Essent Group Ltd. — Q2 2016 Form 10-Q
Business context and reporting period. Essent provides U.S. private mortgage insurance and reinsurance, primarily for loans sold to Fannie Mae and Freddie Mac. This unaudited filing covers the three and six months ended June 30, 2016, compared with the corresponding 2015 periods. Amounts below are in millions of dollars unless stated otherwise.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Net premiums written | $108.5 | $92.4 | $209.0 | $174.7 |
| Net premiums earned | $100.7 | $78.4 | $195.1 | $153.4 |
| Total revenues | $108.2 | $84.1 | $210.6 | $164.1 |
| Provision for losses and LAE | $3.0 | $2.3 | $6.7 | $4.3 |
| Other underwriting and operating expenses | $31.4 | $27.1 | $62.8 | $54.6 |
| Income before taxes | $73.8 | $54.6 | $141.1 | $105.1 |
| Net income | $52.3 | $37.2 | $100.2 | $72.0 |
| Diluted EPS | $0.57 | $0.41 | $1.09 | $0.79 |
Management attributed higher earnings mainly to growth in insurance in force and investment income, partly offset by higher operating expenses, loss provision and taxes. Net premiums earned rose 29% in Q2 and 27% in the first half. The average premium rate was 0.57% in Q2, unchanged year over year; for the first half it was 0.56%, versus 0.57%.
Balance sheet, cash flow and capital
- At June 30, total assets were $1.66 billion, including $1.44 billion of investments and $16.2 million of cash. Stockholders’ equity was $1.25 billion, up from $1.12 billion at year-end 2015.
- First-half operating cash flow was $122.1 million, compared with $89.8 million in 2015. Investing activities used $125.6 million and financing activities used $5.0 million; cash declined $8.4 million to $16.2 million.
- A new three-year secured revolving facility provides up to $200 million. No amount was drawn at June 30 or as of the filing date; the company reported covenant compliance. No other debt balance is reported.
- Management reported substantial liquidity, including $129.2 million of short-term investments and $1.3 billion of fixed maturities. Holding-company net cash and investments were $42.3 million.
- Combined U.S. insurance-company statutory capital was $1.02 billion against $15.0 billion of combined net risk in force, for a 14.8:1 risk-to-capital ratio. Essent Guaranty complied with PMIERs; its available assets of $1.06 billion exceeded minimum required assets of $993 million.
Material changes and operating indicators
- Insurance in force reached $72.3 billion, up from $57.4 billion a year earlier; first-half new insurance written was $14.2 billion versus $12.6 billion. Reported market share was 12.1% for the first half.
- Net investment income increased to $6.7 million in Q2 from $4.7 million, and to $12.9 million for the first half from $9.0 million. Management cited a larger portfolio and a higher pretax yield, 2.1% versus 1.8%.
- Defaults at period-end rose to 1,174 from 605 a year earlier; the reported default rate increased to 0.36% from 0.23%. The company said increases reflected growth and seasoning of the insured book. First-half loss provision included $2.9 million of favorable prior-year development.
- Investment fair value rose to $1.44 billion from $1.28 billion at year-end. First-half other comprehensive income was $24.1 million, principally reflecting unrealized investment gains.
Outlook, risks and unusual items
- Management expected net premiums earned to grow faster than underwriting and other expenses, resulting in a lower full-year 2016 expense ratio than in 2015. No specific earnings or revenue guidance was provided.
- The portfolio is relatively young: 77% of insurance in force was written since January 1, 2014, and substantially all policies were less than three years old. Management expects claims and loss provision to increase as the book seasons; ultimate defaults and claim severity remain uncertain and depend partly on housing, interest rates and employment.
- Key disclosed risks include GSE policy or eligibility changes, competition and alternatives to private mortgage insurance, lower low-down-payment originations, premium adequacy, reserve-estimation uncertainty, investment and interest-rate risk, and regulatory or capital requirements.
- The investment portfolio had $1.9 million of gross unrealized losses at June 30, compared with $8.9 million at year-end; management primarily attributed these to interest-rate changes. A $7,000 other-than-temporary impairment was recorded in the first half.
- Essent paid $42,173 for contract-underwriting remedies in the first half; management said potential related claims were not material. The company reported no material legal proceedings and no material change in previously disclosed risk factors.
- Management said it had sufficient liquidity for operating needs and committed capital expenditures over the next 12 months, while noting that additional capital could be needed for regulatory or GSE requirements, portfolio growth or new business. Essent Guaranty had negative unassigned surplus and would need prior Pennsylvania regulatory approval to pay dividends in 2016.
Important facts for investors to verify
- Whether rising defaults and claims as the young insurance portfolio seasons are matched by adequate reserves and capital.
- How PMIERs available-asset headroom and the 14.8:1 risk-to-capital ratio evolve as insurance in force grows.
- Whether premium growth, persistency and product mix support the expected decline in the expense ratio; reported persistency was 81.0%.
- How investment yields, interest-rate movements and the portfolio’s 3.6-year duration affect investment income, asset values and liquidity.
- Any changes in GSE eligibility requirements, insurance-company dividend restrictions, or use of the $200 million credit facility.