Essent Group Ltd. — Q3 2015 Form 10-Q
Business context and period. Essent provides U.S. residential private mortgage insurance and related reinsurance. This unaudited filing covers the quarter and nine months ended September 30, 2015; balance-sheet comparisons are to December 31, 2014.
Financial and operating performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Total revenue | $91.7 million | $64.6 million | $255.8 million | $166.7 million |
| Net premiums earned | $83.7 million | $60.3 million | $237.1 million | $155.4 million |
| Net income | $40.8 million | $25.1 million | $112.9 million | $59.6 million |
| Diluted EPS | $0.44 | $0.29 | $1.23 | $0.70 |
| Operating cash flow | Not separately presented | Not separately presented | $159.2 million | $101.6 million |
- Revenue grew 42% for the quarter and 53% year to date; net income rose 63% and 89%, respectively. Management attributed the gains primarily to growth in insurance in force and higher investment income.
- Calculated net margin was approximately 44.5% for Q3 2015 versus 38.8% a year earlier, and 44.1% for the first nine months versus 35.8%.
- Loss and loss-adjustment expense provision was $3.4 million for Q3 and $7.7 million year to date. Other underwriting and operating expenses were $28.7 million and $83.4 million, respectively.
- At September 30, total assets were $1.412 billion, total liabilities $335.7 million, and stockholders’ equity $1.076 billion. Investments were $1.241 billion and cash was $18.7 million. The company reported no debt outstanding.
- Cash provided by operations was $159.2 million for the nine months; investing activities used $161.6 million and financing activities used $3.2 million. Cash declined $5.7 million from year-end.
Material changes and business indicators
- Insurance in force reached $62.1 billion, up from $46.4 billion at September 30, 2014. Risk in force was $15.2 billion versus $11.2 billion.
- New insurance written was approximately $7.6 billion in Q3, down from $8.8 billion; nine-month NIW increased to $20.2 billion from $18.3 billion. Q3 flow NIW was broadly stable, while bulk NIW fell substantially year over year.
- Average insurance in force rose to $59.9 billion in Q3 from $43.7 billion. The nine-month average premium rate increased to 0.57% from 0.54%; the Q3 rate was 0.55% in both years.
- Defaults at period-end increased to 814 from 312 a year earlier, and the reported default rate rose to 0.29% from 0.15%. The loss reserve increased to $14.5 million from $8.4 million at year-end 2014.
- Combined U.S. insurance-subsidiary statutory capital was $864.8 million; net risk in force was $13.3 billion, producing a 15.4:1 risk-to-capital ratio. Essent said it was below the generally cited 25:1 maximum.
Outlook, risks and unusual items
- No numerical earnings or revenue guidance was provided. Management said expenses would likely continue to rise as the business grows, while earned premiums were expected to grow faster than underwriting and other expenses.
- Management emphasized that the portfolio is young: 89% of insurance in force was written since January 1, 2013. It expects defaults and claims to increase as the portfolio seasons, with the greatest industry claim incidence typically in years three through six. Future loss severity and defaults remain difficult to predict.
- Fannie Mae and Freddie Mac’s revised Private Mortgage Insurer Eligibility Requirements (PMIERs) were scheduled to take effect December 31, 2015. Essent said it had sufficient insurance-company assets to meet the requirements as of September 30.
- Essent reported substantial liquidity and said it expected to meet operating needs and obligations for the next 12 months. It cautioned that additional capital could be needed for new regulatory requirements, portfolio growth, or new business initiatives. Essent Guaranty had negative unassigned surplus and required Pennsylvania regulatory approval to pay a dividend in 2015.
- Nine-month loss provisions included $2.7 million of favorable prior-year reserve development. Q3 other income benefited primarily from a change in estimated fair value of ACIS contracts; the associated Level 3 derivative liability was $1.8 million and relies on significant unobservable inputs.
- Investment risks include interest-rate, credit, concentration, and prepayment risk. Portfolio duration including cash was 3.7 years; management estimated a parallel 100-basis-point rate move would change portfolio fair value by 3.7%. No material legal proceedings were reported, and management said there were no material changes to previously disclosed risk factors.
Most important facts for investors to verify
- Whether portfolio seasoning leads to materially higher defaults, claims, reserve needs, or loss severity than currently estimated.
- Whether Essent continues to satisfy PMIERs and state capital requirements, and whether restricted subsidiary capital can be accessed or distributed when needed.
- Whether growth in insurance in force and premiums offsets increased cancellations, expenses, and claims; monitor persistency, NIW, and premium mix.
- The assumptions and sensitivity behind Level 3 ACIS contract valuations and the investment portfolio’s exposure to interest rates and credit deterioration.
- The sustainability of reported earnings growth, including the effects of favorable prior-year reserve development, investment income, and the lower effective tax rate.