Business context and reporting period
Essent Group Ltd. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2019. The Bermuda-based group provides U.S. residential private mortgage insurance and reinsurance, principally through Essent Guaranty and Essent Re. Its mortgage insurance helps facilitate sales of low-down-payment loans into the secondary market, primarily to Fannie Mae and Freddie Mac.
New insurance written was $18.0 billion in Q2 2019 and $28.9 billion for the first half; insurance in force reached $153.3 billion at June 30. The company reported 383 employees.
Key financial metrics
Amounts below are in millions of dollars except per-share data and where otherwise indicated.
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net premiums earned | $188.5 | $157.0 | $366.3 | $309.5 |
| Net investment income | $20.6 | $15.1 | $40.5 | $28.8 |
| Total revenue | $211.9 | $173.8 | $412.4 | $341.2 |
| Provision for losses and LAE | $5.0 | $1.8 | $12.1 | $7.1 |
| Other underwriting and operating expenses | $41.5 | $36.4 | $82.6 | $74.6 |
| Income before taxes | $162.7 | $132.9 | $312.5 | $254.5 |
| Net income | $136.4 | $111.8 | $264.1 | $222.8 |
| Diluted EPS | $1.39 | $1.14 | $2.69 | $2.28 |
- Cash flow: First-half operating cash flow was $265.5 million, compared with $342.7 million a year earlier. Investing activities used $296.9 million and financing activities used $8.2 million; cash declined $39.7 million to $25.3 million.
- Balance sheet and debt: Total assets were $3.54 billion and stockholders’ equity $2.70 billion at June 30. Investments totaled $3.17 billion, including $3.10 billion of available-for-sale investments. Credit facility borrowings were $225 million, at a 4.41% weighted-average rate, with contractual maturity May 17, 2021.
- Liquidity and capital: Management reported $25.3 million cash, $251.5 million short-term investments and $2.8 billion fixed maturities, plus $275 million of revolving credit availability. Holding-company net cash and investments were $72 million. Essent Guaranty reported PMIERs 2.0 available assets of $2.09 billion against minimum required assets of $1.18 billion and was in compliance. Combined U.S. insurer risk-to-capital was 13.6:1.
- Investment and other comprehensive income: First-half net unrealized investment gains, net of tax, were $74.4 million, contributing to comprehensive income of $338.5 million. These gains were reported in other comprehensive income, not net income.
Material changes versus the prior comparable period
- Q2 revenue rose about 22% and net income about 22% year over year; first-half revenue rose about 21% and net income about 19%. Management attributed growth primarily to higher premiums from a larger insurance-in-force portfolio and higher investment income.
- Average insurance in force increased to $148.2 billion in Q2 from $118.7 billion a year earlier. Q2 net premiums earned rose 20%; first-half net premiums earned rose 18%.
- Average net premium rate declined to 0.49% in Q2 and 0.48% for the first half, versus 0.51% in both comparable 2018 periods. The filing cites increased ceded reinsurance premiums, business mix and pricing changes as factors.
- Net investment income increased 36% in Q2 and 40% for the first half. Management cited a larger portfolio and a higher pretax investment yield, which reached 2.8% in both 2019 periods from 2.5% in Q2 2018 and 2.4% in first-half 2018.
- Loss provisions increased, while favorable development of prior-year reserves partially offset current-year losses. First-half favorable prior-year development was $11.1 million, compared with $9.4 million in 2018.
- Investments available for sale increased to $3.10 billion from $2.76 billion at year-end 2018; cash declined from $64.9 million to $25.3 million. Stockholders’ equity increased from $2.37 billion, mainly due to earnings and unrealized investment gains.
Outlook, management commentary, risks and unusual items
- Management expected net premiums earned to grow faster than underwriting and other expenses, reducing the expense ratio for full-year 2019 versus 2018. It also said reinsurance use and pricing reductions were expected to weigh on average net premium rates in future periods. No specific earnings or revenue guidance was provided.
- Management expects claims and loss provisions to rise as the relatively young book seasons: 69% of insurance in force was written since January 1, 2017, and management noted that mortgage insurance claims are generally most frequent in years three through six after origination. Default inventory was 4,405 loans at June 30, 2019, versus 3,519 a year earlier.
- Key risks include economic and housing-market deterioration, interest-rate and investment-market changes, uncertainty in loss reserves, competition and customer concentration, changes affecting Fannie Mae and Freddie Mac, and the ability to satisfy GSE eligibility and regulatory capital requirements. The company said no material risk-factor changes had occurred since its 2018 Form 10-K.
- The investment portfolio had $7.5 million of gross unrealized losses at June 30, compared with $44.1 million at December 31, 2018; management attributed most declines to interest rates and credit spreads. A $0.1 million other-than-temporary impairment was recorded in 2019 because the company intended to sell a security after the reporting date.
- Off-balance-sheet maximum exposure to loss from the Radnor Re special-purpose entities was estimated at $59.95 million in the notes, including $57.37 million off balance sheet. The entities were not consolidated. Management reported compliance with credit-facility covenants and PMIERs 2.0.
- After quarter-end, the board declared the company’s inaugural quarterly cash dividend of $0.15 per common share, payable in September 2019. The company was evaluating the potential implications of proposed U.S. PFIC regulations issued July 10, 2019. It reported no material legal proceedings and no material changes in internal controls.
Important facts for investors to verify
- Whether loss reserves remain adequate as the portfolio seasons, particularly given the increase in defaults and dependence on favorable prior-year reserve development.
- Whether PMIERs and state capital requirements remain satisfied as insurance in force and risk in force grow, and how much capital is available at the holding company versus regulated subsidiaries.
- The sustainability of premium growth and investment income relative to lower average premium rates, higher reinsurance cessions and changing interest rates.
- Credit-facility covenants, floating-rate exposure and the May 2021 maturity, along with the liquidity and restrictions associated with assets held in reinsurance trusts.
- The implications of the inaugural dividend for capital allocation and any subsequent developments regarding PFIC tax treatment.