Essent Group Ltd (ESNT) 2015 Q2 法說會逐字稿

Good morning. My name is Susanne, and I will be your conference operator today. At this time, I would like to welcome everyone to the Essent Group, Limited, second quarter 2015 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)

Mr. 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, and Larry McAlee, Chief Financial Officer.

Our press release, which contains Essent's financial results for the second quarter of 2015, was issued earlier today and is available on our website at Essentgroup.com in the Investors 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 February 27, 2015, 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. Earlier today we reported our financial results for the second quarter of 2015. Essent's strong results reflect our continued execution on building a high credit quality and profitable mortgage insurance portfolio. Our outlook remains positive for our franchise and the MI sector, and we continue to be pleased with the pace of the US economic and housing recoveries.

The Essent franchise and our market presence remains strong in our core MI business, while on Bermuda we successfully participated in a another Freddie Mac ACIS deal during the quarter. Essent RE continues to be a opportunity to invest in US mortgage risk, and to better leverage our Bermuda-based holding company structure, creating incremental value for our shareholders.

Now let me discuss our strong results. For the second quarter we earned net income of $37.2 million, representing a 90% increase from $19.6 million earned for the second quarter a year ago. On a per-diluted-share basis, we earned $0.41 for the quarter, compared to $0.23 for the second quarter a year ago. Our strong results were driven by our insurance in force, which increased 46% to $57.4 billion as of June 30, compared to $39.4 billion as of June 30, 2014. Growth in insurance in force increases the amount of premium earned and improves our operating leverage.

For the second quarter, earned premium was $78.4 million, a 56% increase compared to $50.3 million for the second quarter a year ago. Including operating expenses and our strong credit performance, our combined ratio was 37.6% for the second quarter, down from 48.9% for the second quarter a year ago.

During the quarter we generated $7.3 billion of NIW, and grew our active customers to 1,045, representing a 22% increase compared to 860 active customers as of the second quarter a year ago. As a reminder, we define active customers as those which have delivered NIW to us during the last 12 months. We continue to be pleased with the depth and breadth of our franchise and our position in the market place.

On the Bermuda front, we continued seeding 25% of Essent guarantees, GSE eligible NIW to Essent RE, while also participating in the Freddie Mac 2015-4 ACIS transaction. As of June 30, 2015, Essent RE has total risk in force of $1.6 billion.

Turning our attention to Washington, the FHA and GSE issued their updated PMI requirements for lender-paid MI, which will be effective on prospective NIW beginning in 2016. Our initial assessment is that the new factors are consistent with our economic capital framework regarding the amount of capital required on the LPMI product. We will continue to manage our business on a portfolio basis, focusing on our all-in premium yield, and generating strong returns.

Now let me turn the call over to Larry.

Thanks Mark, and good morning, everyone. As Mark noted for the second quarter, we reported net income of $37.2 million, or $0.41 per diluted share. This compares to $34.8 million, or $0.38 per diluted share, for the first quarter of 2015, and $19.6 million, or $0.23 per diluted share, for the second quarter a year ago.

Earned premium for the second quarter was $78.4 million, compared to $75 million for the first quarter, and $50.3 million for the second quarter of 2014. The average premium rate for the second quarter was 57 basis points, compared to 58 basis points last quarter, and 55 basis points for the full year 2014. The provision for losses and loss-adjustment expenses for the second quarter was $2.3 million, compared to $2 million in the first quarter of 2015, and $966,000 in the second quarter a year ago.

The provision for the quarter is in line with the number of defaults and aging of our inventory. The default rate as of June 30 was 23 basis points, as compared to 21 basis points last quarter and 13 basis points as of the end of the second quarter of 2014.

Our expense ratio for the second quarter was 34.6%, a decrease from 36.6% last quarter, and 47% for the second quarter a year ago. Other underwriting and operating expenses for the second quarter were $27.1 million, compared to $27.5 million last quarter, and $23.6 million for the second quarter a year ago. For the full year, we continue to believe that other underwriting and operating expenses will be in the $110-million to $115-million range.

The consolidated balance of cash and investments at June 30, 2015, was $1.2 billion. The cash and investment balance at the holding company at June 30 was $108 million, as compared to $124 million at March 31, 2015. The decrease during the second quarter was primarily due to a $20-million capital contribution to Essent Guarantee.

The combined statutory capital of the US mortgage insurance companies was $816 million, reflecting an increase of $68 million compared to March 31, 2015. This increase was driven by statutory earnings during the quarter, and the $20 million capital contribution from Essent Group. The combined risk to capital ratio at the US mortgage insurance business was 15.3 to 1 at the end of the quarter.

Finally, as of June 30, 2015, Essent group's total consolidated GAAP equity was $1 billion. Also as of June 30, Essent RE had GAAP equity of $162 million, and total risk in force of $1.6 billion. Now let me turn the call back over to Mark.

Thanks, Larry. In closing, we had another strong quarter of operating performance and producing high-quality and growing earnings for our shareholders. The underlying drivers of this performance continue to be solid, and we remain pleased with the returns of our business. Our opening platform remains strong on all fronts, and our team continues to deliver best-in-class service to our customers. Essent is well positioned within our industry and in housing finance, and we remain optimistic about the future of our franchise.

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

(Operator Instructions)

Bose George, KBW.

Hi, guys, good morning, First, a little housekeeping question on taxes. Your tax rate bumped up a bit this quarter. Just curious what drove that? What's the tax rate we should use for the year?

Hi, Bose, it's Larry McAlee. In terms of our tax rate, what we do is at the end of each quarter, we estimate what our effective tax rate will be for the entire year, and we apply that rate to our quarterly earnings. As of the end of the first quarter, our estimated tax rate for the full year was 31%. As we updated our forecasts, we had an increase in the proportion of our US earnings versus our Bermuda earnings, which resulted in our updated effective tax rate for the full year now being 31.5%. We made an adjustment in the second quarter, which results in the 31.9% rate for the second quarter.

Okay, perfect, thanks. Switching to the expectations for the insurance -- new insurance written for the industry, I think Mark last quarter you said -- had talked about I think $175 billion to $185 billion. Clearly we've had a very strong quarter, and curious what your outlook is for the full year?

Hi Bose, good morning. I think given the strong NIW for the first half of the year, I think our new range is probably in the $190-billion to $200-billion mark.

Okay, great. Thanks. One more for me. The Freddie Mac, you guys did the ACIS deal again this quarter. Can you talk about opportunities on the Fannie Mae side, because they've got the CIRT deals? Was that an opportunity for you guys?

I think it's definitely an opportunity. In both in Essent RE we engaged with both Freddie Mac and Fannie Mae, we've participated more on the Freddie Mac side at this time, but I would also say Fannie Mae is an opportunity there.

Okay, great. Thanks.

Mackenzie Kelly, Zelman.

Thanks, good morning. First question, Mark, I wanted to get some additional color around the bulk product that you did this quarter. Where those new originations, or were those ones that have been held on balance sheet? Looking at the mix of credit score and LTV, it seems like it was really high quality and very skewed towards the purchase side. Wanting to get some perspective on how that compares to typical single-premium demand that you see, and whether that could be more of a steady source of incremental volume going forward?

It's a good question. It's really the second type of deal we've done. We did one back in the third quarter last year. It is a little bit season, so it is not new originations. It was one where it was on balance sheet and actually got moved to the GSE, so we underwrote it there. The single premium really is more efficient from that standpoint, so it's not really monthly versus singles like it is in the flow business. It's just a more efficient way to move the loans over to the GSEs.

Got it. On the lender paid new [PMI] rule, can you give any insight on how you're thinking about addressing that in 2016, and maybe getting in front of those by resetting customer expectations around what returns could be, or how you plan on moving forward with that?

I think our approach to LPMI -- we'll obviously look at the pricing and the market. But our approach to LPMI is really not going to change. As I said in the script, the capital required is pretty consistent with how we evaluate it on an economic capital basis.

That's why we always have been pretty diligent, really, since the day we started around managing the mix. We don't control of how lenders sell the product, so I think we participate. As we said before, we don't lead with price. I think that's -- others may do that. We have chosen not to. Again, I think that goes back to how we look at everything on an overall portfolio basis. I think we've been very successful as we manage the mix. But really looking at the all-in portfolio and the yield on the portfolio, and I think the returns there speak for themselves.

Okay, got it. Thanks.

Eric Beardsley, Goldman Sachs.

Hi, good morning. Just curious how far are you now from being self-sustainable on the capital front? How much more would you have to push down over the rest of the year?

I think in general, Eric, we're relatively close to full scale in terms of being self-sustaining. Second half of the year's really going to depend on how much business we write. We put some down in the first half of the year. We could put additional capital down in the second half of the year, but I think around Essent Guaranty we're pretty close to being self-sustaining. Any capital needs that we would have in the future outside of our forecast would really come from Essent RE. But I think in general, Essent Guaranty, we're in pretty good shape.

Great. On the premium rate this quarter, how much contribution did you have from accelerated amortization on singles from refi?

A little less than in the first quarter. That's really the drop in the rate. I think that's -- it's obviously, less refinancings in the second quarter, so that contributed to the drop.

Got it. Lastly, now that we've had refi come in a bit, do you have any thoughts on where persistency could go in the back half of the year?

I'm sorry, could you repeat the question?

I was wondering if you had any thoughts on where persistency could go in the back half of the year, now that refi is coming down some?

It depends, really. Little depends also on where rates are going to be in the second half of the year, but I think our -- I think it's going to be relatively consistent with where it was in the second quarter. We don't see any dramatic changes.

Great, thank you.

Doug Harter, Credit Suisse.

(Technical difficulty) a capital question a little bit. To the extent that you need or want additional capital, how would you think about the options of that equity reinsurance, as your options for that capital?

Hi, Doug, it's Mark. I think like we said in the past, we will evaluate all of the options that equity and also reinsurance. We consistently look at all three. I would say a lot of it's going to be dependent on what the market is at that time for those three options. But we certainly would look at all three at the appropriate time.

Got it. On the reinsurance, interested in your thoughts on what the development with AIG with their reinsurance bond deal that they did, and how you would think about that option?

Again, it's something that we have reviewed. I think it's positive for the business. Again, it's another capital source. If you think of debt and equity as a way for us to fund our business, reinsurance and especially the capital markets part of it is another source of capital, which I think for a company, a growing company of our size, it's always good to have multiple sources of capital over the long term. I look at it as a positive.

Great. Thank you, Mark.

Jack Micenko, Susquehanna.

Good morning. A couple questions initially on expenses. Obviously, guiding to the $110 million to $115 million for the year, but I'm guessing that already contemplates the higher NIW, the $190 million to $200 million view, as some of that will flex up and down on volume. The second question being insurance in force, how much insurance in force do you think that $110 million to $115 million expense level can support, as you look out beyond 2015 into 2016 and 2017?

Again, it's a little early for 2016, 2017 for us to be giving expense guidance. Our view is we are pretty much at full scale in terms of handling insurance in force. The system is very efficient in terms of that. In terms of people, really we have been adding over the course of this year. What could be for underwriting, is the percentage of non-delegated switches. We've added some on the BD side, but I think from an expense standpoint we're relatively at full scale, and could handle a much larger insurance in force given where we are. But again we'll look to invest around opportunities, people, when we think it can help the franchise.

Jack, we've always looked at this from a long-term basis, and that's how we manage the business. I think our nominal expense number is very good relative to others in the industry. It's a big focus. The best managed risk companies are usually the best cost managers, too, and I think we're focused on that. It's one of the things that we can control in the business, but certainly we'll look to invest when it makes sense.

Is it safe to assume a continued glide path of operating leverage there, as we've seen over the last four or five quarters?

Yes, you've seen the numbers. I would expect the leverage to continue on the expense side, no doubt.

Okay, great. On the reinsurance side, $5.5 million of risk this quarter. That's a step down from prior. Is that just volume driven, or are there any -- I think there's some fair-value fluctuation there? Just talking through, I think that number had been closer, in the $20 millions the last couple quarters?

The fair value has to do with the earnings related to it. The volume really has to do with just participants in the market and how much Freddie would award on any one deal to participants. I wouldn't -- again, as we said, we're very optimistic, or cautiously optimistic around Essent RE and the opportunities, but that's going to fluctuate quarter to quarter, just like it does -- NIW does in the US.

Okay, so that's more of an allocation, that the GSE is not an appetite for you guys?

Correct.

Okay, great. Thank you.

Sean Dargan, Macquarie.

Yes, thanks, good morning. Mark, given Genworth's recent troubles and their decision not to take certain capital actions, they claim because they wanted to protect their MI financial strength ratings. I found that interesting because a couple of competitors have been running with low investment-grade financial strength ratings for some time. Do you think your strong financial strength ratings will become more of a selling point going forward?

Sean, it's tough to tell. I think our view is we have always held ratings in high regard, and that's one of the reasons we have sought to get the ratings and make sure we manage the business to maintain the ratings. On the GSE side it's, obviously, a little bit less important. We think it's much more important when banks keep loans on balance sheet and look to use MI partners, so we believe it's an advantage there. Longer term, we think well-run insurance companies have high ratings. I think that's how, that's our approach to the business. I can't comment on Genworth. It's really around how we manage the business.

Got it, thanks. Your loss ratios are staying persistently lower, or stubbornly low. Are you changing -- have you changed at all your internal assumptions around loss ratios over the next two, three years?

No, we're still -- I think, as we said before, it's still relatively early in the game for us. Our book is 15-month seasons. Very pleased with the underwriting quality we're seeing from our lender partners. I think they've done a fantastic job. I think the backdrop of improving economy in housing makes us feel good, but it's too early for us to adjust any estimates at this point.

Great, thank you.

Rick Shane, JPMorgan.

Guys, thanks for taking my question. One of the things we've observed is that the actual losses continue to come in a little bit lower than we expect, and the cure rates seem to be higher. Do you guys -- do we see that -- should we see that as a cyclical issue? Should we see it as a growth issue, or do you think overall credit is going to be better over the next three to four years?

Again -- hi Rick, it's Mark. I think we can comment on what we've seen to date, and it's really been since inception. We have a pretty good look on how the files have come in, and the underwriting quality. I think it bodes well for it. I think we've said this many times. Two significant mitigants that help us in terms of quality -- one is QM, which I think the lenders have all done a great job in managing; and also Freddy and Fannie have really done a nice job. I think they look at the loans. I think it bodes well. I think the quality of the originations that we've seen is probably the best. It's a good time for that. We continue to be pleased with what we're seeing on the front end.

Mark, I probably in some way could've asked the question is a slightly better way, which is that -- okay, let's acknowledge that we're a little bit surprised by how well credit's coming in, or it's better than our modeled expectations. Would you say from your seat you're seeing the same thing, or had you expected it to be about this good?

Again, it's early. It's tough to call it, but I think to date, I can only comment on what we're seeing in the underlying quality, and then using what we're seeing on the claim side. Even loans that are going to claim are job loss, divorce, or death -- really the way it was in terms of pure claim. I think that is a positive. I think that is definitely a positive trend. It always gets back to the quality of underwriting. What we've seen in the five years we have been in business is the underwriting quality has been excellent. The fact that's get reflected in the returns, that's obviously not a surprise. It's just too early for us to pin a number on it.

Amy DeBone, Compass Point.

Hi, thanks for taking my questions. Most of them have actually already been answered, but is there any update on the FHFA deeper PMI coverage pilot program you talked about a few months ago?

I don't have any specific update on that program. In terms of GSE re-share in general, I think our view is the trend is very positive. It continues. If you look at the scorecards, the amount of risk that the GSEs are sharing over the last few years continues to increase, and in multiple forms. Both obviously, through the back end with the capital markets, they've done it through the Bermuda companies. They've done it some with the USMI. Again, I think the trend is very positive for private capital, which MI is part of. I think Essent's relatively well positioned. We've been able to take risk share both out of our Bermuda subsidiary, and we've been able to do it through Essent Guaranty. Again, trend overall is positive. The form, again, it will take many forms.

If there were deeper PMI targets included in the next GSE scorecard, how long to think it would take you to get ready or get prepared to offer deeper coverage? Would that be something that would be a factor?

It's speculative at this point. Until we see the exact form of it and what it would take, it's hard for us to comment. Again, I wouldn't -- my guidance for you is don't get too caught up in the form. Take a step back and look at the overall amount continues to increase. I think that's the real take-away, and that's the real positive for the industry.

Okay, thank you.

Chris Gamaitoni, Autonomous.

On the capital front, do you have an estimate of how much more insurance in force you could add with your -- before needing external capital through some [other form]?

No, I wouldn't be -- I wouldn't look at just that our hold company cash and say -- and try to figure out how much NIW we could write. You have to remember how much cash and earnings we're generating within Essent Guaranty which, obviously, is a strong form of capital. Our view, to cut to the chase, Chris, is we think our holding company cash really is very strong right now. We think the level is -- I think we're very comfortable for the next 12 months. That's probably a better way to look at it.

Perfect. Can you give us a sense of what percentage NIW, LPMI? You mentioned that it was -- the new rules are consistent with how you evaluate it. The disclosure's only singles. Obviously, that's not all LPMI. I'm trying to get a sense of where you are in a mix or participation level?

We don't -- it's not a number we disclose, but I think it's probably -- LPMI is really on -- some of the flow stuff we do is actually relatively small now.

Okay. Is it fair to take that as the singles are much more typical flow refinance related?

Correct. It's obviously more bent toward the refinance product.

Thank you very much. The rest of my questions have been answered.

You're welcome.

Geoffrey Dunn, Dowling & Partners.

Thanks, good morning. Larry, I actually had an accounting question for you. Arch was indicating, I think, that the ACIS deals were going to shift from derivative to insurance accounting, but it seems unclear if that's going to be on a retroactive basis or just going forward. Can you add a little more color to that and what it means for modeling?

Yes, we've heard similar things but we've not had anything confirmed yet, Geoff, in terms of that. To the extent that we confirm that, then we'll evaluate the options in terms of what the terms would be to switch from the derivative accounting to insurance accounting. What's driving it is there's a formula, D1-80, in the current contracts that requires the derivative accounting, if they were to move toward actual loss that would allow the insurers to apply insurance accounting. We'll evaluate that once we get some more specifics from AI.

Was the latest deal you did actual loss? I know Freddie shifted recently, I'm just not sure if the DN-1 deal was that way?

Yes, Geoff, great question. That's correct. The last deal that closed this quarter was actual loss, and we will apply insurance accounting to that.

This concludes today's question-and-answer session. I now turn the call back over to the presenters for their closing remarks.

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

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