Essent Group Ltd (ESNT) 2013 Q4 法說會逐字稿

Good morning. My name is Laura and I will be your conference operator today.

At this time, I would like to welcome everyone to the Essent Group Ltd fourth-quarter 2013 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session.

(Operator Instructions)

I'll now turn the call over to Chris Curran, Senior Vice President of Investor Relations. Please go ahead.

Thank you, operator. Good morning, everyone, and welcome to our call. Joining me today are Mark Casale, Chairman and CEO; Adolfo Marzol, Executive Vice President; and Larry McAlee, Chief Financial Officer.

Our press release, which contains Essent's financials results for the fourth-quarter and full-year 2013, was issued earlier today and is available on our website at www.essentgroup.com in the investor section. Our press release also includes non-GAAP financial measures that may be discussed during today's call. The complete description of these measures and the reconciliations to GAAP may be found in our press release in Exhibit L.

Prior to getting, started I would like to remind participants that today's discussions will include the use of forward-looking statements. These statements are based on current expectations, estimates, projections and assumptions that are subject to risks and uncertainties, which may cause actual results to differ materially. For a discussion of these risks, please review the cautionary language regarding forward-looking statements in today's press release, the risk factors included in our prospectus filed with the SEC on November 1, 2013, and any other reports and registration statements filed with the SEC, which are also available on our website.

Now let me turn the call over to Mark.

Thanks, Chris. Good morning, everyone, and thank you for joining us today. I've been looking forward to this call because it gives me the opportunity to update you on the solid progress that we are making and the momentum our franchise continues to build in the marketplace.

As I discussed during our IPO road show this past fall, we take a long term view when insuring mortgage credit risk. A key element of this approach is our risk management focus, which starts with knowing our customers, maintaining prudent credit guidelines and pricing, and monitoring our growing portfolios and proactive QA and analytics. Because our business is insuring low down payment borrowers, our risk management foundation is critical.

Our goal at Essent continues to be simple: provide investment grade credit enhancements to all of our valued customers while building a high credit quality and profitable mortgage insurance portfolio that delivers predictable topline revenue growth while generating strong returns over the cycle. Our outlook for the MI sector continues to be positive since our business is certainly levered to the improving fundamentals of the US housing market and the growing demand for private mortgage insurance. We believe that we are well-positioned heading into 2014 and are very excited about our prospects and continuing to grow our franchise and delivering high-quality earnings growth to our shareholders.

Now, let me touch on some key indicators of our continued progress. 2013 was a milestone year. During the year we achieved investment-grade ratings from Moody's and S&P, successfully completed our IPO and earned $65.4 million for the full year.

We grew our topline revenue driver, insurance in force, 135% to $32 billion as of year-end. We generated $21.2 billion of NIW in 2013, an increase of 88% as compared to 2012. We estimate that our market share was approximately 12% for 2013.

As you know, market share is an important metric that we look at in measuring the progress of our business and we continue to be very pleased with our market position. Given both our market share and stacking more NIW layers on top of our insurance in force, our earned premium for the fourth quarter of 2013 was $40.3 million, an increase of 144% from the fourth quarter a year ago of $16.5 million. Our expense ratio for the fourth quarter of 2013 was 55.3% versus 100.2% for the fourth quarter 2012. We expect this ratio will continue to decline in 2014.

The credit profile of our insurance portfolio is excellent, ending the year with only 159 loans in default, representing an 11 basis point default ratio. Our loss ratio in the fourth quarter of 2013 was 1.7%.

Our financial profile, which is important to our counter-parties, continues to be very strong. We ended the year with $722 million in consolidated GAAP equity versus $219 million as of year-end 2012. On a statutory basis, our combined risk-to-capital at the end of 2013 was 16.5 to 1.

And finally, our momentum in generating NIW for more customers and expanding the depth and breadth of our franchise continues. The number of active customers, which represent customers generating NIW [force], was 721 for 2013 compared to 463 for 2012. We expect to continue to increase the number of active customers in 2014.

Okay. Now let me touch upon some of the broader items relating to our business. During the second half of 2013, the mortgage industry saw a decline in overall originations due to increasing mortgage rates during the year and lower refinance volume. However, while the overall mortgage origination market declined during this time period, the ratio of purchased volumes increased as compared to refinance volume, which is favorable for our industry since mortgage insurance penetration rates are higher on purchase versus refinance mortgages.

While we are expecting a small origination market in 2014, we are estimating industry NIW to be approximately $150 billion to $160 billion this year. Our current outlook for annual industry NIW over the next few years continues to be in the $150 billion to $200 billion range. This estimate reflex a combination of scenarios and estimates around both the size of the origination market and private mortgage insurance penetration rates.

From a regulatory perspective, two biggest items during the fourth quarter include new leadership at FHFA and a delay in the new GSC eligibility standards. On the new leadership front, we certainly look forward to working with Director Watt and his team regarding private mortgage insurance and the benefits of our product within the housing finance system.

The other important item with FHFA in 2014 will be the finalization of new GSC eligibility requirements. We believe sound standards that are transparent and consistently enforced strengthen our industry.

In December we were notified that the issuance of these standards will be delayed because FHFA wants to share them first with the state insurance regulator for comment prior to being shared with the mortgage insurance industry. We are not quite sure as to the timing; however, we look forward to reviewing these new standards. Given our strong capital levels and high quality insurance portfolio, we believe that we are well positioned regarding potential impacts of these new standards.

Beyond this, there continues to be ongoing legislative efforts to reform the US housing finance system, some of which could have potential to gain traction. We monitor developments in Washington closely and continue to see the MI industry as well positioned for reform, given the policy toward a greater role for private capital.

Now let me turn the call over to Larry to discuss our financials.

Thank you, Mark. Let me start with net income. As Mark mentioned, we earned $65.4 million for the full-year 2013. Note that our full-year results included a $7.4 million tax benefit. In addition, we are $19 million in the fourth quarter, which was net of a small tax provision of approximately $345,000.

As of year-end, the entire valuation allowance against our deferred tax asset was released and we have utilized all of our net operating losses. We will be in a full tax paying position in 2014 and expect our effective tax rate to be slightly above the federal statutory rate due to some nondeductible expenses incurred in our offshore companies.

Other underwriting and operating expenses were $22.3 million in the fourth quarter, which is up $5.8 million, or 35%, compared to the fourth quarter of 2012. In addition, the expense ratio increased from 53.2% in the third quarter of 2013 to 55.3% in the fourth quarter, principally as a result of increased compensation costs and other expenses associated with Essent becoming a public Company. For the full-year 2013, total underwriting and operating expenses were $71.1 million.

In 2014, we expect an increase of in the dollar amount of our expenses driven by higher stock compensation and other public Company expenses, the full-year impact of employees hired in 2013 and other investments we intend to continue to make to grow our franchise. We do, however, expect that our expense ratio will decline in 2014 as the growth in earned premiums will outpace the increase in our other underwriting and operating expenses.

The balance of cash and investments at December 31, 2013 was $810 million. The increase in this position during the fourth-quarter is due to the net proceeds of the IPO of $314 million and net cash flow from operations of approximately $29 million. You should expect an increase in investment income in 2014 compared to 2013 as a result of an increase in the average balance of our fixed income portfolio.

The combined risk-to-capital ratio of the US mortgage insurance business was 16.5 to 1 at December 31, 2013. Combined statutory capital of the US MI business was $416 million and reflects an increase during the fourth-quarter of approximately $100 million resulting from both earnings of the business as well as a $75 million capital contribution from the proceeds of the IPO. We intend to retain the balance of the proceeds from the offering at the holding company and contribute capital to support the growth of the US insurance companies as needed.

In addition, the amount of capital maintained in our insurance companies could be impacted by new mandates coming from the new GSC eligibility standards. As of December 31, 2013, the holding company cash and investment balance was $246 million. I should also point out that we currently have no debt.

Finally, diluted earnings per common share for the fourth quarter were $0.22. Note that our presentation was affected by our transition in the fourth-quarter from the two class method of presenting earnings per share to a more traditional method with the single common share of the Company post-IPO. We've included a schedule in the financial supplement that provides detail with respect to the calculation of earnings per share for the fourth quarter and the full-year 2013.

I will now turn the call back over to Mark.

Thanks, Larry. In closing, 2013 was a very exciting and productive year for our franchise and we look forward to continuing this progress in 2014. Our financial performance was very strong as we continue to grow our high credit quality and profitable book of business over the long term. Our very seasoned business development team continues to build valued customer relationships and expanding the Essent franchise and we are beginning to see the financial benefits of leveraging our efficient operating platform.

Our capital position was further strengthened through our successful IPO during the fourth quarter and are counter-party strength was validated when Essent guaranty achieved an investment grade ratings from both S&P and Moody's with Moody's further upgrading our rating after our IPO. We are confident as we enter 2014 and are very excited about our opportunities in the marketplace.

Now let's turn the call over to your questions. Operator?

(Operator Instructions)

Bose George of KBW.

You mentioned the 12% market share for 2013. Do you have a feel for where that number was in the fourth quarter?

We don't really -- we talked about before, Bose, we don't have a handle yet because the IMF is not out. But I think we are pretty much in the range of where we thought we would be for the fourth quarter and the full year, and probably a little bit ahead of where we thought we'd be at this point in our life cycle.

Okay, great. And then, in terms of credit -- I mean, at the time of your IPO, you guys had guided to losses for 2014, I think, in the $20-million range. You guys had $692,000 of incurreds this quarter. Does it seem like that number could be quite high for next year, and we'd have to take that down?

Hello, Bose. It's Larry McAlee. I don't think we want to give you some guidance specifically as it relates to next year. It will depend a little bit in terms of timing of [default]. I think our long-term expectation, as we had talked about in the road show, still makes sense.

Okay, great. And thanks, and congratulations on your first quarter as a public Company.

Thank you.

Geoffrey Dunn of Dowling and Partners.

Obviously still a young, growing Company -- can you try to frame where you think expenses might be going over the next year or two? Obviously we saw the new public Company cost level this quarter. How should we think about the development as you continue to hire people and build out your Business?

Hi, Geoff. This is Mark. I'll start off, and then I'll turn it over to Larry if he has any thing to add.

I think the fourth-quarter run-rate is actually pretty good estimate for 2014. I would kick that up a bit given that we are continuing to invest in the side of the Business -- on the business development side and, obviously, continuing to invest in certain things. But I think that's a pretty good run rate for 2014, and probably a moderate increase going forward.

Okay. And then, Larry, just on the investment side, obviously you have a big cash balance coming in from the IPO. Should we expect the majority of those proceeds to be invested and bump up your yield? Or are you going to maintain an above-average cash position until you know GSE rules?

No, I think that -- well, I'll segment the question -- as the insurance companies, we'll have substantially all of the investments -- substantially all of our cash position invested. We are going to invest proceeds at the holding Company. We'll probably have them with a similar profile, but we'll maintain a little bit lower duration, and probably a little bit higher cash position at the holding Company.

Yes, but -- Geoff, this is Mark -- no real change in our investment philosophy -- just kind of higher investment income just because higher balances. But we will maintain a pretty conservative approach to the portfolio at this time.

Okay. And then big-picture question -- you said Bermuda was not much of a focus when you were executing your IPO. But following Arch's approval for a quota-share deal, obviously you guys stand out because you're the only other company in the industry that has that type of call option on a Bermuda structure. Can you provide some updated thoughts in terms of maybe using that opportunity from a tax-efficiency standpoint, as well as also maybe looking at other product opportunities like the stacker deals as alternative revenue sources?

As we said on the road show, we continue to view Bermuda opportunistically, both in terms of revenue opportunities and capital efficiencies. So, we have been looking at some of the deals that printed in the fourth quarter. So, I would say we are evaluating more than we probably did on the road show, but we continue to -- and I would continue to guide you guys to look at this opportunistically. But as you mentioned, it's certainly a call option that we have at this time.

Is there any reason you wouldn't look at a quota deal? Is there anything that doesn't make sense about doing that?

No. Really, at this point, anything that's primarily related to US housing finance and mortgage we would certainly take a look at.

Okay, great. Thank you.

Jack Micenko of SIG.

Looking at the NIW in the press release, it was interesting to see somewhat of a migration down on FICO, and obviously there's a risk-based opportunity there on pricing. Was that an intentional migration over the past year, or is that just really more of a maturation of the volume trends and what's out there?

Hi, Jack. It's Mark. No, it is not intentional at all. As the Business shifts -- and you can see it in our [stat] supplement -- as the Business shifts from refinance to purchase, generally you are going to see a little bit higher LTV, a little bit lower FICO on the purchase business. So, it's really just more of a migration.

But it's a good -- you will see the Business at the kind of a 760 level that we've seen really since our inception -- and the rest of the industry has seen. As the Business migrates to purchase mortgages, you'll see that FICO trend down to where you saw it in the fourth quarter.

Okay, great. And then, you had a 20 to 1, I think, Freddie agreement that expired at the end of the year. Is that renewed or amended in any way? I'm just trying to think about if that gives you any insight into the eligibility rules that are out there pending?

No, Jack, that was part of our initial -- this is Larry -- Jack, that was part of our initial approval by the GSEs, and that expired and will not be applicable going forward.

We have no more insight into the GSE eligibility requirements than anyone else.

Okay. And then just one last broader picture. We've got some mixed housing data the last several weeks and months. Could you just talk qualitatively about maybe the 4Q purchase trends by month? And then maybe anything January qualitatively, just in terms of demand environment and volume and that sort of thing?

Jack, it's Mark. I think we continue to look -- and in our opening comments -- we tend to, since we started the Business, really look at this over the long term. We don't get super caught up in month-to-month trends. We don't really need to, given how we stack NIW on top of our insurance in force.

We continue to think that the Business -- the purchase Business -- will continue to grow. Those things have stops and starts. It's obviously seasonal. But we continue to be very optimistic about the longer-term trends of our Business.

All right, great. Thank you.

Mark DeVries of Barclays.

First question: I have a follow-up on the provisional loss ratio line. I understand -- you commented that the guidance you provided during the IPO holds. But I think you conservatively assumed at the time a gradual march towards a more normalized loss ratio.

But it looks like the businesses you've written since inception, and are likely to write over the next year, is coming at an extremely low loss ratio. Is there anything you're seeing in that, that would suggest just delayed seasoning, or is there an optimistic belief that you could see materially lower-than-normal loss ratios on this Business?

Hi, Mark. It's Mark. Again, I think one of the things to look at in the big picture is to look at kind of the late 1990s, and where that book went, and you saw loss ratios kind of in that 1% to 3% range. We tend to think it's going to still be in the upper end of that range. Part of that book -- the lower part of that book got refinanced out on the early 2000s.

So, we're still -- we're cautiously optimistic, but loss ratios -- it takes a long time to season. So, I wouldn't read too much into -- especially a young Company like us -- in quarterly trends in terms of the number of claims and defaults. I learned a long time ago to -- you don't get too excited when things look too good early. So, I wouldn't -- I think we'll continue to be cautiously optimistic, but, to be quite honest, it's too early to tell.

Okay. Fair enough.

Next question: How much cash buffer do you need to maintain at the holding Company? Just trying to get a sense of if you distributed it all -- the excess cash -- down to the writing Company now, what your risk-to-capital ratio would be?

I think you can -- the math is pretty simple, if we downstreamed it all today. We finished the year with about [$246 million] capital to holdco.

We'll continue to contribute funds down into Essent Guaranty, which is our flagship, during 2014. And that really -- that still -- that's our primary goal: to keep funding that into the future. We'll obviously look at other opportunities outside of that, as we discussed on the road show. But right now, the primary focus of that is to put it into Essent Guaranty.

Sure. And there's clearly enough at the holding Company to support a lot of growth for the next year-plus. Have you thought about how much capacity you have to issue debt at the holding Company to support future growth, once you use up the capital from the IPO?

As we talked about on the road show, we believe the capital that we raised probably gets us through 2016, at which point we are self-sustaining. That does not include, as I would remind you, anything outside of the core franchise, should it be Essent Re, GSE [risk share] or other type of opportunities. At the time that we need new -- additional sources of capital, we will certainly look at debt as one of those, in addition to equity. But we have not -- that's not -- we haven't crossed that bridge yet.

Okay. And then, just finally, have you thought about what type of buffer you would want to hold relative to whatever the new GSE eligibility requirements are for risk-to-capital?

It's hard for me to comment on that because I haven't seen the risk-to-capital requirements. I would just, again, point you back to the discussion that we had on the road show is that we set our capital using a variety of stress-test type models. So, we don't have any one type model.

But we really do look at capital from an economic standpoint, and we would certainly use that. That's really the basis of how we funded the Company and capitalized the Company to date, hence why we're a little bit more conservative than the industry. But that's certainly something we will monitor and look at the new GSE requirements, and then compare it to kind of where we think we should be holding capital.

Okay, thanks.

Eric Beardsley of Goldman Sachs.

Wondering where you stood in ramping up your sales force, and how much of the market that you're not addressing today still?

Hi, Eric. It's Mark. It's a good question. We are pretty -- we're not quite there in terms of building out the sales force. We finished the year with approximately 60 business development folks.

As we mentioned in the script, we are a little north of 700 active clients. I would say, to size it for you, we are about 50% of where we want to be in terms of active clients. And we are about 75% of the market-share coverage when you think of NIW, just because, obviously, the larger lenders comprise more NIW. As you sign up with smaller lenders, there's less there.

However, we continue to want to build breadth and depth to our Franchise. So, we are not quite there, but we are well on our way to building out the team, which, from an expense standpoint, I think helps us. But we still have a ways to go in continuing to sign up quality clients.

Great. And then just on your outlook for -- I think it was industry NIW of $150 billion to $160 billion for 2014 -- I guess that seems a little bit conservative to us. Just wondering what your underlying assumptions behind that are?

We look at a variety of factors. We looked at [NBA]. We looked at Fannie. We look at a lot of the street research. I would say kind of $1.1 trillion to $1.2 trillion -- anywhere from 13%, 14% MI penetration rates.

We have seen some continued migration from FHA to conventional. So that's -- the beauty is in the eye of the beholder. So, that's kind of what our best guess estimate is. It certainly could be higher than that.

Okay, great. Thank you.

Sean Dargan from Macquarie.

Just a follow-up in regards to the downward migration in FICO score in new business. Does that change the premium margin that you're able to charge materially from what you were talking about at the time of the IPO?

I think when you migrate from 760 to 740, I don't think it's a material migration up, but it certainly is. As we, again -- we talked about on the road show -- as you -- a couple things to caution you guys on, right? As you move down the FICO curve, premium will be higher, but losses will be higher as well, as is the amount of capital that you have to hold against that risk.

So, I think we look more towards where we want to be from a return basis. But certainly, the premiums will tick a little bit higher as you move down the FICO curve.

Okay, thanks.

And then, if your market share you think is around 12%, which is maybe higher than where you thought you would be at this time, do you think you would be even higher if some competitors didn't cut pricing by 5 basis points?

I think we're -- Sean, we don't -- I wouldn't look at it that way. I think our view is: We continue to sign up quality lenders. We really focus on adding to our client base -- making sure we service our clients really well. We think we have an advantage around our capital and our ratings.

Pricing is -- pricing comes and pricing goes. So, I think the pricing -- our view on pricing right now is we think it's pretty stable. And relative to the risk that we are putting on the books, the capital that we are holding against that risk. And in those terms, we are actually pretty comfortable with the pricing today.

All right. Great. Thank you.

Rick Shane of JPMorgan.

I just want to delve into market share a little bit deeper. You'd made the comment that you're addressing about 75% of the market, with about 50% of the relationships that you hope to achieve long term. Obviously the market starts to get a lot more fragmented.

How much potential is there, for market share, within your existing customer base? And I'm assuming one of the things is that you're pretty bifurcated there, that a number of your -- you have probably some of your legacy customers where you're in the low-20%s or high-teens. But given how quickly you grew the relationships over the last year, I'm assuming that there are a lot of relationships that are low-single digits.

You really touched on two points, Rick, which is the activation of new clients and then the utilization of current clients. We obviously think we have some room on both of those.

But again, I will remind you that we don't really think of market share -- we don't have a goal around that. We believe we are the only mortgage insurer that doesn't pay commissions around going after it. We look at market share really as the result of quality lender relationships, prudent guidelines, prudent pricing. You do all those things -- the market share is the result of that. And I think that's going to be our continued focus on building out for the Business.

We really want to -- we look at -- we worry about two things at Essent. We worry about Essent, and we worry about our customers. And our view is: We try to work with our customers, help them grow their business the right way. And if we can do that, the result will be good growth for Essent.

Got it. Great. Mark, thank you very much.

You're welcome.

Christine Worley of JMP Securities.

Just looking at the persistency, I see it's been ticking up through the year. How should we think about that going forward?

Hi, Christine. It's Larry McAlee. Over the last five quarters, as you'll see in one of the schedules we included in the financial supplement, our persistency rate has been in the low- to mid-80%s, and that's where we would expect it to remain over the near term.

I mean, if we look at the average over the year, or if we take more of what we were seeing in the fourth quarter and use that going forward?

Yes, I would look average over the year. We still think low- to mid-80%s. I know it ticked up in the fourth quarter, but I wouldn't want you to use that and run forward with it.

Okay. Thank you.

Chris Gamaitoni from Autonomous Research.

Most of my questions have been answered. I think the one question I have is: Do you have an indication of your long-term expense ratio target? You're the first new company in about two decades, so we don't have an idea of how cheaper your technology is versus legacy platforms that might be [pushing] assets and those types of questions.

I would say, longer term, we would expect to be within the industry average. I think our target's kind of in that 20% range longer term. Long term is a long time, but I think we do have an efficient platform.

But it is not just -- really what I would point you to in terms of expense ratio in addition to that is just our nominal costs. And that's really what we manage to. We can control our nominal costs. We think we've done a pretty good job in doing that kind of building the Company. And it certainly will be an emphasis as we continue to manage the Company going forward.

Thank you. And then, I saw there was on a new NIW rating, the 95%-plus has increased from 0.5% to 3%. I was wondering how the penetration works in that area, and what you see the opportunity is? I know there's a limited originators going to originate [that band]. So, just any future penetration given -- that's where the FHA's going to share for the MI for that.

Right. But also keep in mind that Fannie and Freddie no longer purchase mortgages above 95%. So, it did tick up maybe abnormally as people tried to close some of those loans in the latter part of the year. But I would say that's going to be a relatively small percentage of our portfolio going forward.

Okay. That makes sense. Thank you so much.

You're welcome.

There are no further questions. At this time, I turn the call back to management.

Thank you, operator. It's Mark. We'd like to thank everyone for participating in our first call today, and enjoy the rest of your week. Thanks.

This concludes today's conference call. You may now disconnect.