Essent Group Ltd. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; unaudited. Essent provides U.S. private mortgage insurance and reinsurance, primarily supporting low-down-payment mortgages sold to Fannie Mae and Freddie Mac.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net premiums earned | $110.8 million | $83.7 million | $305.9 million | $237.1 million |
| Total revenue | $121.3 million | $91.7 million | $331.9 million | $255.8 million |
| Provision for losses and LAE | $5.0 million | $3.4 million | $11.7 million | $7.7 million |
| Other underwriting and operating expenses | $32.8 million | $28.7 million | $95.6 million | $83.4 million |
| Net income | $59.7 million | $40.8 million | $159.9 million | $112.9 million |
| Diluted EPS | $0.65 | $0.44 | $1.74 | $1.23 |
For Q3, revenue rose about 32% and net income about 46% year over year. For the first nine months, revenue increased about 30% and net income about 42%. Management attributed the improvement mainly to growth in insurance in force and earned premiums, higher investment income, and favorable ACIS valuation effects, partly offset by higher expenses, loss provisions, and taxes.
- Business growth: New insurance written was $10.3 billion in Q3 and $24.5 billion for the nine-month period, versus $7.6 billion and $20.2 billion, respectively, in 2015. Ending insurance in force was $77.6 billion, up from $62.1 billion a year earlier; market share was estimated at 12.4% for the nine months.
- Margins and losses: The filing reports no explicit operating-margin measure. Loss provision increased as defaults and the portfolio grew and seasoned. Q3 provision included $6.8 million of current-year losses, partly offset by $1.9 million of favorable prior-year development; nine-month prior-year development was favorable by $4.7 million.
- Cash flow: Nine-month operating cash flow was $198.8 million, investing cash flow was negative $251.8 million, and financing cash flow was positive $44.7 million. Cash declined $8.3 million to $16.3 million. Investing outflows reflected portfolio investment activity and investment of revolver proceeds.
- Financial position: At September 30, total assets were $1.82 billion, investments $1.58 billion, total liabilities $507.5 million, and stockholders’ equity $1.31 billion. Investments increased from $1.28 billion at year-end 2015; equity rose from $1.12 billion.
- Debt and liquidity: The company had $50 million drawn on a $200 million secured revolving facility, leaving $150 million available; the reported borrowing rate was 2.52%. Cash and investments totaled approximately $1.75 billion. Management said liquidity was sufficient for operating needs and committed capital expenditures over the next 12 months.
- Insurance capital: U.S. subsidiaries’ combined statutory capital was $1.08 billion, net risk in force $15.9 billion, and risk-to-capital ratio 14.8:1; the company noted a generally applicable maximum of 25:1. Essent Guaranty reported $1.12 billion in PMIERs available assets against $1.06 billion required and was compliant.
Material changes, outlook, and risks
- Q3 new defaults were 1,015, and ending default inventory rose to 1,453 from 814 a year earlier. The default rate increased to 0.41% from 0.29%. Management expects defaults and claims to rise as the relatively young insurance book seasons, with 80% of insurance in force originated since January 1, 2014.
- During Q3, ACIS contracts were amended and are now accounted for as insurance contracts rather than derivatives. Before the amendment, changes in their fair value affected earnings; a $2.0 million favorable valuation adjustment contributed to Q3 other income. The company also recorded $73,000 of other-than-temporary investment impairments in the quarter, citing intent to sell the affected securities after the reporting date.
- Management expects the expense ratio to decline for full-year 2016 versus 2015 and for 2017 versus 2016 as earned premiums grow faster than underwriting and operating expenses. The filing provides no specific earnings or revenue guidance.
- Key risks include changes in GSE requirements or business practices, failure to meet PMIERs, competition and customer concentration, mortgage-origination trends, uncertainty in loss reserves, economic or housing-market deterioration, interest-rate and investment risks, and potential increases in claims as the portfolio matures. The company reported no material change to previously disclosed risk factors and no material legal proceedings.
- Essent Guaranty had negative unassigned surplus of approximately $4.6 million and would need Pennsylvania regulatory approval to pay a dividend in 2016. The filing says insurance subsidiaries were in compliance with applicable rules and agreements. The $50 million revolver borrowing was contributed to Essent Re to support new business.
Important facts for investors to verify
- Whether default rates, claims, and reserve estimates rise as the young insured portfolio seasons; assess the significance of favorable prior-year reserve development.
- Whether PMIERs available assets continue to exceed required assets, and how much capital headroom remains as insurance in force grows.
- How the ACIS contract amendment affects future premium recognition, earnings comparability, and risk transfer.
- Whether premium growth, persistency, and policy mix support profitability; reported persistency was 79.4%, and monthly and single-premium policies represented 80.9% and 19.1% of nine-month new insurance written.
- Investment portfolio exposure to interest rates, credit quality, and liquidity, including the reported 3.5-year duration including cash.
- Use and cost of revolver capacity, and restrictions on upstreaming capital from regulated insurance subsidiaries.