Essent Group Ltd. (NYSE:ESNT) Q2 2023 Earnings Call Transcript

Essent Group Ltd. (NYSE:ESNT) Q2 2023 Earnings Call Transcript August 4, 2023

Essent Group Ltd. beats earnings expectations. Reported EPS is $1.61, expectations were $1.47.

Operator: Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Essent Group Second Quarter 2023 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] Ty. Phil Stefano, Vice President, Investor Relations. You may begin your conference.

Phil Stefano: Thank you, Rob. Good morning, everyone, and welcome to our call. Joining me today are Mark Casale, Chairman and CEO; and David Weinstock, Chief Financial Officer. Also on hand for the Q&A portion of the call is Chris Curran, President of Essent Guaranty. Our press release, which contains Essent’s financial results for the second quarter of 2023 was issued earlier today and is available on our website at Essentgroup.com. 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 and uncertainties, please review the cautionary language regarding forward-looking statements in today’s press release, the risk factors included in our Form 10-K with the SEC filed on February 17, 2023, 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.

Mark Casale: Thanks, Phil, and good morning, everyone. Earlier today, we released our second quarter 2023 financial results, which continue to benefit from our high-quality insurance portfolio and favourable credit performance. Also, rising interest rates continue to drive higher investment income and elevated persistency, which supports the growth of our in-force portfolio despite pressure on new business volumes. Our long-term outlook in housing remains constructive as we believe that demographic-driven demand and low inventory should provide foundational support to home prices. While there is still uncertainty surrounding the U.S. economy, we remain confident in our robust capital position and the strength of our buy, manage and distribute operating model.

And now for our results. For the second quarter of 2023, we reported net income of $172 million compared to $232 million a year ago. As a reminder, our results last year were favourably impacted by the release of certain reserves associated with COVID-related defaults. On a diluted per share basis, we earned $1.61 for the second quarter compared to $2.16 a year ago, and our annualized return on average equity was 15%. As of June 30, our insurance in force was $236 billion, a 9% increase compared to a year ago. Our 12-month persistency on June 30 was 86%, and approximately 75% of our in-force portfolio has a note rate of 5% or lower. We expect that the current level of rates should support elevated persistency through the back half of this year.

The credit quality of our insurance in force remains strong, with a weighted average FICO of 746 and a weighted average original LTV of 92%. Embedded HPA continues to benefit our business as the mark-to-market on the in-force portfolio mitigates the risk of claims, especially in light of the supply constraints in housing inventory. On the business front, our industry remains competitive, while the pricing environment remains constructive. We continue to focus on optimizing our unit economics and leveraging our proprietary scoring engine, EssentEDGE and selecting and pricing long-tail mortgage credit risk. Overall, we remain pleased with the business we are writing and the related expected returns. We continue to execute upon our diversified and programmatic reinsurance strategy while focusing on optimizing our cost to reinsurance.

During the quarter, we successfully executed the tender of two seasoned ILN deals, which retired $637 million of bonds that did not provide any regulatory or economic capital credit. Also last week, we priced our ninth Radnor Re ILN transaction, selling $281 million of bonds covering production from August of last year through the first half of 2023. Our belief remains that access to multiple sources of capital is a key element of our operating model, and we are pleased with the executions of both the tender and the latest ILN deal. As of June 30, Essent Re’s third-party annual rate run revenue are approximately $80 million, while our third-party risk in force is approximately $2 billion. During the quarter, Essent Re continued to capitalize on the current environment to optimize returns and contribute to the profitability of our franchise.

Cash and investments as of June 30 were $5.4 billion, and the annualized investment yield for the second quarter was 3.5%, up from 2.5% a year ago. Our new money yield in the second quarter approximated 5%, providing continued tailwinds for our investment portfolio. As a reminder for every 1 point increase in the investment yield, there is a roughly 1 point increase in ROE. We continue to operate from a position of strength with $4.7 billion in GAAP equity access to $1.4 billion in excess of loss reinsurance and over $1 billion of available holding company liquidity. With the trailing 12-month underwriting margin of 78% and operating cash flow of $697 million, our franchise remains well positioned from an earnings, cash flow and balance sheet perspective.

Our strong financial performance affords us the ability to take a balanced approach between capital deployment and distribution. This includes the approximately $93 million associated with the Title acquisition, we completed at the start of the third quarter. Similar to when Essent Re started, we view Title as a long-term and attractive call option for the future growth of the Essent franchise. Year-to-date through July 31, we repurchased approximately 1.1 million shares for $46 million. Further, I’m pleased to announce that our Board has approved a common dividend of $0.25. We continue to see our dividend as a meaningful demonstration of the confidence we have in the stability of our cash flows and the strength in our capital position. Now let me turn the call over to Dave.

David Weinstock: Thanks, Mark, and good morning, everyone. Let me review our results for the quarter in a little more detail. For the second quarter, we earned $1.61 per diluted share compared to $1.59 last quarter and $2.16 in the second quarter a year ago. As Mark previously mentioned, our second quarter 2022 results benefited from the release of approximately $63 million of reserves associated with COVID-related defaults from 2020. Net premium earned for the second quarter of 2023 was $213 million and included $17.7 million of premiums earned by Essent Re on our third-party business. The average base premium rate for the U.S. mortgage insurance business in the second quarter was 40 basis points, consistent with last quarter.

The net average premium rate was 33 basis points in the second quarter of 2023, down 1 basis point from last quarter due primarily to the net impact of the successful ILN tender Mark discussed. Ceded premium increased to $39.5 million in the second quarter compared to $33.6 million in the first quarter, largely due to the tender. Net investment income increased $2 million or 5% in the second quarter of 2023 compared to last quarter due primarily to higher yields on new investments and floating rate securities resetting the higher rates. Other income in the second quarter was $8.1 million, which includes a $2.7 million gain associated with the fair value of embedded derivatives and certain of our third-party reinsurance agreements. This gain was largely due to a decrease in our derivative liability, resulting from the reduction in outstanding insurance linked notes from the completed tender offer.

This compares to a $368,000 decrease in the fair value of these embedded derivatives in the first quarter of 2023. The provision for loss and loss adjustment expense was $1.3 million in the second quarter of 2023 compared to a benefit of $180,000 in the first quarter of 2023 and a benefit of $76.2 million in the second quarter a year ago. At June 30, the default rate was 1.52%, down 5 basis points from 1.57% at March 31, 2023. Other underwriting and operating expenses in the second quarter were $42.2 million, a decrease of $6 million from the first quarter. The first quarter included higher transaction costs associated with our Title acquisition and higher payroll taxes associated with the vesting of shares and incentive payments, which historically occur in the first quarter.

The operating expense ratio was 20% this quarter, a decrease from 23% for the first quarter. We continue to estimate that other underwriting and operating expenses will be approximately $175 million for the full year 2023, excluding expenses associated with the Title acquisition and related transaction costs. Income tax expense in the second quarter of 2023 includes $5.3 million of net discrete tax expense associated with prior year tax returns. For the balance of 2023, we currently estimate income tax expense will be a 15.2% annualized effective tax rate. During the second quarter, Essent Group paid a cash dividend totalling $26.5 million to shareholders, and we repurchased $29.5 million of shares under the authorization approved by our Board in May 2022.

As Mark noted, our holding company liquidity remains strong and includes $400 million of undrawn revolver capacity under our committed credit facility. At June 30, we had $425 million of term loan outstanding with a weighted average interest rate of 6.87%, up from 6.52% at March 31. At June 30, 2023, our debt-to-capital ratio was 8%. During the second quarter, Essent Guaranty paid a dividend of $90 million to its U.S. holding company. Based on unassigned surplus at June 30, the U.S. mortgage insurance companies can pay additional ordinary dividends of $278 million in 2023. At quarter end, the combined U.S. mortgage insurance business statutory capital was $3.2 billion with a risk-to-capital ratio of 10.5:1. Note that statutory capital includes $2.2 billion of contingency reserves at June 30.

Over the last 12 months, the U.S. mortgage insurance business has grown statutory capital by $181 million, while at the same time paying $300 million of dividends to our U.S. holding company. As Mark noted, effective July 1, 2023, Essent U.S. Holdings acquired all of the outstanding shares of the capital stock of Agents National Title and all of the membership interest of Boston National Title, for $92.6 million in cash. The acquisition was funded using existing cash and short-term investments and the purchase price is subject to customary post-closing adjustments. Now let me turn the call back over to Mark.

Mark Casale: Thanks, Dave. In closing, our capital position, liquidity and underlying results remain strong. The high quality of our portfolio and strong employment are driving credit performance while our interest rates are benefiting the persistency of our in-force book and investment income. This strong operational performance continues to generate excess capital, which we will deploy using a measured approach between investment in growing our franchise and distribution. We remain confident in our buy managed and distributed operating model and believe a measured approach to our capital is in the best long-term interest of Essent and our stakeholders. Now, let’s get to your questions. Operator?

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Q&A Session

Operator: [Operator Instructions] And your first question comes from the line of Mihir Bhatia from Bank of America.

Mihir Bhatia: I wanted to start by asking about the reinsurance transaction. Are these the first of these vectors that you’ve done did they have an impact on premiums in the quarter? I think one of your competitors talked about that a little bit, having done them for the first time this quarter. Just wondering, if you could maybe give us some color on that? Just the economics of the transaction, how you expect it to impact future quarters ceded premiums or premium rate.

Mark Casale: A couple of things, on the tender, think about it, I think around $8 million of it was additional ceded premium for this quarter. That’s why you saw the jump. But longer term, we should see approximately $40 million of savings. So, all in kind of $30-ish million, which you’ll see a reduction in the ceded premium in future years, and that’s really — those are the two deals that really didn’t give us a lot of either PMIERs capital or capital — economic capital credit. So, we don’t see us tendering any other deals at this time. But we — again, that was a unique circumstance because those deals got locked out with the COVID default. So, they really didn’t pay down. So, it was a good opportunity. We talked about in past quarters optimizing that reinsurance cost. So, this is a good example of us able to do that.

Mihir Bhatia: Got it. That is quite helpful. And then just switching gears to the Title business maybe now that the transaction is closed. Maybe talk a little bit about what your initial focus is going to be? How fast do you think the integration can go to the extent there is much integration to do. And just what you — what should we be expecting in the near term from that business, even if it’s just a really high level from like a revenue standpoint or something?

Mark Casale: Yes. I mean, again, we just closed it just a little over a month ago. So, we’re really just getting started on the integration. Here it’s two different companies. We’ll run them as kind of divisions within Essent Title. So, the integration process is really going underway, and it’s probably — it’s quite extensive. Again, I would look at this. I said this back in February, this acquisition was more akin to us buying the Triad platform back in 2009. With that, we got an operating platform. We’ve got some really good people, but it was — we were Essentially a start up. And the Title business that we acquired is it’s not quite a start-up, but it’s more start-up like. So we’re going to approach it that way.

We’re going to build out the infrastructure improvements to be made around the system. There’s going to be investments, and we’re going to take a long-term approach. So, like I said, again, in the script, think of it as a call option for the investors. It was 2% of our GAAP equity. This is a 3-, 5-, 10-year program. This is the chance for us to build another significant operating business, but they don’t happen overnight. I mean when we started Essent and we wrote our — we started building it in ’09. We did our first loan in ’10. We didn’t break even at ’12. So this is not going to be very material at all from a financial perspective. So I wouldn’t model much at all for the next — I think it’s going to take us realistically 12 to 18 months just to stand it up to get it to where we can foresee kind of future growth, both on the agency side and the lender services side.

It’s — these are again the — these are smaller companies. And that’s really what we wanted. We wanted this start-up type platform to allow us to kind of build out. But again, near term, financially from a modelling perspective here, I wouldn’t put much in.

Operator: And your next question comes from the line of Rick Shane from JPMorgan. Your line is open.

Rick Shane: Look, you guys have been consistently innovative both from an operational perspective, but also in terms of your use of technology. We are arguably on the cusp of maybe the next really significant technology evolution in terms of machine learning and AI. I am curious as a data heavy company, but also a midsized business with midsized resources, how you will take advantage of this and how you’re pursuing this? And particularly, anything you’re seeing through your venture portfolio that’s intriguing.

Mark Casale: Yes, Rick, taking a step back, just on the MI side, let me try to break it into pieces, right? On the MI side, we’re pretty far in, in terms of the use of artificial intelligence and machine learning around the engine and we have been for quite a while. It’s all hosted in the cloud. Most of our operating platform now is in the cloud. So, we’ve kind of shifted that into the cloud, which there’s a big protection from a cyber perspective. We believe a lot of computing power up in the cloud, but there’s a cost to it, too. So you put out a good point. We’re not — we don’t have endless resources. So you really — just like I talked about on the reinsurance side, we have to optimize kind of the IT cost. I would say we’re in a really good spot on the MI side.