Eric. I mean we had 10% unemployment, and defaults were 5%. Our PMIERs excess at the time without the haircut was still in pretty good shape. I don't have the exact number off – at the top of my head. But I would look at that. I think – and then it's a continuum. So you can kind of do the math. And again, it's important to just point out the procyclicality nature of the calculation. So you have, in general, $0.05, $0.06, $0.07 of capital for a performing loan and then it goes up to $0.55 when you miss two or three payments. So that gross required asset could jump up. We get a nice deduction for the reinsurance. But again, if there's a potential dislocation in the reinsurance market, which by the way, we saw in COVID – and you always expect. We've been, again, around this business long enough to know and to go and get stuff – the capital markets gets going. So you have to think about core capital in that sense. Not that they're going to go away. Not that we wouldn't be an active issuer, but you have to be prepared for that. You have to be prepared that delinquencies go up to a certain amount. There's no haircut from the GSEs, and you have adequate capital to support the insurance company because, again, we look at the next downturn also as an opportunity to pay claims in a very fast and efficient manner, which I think longer term will only strengthen the reputation of the industry, both amongst our lenders and down in Washington. And those are the things – so you have to think about those…

Thank you. And it appears we have no further questions this morning. I'd like to turn the call back to our management team for any closing comments.

Okay. Well, thanks, everyone, for your participation, and have a great weekend.

Thank you very much. Again, ladies and gentlemen, that will conclude the Essent Group third quarter 2022 earnings conference Call. We'd like to thank you all so much for joining us and wish you all a great remainder of your day.