Essent Group Ltd. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Unaudited consolidated results; financial amounts below are in U.S. dollars unless stated otherwise.
Business context
Essent provides private mortgage insurance and reinsurance for U.S. residential mortgages, principally those sold to Fannie Mae and Freddie Mac. Its primary insurer, Essent Guaranty, was compliant with revised PMIERs 2.0 at quarter-end.
Financial results and key metrics
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenue | $226.4 million | $185.0 million | $638.8 million | $526.2 million |
| Net premiums earned | $203.5 million | $166.7 million | $569.8 million | $476.2 million |
| Net investment income | $21.1 million | $16.6 million | $61.6 million | $45.5 million |
| Provision for losses and LAE | $10.0 million | $5.5 million | $22.1 million | $12.6 million |
| Net income | $144.6 million | $116.0 million | $408.8 million | $338.8 million |
| Diluted EPS | $1.47 | $1.18 | $4.16 | $3.46 |
- Q3 revenue increased 22.4% and net income increased 24.7% year over year; nine-month revenue and net income rose approximately 21% each. Management attributed the improvement mainly to portfolio growth and higher investment income.
- Q3 net premiums earned rose 22%, while average net premium rate declined to 0.49% from 0.50%. The calculated Q3 operating-expense ratio (other underwriting and operating expenses divided by net premiums earned) was approximately 20.4%, versus 22.1% a year earlier. The filing provides no reported overall profit-margin target.
- New insurance written was $18.7 billion in Q3, up from $13.9 billion; nine-month NIW was $47.7 billion, versus $36.1 billion. Insurance in force reached $161.0 billion, up from $131.2 billion a year earlier. Persistency was 82.1%.
- At September 30, total assets were $3.72 billion, investments $3.31 billion, cash $49.6 million, and stockholders’ equity $2.86 billion. Equity increased from $2.37 billion at year-end 2018, reflecting earnings and unrealized investment gains.
- Nine-month operating cash flow was $424.6 million, down from $486.0 million. Investing cash outflow was $416.4 million; financing cash outflow was $23.5 million. Cash declined $15.4 million from year-end.
- Credit-facility borrowings were $225 million, with a $275 million revolving capacity available; the facility matures May 17, 2021. Weighted-average borrowing rate at quarter-end was 4.05%. The company reported covenant compliance.
- Combined U.S. insurance-company risk-to-capital ratio was 13.4:1. Essent Guaranty reported $2.21 billion of PMIERs Available Assets against $1.39 billion of Minimum Required Assets.
Material changes versus prior comparable periods
- Growth in average insurance in force drove higher earned premiums, although ceded premiums, pricing changes, and business mix contributed to lower average net premium rates.
- Q3 default inventory increased to 5,232 from 3,538 a year earlier, and the reported default rate rose to 0.75% from 0.61%. Loss provision increased, partly offset by favorable prior-year reserve development of $4.7 million in Q3 and $15.8 million year to date.
- Investment portfolio fair value rose to $3.23 billion from $2.76 billion at year-end 2018. Unrealized investment gains lifted accumulated other comprehensive income to $62.7 million from a $29.0 million loss.
- Operating cash flow decreased despite higher net income, principally because of increased purchases of U.S. Mortgage Guaranty Tax and Loss Bonds.
Outlook, commentary, risks and unusual items
- Management expected net premiums earned to grow faster than underwriting and other expenses, resulting in a lower full-year 2019 expense ratio than in 2018. The filing provides no earnings or revenue guidance.
- Management said liquidity was sufficient for operating needs, obligations, and committed capital expenditures over the next 12 months. It noted that additional capital could be needed for regulatory or GSE requirements, portfolio growth, or new initiatives.
- Management expects claims and loss provisions to increase as the relatively young insured portfolio seasons; 73% of insurance in force was written since January 2017. Actual losses depend on defaults, housing prices, interest rates, employment, and loan characteristics.
- Effective September 1, Essent Guaranty began a quota-share arrangement covering eligible policies written through December 2020: 40% of risk on eligible single-premium policies and 20% on other eligible policies. Risk in force ceded under the agreement was $320 million at quarter-end.
- The company declared its first quarterly cash dividend of $0.15 per share during Q3; a further $0.15 dividend was declared in November, payable December 16, 2019. Essent Re also paid a $40 million dividend to the holding company during the nine-month period.
- Moody’s upgraded Essent Guaranty to A3 with a stable outlook on October 17, 2019. The company reported no material legal proceedings, no material changes to previously disclosed risk factors, and effective disclosure controls.
- Key risks include changes to GSE rules or eligibility, competition and reduced low-down-payment mortgage originations, reserve-estimation uncertainty, economic and housing-market deterioration, investment and interest-rate risk, reinsurance counterparty exposure, and restrictions on subsidiary dividends. The investment portfolio’s effective duration was 3.3 years; management estimated a 100-basis-point parallel rate move would change its fair value by approximately 3.3%.
Important facts for investors to verify
- Whether portfolio seasoning leads to higher default rates, claims, and loss reserves, and whether favorable prior-year reserve development continues.
- How reinsurance affects net premium rates, retained risk, PMIERs capital, and future claim recoveries; review reinsurer credit quality and contract termination terms.
- Whether premium growth and investment income can offset pricing pressure, increased ceded premiums, and operating-cost growth.
- Liquidity and capital availability at the holding company and regulated insurance subsidiaries, including facility maturity, dividend restrictions, and compliance with PMIERs and statutory requirements.
- Investment portfolio exposure to interest rates, credit spreads, prepayments, and less-liquid holdings; assess the implications of assets held in reinsurance trusts.