Essent Group Ltd. quarterly report, Q1 FY2016

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Essent Group Ltd. — Q1 2016 Form 10-Q

Business context and reporting period

Essent provides private mortgage insurance and related reinsurance for U.S. residential mortgages. This unaudited filing covers the three months ended March 31, 2016, compared with Q1 2015; balance-sheet comparisons are with December 31, 2015. The company reported an estimated 11.9% private mortgage insurance market share, $67.7 billion of insurance in force (IIF), and $16.7 billion of risk in force at quarter-end.

Financial results and position

  • Revenue: Total revenue was $102.5 million, up 28% year over year. Net premiums earned were $94.4 million, up 26%; net premiums written were $100.5 million, up 22%. Net investment income increased to $6.2 million from $4.3 million.
  • Profit: Net income was $48.0 million, up 38% from $34.8 million. Diluted EPS was $0.52 versus $0.38. Income before taxes was $67.3 million; income tax expense was $19.4 million and the effective tax rate was 28.8% (31.0% in Q1 2015).
  • Margins and expenses: Calculated from reported figures, net income was 46.8% of revenue versus 43.5% a year earlier. Other underwriting and operating expenses rose 14% to $31.4 million; provision for losses and LAE increased to $3.7 million from $2.0 million.
  • Cash flow: Operating cash flow was $67.5 million, compared with $47.2 million. Investing activities used $61.1 million and financing activities used $2.8 million. Cash increased $3.6 million to $28.2 million.
  • Balance sheet and liquidity: Total assets were $1.57 billion and stockholders’ equity was $1.18 billion at March 31. Investments totaled $1.37 billion, including $83.5 million of short-term investments. The company reported no debt; holding-company net cash and investments were $70.7 million.
  • Capital: U.S. insurance subsidiaries’ combined statutory capital was $960.8 million, with a 14.8:1 risk-to-capital ratio. Essent Guaranty was in compliance with GSE eligibility requirements (PMIERs); the filing states statutory capital exceeded regulatory requirements.

Material changes versus Q1 2015 and year-end

  • Growth in average IIF—from $52.0 billion to $66.4 billion—was the principal driver of higher earned premiums. The average premium rate declined to 0.56% from 0.58%.
  • IIF ended the quarter at $67.7 billion, up from $53.3 billion a year earlier. Q1 2016 included $5.37 billion of flow NIW and $93 million of bulk NIW; cancellations were $2.99 billion.
  • Defaults at quarter-end increased to 1,060 from 505 a year earlier; the default rate rose to 0.34% from 0.21%. The loss reserve increased to $20.5 million from $10.1 million a year earlier. Prior-year loss development remained favorable by $1.3 million in Q1 2016.
  • Investment fair value rose to $1.37 billion from $1.28 billion at year-end. Other comprehensive income included $13.4 million of after-tax unrealized investment gains.

Outlook, commentary, risks and unusual items

  • Management expected the expense ratio for full-year 2016 to decline versus 2015 as earned premiums grow faster than underwriting and operating expenses. No specific earnings or revenue guidance was provided.
  • Management expects defaults, claims and loss provisions to rise as the relatively young insurance portfolio seasons; 72% of IIF was from business written since January 1, 2014. Actual losses depend on portfolio characteristics and economic factors, including home prices, interest rates and employment.
  • On April 19, 2016, after quarter-end, Essent entered a three-year secured revolving credit facility with $200 million of committed capacity. No amounts had been borrowed as of the filing date. Management said liquidity was sufficient for the next 12 months, while noting additional capital could be needed for regulatory or GSE requirements or business growth.
  • Essent Guaranty had negative unassigned surplus of approximately $33.1 million and would need Pennsylvania regulatory approval to pay dividends in 2016. Essent Re had $233.3 million of total equity and a $100 million minimum-equity commitment under its quota-share agreement.
  • Investment risks include interest-rate, credit, concentration and prepayment risk. Portfolio effective duration, including cash, was 3.7 years; a parallel 100-basis-point rate shift was estimated to change portfolio fair value by 3.7%. Certain ACIS derivative valuations use significant unobservable inputs and are judgment-sensitive.
  • No material legal proceedings or material changes to previously disclosed risk factors were reported. Management reported effective disclosure controls and no material change in internal control over financial reporting.

Important facts for investors to verify

  • Whether IIF and premium growth can continue despite the lower average premium rate and changing business mix.
  • How default rates, claims, reserve estimates and prior-year favorable development evolve as the young portfolio seasons.
  • Ongoing PMIERs and state-capital compliance, including the practical availability of subsidiary capital and dividends.
  • Investment portfolio sensitivity to rates and credit conditions, and the assumptions underlying ACIS derivative valuations.
  • Terms, collateral and potential use of the $200 million revolving facility, and whether management’s liquidity outlook changes.