Essent Group Ltd. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods unless otherwise noted. Essent provides U.S. residential mortgage insurance and reinsurance. Financial statements are unaudited.
Business context and key metrics
- New insurance written was $12.9 billion in Q2 and $22.2 billion in the first half, versus $11.4 billion and $19.4 billion, respectively. Insurance in force reached $122.5 billion, up from $95.5 billion a year earlier; risk in force was $30.2 billion.
- Persistency was 83.0%. Average net premium rate was 0.51%, down from 0.53%. Monthly and single-premium policies represented 83% and 17% of first-half new insurance written.
- One lender accounted for 10% of first-half revenue. The ten largest customers generated 40.3% of first-half flow NIW.
Financial results
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net premiums written | $168.4m | $134.1m | $333.6m | $253.4m |
| Net premiums earned | $157.0m | $126.6m | $309.5m | $244.2m |
| Net investment income | $15.1m | $9.4m | $28.8m | $17.8m |
| Total revenue | $173.8m | $137.6m | $341.2m | $265.2m |
| Provision for losses and LAE | $1.8m | $1.8m | $7.1m | $5.5m |
| Other underwriting and operating expenses | $36.4m | $35.7m | $74.6m | $72.0m |
| Income before taxes | $132.9m | $99.0m | $254.5m | $185.8m |
| Income tax expense | $21.2m | $26.8m | $31.7m | $47.1m |
| Net income | $111.8m | $72.1m | $222.8m | $138.7m |
| Diluted EPS | $1.14 | $0.77 | $2.28 | $1.49 |
- Net premiums earned rose 24% in Q2 and 27% in the first half, primarily reflecting growth in average insurance in force; the lower premium rate and ceded reinsurance premiums partly offset growth.
- Net investment income increased as the average investment portfolio grew and yields improved. Pre-tax yield was 2.5% in Q2 and 2.4% for the first half, compared with 2.2% in both 2017 periods.
- Lower income taxes reflected the reduction in the U.S. statutory corporate tax rate from 35% to 21%, the expected share of earnings generated in Bermuda, and first-half excess tax benefits from share vesting.
- Comprehensive income was $104.5m in Q2 and $186.8m for the first half. First-half other comprehensive loss was $36.0m, largely from unrealized investment depreciation.
Cash flow, balance sheet and capital
- First-half operating cash flow was $342.7m, versus $144.4m; investing cash use was $304.9m, versus $209.5m; financing cash use was $56.6m, versus $65.2m provided in 2017. Cash ended the period at $24.7m.
- At June 30, total investments were $2.56bn, total assets $2.85bn, total liabilities $745.9m and shareholders’ equity $2.10bn. Equity increased from $1.94bn at year-end, mainly from net income, partly offset by investment-related accumulated other comprehensive loss.
- Credit facility borrowings were $225m, compared with $250m at December 31, 2017; the weighted-average rate was 4.05%, versus 3.49%. The facility was amended to $500m committed capacity, including a $275m revolving component, plus a $100m uncommitted line. $275m of revolving capacity was available at quarter-end. Borrowings mature May 17, 2021.
- Management said liquidity was sufficient for expected operating needs and obligations over the next 12 months. Cash and investments at the holding company were $76.0m. Some subsidiary assets are held in trusts or otherwise subject to regulatory and contractual constraints.
- The combined U.S. insurer risk-to-capital ratio was 14.0:1. Essent Guaranty reported PMIERs available assets of $1.74bn against minimum required assets of $1.35bn and was in compliance. Statutory capital of the U.S. insurance subsidiaries exceeded regulatory requirements.
Material developments, outlook and risks
- In March 2018, Essent Guaranty entered fully collateralized excess-of-loss reinsurance covering up to $424.4m of losses on a 2017 policy portfolio. Coverage declines over ten years; Essent retains the first $224.7m of aggregate losses and losses above the coverage layer. The filing estimates $18.2m of off-balance-sheet maximum exposure associated with the reinsurer VIE.
- First-half loss provision included $16.5m of current-period losses, offset by $9.4m favorable prior-year development. Defaults rose to 3,519 from 1,776 a year earlier, and the default rate was 0.64% versus 0.41%. Management expects claims and losses to rise as the relatively young portfolio seasons.
- Hurricane-related defaults declined to 801 from 2,288 at year-end 2017; reserves for these defaults remained $11.1m. Management uses a lower estimated claim rate for these defaults, and future reserve effects depend on their performance.
- Management expected the full-year 2018 expense ratio to decline versus 2017 as earned premiums grow faster than expenses. June pricing reductions for future new business are expected to reduce average net premium rates in future periods. No specific earnings or revenue guidance was provided.
- Key risks include changes to Fannie Mae and Freddie Mac or PMIERs, mortgage market and low-down-payment origination trends, competition and customer concentration, portfolio seasoning and uncertain loss estimates, economic and housing conditions, interest-rate and investment risks, and access to capital. Updated PMIERs were expected to be finalized in Q3 2018 and take effect at the end of Q1 2019.
- The filing reported no material legal proceedings, no material changes to previously disclosed risk factors, and no material changes in internal control over financial reporting. Disclosure controls were deemed effective. Adoption of revenue and financial-instrument accounting updates had no material effect; lease accounting adoption was expected to increase reported assets and liabilities, with impact still under evaluation.
Important facts for investors to verify
- Whether the expected PMIERs revisions change required capital or Essent Guaranty’s reported asset cushion.
- How defaults, claim frequency, reserve adequacy and favorable prior-year development evolve as the insurance portfolio seasons.
- The effects of the new reinsurance arrangement, including coverage, costs, collateral and the stated off-balance-sheet exposure.
- Whether pricing reductions, persistency, cancellations and customer concentration affect premium growth and profitability.
- Investment portfolio sensitivity to interest rates and credit spreads, including the sizable increase in unrealized losses.
- Credit facility terms, covenant compliance, and the availability of capital at the holding company and regulated subsidiaries.