Essent Group Ltd. — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The filing is an annual report, not a standalone fourth-quarter filing; unaudited Q4 results are noted below. Essent is a Bermuda-based holding company whose principal business is U.S. private mortgage insurance, with related reinsurance operations.
Financial performance and operating metrics
| Metric | 2016 | 2015 | Change or context |
|---|---|---|---|
| Total revenue | $458.3 million | $353.3 million | Up 30% |
| Net premiums earned | $422.7 million | $326.5 million | Up 29%, primarily reflecting growth in average insurance in force |
| Net premiums written | $441.3 million | $370.6 million | Up 19% |
| Net investment income | $27.9 million | $19.9 million | Up 40%; average portfolio balance and reported yield increased |
| Provision for losses and LAE | $15.5 million | $11.9 million | Increased with defaults and portfolio seasoning; included favorable prior-year development of $6.4 million |
| Other underwriting and operating expenses | $130.9 million | $113.0 million | Up 16%, reflecting business growth, staffing and compensation |
| Income before tax | $311.9 million | $228.4 million | Up 37% |
| Net income | $222.6 million | $157.3 million | Up 42% |
| Diluted EPS | $2.41 | $1.72 | Up 40% |
| Loss / expense / combined ratios | 3.7% / 30.9% / 34.5% | 3.6% / 34.6% / 38.3% | Expense and combined ratios improved; loss ratio edged higher |
At year-end, insurance in force was $83.3 billion, up from $65.2 billion, and risk in force was $20.6 billion, up from $16.1 billion. New insurance written was $34.9 billion versus $26.2 billion; estimated flow-market share was 12.9%. Average premium rate rose to 0.57% from 0.56%, while persistency declined to 77.7% from 80.2%. Loans in default were 1,757, or 0.47% of policies in force, versus 1,028, or 0.35%, a year earlier.
Q4 2016: Net premiums earned were $116.8 million, net income was $62.7 million, and diluted EPS was $0.68. Q4 2015 net income was $44.5 million and diluted EPS was $0.48.
Balance sheet, cash flow and capital
- Total assets were $1.883 billion and stockholders’ equity was $1.344 billion, compared with $1.469 billion and $1.119 billion, respectively, at year-end 2015.
- Cash and investments totaled approximately $1.643 billion, including $1.615 billion of investments and $27.5 million of cash. Investments represented 87.2% of total assets and were predominantly investment-grade.
- Operating cash flow was $273.5 million, compared with $224.1 million in 2015. Investing activities used $365.3 million; financing activities provided $94.8 million. Cash increased by $2.9 million.
- The company had $100 million drawn under a $200 million, three-year revolving facility; the weighted-average borrowing rate was 2.73%. Total liabilities were $539.2 million. Management said liquidity was sufficient for expected obligations and committed expenditures over the next 12 months.
- U.S. insurance subsidiaries’ combined statutory capital was $1.144 billion and combined net risk in force was $16.802 billion, producing a 14.7:1 risk-to-capital ratio. Essent Guaranty complied with PMIERs; its reported available assets of $1.18 billion exceeded minimum required assets of $1.13 billion by approximately $50 million.
- Essent Re had $401.3 million of GAAP equity and $4.2 billion of net risk in force. The company contributed $130 million to Essent Re during 2016. Certain assets supporting reinsurance obligations were held in trusts.
Material changes, outlook and notable items
- Growth in insurance in force and average premium rate drove premium growth and earnings. Investment income also increased as the average portfolio balance grew and reported pre-tax yield rose to 2.1% from 1.9%.
- The default rate rose as the book expanded and seasoned. Management expects defaults, claims and loss provisions to increase as the young portfolio ages; it noted that 83% of year-end insurance in force originated since January 2014, while historical claim incidence is highest in years three through six.
- Management expected the expense ratio for full-year 2017 to decline versus 2016 as earned premiums grow faster than expenses. It also expected a lower effective tax rate in 2017 as a greater share of consolidated earnings was expected to arise in Bermuda. These are expectations, not quantified earnings guidance.
- In the third quarter, ACIS contracts were amended and changed from derivative accounting to insurance accounting. At year-end the company reported no derivative instruments. The filing attributes part of the increase in other income to favorable valuation adjustments on ACIS contracts previously accounted for as derivatives.
- Loss reserves are established for loans in default, not for future defaults on currently performing insured loans. Reserves therefore depend on estimates and may not reflect ultimate losses on the entire in-force portfolio. Favorable prior-year reserve development was $6.4 million in 2016.
- Key risks include dependence on Fannie Mae and Freddie Mac and their eligibility rules, competition from other insurers and government programs, large-customer concentration, low-down-payment mortgage volumes, persistency, investment and interest-rate risk, and the expected maturation of the insured book. The top ten customers generated 35.1% of 2016 flow NIW; one customer represented 12% of revenue.
- The filing reports no material legal proceedings. It also notes a CFPB inquiry received in January 2012 concerning captive reinsurance practices; Essent stated it had no such arrangements, but the filing text does not clearly state the inquiry’s final disposition.
- The company paid no common-share dividends and said it did not expect to do so for the foreseeable future. Subsidiary dividend payments are subject to regulatory restrictions. The auditor reported that the consolidated statements were fairly presented under GAAP and that internal control over financial reporting was effective.
Important facts for investors to verify
- Whether the anticipated 2017 decline in expense and tax ratios materialized, and how much earnings growth depended on Bermuda-generated income.
- How defaults, claims, claim severity and reserve development evolve as the portfolio reaches its historically higher-claim years; distinguish favorable prior-year development from underlying current-year loss experience.
- Whether Essent maintains PMIERs compliance and adequate assets above minimum requirements as risk in force expands, including the effects of regulatory or GSE rule changes.
- Customer concentration and retention, especially the customer contributing 12% of revenue, as well as trends in market share, pricing and policy persistency.
- The final status of the CFPB inquiry, and the effects of changes to GSE policy, mortgage-insurance eligibility, and competition from FHA or other credit-risk-transfer alternatives.
- Availability of holding-company liquidity and permitted subsidiary dividends, given the $100 million facility borrowing and restrictions on upstream distributions.