Essent Group Ltd (ESNT) 2014 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Essent Group, Ltd. second-quarter 2014 financial results conference call.

(Operator Instructions)

Please note that this call is being recorded today, Friday August 8, 2014 at 10:00 AM Eastern time. I would now like to turn the meeting over to your host for today's call, Chris Curran, Senior Vice President of Investor Relations. You may begin your conference.

Thank you, operator. Good morning, everyone. 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 financial results for the second quarter of 2014 was issued earlier today and is available at our website at 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 reconciliation 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 are being recorded and 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 Form 10-K filed with the SEC on March 10, 2014, and any other reports and registration statements filed which 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 updating you on the strong and steady progress that Essent continues to make, and to comment further on draft PMIERs.

For the second quarter, I am pleased to report that we earned $19.6 million, or $0.23 per diluted share, while growing our insurance in force to $39.4 billion. Our net income for the quarter increased 30% from $15 million earned last quarter, while our insurance in force increased 13% from last quarter and 74% compared to a year ago. Our growth in insurance in force continues to fuel our top-line revenues.

Earned premium for the quarter was $50.3 million, a 12% increase from the first quarter and an 83% increase compared to a year ago. Our goal at Essent remains simple -- to build a high credit quality and profitable mortgage portfolio which can deliver predictable top-line revenue growth and generate strong returns over the cycle.

We continue to be well positioned in the marketplace and generating NIW, and expanding the number of active customers. For the quarter we generated $5.9 billion of NIW, and we estimate our market share was approximately 14%.

For the 12-month period ended June 30, 2014, the number of active customers generating NIW was 860 as compared to 620 a year ago. Our credit quality remains excellent and we continue to gain operating leverage.

In addition to our strong quarter I am pleased to report that we have recently begun executing on opportunities which extend our franchise and leverage our mortgage risk expertise. In July, through a competitive bidding process, Essent was selected by Fannie Mae to be the sole insurer on a $1.5 billion pool of loans.

Also in July, our Bermuda reinsurance subsidiary, Essent Re, was selected by Freddie Mac to participate in its most recent ACIS transaction. We have always viewed GSE-expanded risk share and Bermuda Reinsurer as two areas of opportunity for our franchise, and we are excited to participate in each of these transactions.

Finally, Essent Guarantee has entered into a quota-share reinsurance agreement with Essent Re to cede 25% of its GSE-eligible NIW to Essent Re effective July 1, 2014. The terms of this transaction have been approved by the GSEs and are subject to regulatory approval by the Pennsylvania Department of Insurance. We believe that the quota share will improve our capital efficiency and provide incremental shareholder value.

Now, let me turn the discussion to the draft PMIERs. We are pleased that the new standards are out for public comment. Strong standards are very important in restoring broad confidence in our industry, and in the beneficial role that private mortgage insurance plays in housing finance. We commend the FHFA, Freddie Mac and Fannie Mae for all their efforts in advancing this important work.

We believe that the framework of the PMIERs is fundamentally sound, built around maintaining sufficient, high-quality assets to pay claims in a stressful environment. The objective of the standards is to align asset requirements to the level of risk in an insurer's portfolio. We are supportive of this approach because we have been applying a similar risk-based capital framework to our portfolios since inception.

Of course risk-based capital frameworks are complex by nature and none are perfect. But it is important not to let perfect be the enemy of good. During the financial crisis, three mortgage insurers went into run off and there remain fundamental questions about the industry's financial strength and claims-paying ability.

While we are open to refinements to better align capital to risk, the fundamental integrity and transparency of the new standards should not be compromised. Establishing strong standards to ensure that capital will be available for GSE-approved mortgage insurers to pay claims in times of stress benefits both lenders and policyholders.

For us, given the risk profile of our insurance in force, the PMIERs line up reasonably well with our economic capital models and the approximate 16 to 1 risk to capital that we have been managing our business to. Accordingly we continue to believe that our returns on our June 30 insured portfolio will be in the mid teens. I should also note that these returns incorporate a full statutory US federal tax rate and do not reflect financial leverage.

Now, let's touch on new business. On applying the PMIERs to our second-quarter NIW, this too aligns closely with our risk-based capital view of 15 to 1. The primary reason for the higher capital on new business versus our total insured portfolio is the increase in the amount of purchased mortgages that we have been insuring. These loans have slightly lower FICOs and slightly higher LTVs than our existing portfolio. We believe that the returns on our recent NIW will also be in the mid-teen range.

Looking ahead, we do not believe that the PMIERs will disrupt access to credit. We think private mortgage insurance will remain an exceptional value for borrowers, and be very competitive with FHA. When isolating the cost to a borrower of just private mortgage insurance versus FHA, private MI is the clear winner.

Accordingly, Essent is well-positioned to continue serving the market and supporting the flow of credit. And I continue to be very excited about Essent's long-term prospects.

Now let me turn the call over to Larry.

Thanks, Mark. Good morning, everyone. In addition to the strong financial results Mark discussed at the beginning of our call, I want to touch on some additional items. Our provision for losses and loss adjustment expenses for the second quarter was $966,000, compared to $902,000 in the first quarter of 2014, and $580,000 in the second quarter a year ago. This is in line with the slight increase in our default rate to 13 basis points as of June 30 from 12 basis points last quarter and 9 basis points a quarter a year ago.

Our expense ratio for the second quarter was 47%, a decrease from 52% last quarter and 57% for the second quarter of 2013. Other underwriting and operating expenses for the second quarter were $23.6 million, which are consistent with our expenses in the first quarter of $23.5 million and $8.1 million higher from the second quarter a year ago. We believe that for the full year 2014 other underwriting and operating expenses will be in the $95 million to $100 million range.

The balance of our cash and investments at June 30 was $860 million. Additionally, as of quarter end, the Holding Company cash and investment balance was $171 million as compared to $207 million at March 31, 2014.

As we noted in our press release, in the third quarter, Essent Group, Ltd. intends to contribute $100 million to Essent Re. This amount will be used to support the ongoing affiliate quota-share reinsurance transaction and participation in the Freddie Mac ACIS deal. Under the terms of the ACIS transaction, Essent Re will insure $28.5 million of risk associated with Freddie Mac's 2014 DN1 stacker transaction.

The combined risk to capital ratio of the US mortgage insurance business was 16.2 to 1 at the end of the second quarter. Combined statutory capital of the US mortgage insurance business was $600 million, and reflects an increase during the second quarter of approximately $72 million resulting from statutory earnings and a $40 million capital contribution from the holding company. Finally, total consolidated GAAP equity as of June 30 was $768 million.

Now, let me turn the call back over to Mark.

Thanks, Larry. In closing, we had an excellent quarter in our core business and our momentum continues in expanding our franchise. Participating in Fannie Mae's risk-share deal, and Essent Re executing upon its first transaction with Freddie Mac, is exciting for the future of our franchise. In addition, the affiliate reinsurance provides an opportunity to further leverage our Bermuda structure and increase shareholder value.

As for the PMIERs, we look forward to final standards for our industry being in place soon. We believe they will strengthen confidence in and restore credibility to our industry for both agency and non-agency business. It is now the time to look forward and put these standards behind us so we can continue to facilitate homeownership, give lenders transparency into the financial strength of their MI providers, and become an even more attractive place for investors to deploy their capital. We remain very optimistic about the future of Essent, our industry, and the value of mortgage insurance in housing finance.

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

(Operator Instructions)

Your first question comes from the line of Bose George with KBW.

Congratulations on a good quarter. First question, on the tax rate on the stuff that's being reinsured out of Bermuda, is that going to be a zero tax rate, so the blended tax rate trends down over time as that book builds?

Bose, it is Mark. It is zero tax rate in Bermuda. Currently, for this year, our tax rate you will see very little impact, and you should see that go slightly down over the ensuing years.

Great. And then in terms of the capital efficiency of that reinsurance, how should we think about it? How much capital do you need there for the equivalent amount of insurance?

The way to look at it, just taking a step back, as we discussed in the script, we use economic capital for all of mortgage decisions whether in the US or in Bermuda. As for affiliate reinsurance from Essent Guaranty to Essent Re, we will apply the same capital standards that we do on the Essent Guaranty book. No difference.

Okay. And then just in terms of the new business, the risk-sharing transactions, can you just comment on the ROEs there?

We don't comment on individual ROEs. I would just say returns on both of those transactions are in line with our portfolio expectations.

Okay. Great. Thank you.

Your next question comes from the line of Eric Beardsley with Goldman Sachs.

Thank you. Just on your second-quarter NIW, I think you said that the required risk to capital under the PMIERs would be 15 to 1 on that. Is that assuming any buffer or increase in delinquencies over time?

Yes, it does, Eric. Again, this is our economic capital that we use. And like I said, it lines up very closely with PMIERs. So, yes, it includes delinquencies.

Okay. So, your economic capital is 15 to 1? Or that is essentially the same as the PMIERs?

The answer is yes. It's essentially 15 to 1 and it lines up with PMIERs.

Okay, great. If there are parts of the rule that you would want to see changed, what might they be?

I think in parts of the rule, I think our view is there are certain things that we would look to, to recommend to better align the capital risks. But it's important, really, to make sure there's really no watering down of the framework. I think strong capital is important. And I think we got caught up in some of the details without taking a step back and saying how much capital do we need against the assets. I know Adolfo may have a comment on this, too.

Yes, I think what I would add, Eric -- and Mark has said it well -- we think that a strong framework really positions the industry positively for the future. If you look at things like Johnson-Crapo, for example, and the other major housing refinance reform bills, they generally anticipate some degree of federal standards and oversight for the MI industry. We think that's going to be important as a complement to state regulation for MI to keep playing a big role and potentially play a bigger role. So, we think the PMIERs really are a cornerstone of starting to establish that kind of framework for the industry going forward. That's why we think it's important that they be sound and that we not lose the integrity and the transparency.

Okay. And then, just lastly, would you be able to disclose what your NIW was in July?

No, Eric, we don't disclose monthly NIW.

Great, thank you.

Your next question is with Jack Micenko with SIG.

Good morning. Mark, I think it was the fourth-quarter call you had a pretty accurate comment and view on industry NIW. At the time it was thought to be very conservative. It's turned out to be pretty dead on. I'm wondering how you think about the business broadly for the second half of the year and into 2015 on an industry NIW basis?

Hey, Jack, good question. I think in the first half of the year we were roughly 70 billings. I think we're on target for that -- I think we said 150 to 160 billings. So, we're probably in the lower end of that rage. In terms of next year, I think we would see moderate growth to that.

Still probably within, maybe a tick higher on the range, especially what we're seeing on the lender front and the shift to purchase mortgages as the lenders have really started to make that transition. So, again, we look at, in terms of the overall volume, is more of a bell curve, so, lower in the first part of the year, and then it heats up second and third quarters, and then would drift down in the fourth quarter. Which is how the mortgage business has normally been over the years, absent the recent spike in refinances. Overall strong, pretty good growth for the industry going forward.

Okay. And then one of the things we talked about in the past, too, loan level price adjustments and the potential drag and impact there. I know that the deadline on the GSE and LLPA discussion or comment period has been pushed back to align with the PMIERs comment period. I'm wondering if you have any thoughts on LLPAs overall, and if there's any maybe coincidence there, or the conversations you might be having bringing the LLPAs into the discussion, as well, around the new capital rules.

Yes. Hey, jack. I'll start off and let Adolfo add anything. We don't have any insight into the timing of all of this. Again, I think it does tie back to PMIERs and the fact that strong capital standards will then give regulators more confidence. We would expect more confidence and MI counterparties may lessen the requirement for these type of loan level price adjustments.

Yes, Mark. This is Adolfo. What I would add to that is I think this is the point around which there is strong alignment within the MI industry in that, with the new master policies that are going into place October 1, and with the ultimate finalization of the mortgage insurer eligibility requirements, we think that's really a compelling foundation to make sure that the value of MI is fully reflected in GSE pricing and G-fees. And if that being fully reflected is the foundation then for some adjustment to LLPAs, we think that could be very positive for the industry. We certainly feel that way and I've had a lot of conversation with industry peers who share that perspective.

Okay, great. And then just real quick housekeeping -- can you give us the customer count for 1Q, as well as year end? I'd gotten it for this quarter but I don't seem to have it in my model for 4Q and 1Q. If it's handy. If not we can talk after.

Yes, we'll follow up. I don't have it off the top of my head.

Okay, great. Thanks, guys.

Your next question comes from the line of [Sean Jarjee] with Macquarie.

I want to follow up on something Mark said about private MI being the clear winner versus FHA for borrowers from I guess a price point comparison. I think some of the more bullish sentiment on your stock in the industry before PMIERs was that you would be able to penetrate into lower FICO buckets and less favorable LTV buckets. I'm just wondering, has your thinking changed on your ability to bring down the average FICO score of an insured borrower due to PMIERs?

No. It hasn't really impacted it much at all, Sean. I just get back to really how we grow at Essent. I think we look more at our growth in insurance in force and how we're growing that. And we're not getting too caught up in where exactly the growth is coming from.

Okay. I think I've heard you say in the past that in the 1990s the average FICO score of a borrower that was insured was maybe 25 points lower than where it is now. Is that still something you think the industry can move to?

It's hard to tell. I think one thing, Sean, you need to think about is, when the GSEs raised the limits on loan levels a few years ago, some of that jumbo market has actually come into GSE-conforming business. That's another reason why the FICOs are a little bit higher. So, it's not a matter of this moving down the FICO spectrum. There's also a lot of credit quality that was done pre crisis that is clearly non-QM compliant, and is really not in a lot of the underwriting guidelines today. So, certainly it could move down there in terms of the averages. We think the pricing down there is higher. So, we think all-in it could still definitely get to that, but it's hard to tell at this point.

All right. Great. Thank you.

Your next question comes from the line of Douglas Harter with Credit Suisse.

Thanks. I was wondering, could you talk about what cash needs you have at the Holding Company, and how much cash you would feel like you would need to hold back?

Hey, Doug, it's Mark. I think we got this question last quarter. We constantly evaluate the capital needs for the entire company and really align that with our growth forecast. I don't think we try to pin a number on holdco cash. But I think, again, we're constantly evaluating those needs against -- aligning it out with the growth forecasts. And I think the underpinning of that, too, is we built Essent on strong capital levels. And I think that's important for us to maintain those type of capital levels. It's really important to the long-term success of Essent.

As you manage those growth, would you think about external reinsurance to help manage those capital levels?

I think when we look at capital, we would evaluate all sources of capital, not focus on any one in particular.

Great. Thank you, Mark.

Your next question comes from the line of Mark DeVries with Barclays.

I was hoping to get a little more color on the structure of these two GSE deals you announced. And the ACIS deal, how is your enhancement structured around that? And what type of premium do you expect on that?

Mark, it's Mark. Similar to the base business we're not going to comment on any particulars. I would just say in line with our portfolio returns. I think we're excited in terms of just increasing the franchise value outside of Essent Guaranty. Although the Fannie Mae deal is within the Essent Guaranty, the Freddie Mac stacker transaction is within Essent Re. So, I think we're excited that we're broadening the franchise, and the returns are in line with our overall expectations.

Okay. And you may not be able to comment on this, but on the Fannie deal, is that primary MI or is that more full level coverage?

Again, we're not going to comment on any particulars of the deal. We don't want to get into that habit moving forward. Again, I think taking a step back for investors we manage, we're a portfolio business. And we're growing that portfolio. That's really the strength of Essent, is how we grow the insurance in force, manage our expenses, keep our eye on risk and pricing. And I think when -- as we look at the business, look at any individual transaction, we look at it within that context.

Okay. Fair enough. I don't know if there's any color you can provide us just on the amount of risk there so we can model it out going forward, that would be helpful.

Next question, I think we also calculate your market share as 14%. But it's actually an actual number now because I think everyone's reported their numbers. And that's up quite substantially from 12.8% last quarter. And, Mark, I know you don't focus on market share, but was just hoping you could comment on what is allowing you to show that kind of improvement. Is it continuing to improve wallet share at your existing customers, adding new ones, or a combination of both?

I think it's a combination of both, Mark. It's activation of new clients and then utilization of existing clients. I think that's been our goal since the beginning, since we met you probably a year ago, and this is our [two] quarters of public release. We're continuing to add customers. We are a customer-centric company. And our view is, the more we can be in front of our customers, help them grow their business, make sure we're prudent around pricing and risk with them, and be a good partner to them, I think we will continue to reflect that. That will continue to be reflected in our growth in our portfolio.

Okay. And do you have an updated sense of how much of the market you are now serving?

No real update from -- I probably touched more since the last call. Pretty much we're getting there in terms of overall market coverage.

Okay. Great. Thank you.

Your next question comes from the line of Rick Shane with JPMorgan.

Good morning, guys. Thanks for taking my question. And I'm not sure you're going to answer this but I would love to follow up on what Mark was just asking about. When you think about the Fannie transaction, can you at least -- and, again, I realize you're not going to give us specifics, but I would love to talk about the P&L geography a little bit in terms of what the average premium rate might look like versus normal business. Is it higher, lower, what the expense ratio looks like versus tradition business, is it higher or lower? Just so we can at least think about how this is going to impact the direction of the models going forward.

Yes, and I understand you guys from a modeling perspective. But, again, I'll focus you just on the portfolio, and, really, the all-in premium that we have in the portfolio. So, go to that line in the stat supplement. Our all-in premium has been relatively flat the last six quarters, about 54 basis points. Again, I would zero in on that for modeling clues. But, again, we're just not going to break it out. It's not that material to the overall portfolio. And I think that's something, again, for somebody to keep in context. We are managing a portfolio of loans of different customers, and we really zero in on how that portfolio is growing, and the all-in economics of that portfolio.

Got it. Thank you.

Your next question comes from the line of Chris Gamaitoni with Autonomous Research.

Good morning. Thanks for taking my call. What is the loss ratio that you are using in that normalized mid teens number?

Hey, Chris. We don't disclose loss ratios. Again, as I said in previous calls, I would go back to that late 1990s time frame when you're looking at claim rates of that 1.5% to 2.5% range. Again, it's important to look at claim rates because that's really lifetime losses versus getting caught up in terms of loss ratios. But that 1.5%, 2.5%, probably I would say in the mid to the upper part of that range. That range, the lower part of that range, in the late 1990s, a lot of those guys got refi'd out so it made the claim rate look a little bit lower. But kind of that 1.5% to 2.5%, the upper end of that range is a good proxy.

Okay. And then on the comments that PMIERs will impact your business, at least according to my modeling it doesn't impact the high end based off. So, your current mix, we come up with the same numbers. But on the lower end it seems to be very penalized heavily. Is it the assumption that you just won't move down to below [680]?

No, not at all, Chris. I think part of it is not a lot of business is getting done there today because of some of the going FHA, because of the LLPAs. There's just not a lot of business in general. So, our view is as -- just like we do with the rest of our book -- as business starts to get into volume, if there's more volume there, we will start to obviously look at pricing. But we do that throughout the whole book. One of the things I would point out is if you get to the lower band of that FICO band, 620 to 639, I think we're one of the higher priced in the industry. So, again, we constantly look at pricing -- again, within the context of our overall portfolio.

Okay. And then, can you walk me through -- the press release states that the Essent reinsurance quota share improves capital efficiency, but then you said on the call it's the same capital. So I'm a little confused.

Chris, I think, again, it goes down to, from a capital standpoint, how much economic capital we believe we have to hold. Whether it's in Essent Guaranty or Essent Re is not the difference. The thing to point out is there's a full statutory tax rate at Essent Guaranty and the tax rate for Essent Re is zero.

Okay. So it's a tax rate. That's perfect. And that deal complies with the new PMIERs which consolidate affiliate reinsurance. Is that because it's owned by Group and not Guaranty?

Yes. They would comply. We would expect PMIERs to apply for Essent Re just as it does for Essent Guaranty.

Okay. Thank you.

(Operator Instructions)

Your next question comes from the line of Geoffrey Dunn with Dowling & Partners.

Good morning. Mark, first question, over the last year you've indicated you don't think you have a need for capital through 2016. Given the trajectory of the traditional business but also the opportunities for other types of business like the ACIS deal this quarter, is that still your thought?

Jeff, I think we constantly evaluate our capital needs. And we're always going to align those with our growth forecasts. And, again, like I said this earlier, we built Essent on strong capital levels. We think the strong capital builds customer confidence, it builds investor confidence. That has been the tenet of how we built Essent, and I think we will continue to have that philosophy. But then, obviously, when we put pencil to paper it's really evaluating the needs versus our forecasts.

And then to follow up on the last question, forgetting an overall portfolio view, as you're currently priced, in your two break points below 680, do you think your rates are adequate under PMIERs to generate an acceptable return?

I think, again, we look at it in the overall portfolio. Again, there's not much volume getting done there today anyway, Geoff. So, in terms of looking at it, is there room for price movement? -- I think there is. If you compare, again, private MI just in that lower bucket, the pricing of private MI with FHA today is a pretty wide gap. Again everyone -- the industry is very smart too. We price, the whole industry, we price against capital. There's possibly room.

And the last question, you're going to hold a similar kind of capital leverage for the quota business off shore. How do we think about the capital allocation on these types of reinsurance deals? Obviously it's a different transaction than traditional MI, which is why the property casualty subs seem to be writing it. But in terms of trying to evaluate the capital you put to work, how do we differentiate that?

Again, time will tell as you see some of the book building up. I would just tell you we're going to look at really applying economic capital across the organization. That's a tenet we have had from the beginning. We are able to now put that to work in other types of transactions.

But economic capital is really going to be really the thing that we look at. And we will consider, obviously, we have PMIERs, we have our state capital rules, the rating agencies have their rules. But we are not going to be in the capital arbitrage business. We are really going to hold as much capital as we think we need to hold against a risk in any particular transaction.

Okay. And then last question -- on the pool deal that you announced, is that in line with the traditional XOL with the stop-loss type of structure?

Again, we're not going to comment on the particulars of it. Again, look to the earned premium line in the stat supplement going forward. Again, these are returns that are fairly similar with our existing business -- right in line with our expectations, in fact.

Asked differently, then, are you going to break out the associated risk in force with this insurance in force?

Yes, we will. We will break out the flow versus the pool.

All right. Great. Thank you.

There are no further questions at this time. I will now turn the call back over to Mark Casale for closing remarks.

Thank you, operator. We would like to thank everyone for participating in today's call. And enjoy your weekend.

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