Essent Group Ltd. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; financial statements are unaudited. Essent is a Bermuda-based provider of U.S. private mortgage insurance and reinsurance. Unless noted, dollar amounts below are in millions.
Financial and operating highlights
| Metric | Q1 2014 | Q1 2013 or prior date |
|---|---|---|
| Net premiums earned | $44.8 | $21.3 |
| Total revenue | $47.8 | $23.0 |
| Income before tax | $23.5 | $7.3 |
| Income tax expense / effective tax rate | $8.5 / 36.0% | $0.1 / 1.9% |
| Net income / diluted EPS | $15.0 / $0.18 | $7.2 / $0.23 per Class A share |
| Operating cash flow | $12.5 | $14.8 |
| Total assets / stockholders’ equity | $905.0 / $740.1 | $854.0 / $722.1 at Dec. 31, 2013 |
| Investments at fair value | $847.3 | $332.6 at Dec. 31, 2013 |
| Cash and short-term investments, net | $235.2, including $135.3 at the holding company | — |
| Debt | None | — |
Net income margin was approximately 31.4% of revenue, broadly in line with approximately 31.3% a year earlier. The filing does not present a single operating-margin measure.
Business trends and changes versus prior year
- Net premiums earned rose 110% and net premiums written rose 56%, primarily reflecting portfolio growth. Average insurance in force (IIF) increased to $33.35 billion from $15.50 billion; ending IIF was $34.78 billion versus $17.43 billion.
- New insurance written (NIW) declined to $3.63 billion from $4.32 billion, while cancellations increased to $881 million from $520 million. Essent reported 12.9% NIW market share for the quarter, excluding HARP, versus 12.1% for full-year 2013.
- Net income more than doubled, primarily on higher earned premiums and investment income. Net investment income increased to $1.90 million from $0.73 million as the average cash and investment portfolio grew; investment yield declined to 1.0% from 1.2%.
- Other underwriting and operating expenses rose 57% to $23.46 million, including compensation and benefits of $15.67 million. Headcount was 302 versus 223 at March 31, 2013.
- The loss and LAE provision was $0.90 million, including $0.38 million of favorable prior-year development. Defaults rose to 192 from 75; the reported default rate increased to 0.12% from 0.10%.
- Cash fell by $468.8 million during the quarter, largely as cash was deployed into investments: investing cash outflow was $479.9 million. The investment portfolio expanded substantially, and short-term investments rose to $261.5 million from $14.1 million at year-end.
Liquidity, capital, and outlook
- Management said liquidity was sufficient for operating needs and obligations for the next 12 months. Total cash and investments were $856.1 million at March 31, 2014; the company had no debt.
- Combined statutory capital was $528.2 million against net risk in force of $8.49 billion, for a 16.1:1 risk-to-capital ratio. The filing cites a generally applicable maximum permitted ratio of 25:1, while noting capital rules may change.
- Essent Guaranty had negative unassigned surplus and would need prior Pennsylvania regulatory approval to pay dividends in 2014. The filing says insurance subsidiaries complied with applicable requirements.
- Management expected the effective tax rate in 2014 to approach the statutory rate. It also expected operating expenses to rise with growth, but premiums earned to grow faster over time, reducing the expense ratio.
- No numerical earnings or revenue guidance was provided. Management cautioned that claims and losses may increase as the young insurance portfolio seasons; 95% of IIF related to policies originated since January 1, 2012, and claims incidence is generally highest in years three through six.
Risks, contingencies, and notable items
- Key exposures include changes to Fannie Mae and Freddie Mac or their eligibility rules, competition and alternatives to private mortgage insurance, housing and economic deterioration, interest-rate and investment risks, premium adequacy, reserve-estimation uncertainty, and regulatory capital changes.
- Unrealized investment losses were attributed principally to interest-rate changes; issuers were current on scheduled payments, and no other-than-temporary impairment was recorded. The portfolio’s effective duration including cash was 3.0 years; excluding cash, 4.3 years.
- Management considered potential contract-underwriting indemnification claims immaterial; no material indemnification provision was recorded. The company reported no material legal proceedings and no material change in previously disclosed risk factors.
- Income tax expense increased sharply from the prior-year quarter as the company moved beyond its prior valuation-allowance position; the current-quarter effective rate was 36.0%. The deferred tax asset declined to $2.9 million from $10.3 million at year-end.
- Disclosure controls were assessed as effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether NIW, policy persistency, and premium growth can sustain earnings as the portfolio matures; reported persistency was 87.9%.
- How default frequency, claim severity, and reserve adequacy develop as the young book enters higher-claim years, including the effect of favorable prior-year reserve development.
- Whether the 16.1:1 risk-to-capital ratio remains adequate under changing state and GSE requirements, and what capital support or dividend restrictions may follow.
- How much of the $235.2 million of net cash and short-term investments is accessible at the holding company versus regulated insurance subsidiaries.
- The sustainability of earnings after the unusually low prior-year tax expense, and the sensitivity of investment value and income to interest-rate changes.