Essent Group Limited (NYSE:ESNT) Q2 2016 Earnings Conference Call August 4, 2016 10:00 AM ET
Chris Curran - VP, IR
Mark Casale - Chairman & CEO
Larry McAlee - CFO
Jack Micenko - SIG
Mackenzie Aron - Zelman
Douglas Harter - Credit Suisse
Bose George - KBW
Chris Gamatoni - Autonomous Research
Max Meyer - Wells Fargo Securities
Good morning. My name is Chrissy and I will be your conference operator today. At this time, I would like to welcome everyone to the Essent Group, Ltd., second quarter 2016 conference call. [Operator Instructions] I would now like to turn the call over to Chris Curran, Senior Vice President of Investor Relations. You may begin, sir.
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 2016, was issued earlier today and is available on our Web site at essentgroup.com in the Investor section. Our press release also includes non-GAAP financial measures that may be discussed during today's call. Complete descriptions of these measures and the reconciliations to GAAP may be found in our press release in Exhibit L.
Prior to getting started, I would like to remind participants that today's discussions 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 29, 2016, and any other reports and registration statements filed with the SEC which are also available on our Web site.
Now, let me turn the call over to Mark.
Thanks, Chris. Good morning, everyone, and thank you for joining us today. I am pleased to report that Essent had another strong quarter of financial performance, as the underlying fundamentals of our business remain solid. Portfolio growth, strong credit performance and a leverageable expense base continue to be the primary drivers of our high quality and growing earnings. As a franchise that invests in U.S. mortgage credit risk, we are well positioned in both the U.S. and in Bermuda in growing our insured portfolio and generating strong returns. We remain positive on housing as low rates, affordability and supply demand imbalances continue to support housings recovery and the strong mortgage origination market. This favorable backdrop is contributing to higher industry NIW levels which we believe will be 5% to 10% higher in 2016 versus 2015. For Essent, a larger NIW market is positive since it accelerates growth in both our insured portfolio and earnings.
Now let me touch on our results. For the second quarter, we increased net income 41% to $52 million from $37 million for the second quarter of 2015 and generated a 17% return on equity. On a per diluted share basis we earned $0.57 for the second quarter, compared to $0.41 for the second quarter a year ago. Our earnings growth continues to be driven primarily by our insurance in force, which grew 26% to $72 billion from June 30 a year ago.
Our balance sheet remains strong, with over $1.6 billion in total assets and over $1.2 billion of equity at June 30. Also, we grew adjusted book value per share 19% on an annualized basis to $13.08 compared to $12.49 at March 31, 2016. We continue to be pleased with our portfolio's credit profile and performance. Our insured portfolio ended the quarter with a weighted average FICO of 749 and a default ratio of 36 basis points on over 328,000 policies. We believe guardrails, such as QM and improved quality assurance by the GSEs, lenders and MIs, have strengthened loan underwriting processes. These changes, combined with strong borrower profiles, have improved the quality of loans being originated today which benefits our policyholders and shareholders.
Shifting our attention to the marketplace, our industry continues to be competitive. However, we remain pleased with our solid market position and strong customer relationships. Additionally, we believe that pricing is stabilizing for BPMI now that the industry has transitioned to a more risk-based framework under the PMIREs. As a reminder, BPMI continues to be the majority of business that Essent and our industry writes. We believe that the PMIREs are pricing guardrails and are a long-term positive for our industry. They shine a light on pricing and increase transparency around returns and capital management. In Bermuda, Essent Re continues reinsuring Essent Guaranty through our affiliate quota share and participating in GSE risk share through the ACIS and CIRT transactions. Although the majority of Re's business is the quota share, we continue to be pleased with our growth in GSE risk share. GSE risk share also offers us a unique opportunity of reinsuring loans with LTVs of 80 and below. This business is incremental to our strong above-80 LTV franchise and increases shareholder value. Looking forward, we remain optimistic about Essent Re's prospects.
Finally, on the Washington front, our industry remains engaged with the FHFA and GSEs on frontend and deep MI opportunities. In addition, we are collaborating with USMI on drafting a response to the recent RFI on credit risk transfer. We believe that a well-capitalized MI like Essent can play an expanded role in GSE risk share. We like our prospects and are well positioned to participate in any pilot programs.
Now, let me turn the call over to Larry.
Thanks, Mark, and good morning, everyone. For the second quarter, we reported net income of $52 million, or $0.57 per diluted share. Net income for the quarter is up 9% over the first quarter of 2016 and 41% over the second quarter a year ago. Earned premium for the second quarter was $101 million, an increase from $94 million or 7% over the first quarter, and an increase from $78 million or 29% over the second quarter of 2015. The average premium rate for the second quarter was 57 basis points, in line with 56 basis points for the first quarter and 57 basis points for the second quarter a year ago. We continue to be pleased with the credit performance of our insured portfolio ending the quarter with a default ratio of 36 basis points.
The provision for losses and loss adjustment expenses for the second quarter was $3 million, a decrease from $3.7 million in the first quarter and an increase from $2.3 million in the second quarter a year ago. Other underwriting and operating expenses were $31 million during the second quarter which was consistent with the first quarter. The expense ratio was 31.2%, a decrease compared to 33.2% in the first quarter and 34.6% for the second quarter of 2015. Our effective tax rate for the second quarter was 29.2% and for the six months ended June 30, 2016, it was 29%, which represents our current estimate of the annual effective tax rate for the full year 2016.
The consolidated balance of cash and investments at June 30, 2016, was $1.5 billion. The cash and investment balance at the holding company was $42 million, a decrease from $71 million as of March 31, 2016. This decrease was primarily driven by a $30 million capital contribution to support the continued growth in Essent Re. As of June 30, 2016, the combined U.S. mortgage insurance business statutory capital was slightly over $1 billion with a risk to capital ratio of 14.8 to 1, essentially flat from the end of the first quarter. On the Bermuda front, Essent Re had GAAP equity of $276 million supporting $3.2 billion of net risk in force as of June 30, 2016. Finally, as discussed in our first quarter call, we closed on the $200 million revolving credit facility. As of June 30, 2016, no amount has been drawn under the facility.
Now, let me turn the call back over to Mark.
Thanks, Larry. In closing, Essent had another strong quarter of financial performance as we continued to generate high quality earnings growth and strong returns. The current housing and mortgage environment is positive for our franchise as industry NIW levels are robust and the related credit quality is excellent. We believe that the housing recovery is still in the early stages and that Essent is well positioned to continue growing its franchise both here in the States and in Bermuda. We remain optimistic about Essent's prospects and the role of private mortgage insurance in U.S. housing finance.
Now let's turn the call over to your questions. Operator?
[Operator Instructions] our first question comes from the line of Jack Micenko, SIG. Your line is open.
Good morning, guys. On the severity rate, it looked like it ticked down pretty notably. I'm thinking that drove the bigger loss incurred as well. What's going on to bring that severity rate so much in the quarter?
Hey, Jack, this is Larry. I think it's still probably a lot of small numbers. We only paid 31 claims in the quarter. If you look in the first quarter, the severity rate was 93%. For the full year 2015 the severity rate was 92%. So I think you'll see some anomalies quarter to quarter while the default inventory is still relatively low.
Okay, great. And then bigger picture question, Mel recently kind of poo-pooed fee cuts at the FHFA, the GSEs. Does that hurt the upfront coverage outlook? I know some of the economics for the incremental coverage were coming from proposed fee cuts. Does that change the forward opportunity there in any way?
No, Jack, it's Mark. I don't think, I don't really think it impacts it in any way. I think it's a little bit bigger than that. It really gets back to the broader themes, right? We're talking big picture. Big picture, the GSEs continue to share risk with the private markets. They've been doing it now for a few years on the capital market side. They're growing the business with the multi lines, and I think the opportunity with the U.S. MI industry is another pocket of capital that they can utilize. So I think they're talking about these pilot type programs, there's an RFI out there, I think the trends are good. It might take time, it's not a quarter-by-quarter watch, but I think over time we'll continue to see the GSEs continue to share risk and obviously the markets are growing, so there's more risk to share. So I would look at it that way. I don't think the numbers are as important.
Our next question comes from the line of Mackenzie Aron from Zelman. Your line is open.
I have a couple of question on just the single premium. One, just what drove the sequential decline in the single premium share volume? And then secondly, was there any contribution from single premium cancellations on the premium yield this quarter?
Yes, definitely on the average premium, it probably added a couple of basis points to the annual premium yields. We've been guiding more to that mid-50, so it was a touch higher in the second quarter. And I don't think in terms of our percentage it's -- I wouldn't look to anything in the quarter. I think we've been, since we started the company, we're kind of in that 80-20 range. So some quarters may be below, some it's high. So I think it's just a matter of where the market is. With purchase we tend to do a little bit less singles, but I wouldn't read too much into it.
And just to follow up on that, is there anything that you're seeing incrementally in the LPMI market? I know you mentioned that pricing had stabled on the borrower paid, but what are you seeing kind of from a supply perspective in LPMI?
In terms of supply, we're seeing probably a little bit less. It looks like the industry as a whole probably did a little less single premiums. What we see in the market, I think this is encouraging, is with the higher FICOs, with the new risk based pricing on the BPMI, it's become much, a little bit more attractive, or more attractive to put a borrower into a monthly product versus a single. And we're seeing that especially in the higher FICOs. And again, when we think about singles, we always put it back to the borrower. What's the best rate or the best product for the borrower? Because I think that's what really drives both credit and pricing decisions. So yeah, but you are seeing a little bit. On the frontend it's a little bit more pushed to monthlies which I think is a good trend.
Our next question comes from the line of Douglas Harter from Credit Suisse. Your line is open.
I was hoping you could talk a little bit about what drove the prior year reserve release in this quarter. And sort of I guess that's been a pretty consistent trend and I'm just wondering if you can give us a little more detail on that?
Really no individual factors drove that. What you really saw was that in the first quarter we saw an increase in our average reserve per default from about 17,000 to 19,000 and it was really due to aging of the inventory from December 31st -- until March 31. In the second quarter our average reserve per default stayed relatively flat. So what contributed to the provision this year was just really an increase in new defaults.
Our next question comes from the line of Bose George from KBW. Your line is open.
Can you talk a little bit about the outlook for the premium? Where's the premium on the new insurance you're writing? Just any color on how that's trending?
I think we said this in the past, we thought with the new pricing, I'll call it the reconfiguration of the pricing grid with the PMIREs, that you would see monthlies go down in that two to three basis point range kind of on a risk adjusted apples to apples basis. That's pretty much what we're seeing. And it's pretty much fully baked now into the quarter. We saw most of our lenders had adopted it. But when you get back to the big picture, we printed 57 basis points for the earned premium yield. And again, we still think mid 50s as an earned premium yield for our portfolio going forward is still a good gauge.
Okay, so the 55 kind of incorporates most of that change already?
Yes. Keep in mind, this is a portfolio now that's $72 billion, so as we grow the portfolio, it's going to take a long time for two or three basis points to kind of work its way through. So again, it gets back to what we said before. We thought the pricing change was actually a very positive change for the industry. It kind of reconfigured the pricing to better price, the lower FICOs, and you priced up to below 700s. And I just think there was a lot of activity and discussion amongst investors and analysts as to it was detrimental to the industry. I think we had said, and I think we've been pretty consistent, that we didn't think the change was that significant.
And I would say longer term it's probably positive versus a detriment just because we're better positioned below 700 from a pricing standpoint. So should the pricing start to drift below 700, more of the business goes below 700, I think we're better equipped on a return basis to handle the business now. So again, longer term a positive and it's a year now since it started leaking into the market and there really just hasn't been that much change to the overall pricing or return to the business. I mean I think we had a return of equity of 17% for the quarter. So again, lots of consternation amongst folks, but I think when you look at the real results, not estimated results or forecasted ROEs, but actual GAAP ROE, I think they remain right where we thought they'd be.
Okay, great. That's helpful. Thanks. And actually, just switching over to the GSE risk sharing, the growth there was pretty strong. Is there anything kind of lumpy there or do you feel like the trajectory of growth in risk sharing could pick up more meaningfully?
Yeah, I think it's actually very lumpy. I would look at it more like the bulk business. So the GSEs did a lot of transactions in the second quarter and I think the third quarter is actually forecast to be pretty light. So I could look at it, really focus on the risk in force which I think ended the quarter at 305 million which we think is strong. But I would look at that. And again, I think the story for us in Bermuda is a lot like our story in the States going back 4 or 5 years ago. We'll continue to just stack. So we'll do the risk when we can get it. It's a little bit lumpier so it's not like an NIW type market but we'll continue to stack it. We love the fact that it gives us another platform to write risk it's below 80, so it diversifies the book a little bit. So I think all those sort of things. But I wouldn't look at any one quarter and say we're growing or not growing. I think you'll see, you'll continue to see growth on the risk enforced side and that's the real gauge.
Okay, great. Actually, just one more. I just wanted to get your latest thoughts on the industry new insurance written expectation for 2016?
Yeah, I think we said it in the opening remarks, we think it will be 5% to 10% higher. I think it was 215 billion in '15 and now just because of the strong second quarter and the strong first half, we're looking at 5% to 10% higher. Which again is another, it's another key indicator of the business, Bose. I mean it's I think 70 billion for the second quarter was more than the industry wrote in 2011 and we said we follow housing. And I think the strong origination market, new homeowners continue to come back into the market. Purchases are up a pretty healthy pace over last year, so I think that bodes well for the industry this year and hopefully going forward.
Our next question comes from the line of Chris Gamatoni from Autonomous Research. Your line is open.
Good morning. All my questions have actually been asked. Thanks for taking my call.
[Operator Instructions] And our next question comes from the line of Max Meyer from Wells Fargo. Your line is open.
First, I was wondering if you guys looked at the recent private risk sharing deals with some institutions, and if so, what the returns have looked like.
Are you talking about the large bank deals where they're sharing their…
No, we have not been involved in those. It's tough for us to look at the pricing because we don't really get exposed to it. So we don't have a real view on it. I think again, I would just go back to my earlier theme, that's another avenue to which the GSEs will look to share risk with private capital. So we look at it as a positive. We don't really need to participate in every single one of their risk sharing opportunities. We feel very comfortable where we are, working with them in Bermuda as they share with the multi lines. We really kind of participate in that part of their risk sharing and we look forward to participating in any pilots they have where they just work with the USMIs. But in terms of just working with banks and getting involved with that, no, we have not. We haven't seen it and I think the opportunity is relatively small.
And then just one other question, you guys traded a healthy book value. A number of people have said that [indiscernible] right now. I'd like to get your thoughts on direct consolidation.
I think in terms of consolidation, our view is you have to really look at it as how much capital supports the risk that the industry is generating. And not necessarily focus on the number of participants. There were seven or eight participants when we started. There's seven now. I think the industry, especially over the last couple of years, has really good access to capital both on the debt and equity side. And I think that will continue. So I think the industry has a lot of access to capital and probably more capital which will support the growing risk as we've seen with the NIW for this year. We would expect the industry insurance in force, which is approximately 850 billion, that's going to continue to grow. So how much capital is really needed to support that amount. And we feel like there's more than enough capital.
And we also think that as the industry continues to build their capital through earnings and ability to access outside capital, it will be able to take in even more risk which is why we're in discussions with the GSEs around potential credit risk transfer. So I think it bodes pretty well. So again, I wouldn't get too caught up in consolidation. I think from a lender perspective, I think seven -- it's really a lender's choice. They can decide to use one or two, or they can decide to use all seven. I don't think it's the industry's role to consolidate to help a lender per se. I think they can make their own choice. And I would throw it the other way. I mean how many industries only have seven participants? Your industry doesn't, the lender industry doesn't. We actually think 7 is a pretty good number. So we're not -- we really worry about Essent at the end of the day. And I think given our market position, our customer relationships and how we're building the portfolio with the right premium, credit characteristics and lender characteristics, we're perfectly, we feel very comfortable that we'll be able to continue to grow our portfolio and generate returns for our shareholders.
There are no further questions in the queue at this time. I will turn the call back over to management for any closing remarks.
Thank you, Operator. We would like to thank everyone for participating in today's call and enjoy the rest of your week.
Ladies and gentlemen, this does conclude today's conference call. Thank you for joining us today. You may now disconnect your lines.
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