Essent Group Ltd. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Essent provides U.S. residential mortgage insurance and reinsurance. All figures below are in U.S. dollars; financial statement amounts are unaudited.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $137.6m | $108.2m | $265.2m | $210.6m |
| Net premiums earned | $126.6m | $100.7m | $244.2m | $195.1m |
| Net investment income | $9.4m | $6.7m | $17.8m | $12.9m |
| Provision for losses and LAE | $1.8m | $3.0m | $5.5m | $6.7m |
| Other underwriting and operating expenses | $35.7m | $31.4m | $72.0m | $62.8m |
| Net income | $72.1m | $52.3m | $138.7m | $100.2m |
| Diluted EPS | $0.77 | $0.57 | $1.49 | $1.09 |
| Operating cash flow | — | — | $144.4m | $123.1m |
Q2 revenue increased about 27% and net income about 38% year over year; for the first half, revenue rose about 26% and net income about 38%. Management attributed the improvement principally to growth in insurance in force and investment income. Growth was partly offset by higher operating expenses, interest expense and taxes. Net premiums earned increased 26% in Q2 and 25% for the first half, while average premium rates declined to 0.53% from 0.57% and 0.56%, respectively.
Balance sheet and liquidity: At June 30, total assets were $2.15bn, investments $1.84bn, cash $27.7m, total liabilities $655.0m and stockholders’ equity $1.50bn. Equity was $1.34bn at December 31, 2016. Six-month investing cash outflow of $209.5m largely reflected investment purchases; financing cash inflow was $65.2m, including net credit-facility borrowing. Cash increased only $0.1m during the period.
Business, capital and debt
- Insurance in force reached $95.5bn, up from $72.3bn a year earlier; risk in force was $23.7bn. First-half new insurance written was $19.4bn versus $14.2bn, with estimated market share of 15.9%.
- Persistency was 80.1%; the average premium rate was 0.53%. The default rate was 0.41%, versus 0.36% a year earlier, and ending defaults rose to 1,776 from 1,174.
- Combined U.S. insurer net risk in force was $18.9bn and statutory capital $1.27bn, producing a 14.9:1 risk-to-capital ratio; the filing notes a generally applicable maximum of 25:1. Essent Guaranty remained compliant with PMIERs. Its reported available assets of $1.31bn exceeded minimum required assets of $1.28bn, based on the company’s interpretation.
- A May 2017 amended and restated secured credit facility provides $375m of committed capacity, including a $250m revolver, $125m term loans and a $75m uncommitted line. Borrowings were $175m at June 30, at a weighted-average interest rate of 3.21%; $200m remained available. The term loans mature May 17, 2021. The company reported covenant compliance.
Material changes, outlook and risks
- Loss provision declined year over year, despite more defaults, partly because prior-year reserve development was favorable: $6.7m for the first half of 2017 versus $2.9m in 2016. Management cautioned that defaults and claims may rise as the young portfolio seasons; 74% of insurance in force was originated since January 1, 2015. Reserve estimates depend on default cures, housing and economic conditions, and claim severity.
- Management expected net premiums earned to grow faster than underwriting and other expenses, resulting in a lower full-year 2017 expense ratio than in 2016. No numerical earnings or revenue guidance was provided. Management believed liquidity was sufficient for operating needs and obligations over the next 12 months, while noting possible additional capital needs from regulatory or GSE requirements, portfolio growth or new initiatives.
- Key exposures include changes to Fannie Mae and Freddie Mac or PMIERs, mortgage-market competition and low-down-payment loan volume, portfolio seasoning and loss-reserve uncertainty, housing and employment conditions, interest rates, investment credit and liquidity risk, and access to capital. PMIERs updates were expected no earlier than 2018, with effectiveness no sooner than the fourth quarter of 2018, according to the company’s understanding.
- Investment portfolio fair value was $1.84bn; effective duration including cash was 3.8 years. A 100-basis-point parallel yield-curve move was estimated to change portfolio fair value by 3.8%. Unrealized losses were attributed principally to market interest rates and credit spreads; no other-than-temporary impairments were recorded in the first half of 2017.
- Contract-underwriting remedies paid were approximately $68,000 in the first half; management considered potential claims as of June 30 immaterial. The company reported no material legal proceedings, no material changes to previously disclosed risk factors, effective disclosure controls, and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether favorable prior-year reserve development persists as the portfolio matures and defaults move toward historically higher-claim years.
- The trend in default rates, cures, claims paid, reserve adequacy and claim severity relative to growth in insurance in force.
- The company’s PMIERs asset cushion and compliance under any revised GSE requirements.
- Credit-facility covenants, floating-rate borrowing costs and the effect of debt-funded growth on liquidity and capital.
- Whether lower average premium rates and business mix offset continued insurance-in-force growth, and whether the anticipated full-year expense-ratio decline materializes.