Essent Group Ltd. — Q3 2014 Form 10-Q
Business context and reporting period. Essent provides private mortgage insurance and reinsurance for U.S. residential mortgages, primarily loans sold to Fannie Mae and Freddie Mac. This unaudited report covers the three and nine months ended September 30, 2014; financial statement amounts below are in U.S. dollars, millions, unless noted. Essent reported 86.5 million common shares outstanding as of November 7, 2014.
Financial performance and position
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Total revenue | $64.6 | $36.5 | $166.7 | $89.1 |
| Net premiums earned | $60.3 | $34.3 | $155.4 | $83.0 |
| Net investment income | $3.4 | $1.1 | $8.4 | $2.9 |
| Provision for losses and LAE | $1.4 | $0.3 | $3.3 | $1.6 |
| Other underwriting and operating expenses | $24.5 | $18.2 | $71.6 | $48.8 |
| Income before taxes | $38.8 | $17.9 | $91.9 | $38.7 |
| Income tax expense (benefit) | $13.7 | $2.3 | $32.3 | $(7.7) |
| Net income | $25.1 | $15.6 | $59.6 | $46.4 |
| Diluted EPS | $0.29 | Not comparable* | $0.70 | Not comparable* |
*2013 EPS was reported for Class A and Class B-2 shares; the company’s common-share structure changed in connection with its November 2013 IPO.
- Growth and margins: Q3 net premiums earned increased 76% year over year and 9M premiums increased 87%, primarily from growth in average insurance in force (IIF). Average premium rate was approximately 0.55% in Q3 and 0.54% for 9M, similar to the comparable 2013 periods. Other underwriting and operating expenses rose 34% in Q3 and 47% for 9M, reflecting higher staffing, stock compensation, business expansion and public-company costs.
- Insurance activity: Q3 new insurance written was approximately $8.8 billion, including $1.5 billion of bulk business; 9M NIW was approximately $18.3 billion. IIF reached $46.4 billion, up from $28.2 billion a year earlier, and risk in force was $11.2 billion. Persistency was 88.5%.
- Claims: The default inventory rose to 312 loans from 116 a year earlier; the default rate increased to 0.15% from 0.09%. The nine-month loss provision included $0.7 million of favorable prior-year development. Management attributed higher defaults principally to portfolio growth and seasoning, while noting that the book is still young.
- Cash flow and liquidity: 9M operating cash flow was $101.6 million, versus $89.3 million. Investing cash outflow was $557.6 million, largely reflecting investment of available funds; financing cash outflow was $4.0 million. Cash declined to $17.6 million from $477.7 million at year-end 2013 as cash was invested. The company reported $907 million of net cash and investments, including $47.1 million at the holding company, and said it expects sufficient liquidity for the next 12 months.
- Assets, capital and debt: Total assets were $991.6 million and stockholders’ equity was $794.9 million at September 30, 2014. Investments totaled $897.2 million, compared with $332.6 million at year-end 2013. The filing shows no borrowings or debt balance; liabilities were $196.7 million, mainly unearned premium reserves, tax liabilities and operating accruals. U.S. insurance subsidiaries’ combined statutory capital was $664.2 million, with net risk in force of $10.7 billion and a 16.1:1 risk-to-capital ratio.
- Investment and market risk: The investment portfolio was investment grade; 47.9% was rated Aaa and no investments were below Baa3. Portfolio duration including cash was 3.5 years; management estimated a 100-basis-point parallel rate move would change fair value by approximately 3.5%.
Material changes, outlook and risks
- Essent Re began operations in July 2014, entered a Freddie Mac ACIS transaction covering up to $28.5 million of risk, and began reinsuring 25% of Essent Guaranty’s eligible new business. Essent Re had $102.1 million of equity, just above its $100 million minimum under the quota-share agreement.
- Net income increased in Q3 and 9M 2014, driven mainly by higher earned premiums and investment income. The 9M comparison is affected by a $7.7 million income tax benefit in 2013 from release of a deferred-tax valuation allowance; 2014’s effective tax rate was approximately 35%.
- Management expects claims and loss provisions to increase as the young insurance portfolio seasons; it noted industry claims are generally highest in years three through six after origination. Management also expects expenses to rise with growth, but expects earned premiums to grow faster over time, reducing the expense ratio. No specific earnings or revenue guidance was provided.
- FHFA’s draft Private Mortgage Insurer Eligibility Requirements, released for comment in July 2014, proposed revised financial, capital, liquidity and operational standards for insurers serving the GSEs. Final requirements and timing remained uncertain and could require additional capital.
- Key risks include changes to Fannie Mae and Freddie Mac or their eligibility rules, competition and alternatives to private mortgage insurance, reduced low-down-payment originations, economic and housing-market deterioration, reserve-estimation uncertainty, interest-rate and investment risk, customer concentration, and constraints on dividends from regulated subsidiaries. Essent Guaranty had negative unassigned surplus and would need regulatory approval to pay dividends. The company reported no material legal proceedings and no material change in previously disclosed risk factors.
- A North Carolina office lease extension through 2025 increased total lease commitments by $10.7 million. Subsequent to quarter-end, an executive vice president announced retirement effective March 31, 2015.
Most important facts for investors to verify
- Whether final PMIERs requirements alter Essent’s capital needs, GSE eligibility or ability to grow its business.
- How default frequency, cures, claim severity and reserve development evolve as the young insurance portfolio seasons.
- Whether the growth in IIF and NIW remains profitable after operating costs, premium mix, cancellations and reinsurance effects.
- The availability of capital at regulated subsidiaries, including Essent Guaranty’s dividend restrictions and Essent Re’s $100 million minimum-equity requirement.
- The investment portfolio’s sensitivity to interest rates, credit deterioration and liquidity needs.