Essent Group Ltd (ESNT) 2014 Q4 法說會逐字稿

Good morning, my name is Kelly, and I will be your conference operator today. At this time, I would like to welcome everyone to the Essent Group Limited fourth-quarter 2014 conference call.

(Operator Instructions)

Thank you. Chris Curran, Senior Vice President of Investor Relations, you may begin your conference.

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 financial results for the fourth quarter and full year of 2014, was issued earlier today, and is available on 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 M.

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 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.

In our first full year as a public company, Essent had a very successful 2014. During the year, we continued expanding our Franchise, growing our insurance in force, and delivering high-quality earnings growth to our shareholders. As I have stated before, our goal is simple, and that is to build a high credit quality and profitable mortgage insurance portfolio.

We are optimistic heading into 2015. Our outlook for the MI sector remains positive, based on the improving fundamentals of the US housing market and the economy. Given the solid market presence that we have established over the past five years, we are excited about our prospects in the core MI business.

In addition, we continue to view GSE risk-share and Bermuda as long-term opportunities for us. During 2014, we participated in risk-share transactions out of both Essent Guaranty and our Bermuda-based reinsurer, Essent Re. Activating Essent Re in 2014 expands the use of our mortgage credit risk expertise, and helps leverage our Bermuda holding company structure, thereby creating incremental value for our shareholders.

Our capital levels are strong, ending the year with $956 million of GAAP equity, and no financial leverage. In November, we issued 6 million shares, and successfully raised $127 million of primary capital that is targeted to support future growth.

In addition, our solid market presence, growing profitability, and strong capital levels are reflected in our investment-grade financial strength ratings of BBB+ with S&P, and BBB flat with Moody's. We take a long-term view of our Business of investing and mortgage credit risk, and firmly believe that strong capital levels beget more opportunities in the marketplace.

Now let me touch on some of our strong financial results. For the full year, we earned $88.5 million or $1.03 per diluted share; while for the fourth quarter, we earned $28.9 million or $0.33 per diluted share.

We ended the quarter with insurance in force of $50.8 billion, a 9% increase from the third quarter, and a 58% increase from the fourth quarter a year ago. Our insurance in force continues to drive our top-line revenue growth.

Net premium earned for the quarter was $67.8 million, a 12% increase from the third quarter, and a 68% increase from the fourth quarter a year ago. Finally, our combined ratio for the quarter was 42%, a decrease from 43% last quarter, and 57% from the fourth quarter a year ago.

During the quarter, we generated $6.5 billion of NIW, while the full year we generated $24.8 billion. In addition, for all of 2014, we increased our active customers to 1,000, a 39% increase from 721 active customers in 2013. Although competition in our industry is strong, we remain comfortable with our solid market position.

In addition, we manage our insured risk on a portfolio basis, focusing on premium yield, expected losses, expenses and returns. For the fourth quarter, our premium yield was 56 basis points, and we continue to be pleased with the unit economics and pro forma returns on our insured portfolio.

For 2015, we are estimating industry NIW to be approximately $175 billion to $185 billion. This estimate reflects a combination of scenarios and estimates around the size of the origination market and private MI penetration rates. However, I should note that these estimates could be impacted by a number of factors, including the new FHA pricing, any changes in G-fees and the final PMIERs.

Turning our attention to Washington, we expect final PMIERs by the end of this quarter, or shortly thereafter. As for FHA's price decrease: While the new pricing is more competitive for certain FICOs and LTVs, the substantial majority of NIW being generated by us is outside of the impacted ranges. In addition, while it is uncertain as to whether G-fees will be lowered, to the extent that they are, private MI becomes much more competitive in many of these ranges. Ultimately, we believe that G-fees should reflect the appropriate level of credit for private mortgage insurance.

Finally, the FHFA recently issued its 2015 scorecard. Goals this year include increasing the amount of GSE risk-share to $270 billion, from $180 billion in 2014. Directionally, we think this is positive for private capital investment, and an area that Essent targets as an opportunity in expanding our Franchise and increasing shareholder value.

Now let me turn the call over to Larry to cover more of the financials.

Thanks, Mark, and 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.

For the quarter, we reported net income of $28.9 million or $0.33 per diluted share. This compares to $25.1 million or $0.29 per diluted share for the third quarter. Our effective tax rate for the fourth quarter was approximately 35%.

As a reminder, we began writing business in Essent Re effective July 1, 2014. The average risk in force and contribution to consolidated income from Essent Re in 2014 was small. In 2015, the contribution of earnings from Essent Re will increase as a result of revenues generated on the current in force book, as well as new business written for the full year.

Accordingly, we expect our effective tax rate to decline in 2015, as compared to 2014. The actual effective tax rate for 2015 will be dependent on the mix of earnings from our US mortgage insurance business, as compared to our Bermuda business. Based on our current forecast, we expect our effective tax rate for 2015 to decline to the low-30% range.

Our provision for losses and loss adjustment expenses for the fourth quarter was $3 million, compared to $1.4 million in the third quarter, and $692,000 in the fourth quarter a year ago. Our provision for the quarter is in line with the increase in our default rate to 20 basis points from 15 basis points last quarter, and 11 basis points at the end of 2013. Our expense ratio for the fourth quarter was 37.8%, a decrease from 40.6% last quarter, and 55.3% for the fourth quarter a year ago.

Other underwriting and operating expenses for the fourth quarter were $25.6 million, slightly higher than our forecast, slightly higher than our expenses in the third quarter of $24.5 million, and $3.4 million higher from the fourth quarter a year ago. Looking forward, we believe that for the full-year 2015, other underwriting and operating expenses will be in the $110 million to $115 million range.

The consolidated balance of cash and investments at December 31 was $1.1 billion, as compared to $915 million as of September 30. The increase during the quarter was due to the net proceeds of $127 million from the equity offering in November, and the operating cash flows generated by the Business.

The cash and investment balance at the holding company at December 31 was $126 million, as compared to $47 million at September 30. The primary reason for the increase was due to the capital raise previously discussed, partially offset by a $50-million capital contribution to Essent Re. This contribution was made in the fourth quarter to support the expected growth of the Business in the first quarter of 2015, the second Freddie Mac ACIS deal executed in the fourth quarter, and the ongoing 25% quota share with Essent Guaranty. Note: There was no capital contribution needed from the holding company to Essent Guaranty during the fourth quarter.

The combined statutory capital of the US mortgage insurance companies was $706 million, reflecting an increase of approximately $42 million compared to September 30, 2014. This increase was primarily driven by statutory earnings. The combined risk-to-capital ratio of the US mortgage insurance business was 16.2 to 1 at the end of the quarter.

As of December 31, 2014, total consolidated GAAP equity was $956 million. Also as of December 31, Essent Re had GAAP equity of $155 million, and total risk in force of $836 million, as compared to $102 million and $462 million, respectively, as of the end of the third quarter.

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

Thanks, Larry.

Before getting into my closing remarks, I would like to take a moment to thank my colleague, Adolfo Marzol, for all of his valued contributions over the past six years. In November, we announced Adolfo's retirement, effective March 31 of this year. Adolfo played an integral role in our success, from start-up through today. His solid reputation and deep knowledge of the US mortgage industry helped Essent establish strong relationships in Washington.

Adolfo has been tireless in promoting the benefits of Essent and private mortgage insurance in housing finance. And he played a leading role in starting our industry trade group, USMI. Adolfo, on behalf of all of our employees and the Board, thank you for your dedication and service to Essent, and we wish you the very best.

In closing, we had a great quarter, as well as an excellent 2014. During the year, we grew and strengthened our Franchise, while producing strong and growing earnings for our shareholders. The entire Essent team made great process in expanding the Essent Franchise throughout the US, as well as in activating Essent Re.

Our operating platform remains strong on all fronts, and our team continues to deliver best-in-class service to our customers. Essent is well positioned heading into 2015, and we are optimistic about the future of Essent and the value of private mortgage insurance in housing finance.

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

(Operator Instructions)

Douglas Harter, Credit Suisse.

Thanks. Mark, when you take a look at the new vintages being written, how do you think that the credit quality of that compares to the prior couple years?

Doug, it's a good question. I think it's very similar.

I know that the FICOs are a little bit lower, and the LTVs a touch higher. But that's generally because of the switch from purchase from refinance of the purchase business. But in general, we've been very pleased with not only the quality of the originations, but the consistency, since we started writing back in 2010.

What is your expectation that the newer vintages could follow the early loss curves that we've seen, which I think you would probably agree have been better than you expected over the past couple years?

Again, our book is relatively young, and I still like to caution everyone around that. We've done this before. I'll point you to the late 1990s, where that's obviously -- book was baked, and saw the losses there, and that 1% to 3% claim rate. We still think it's in that range, probably a touch in the 2% to 3% range.

But yes, you can read that into 2010 and later. But again, for us, the book is still young. But obviously pleased with the performance to-date.

Great. Thank you, Mark.

Sure.

Eric Beardsley, Goldman Sachs.

Hi, thank you. On your NIW outlook for 2015 for the industry, how much of an impact from the FHA premium cut are you baking into that?

Hi, Eric, it's Mark. I would say kind of mid-single digits, given the analysis that we've done on our portfolio, and combining the quantitative effects of the FHA pricing, along with some of the qualitative factors.

That being said, we're quite positive, even on the pricing, just from an industry outlook. Our view is, lower FHA pricing could help spur more economic and housing activity, which helps our lender partners. And as our lender partners -- as their business improves, our business improves. So we take a little bit of a different look at it than some of the others.

Got it. And then just on the OpEx guidance, for 2015, it sounds just a touch higher than where you were thinking, around the 7% to 10% growth rate moving forward. Is that because you're seeing more opportunities, whether it be in Bermuda or other areas?

Maybe a touch more on the opportunities. I do think that guidance was more over a three- to five-year range, in general. So it could be different in certain years.

Certainly we're spending a little bit more around Bermuda because of some of the opportunities. But we feel pretty comfortable still. Taking a step back, just the nominal expenses that we have relative to some others in the industry, we feel very comfortable. And we think longer-term, it's an advantage for us

Got it. And then just lastly, we've heard quite a bit of noise in the competitive environment in terms of some folks getting more aggressive on the single premium, and potentially that volume increasing in 2015. Are you feeling similar pressures, or are you observing those same trends?

Eric, I think, again, taking a step back, we said before, we really look at the impact on our portfolio. We're a portfolio growth story. Our portfolio continues to grow. 58% of our portfolio grew. Our premiums grew 68%.

So we've seen pricing pressure in different pockets since we started the Company. We saw them at BPMI singles. I think some of that has shifted because of a QM to LPMI. So you're seeing a little bit more activity in that business. But all in all, from an Essent perspective, I think we're pretty pleased with the make-up of our portfolio and the profitability of the portfolio.

Great, thank you.

Jack Micenko, SIG.

Hi, good morning. One of the areas you're a little bit different is, some of the loss year stuff. And 50% increase expected in the risk-share business out of the year-end report. I think you highlighted it a little more in your comments today.

I mean, how do we think about that as a growth driver for Essent? Should we think about a like-kind 50% increase in your business there on a NIW basis? How should we think about that for 2015?

Jack, it's Mark. We think it's a longer-term opportunity. I would repeat what we said in the third quarter, is that we're cautiously optimistic about some of the prospects.

The issue is just really how to quantify that, and the GSE risk-share is still relatively new. We've been pleased with the activity to-date. Again, longer-term, although we can't quantify it, it really is becoming another platform for us to invest in mortgage risk. And I think that's what excites us about it. But for us to give you real guidance around quarterly flow and so forth, I think it's just too early.

Okay, that's fair enough. One other question. Obviously Florida and Texas are huge housing states, and they're also big MI states.

It looks like Florida and Texas for you has continued to grow as a slice of the pie. I'm wondering if that's intentional and targeted, or that's you just growing into what a normal housing footprint looks like? Thanks.

Yes, I think it's more the latter. As we grow customers and get more geographically diverse with our customer base, you're seeing our portfolio match the population of US.

All right, thank you.

Bose George, KBW.

Hi, guys, good morning. First a question on the premium. Just curious what's driving the increase in the premium.

It was 54 basis points earlier in the year, and now it's 56 basis points. Is it the purchase volume trends that you noted earlier?

Pretty much, Bose. As that's working it's way through the portfolio. Again, that's obviously a higher price, giving us a touch lower on the FICAs and a touch higher on the LTD.

So as that works its way through the portfolio, you've seen a little slight uptick. But it's generally, relatively -- again taking a step back, it's relatively flat over the past year.

Okay, great. And then the comment you made about the single-digit impact from the lower FHA pricing. Does that assume no changes in the LLPAs?

Yes.

So to the extent there are, it could end up being potentially no impact at all up there, meaningful cuts there?

It depends obviously what the changes -- if there are any changes, what the magnitude of them are. But surely that would change our view.

Very well. Okay, great. One last thing, just on the Freddie Mac ACIS deals. Where do those premiums fall through your income statement?

Bill, this is Larry responding. That is in other income. We've concluded that the accounting for at least the initial contracts are derivatives, so we're flowing that through other income. The impact in the fourth quarter and, really, entire-year 2014, is very small.

Okay, great. Thanks a lot.

Sean Dargan, Macquarie.

Thanks, good morning. I have a question about your NIW estimate. You quantified what you think the impacts from the FHA pricing move will be. Does that estimate assume that LLPAs and G-fees stay where they are now?

Yes, it does Sean.

Okay. So there's some potential upside from that.

And then, we've seen some rationalization in the larger Bermuda reinsurance market, with some M&A activity there. Just wondering if you think there's any opportunity to reinsure other primary areas of business?

Well, there's always opportunity. But I think we're more focused on the GSE risk share this time. We like it. It's a little bit more of a diversification around the risk profile for the Company.

Okay, thank you.

Rick Shane, JPMorgan.

Thanks, guys, good morning, and I appreciate you taking my questions. Just one quick question. You answered a question about geographic diversity. I'm curious if, within the portfolio, you're starting to see any divergence in credit performance related to what we're seeing economically in the oil patch states?

Hi, Rick, it's Mark. No. The short answer is no, we haven't seen an impact.

I think the precipitous drop in oil prices caught everyone by surprise. But it's still too early to tell. It's certainly something we're looking at, and will continue to look at and report in future quarters. But right now, it's early, and we're not seeing any change whatsoever.

Got it. And Mark, given your relationships with the lenders, do you have much ability to tweak your underwriting in those states if it becomes a concern and you pull back? Or do you, from a relationship perspective, need to continue to take the volume there?

I think as a risk organization, we would always align our underwriting guidelines with potential risk. So yes, we have strong relationships with lenders, and I think we would compare information with lenders. I think that's part of what we do with some of partnerships with our lenders, is share that type of information and work together to make sure we're both managing our risk appropriately.

Got it. Great, thank you.

Amy DeBone, Compass Point

Hi, good morning, thank you for taking my questions. Most of them have actually already been asked.

But you explored the opportunity provided by the non-agency mortgage market. ARCH recently announced the launch of AMT just a few weeks ago. And given it's, essence, investment grade rating and improving capital position, it seems like it could be an opportunity to diversify in new business away from the agencies.

Yes, hi, Amy, it's Mark. I think our view on the non-agency -- I think it's still somewhat range-bound, and I think it will continue to be range-bound until yields are increased or rates rise to attract the investors into that market. But it's certainly something we look at and we're following. But again, I think we're more focused right now on the opportunities with the GSEs, both within Essent Guaranty, and obviously within Essent Re.

Okay, thank you.

Chris Gamaitoni, Autonomous.

Good morning, guys, thanks for taking my call.

Sure.

Sorry, I missed the guidance on OpEx. Would you mind repeating that for me?

$110 million to $115 million.

And then on the new client ties, could you just talk about what the profile of this client -- are you're moving them -- is it more wins on the smaller, more purchase-centric originators? Just how that customer acquisition is going. Do you need more staffing? Those types of color on that. And then how many more clients you think you need to be fully at your goal?

We said before, I think, our longer-term goal is 1,500, which would put us pretty much in line with most of the industry. We're a few years away of getting there.

We're very pleased with the staffing. I don't think we're fully staffed. We're always look for opportunities for smart people in territories. It's an iterative process in terms where we see the opportunities and where we add people.

I think with the clients, I would say it's mostly on the smaller end. Again, it gets to the tail on some of the stuff. So the impact on the overall market or the overall market size, in terms of how much we penetrate, gets to be a lot smaller. Or the increases are smaller as you add lenders. But again, we still -- we're a big believer in breadth and depth of our client base. And we're obviously very pleased with how we grew that in 2014, and something we'll continue to focus on over the next few years.

Perfect. And do you have any color on the tax-adjusted return differentials between the flow business and the [lisheran] transactions you're doing in Bermuda Re?

As we said before, we don't really comment on individual-type transactions. I would just say the returns of the business are pretty consistent in those entities

Perfect, thank you.

(Operator Instructions)

Mike Zaremski, BAM Funds.

Hi, good morning. Mark, you sounded cautiously optimistic or uncertain about the long-term opportunity for the non-traditional GSE risk-sharing market to expand further. I'm curious, is it more of a lack of demand from the private market? I mean, obviously you guys are interested in it, but maybe others aren't?

Or is it a lack of supply and reform clarity from the FHFA? Or maybe it's both.

I mean, one, I would emphasize the optimistic part of the cautiously optimistic. I think we continue to see flow. I think the caution comes from -- it's still relatively new. The GSEs have only been doing risk-share for 1.5 years. And given that where they are in conservatorship, it's something that could change. And I think that's why we want to do just hedge our bets there, in terms of speaking to folks about it.

But again, I think we've been pleased with how we've established Essent Re activity in 2014, and some of the opportunities we're seeing. But it's not like the US business, where there's a charter and they have to use mortgage insurance. So that's all. I wouldn't read too much more into it.

Okay. So you do think there's enough demand from other companies, other than Essent and some other asset managers out there that like these transactions?

I think there's been demand both on the insurance side and on the funded side. And you can speak to the GSEs about that. I think the programs have been very successful. They've done a great job with this initiative at both of the GSEs.

Okay, got it. And lastly, if I missed it in the prepared remarks you can just tell me. But persistency looks like it declined a bit this quarter. If you can talk about the drivers and how you're thinking about persistency in the new year?

I think it obviously dropped a little bit. But I think that was due to -- the primary driver was really, the refinance activity ticked up a little bit towards the end of the year. And our guess, just talking to lenders, it will tick up a little bit in the first quarter of this year, but then should flatten out a little bit.

Makes sense, thank you.

There are no further questions at this time. I now turn the call back over to the presenters.

Thank you, operator. We'd like to thank everyone for participating in today's call. And have a great weekend.

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