Business context and reporting period
Essent Group Ltd. is a Bermuda-based holding company providing U.S. residential private mortgage insurance and reinsurance, primarily supporting low-down-payment loans sold to Fannie Mae and Freddie Mac. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods unless noted. Dollar amounts below are in millions.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $185.0 | $150.2 | $526.2 | $415.4 |
| Net premiums earned | $166.7 | $137.9 | $476.2 | $382.2 |
| Net investment income | $16.6 | $10.6 | $45.5 | $28.5 |
| Provision for losses and LAE | $5.5 | $4.3 | $12.6 | $9.8 |
| Income before taxes | $140.1 | $107.4 | $394.6 | $293.2 |
| Net income | $116.0 | $78.4 | $338.8 | $217.1 |
| Diluted EPS | $1.18 | $0.82 | $3.46 | $2.31 |
Net income grew approximately 48% in Q3 and 56% for the nine-month period. Net income as a share of revenue was approximately 62.7% and 64.4%, respectively, versus 52.2% and 52.3% in 2017. Management attributed higher earnings mainly to portfolio growth, higher investment income and lower taxes, partly offset by increased loss provisions and interest expense. The effective tax rate was 16.2% in 2018 versus 27.0% in 2017, primarily reflecting the lower U.S. corporate tax rate and the expected share of earnings generated in Bermuda.
For the nine months, operating cash flow was $486.0 million, compared with $252.0 million; investing cash flow was $(443.0) million, compared with $(485.1) million; and financing cash flow was $(56.7) million, compared with $263.3 million. Cash declined $13.7 million to $29.8 million. At September 30, total investments were $2.69 billion, total assets $2.99 billion, stockholders’ equity $2.22 billion, and credit-facility borrowings were $225 million principal ($223.5 million carrying value). The company reported $275 million of available revolving capacity. The facility matures May 17, 2021; the company was in covenant compliance.
Material changes versus the prior comparable period
- Net premiums earned increased 21% in Q3 and 25% year to date, driven by higher average insurance in force (IIF), partly offset by lower average net premium rates.
- Insurance in force reached $131.2 billion, up from $103.9 billion a year earlier; nine-month new insurance written was $36.1 billion versus $32.6 billion.
- Net investment income increased as the average portfolio grew and the reported pretax yield rose to 2.6% for Q3 and 2.5% year to date, from 2.3% and 2.2%.
- Loss provision rose to $12.6 million for the first nine months, while defaults reached 3,538 from 2,153 a year earlier. Favorable prior-year reserve development was $12.6 million, versus $9.5 million in 2017.
- Income tax expense fell to $55.8 million from $76.1 million for the first nine months. Interest expense increased to $7.6 million from $3.4 million.
- Accumulated other comprehensive loss widened to $47.4 million from $3.3 million at year-end 2017, largely reflecting unrealized investment losses. Total investments increased from $2.31 billion at year-end.
Outlook, commentary, risks and unusual items
- No numerical earnings or revenue guidance was provided. Management expected the 2018 expense ratio to decline from 2017 as earned premiums grow faster than underwriting and operating expenses.
- A June 2018 reduction in published prices is expected to lower average net premium rates in future periods. The Q3 average net premium rate was 0.50%, versus 0.53% a year earlier; nine-month rates were 0.51% and 0.53%.
- Management expects losses and claims to rise as the relatively young insurance portfolio seasons: 77% of IIF was originated since January 1, 2016. It cautioned that future defaults and reserve severity depend on portfolio characteristics and economic conditions.
- Essent Guaranty was compliant with existing PMIERs. Revised PMIERs 2.0 are expected to take effect March 31, 2019; management expects continued compliance. Under the existing framework, Available Assets were $1.82 billion versus Minimum Required Assets of $1.46 billion.
- In March 2018, Essent Guaranty entered fully collateralized excess-of-loss reinsurance covering up to $424.4 million of specified 2017-vintage exposure. The agreement reduces risk in force and PMIERs asset requirements; the company’s estimated off-balance-sheet maximum exposure associated with the reinsurer was $21.0 million.
- Hurricane-related defaults declined to 301 from 2,288 at year-end 2017; related reserves remained $11.1 million. Future claims from these defaults remain uncertain.
- One lender accounted for 10% of nine-month revenue; the top ten customers represented 42.8% of nine-month flow NIW. The loss of a significant customer could materially affect results.
- Investment fair value included $57.4 million of gross unrealized losses, principally attributed to interest-rate and credit-spread changes; the company reported no other-than-temporary impairments. A 100-basis-point parallel rate move was estimated to change portfolio fair value by 3.7% including cash.
- Management said liquidity was sufficient for expected obligations and committed capital expenditures over the next 12 months, while noting that new regulatory or GSE capital requirements, portfolio growth or new initiatives could require additional capital. No material legal proceedings or material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Track default inventory, claims, reserve adequacy and the sustainability of favorable prior-year reserve development as the book seasons.
- Assess the effects of pricing reductions, persistency, business mix and ceded reinsurance on premium rates and profitability.
- Confirm continued PMIERs compliance and available capital under PMIERs 2.0, as well as statutory capital and dividend restrictions.
- Monitor investment valuation, unrealized losses, interest-rate sensitivity and the liquidity of assets, including assets held in reinsurance trusts.
- Review customer concentration, especially the lender contributing 10% of nine-month revenue, alongside mortgage origination trends and GSE or regulatory changes.