Essent Group Ltd (ESNT) 2015 Q3 法說會逐字稿

Good morning. My name is Angel and I'll be your conference operator today. At this time I would like to welcome everyone to the Essent Group Limited third 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.) 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, and Larry McAlee, Chief Financial Officer.

Our press release, which contains Essent's financial results for the third quarter of 2015, 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 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 27th, 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 another strong quarter, as we continue building a high credit quality and profitable mortgage insurance portfolio. As managers of long term mortgage risk, we are pleased with the growth and credit performance of our insured portfolio, as well as the returns that we are generating for our shareholders. The Essent franchise and our market presence are strong, and our outlook for the MI sector and housing remains positive.

Now let me touch on our results. For the third quarter, we earned net income of $40.8 million, representing a 63% increase from $25.1 million earned for the third quarter a year ago. On a per diluted share basis, we earned $0.44 for the quarter compared to $0.29 for the third quarter a year ago.

Our strong earnings continue to be driven by growth in our insured portfolio. During the quarter, we generated $7.6 billion of NIW and grew our insurance in force to $62.1 billion. Earned premium for the quarter was $83.7 million, a 39% increase from $60.3 million for the third quarter of 2014.

Our insured portfolio's premium yield for the quarter was 55 basis points while its credit metrics remained strong, ending the quarter with a weighted average FICO of 751 and a default rate of 29 basis points.

Overall, our industry remains competitive, with seven players operating and sourcing business from lenders throughout the US. While there has been increased scrutiny on MI pricing as a result of recent competitor actions, pricing, in our view, has always been competitive.

Whether through rate cards or pricing engines, we believe the industry continues to migrate towards more granular risk-based pricing. This has been the trend since midway through the financial crisis, and recent competitor actions are consistent with this.

At Essent, we will continue to manage our business on a portfolio basis, targeting all-in premium yields and mid teen returns. In fact, our insured portfolio today is risk-based, reflecting a mix of different pricing and credit attributes.

In today's competitive environment, we are well positioned from both a portfolio growth and return perspective, given our solid market presence and efficient operating platforms at both Essent Guaranty and Essent Re.

Now turning our attention to Bermuda, we continue to be pleased with our affiliate quota share as well as our progress in participating in GSE risk share transactions. During the quarter, we participated in another Freddie Mac ACIS deal while also participating for the first time in two Fannie Mae CIRT transactions.

On the Washington front, Essent is supportive of US MI's efforts of having our industry play a larger role in transitioning US mortgage risk from the taxpayer to private capital. We have always believed that our industry can efficiently help achieve this.

Finally, on the recent rumors of another FHA price reduction, we are not aware of anything imminent. However, we believe that the private MI industry and FHA can coexist and play complementary roles in supporting a robust US housing finance system. Even with the FHA price reduction earlier this year, there has been little impact on this year's industry NIW level.

Now let me turn the call over to Larry.

Thanks, Mark, and good morning, everyone. As Mark noted, for the third quarter we reported net income of $40.8 million, or $0.44 per diluted share. This compares to $37.2 million, or $0.41 per diluted share, for the second quarter of 2015, and $25.1 million, or $0.29 per diluted share, for the third quarter a year ago.

Earned premium for the third quarter was $83.7 million compared to $78.4 million for the second quarter and $60.3 million for the third quarter of 2014. The average premium yield for the third quarter was 55 basis points, down slightly compared to 57 basis points last quarter, primarily as a result of a lower level of single premium policy cancellations.

The provision for losses and loss adjustment expenses for the third quarter was $3.4 million compared to $2.3 million in the second quarter of 2015 and $1.4 million in the third quarter a year ago. The provision for the quarter is in line with the increase in the number of defaults and aging of our inventory.

The default rate as of September 30th was 29 basis points as compared to 23 basis points last quarter and 15 basis points at September 30th, 2014.

Our expense ratio for the third quarter was 34.3%, a slight decrease from 34.6% last quarter and a decrease from 40.6% for the third quarter of 2014. Other underwriting and operating expenses for the third quarter were $28.7 million compared to $27.1 million last quarter and $24.5 million for the third quarter a year ago.

The combined statutory capital of the US mortgage insurance companies at the end of the third quarter was $865 million, reflecting an increase of $48 million compared to June 30th, 2015. This increase was driven by statutory earnings during the quarter.

The combined risk to capital ratio of the US mortgage insurance business was 15.4 to 1 at the end of the quarter. Looking forward, we expect statutory earnings will be sufficient to support the forecasted growth in the US mortgage insurance companies.

The consolidated balance of cash and investments at September 30th, 2015 was $1.3 billion. The cash and investment balance at the holding company at September 30th, 2015 was $69 million as compared to $108 million at June 30th, 2015. The decrease during the third quarter was due to a $41 million capital contribution to Essent Re to support the affiliate quota share and GSE risk share activity.

With this contribution, as well as the balance of cash and investments at the holding company as of September 30th, we believe that we have sufficient capital to support our forecasted growth in Essent Re through the end of 2016.

Finally, as of September 30th, 2015, Essent Group's total consolidated GAAP equity was $1.1 billion. Also as of September 30th, Essent Re had GAAP equity of $212 million and total risk in force of $2 billion.

Now let me turn the call back over to Mark.

Thanks, Larry. In closing, we had another strong quarter of operating performance, and the underlying drivers of our results continue to be solid. We are pleased with the credit performance of our growing insured portfolio and the returns that we are generating.

While our industry remains competitive, as investors in long tail mortgage credit risk, we will continue to manage our business on a portfolio basis and target mid teen returns. 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.) Mark DeVries, Barclays Capital.

Yes, thanks. Appreciate the comments. I think, Mark, you indicated you expect to see competition continue to drive the industry towards more discrete risk-based pricing. Could you talk about the implications for the industry's overall share of high LTV lending in the scenario like that if the FHA doesn't move pricing either up or down?

Well, when I say more discrete pricing, it doesn't necessarily mean at all the FICO bands. I mean, just in terms of flat CARs, I wouldn't necessarily jump to that conclusion.

It's really meaning pricing the risk for the appropriate return and also taking into consideration the overall size of the market. I think that's one thing that we want investors to be clear around, is that we want to make sure we're serving as big a market as we can.

And so, the comment was more people will fine-tune it. But, in general, we don't see pricing changing that much in the industry at this time. At Essent, we're still focused on growing the portfolio and targeting certain premium yields that we do. So, I wouldn't read too much into it.

Okay. But, you're not necessarily seeing signs that competitors are lowering their return expectations for certain business as they get a little bit more -- as they sharpen their pencil on some of their buckets, are they?

Yes, I think from our standpoint, given the current competitive environment and what we're seeing in pricing today, we feel very comfortable around our mid teen return estimate.

Okay, that's helpful. And I think we saw in the quarter, at least in the secondary market for credit risk transfer bonds, there was a decent amount of spread widening. Are you seeing an opportunity as you price new deals on the MI side to potentially push up your returns a little bit on that business?

You're talking about the core business, or on the GSE risk share?

Yes, the GSE risk-sharing transactions.

Yes. And again, I think what we said before. I mean, we're pretty comfortable with the returns. Yes, it is market sensitive, so that is an opportunity for us. As the market widens, those deals get priced off the market, so that does enhance the returns for the insurers.

Okay, great. Thank you.

Sure.

Douglas Harter, Credit Suisse.

Hi. This is actually Sam Cho filling in for Doug Harter. So, I know the focus has been on pricing pressures, but are there any other aspects of competition that are playing out in the industry that might have slipped to the wayside because of all these pricing moves?

Again, I think folks are reading too much into pricing rumors and pricing pressure. I think the market is competitive. It's always been competitive. It was competitive the day we started the business with a few guys on the way out, did some things on pricing, and it's competitive today.

Again, that's one way, and it's not the only way, that mortgage insurers compete. Obviously, it's on turn times, servicing, how often you're calling your clients. There's a lot more hard work and kind of shoe leather sweat equity in the business that folks don't always appreciate.

And I think our sales force has done a tremendous job out there really starting the business from scratch and getting these lender relationships over the last five years. And a lot of it is because of service and how well you call on clients.

Is price important? Of course it is. But, at the end of the day, we built the business and built our portfolio in a competitive environment. And we have no doubt that we'll continue to build the business in today's environment and tomorrow's environment, because we're focused on growing the portfolio, remaining disciplined not just around pricing, around credit, around expenses, all the things that make a -- that lead to a well run insurance company.

Got it. Now, shifting gears, in the other revenue line there was the positive fair value change in the insurance policies by Essent Re. What was the driver of the $1.3 million?

Yes, this is Larry McAlee. I'll respond to that question. And we've talked about this in prior quarters. But, the initial contracts that we wrote in Bermuda, the ACIS contracts with Freddie Mac, are accounted for as derivatives.

So, in the second quarter, we recorded a loss of $391,000, and that related to a speed up in prepayment speeds. In the third quarter, prepayment speed slowed and the valuation adjustment was favorable of about $1.2 million -- $1.3 million.

Got it. Thank you.

Bose George.

Hey, guys. This is Chas Tyson on for Bose. I was just wondering, back to the pricing, as you see the industry maybe move more towards risk-based pricing, if you consider some of the programs that competitors have introduced to be price cuts or just price restructuring and kind of a different method of pricing, and if risk-based pricing presents kind of an attractive opportunity for Essent to introduce at some point.

Well, Chas, as I said in my comments, the industry is being risk priced, and really starting right post crisis when the FICO bands got expanded. So, that'll continue to happen. Again, don't read too much into it. These are subtle changes.

In terms of certain competitors with new offerings, we don't react to that so much. I mean, this is a business where we're really focusing on growing the portfolio, making sure we have appropriate premiums around that portfolio.

So, again, from a pricing perspective, yes, there could be some fine-tuning. But overall, we don't see the overall premium yields in the business changing relative to the capital that's supporting the business.

Got it. So, you guys are comfortable with kind of the way you're currently pricing the business as opposed to more of a black box model that some competitors are either using right now or introducing in the future.

Well, again, don't get confused with the delivery of pricing, whether it's through rate cards or electronically. Those are just two different forms of pricing.

We have the ability and, with a couple of clients, have delivered pricing electronically. And I'm sure most of the industry could do the same thing. It's really about, again, what's the all-in premium yields in the portfolio. What are the actual returns that businesses are generating?

We went through this with PMIERs where folks focused on capital within certain cells. And I think we focused folks back on the portfolio, and we'll do the same thing today. I wouldn't look at any one competitor's pilot rate program or other type of introduction to pricing as something that's going to take hold of the industry.

Again, from our focus, we feel well positioned, given our structure and given how pricing is today, what we're currently seeing in the market that will continue to drive strong returns.

Okay, makes sense. And then, you noted that you're pretty comfortable with your capital position at Essent Re through the end of 2016. I'm just wondering how we should think about the capital requirements for that business going forward and what kind of capital will be required post 2016 maybe.

Yes. I mean, again, we're not going to read too much into that. I think given -- I think it's a pretty solid statement to say we're comfortable with capital through 2016. We'll obviously update the market as we get through next year. But, as of right now, we feel comfortable with the capital situation at the company.

Okay. And should we be thinking about that kind of on a PMIERs like risk to capital type metric? I think we've usually heard kind of around 14 to 15 times risk to capital quoted as PMIERs compliant.

Well, again, our economic capital and PMIERs are relatively the same. I wouldn't jump to 14 to 15.

Again, remember a lot of this is done on a portfolio basis versus new originations. I think, given where we are in a risk to capital standpoint today, we feel, again, very comfortable.

Sure. And then, last one just on the 25% seed to Essent Re. How do you think about reassessing or requesting higher seed? I mean, what do you think about it in your conversations with regulators or as you look at the mix of the business? And what timeline do you think, if you were going to request something like that, it would happen over?

Yes. I mean, I would say right now we're very comfortable with the 25% quota share going forward.

Okay. Thank you.

Mackenzie Kelly.

Thanks. Good morning. Mark, just first wanted to get some updated thoughts from you about TRID and what you're been hearing from your customers in terms of how just the first month of implementation has been going and any expectations for implications for MI that you might see, and just lastly whether you're anticipating any potential delays next quarter or in the first quarter related to those applications.

Yes. I mean, the first applications that were taken in early October, a few -- I mean, some have already turned into loans. They actually started turning into loans in the third week of October. So, based on a lot of my conversations with lenders, it's gone very well, very smooth.

Again, a good testament to our lender partners. I mean, these guys have been working on it -- that group's been working on it for a year. The MBA did a great job of helping coordinate a lot of that stuff, but the lenders did a great job. So, what we're hearing to date is it's gone very well, and I would expect it.

Mortgage bankers are very adaptable and have always -- our clients have dealt with regulations since I've been in the business for 20 plus years, and have always managed to handle it extremely well.

Okay, good to hear. And just secondly, on the deep cover proposal that was released a couple of weeks ago, just wanted to kind of get your bigger picture thoughts on what your initial take of that was. And is it in line with what you were hoping to see from the trade group, and what are the next steps at this point in terms of moving along that process with the FHA and the GSEs?

Yes. I mean, I thought the trade group did an excellent job with it. It's a first step, right?

I know it's a first step in a path forward in terms of using more -- having the GSEs use more permanent capital as solutions versus just -- right now probably about 70% of the risk share is through the capital markets and 30% is through the multi lines and not a lot through private mortgage insurance at all on the lower LTV. And we see a more -- I see a more balanced path going forward.

Capital market execution is great, but it's levered and it's obviously market dependent where you want more through the cycle type capital and permanent capital. And so, I think -- this is the first step, I think, in terms of working with the GSEs and FHFA. And I'm positive going forward.

But, it's hard to put a timeline on it. But, I think it's a -- I thought it was a very solid first step.

Okay, great. Thanks.

Jack Micenko.

Hey, good morning. Mark, wanted to talk a bit about persistency, I think lost in some of the pricing concerns out there. In the model, it seems like persistency improvement would more than off shadow any sort of -- some degree of modest compression on pricing if it were to happen. You guys were running high 80%'s about a year ago, and I know the portfolio is still in its infancy, but down to an 80% now. I mean, where do you think persistency can go in the industry if we sort of see this slow grind higher consistently on rates through 2016 and 2017? Just curious there.

Yes. I mean, it's hard to call it, Jack. I mean, it's really so interest rate dependent. I would say just right now, I mean, sort term we're comfortable with the 80% number. It's dependent on NIW. I mean, it's dependent, like I said, on rates.

So, if rates tick up, you'll see persistency tick up and you'll see there's a correlation with NIW. All-in, I would really just focus on the growth in the insurance portfolio. That's where it all comes out in the wash.

So, again, I think we feel pretty comfortable with how we're growing the portfolio with the combination of NIW, persistency. Really the insurance in force growth for us has been very strong, I think 8% quarter-over-quarter and 35% year-over-year. So, that's all factored in. But, I think over the next couple quarters 80% is a decent number.

Okay. And then thinking through some of the products that are coming out now and more of an opaque model, and I know one of the larger competitors has been doing it for some time. But, just thinking through that, I'm curious what your thoughts are around some of the larger banks and that kind of product. I mean, the risk tolerance at some of the banks seems to be quite high. They've -- actually some of them moved away from FHA. With some of the legacy issues that they've experienced through the downturn, it just seems like, with some of the disclosures and compliance issues, that maybe a black box model may be a challenge for the banks. I'm just curious what your take is on that.

Yes. I think it depends on the lender. I think we have shown the ability to tailor our offerings, whether it's pricing, underwriting, training to the needs of the lender. Some lenders have the systems to deploy different forms of pricing delivery and some don't.

So, again, I wouldn't read too much into it. If the industry goes more towards where lender systems can handle electronic delivery and the ability to fine-tune pricing down to the loan level, then I would think the whole industry could -- we know certainly at Essent we could deal with it. Others could certainly comply.

So, again, really focus, get back on to the -- what are the premium yields on the portfolio and not try to pick through kind of certain cells. I think you'll lead yourself to a false conclusion. All-in premiums on our portfolio remain strong.

And again, this is -- Jack, this has been through an industry where someone's had a black box since the day we started, and we still managed to grow the business. A lot of lenders and a lot of loan officers like transparency. And if you have a 250 branch system you like the transparency of a rate card. Someone else who's centralized may like handling, have it more electronic delivery.

Our view and what we'll do is continue to understand the needs of our lenders, do what we need to do to help them grow their business the right way. And in turn, when we do that, and we have done that, helps us grow our business.

Okay, great. Thank you.

Sean Dargan.

Thank you and good morning. I have a question about the average premium yield. It came in 2 basis points sequentially. And did I hear somebody say that that was because that there was a lower level of single premium cancellation in the quarter?

Hey, Sean. It's Larry. That's correct. Some of the tick up earlier in the year was due to an increase in single premium policy cancellations. And we had the corresponding offsetting effect this quarter.

Okay. So, assuming that there is not an all out pricing war and pricing more or less stays where it is, where would the portfolio premium yields migrate in the near term?

Yes. I mean, I think it's -- that there's no real change to it. I kind of -- we've always said it's been around this level. And it kind of ticked up because of the cancellation. But, kind of that low to mid 50s is a good number.

Okay. And then, just in terms of required capital --.

And Sean, just to comment on your price war, there is no price war out there. I mean, pricing has always been competitive. And I wouldn't necessarily look at history to look at the future.

I think there's a -- it's a return driven mindset with PMIERs. I think the discipline in the industry over the last few years has actually been excellent. So, I wouldn't look at a move of certain players as to how the whole industry is going to react.

The portfolio remains strong in terms of portfolio yields and returns, and we expect it to remain strong. I mean, there was LPMI pricing discussion just two quarters ago. And I think at Essent we'll maintain our discipline and continue to help our lenders grow their business the right way while we're focusing on growing the portfolio.

All right. Thank you. Thinking about statutory capital, so you said that you have enough stat capital at Essent Re to continue to write new business through the end of 2016. Did I hear that at Essent Guaranty you're generating enough stat capital to support new business for a period longer than that?

Yes, Sean. It's Larry again. Right now, based on our forecast, we expect that the statutory earnings of Essent Guaranty will be able to support the growth of the business.

Okay. So, that's as far as you can see?

Yes.

Based on current forecasts.

Yes.

Thank you.

Sure.

Rick Shane.

Hi, guys. Thanks for taking my question. So, in some ways we're probably a little bit approaching a transition in the business model in that the last two years or three years have really been about the trajectory on operating leverage. And that's well established and that's going to continue, but the rate of improvement is going to slow.

And I think the next two or three years are really going to be about the trajectory of credit and provision expense. And we're starting to see that come through, and I think over the next 12 to 24 months that's going to be the metric that moves around the most. And I think understanding how that plays out is critical.

When we look at our model, one of the things that we're noticing is delinquencies are coming through pretty much as we've assumed, but the actual payment on losses are lower than we would have expected. And I'm wondering what's driving that, if that's consistent with what you're seeing.

And I'm wondering -- I could attribute it, I think, to three potential factors. One would be a higher percentage of cures. The second would be lower loss severities, and the third would be -- and this might be the most interesting, if there're just delays in the foreclosure process and so the payments on losses are just getting dragged out. I'd love to get your thought on those different variables.

Yes. I mean, Rick, thanks for asking the question. It's a good question. I wouldn't read too much into us at all. I think our default levels are actually very low, and we're seeing probably a normal course from our defaults in declining payments.

I think what's driving our low losses is we are -- our level of delinquencies is actually very low. And I think, again, that's -- we've talked about this on past calls. Although our book is still relatively new in terms of the seasoning, the quality of what we're underwriting and the losses to date have been better than expectations.

And I think for 2016 we are thinking through increased disclosures around incurred loss ratios. And by then, another three, six months, the book will be -- especially our earlier books will be seasoned enough to let you guys -- let the investor community see where we are in terms of loss ratios, what I think will help you guys build your models out a little bit better.

Terrific. And I think what you're suggesting there, and I would -- if you are I would really encourage it. Are you saying that you might provide that on a vintage basis so that that way we can really sort of parse it out?

Absolutely.

Excellent. Thank you.

(Operator instructions.) Amy DeBone.

Hi. Just to circle back real quick to the risk share deals, are the economics of Fannie CIRT programs similar to the ACIS program? And then, would you expect the economics to potentially improve if first year targets increase significantly for 2016?

That's a good question, Amy. I would say yes. To answer your first question, the returns are very similar across both types of transactions.

In terms of pricing, if they were to increase the amount, I think it depends on the sources of capital and how much is out there. I think from our standpoint, and our view really has been -- our strategy is how do we position ourselves for when the market gets a lot bigger, very similar to how we built the business in the US.

If you remember, we built the US business when the NIW market was very small, but built out the infrastructure and the capability to take advantage of a larger market, which has happened over the last few years. We see a similar thing playing out in Bermuda.

We have the infrastructure. We continue to build it out. We're doing deals. So, if the market was to get larger and the returns stay in line with our expectations, we feel like there's a nice opportunity for us to continue to grow that business.

Okay. And then, speaking of market share, it looks like market share remained pretty flat quarter-over-quarter, around 12%. Is your expectation -- I think you mentioned last quarter just to kind of maintain the current level. Is that still the expectation for the foreseeable future?

I think our expectation is to continue to grow our portfolio, making sure we have appropriate premium yields and return targets for our shareholders. So, we're not going to manage market share around -- as you'll see, in terms of some of the other competitors where market share has come down a lot and others going up, you can manipulate that based on different pricing schemes, especially around LPMI.

This is a long term business. We're going to continue to manage it for the long term. Market share is an important metric, but it's really the result of calling on good lenders, having good premiums and good credit characteristics. We're not going to let that metric drive the business or drive the strategy of the Company.

We're in this for the long haul. This is long term mortgage credit risk. It's a business where you don't know what your cost of goods sold is for three years. So, you have to be careful around how you price it and make sure, from our standpoint, the support of our core shareholders, full expectation to continue to grow the business the way we've done it in the past.

Okay. Thank you.

(Operator instructions.) There are no further questions at this time. I turn the call back to the presenters.

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

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