Essent Group Ltd. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014; unaudited. Unless noted otherwise, amounts below are in millions of dollars. Comparisons are with the corresponding 2013 periods.
Business context
Essent provides private mortgage insurance and reinsurance for U.S. residential mortgages, primarily supporting loans sold to Fannie Mae and Freddie Mac. It reported approximately $39.4 billion of insurance in force (IIF), $9.7 billion of risk in force (RIF), and an estimated 14% share of new insurance written (NIW) for the first half of 2014. Its insurance portfolio was young: 96% of IIF was originated since January 2012.
Financial performance and position
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net premiums written | $63.5 | $44.9 | $115.7 | $78.3 |
| Net premiums earned | $50.3 | $27.5 | $95.1 | $48.7 |
| Total revenue | $54.3 | $29.6 | $102.1 | $52.6 |
| Losses and operating expenses | $24.6 | $16.1 | $49.0 | $31.8 |
| Income before taxes | $29.7 | $13.4 | $53.1 | $20.8 |
| Income tax expense (benefit) | $10.1 | $(10.2) | $18.6 | $(10.0) |
| Net income | $19.6 | $23.6 | $34.6 | $30.8 |
| Diluted EPS | $0.23 | Not comparable | $0.41 | Not comparable |
Premiums earned rose 83% in Q2 and 95% for the half, mainly reflecting growth in average IIF. Investment income increased to $3.1 million for Q2 and $5.0 million for the half. The expense ratio, calculated as losses and expenses divided by revenue, improved to about 45% from 55% in Q2 and to 48% from 61% for the half. Net income fell in Q2 despite higher pretax income because 2014 included tax expense, while 2013 benefited from a deferred-tax valuation allowance release. First-half net income increased year over year.
At June 30, total assets were $925.4 million, investments $845.9 million, cash $14.2 million, liabilities $157.4 million, and stockholders’ equity $768.0 million. No conventional borrowings are identified in the supplied filing text; amounts due under the asset purchase agreement were $2.5 million. The company reported $45.2 million of operating cash flow for the first half, versus $47.8 million a year earlier. Investing activities used $504.7 million, largely as funds were invested in securities; cash declined by $463.5 million to $14.2 million. Management reported $855.2 million of net cash and investments, including $171 million at the holding company, and said liquidity was sufficient for expected needs over the next 12 months.
Combined statutory capital was $599.9 million and combined net RIF was $9.7 billion, giving a 16.2:1 risk-to-capital ratio, compared with a generally applicable state maximum of 25:1. Statutory capital exceeded regulatory requirements. The investment portfolio was investment grade; 51.7% was rated Aaa. Portfolio duration was 3.3 years including cash, with management estimating a 3.3% fair-value change for a parallel 100-basis-point rate move.
Material changes and developments
- IIF increased to $39.4 billion from $22.6 billion a year earlier; Q2 NIW was roughly flat at $5.9 billion, while first-half NIW declined to $9.5 billion from $10.2 billion.
- Defaults increased to 235 from 90 a year earlier, and the reported default rate rose to 0.13% from 0.09%. Loss reserves were $4.5 million, including $0.6 million of favorable prior-year development for the first half.
- Operating expenses rose to $23.6 million in Q2 and $47.1 million in the half, reflecting workforce growth, stock compensation, business expansion, and public-company costs. Staff numbered 323 versus 259 at June 30, 2013.
- Cash and investments shifted substantially toward securities: investments rose to $845.9 million from $332.6 million at year-end 2013, while cash declined from $477.7 million to $14.2 million.
Outlook, risks, and unusual items
- Management expected 2014’s effective tax rate to approach the U.S. federal statutory rate and anticipated a lower rate from 2015 as a greater share of earnings was expected in Bermuda. These are expectations, not earnings guidance.
- Management expects claims and loss provisions to rise as the young insurance book seasons; claim frequency is typically highest in years three through six. Actual losses depend on loan and borrower characteristics, housing prices, interest rates, employment, and cure experience.
- FHFA released draft Private Mortgage Insurer Eligibility Requirements (PMIERs) on July 10, 2014. If adopted, revised financial, liquidity, and operational standards could affect required capital and GSE eligibility. The public input period was expected to close September 8, 2014.
- Essent Re issued its first policy in July, covering up to $28.5 million of potential losses on a Freddie Mac loan pool. Essent Guaranty was also selected as sole insurer for a Fannie Mae pool of approximately $1.5 billion. A planned 25% quota-share reinsurance arrangement, effective July 1, was subject to Pennsylvania regulatory approval; the parent expected to contribute $100 million to Essent Re.
- Dividend capacity at Essent Guaranty was constrained: it had negative unassigned surplus and required Pennsylvania approval for distributions in 2014. The company cited GSE eligibility changes, competition, mortgage market volumes, reserve uncertainty, investment risk, and potential increases in claims among key risks.
- A North Carolina office lease extension to 2025 increased total operating lease obligations by $10.7 million. The filing reported no material legal proceedings, no material change in previously disclosed risk factors, and effective disclosure controls.
Important facts for investors to verify
- Final PMIERs requirements, their implementation timing, and Essent’s resulting capital and liquidity needs.
- Development of defaults, claims, reserve adequacy, and loss experience as the young portfolio seasons.
- Actual completion and regulatory approval of the 25% quota-share arrangement, including the planned $100 million contribution to Essent Re.
- Whether reported liquidity, statutory capital, and dividend restrictions support planned growth and obligations at both holding-company and insurance-subsidiary levels.
- Underlying tax-rate assumptions and the sustainability of premium growth, expense trends, and earnings as the business expands.