Essent Group Ltd. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Essent provides U.S. private mortgage insurance and reinsurance; results were heavily affected by COVID-19-related mortgage delinquencies and reserve estimates.
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Total revenue | $236.1 million | $211.9 million | $464.9 million | $412.4 million |
| Net premiums earned | $211.5 million | $188.5 million | $418.0 million | $366.3 million |
| Provision for losses and LAE | $175.9 million | $5.0 million | $183.9 million | $12.1 million |
| Net income | $15.4 million | $136.4 million | $164.9 million | $264.1 million |
| Diluted EPS | $0.15 | $1.39 | $1.64 | $2.69 |
| Operating cash flow | Six-month: $345.8 million | Prior-year six-month: $265.5 million |
- Q2 revenue increased 11.4% year over year, while net income fell 88.7%, principally because of the COVID-related loss provision. Six-month net income declined 37.6%.
- Q2 net premiums earned rose 12%; average insurance in force increased to $168.6 billion from $148.2 billion. New insurance written was $28.2 billion in Q2 and $41.7 billion in the first half.
- Q2 net investment income was $19.9 million, versus $20.6 million; the reported pre-tax investment yield fell to 2.2% from 2.8%. Q2 other income rose to $6.0 million, including favorable fair-value changes in reinsurance embedded derivatives and higher Triad service fees.
- At June 30, assets were $4.90 billion, investments $4.43 billion, cash $72.8 million, liabilities $1.28 billion and stockholders’ equity $3.62 billion. Available-for-sale investment fair value included $120.4 million of accumulated unrealized gains in equity.
- Six-month operating cash flow was $345.8 million; investing cash outflow was $944.9 million and financing cash inflow was $600.5 million. Cash ended at $72.8 million.
Material changes, capital and liquidity
- Defaults rose to 38,068 at June 30, 2020 from 4,405 a year earlier; 34,352 were classified as COVID-19 defaults. The default rate was 5.19%, versus 0.66%.
- Loss and LAE reserves reached $250.9 million, compared with $69.4 million at year-end 2019. The COVID-19 default reserve was $189.0 million; management estimated a 100-basis-point change in the reserve rate on new COVID-19 notices would change reserves by about $26 million.
- Management recorded an approximately 7% reserve rate against risk in force for COVID-19 notices received in Q2, expecting fewer claims than under historical default-to-claim experience because of forbearance and borrower/loan characteristics. Estimates remain subject to significant uncertainty.
- Essent completed a public offering of 13.8 million shares in June at $33.25 per share, generating about $440 million net. Credit-facility borrowings increased by $200 million; $425 million was outstanding at June 30, with $75 million of revolving capacity remaining. The facility matures May 17, 2021; the weighted-average rate at quarter-end was 1.93%.
- Management reported $702.2 million of net cash and investments at the holding company and said liquidity was sufficient to meet expected obligations and committed capital expenditures for the next 12 months. Essent Guaranty had $2.59 billion of PMIERs available assets versus $1.46 billion of minimum required assets and remained compliant. Its dividend payments require GSE written approval from June 30, 2020 through March 31, 2021.
- Combined U.S. insurer risk-to-capital was 11.7:1. A quarterly dividend of $0.16 per share was declared for payment in September 2020.
Outlook, risks and unusual items
- No earnings or operating guidance was provided. Management expects claims and incurred losses to rise as the portfolio seasons; 68% of insurance in force was written since January 2018 and was less than three years old.
- Management said CARES Act and GSE forbearance programs may reduce the share of delinquencies that become claims, but may lengthen resolution times and increase severity on claims that do occur. The duration and economic effects of COVID-19, borrower performance after forbearance, housing prices, unemployment and future delinquencies could materially change reserves and capital needs.
- Based on delinquencies, insurance-linked note transactions became subject to a trigger event on June 25, 2020: note principal amortization and related reinsurance coverage amortization are suspended while the trigger continues.
- Management could not reliably estimate full-year 2020 pretax income or an annual effective tax rate because of COVID-19 uncertainty; interim tax expense used the actual year-to-date effective rate.
- Other risks include investment-market and interest-rate exposure, reinsurance availability and counterparty performance, GSE/PMIERs requirements, and possible additional capital needs. The filing reported no material legal proceedings and no material change in previously disclosed risk factors.
Important facts for investors to verify
- Subsequent delinquency, cure and claim trends among the 34,352 COVID-19 defaults, and the adequacy of the $189.0 million associated reserve.
- Whether the assumptions behind lower COVID-19 reserve rates remain supported as forbearance periods expire and borrowers resume or fail to resume payments.
- Continuing PMIERs compliance, the impact of default-related asset requirements and the duration or effects of the insurance-linked note trigger.
- Liquidity and refinancing plans for the $425 million credit-facility balance ahead of its May 2021 maturity, alongside any restrictions on subsidiary dividends.
- The effect of investment yields, portfolio growth, reinsurance costs and the young insurance-book mix on future earnings and cash generation.