Essent Group Ltd. (ESNT) Earnings Call Transcript & Summary

Hello, and welcome to the Essent Group Ltd. First Quarter Earnings Call. [Operator Instructions] I will now turn the conference over to Phil Stefano. Please go ahead.

Thank you, Sarah. 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 first 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 filed with the SEC 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.

Thanks, Phil, and good morning, everyone. Earlier today, we released our first quarter 2023 financial results, which continue to demonstrate the earnings power of our business. Our financial performance for the first quarter benefited from rising interest rates and favorable credit performance. Higher rates translated to higher investment income, along with higher persistency, which supports the growth of our in-force portfolio despite lower origination volumes. As we continue through 2023, we remain confident in our buy, manage and distribute operating model. While we recognize the uncertainty surrounding the economy in the near term, we continue to manage the business considering a range of scenarios. We remain constructive on housing over the longer term as we believe that demographic-driven demand and low inventory should provide foundational support to home prices. And now for our results. For the first quarter of 2023, we reported net income of $171 million compared to $274 million a year ago. On a diluted per share basis, we earned $1.59 for the first quarter compared to $2.52 a year ago, and our annualized return on average equity was 15%. As of March 31, our insurance in force was $232 billion, a 12% increase compared to a year ago. Our 12-month persistency on March 31 was 84%, and approximately 80% of our in-force portfolio has a note rate below 5%. Given current rates, we anticipate that persistency could remain elevated in the short term. 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%. While certain MSAs could experience price corrections, we believe home prices nationwide will generally be flat in the coming years. We also anticipate that the embedded home equity within the existing book should continue to mitigate the risk of near-term claims. On the business front, during the quarter, we continued raising rates through our risk-based pricing engine, EssentEDGE. We believe that the pricing environment remains constructive and is reflective of ensuring long-tail mortgage credit risk given the macroeconomic backdrop. As of March 31, Essent Re's third-party annual run rate revenues are approximately $70 million, while our third-party risk in force was 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 March 31 were over $5 billion, and the annualized investment yield for the first quarter was 3.4%, up from 2.1% a year ago. Our new money yield in the first quarter approximated 5%, providing continued tailwinds for our investment portfolio. As a reminder, for every 1 point increase in the investment yield, there is roughly a 1 point increase in ROE. We continue to operate from a position of strength with $4.6 billion in GAAP equity, access to $2.1 billion in excess of loss reinsurance and over $1 billion of available holding company liquidity. With a trailing 12-month underwriting margin of 87% and operating cash flow of $595 million, our franchise remains well positioned from an earnings, cash flow and balance sheet perspective. We continue to take a measured approach to capital and remain committed to managing it for the long term. Our strong financial performance affords us the ability to take a balanced approach to capital between distribution and deployment, which includes the $100 million for our planned title acquisition announced in February. While we have initiated an integration and transition process for the pending title transaction, the companies will continue to operate independently until we close the deal later in the year. As noted in the past, we believe allocating capital for growth is a better value creator for the shareholders over the long term. However, we also recognize that returning capital to shareholders generates meaningful returns for investors. Year-to-date through April 30, we repurchased approximately 800,000 shares for $32 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.

Thanks, Mark, and good morning, everyone. Let me review our results for the quarter in a little more detail. For the first quarter, we earned $1.59 per diluted share compared to $1.37 last quarter and $2.52 in the first quarter a year ago. As a reminder, our first quarter 2022 results benefited from the release of approximately $100 million of reserves associated with COVID-related defaults from 2020. Net premium earned in the first quarter of 2023 was $211 million and included $14.7 million of premiums earned by Essent Re on our third-party business. The average premium rate for the U.S. mortgage insurance business in the first quarter was 40 basis points and the net average premium rate was 34 basis points, both consistent with the fourth quarter of 2022. Net investment income increased $5.4 million or 14% in the first quarter of 2023 compared to last quarter due primarily to higher yields on new investments and floating rate securities resetting to higher rates. Other income in the first quarter was $4.9 million, which includes a $368,000 loss due to a decrease in the fair value of embedded derivatives in certain of our third-party reinsurance agreement. This compares to a $6.5 million decrease in the fair value of these derivatives in the fourth quarter of 2022. The provision for loss and loss adjustment expenses was a benefit of $180,000 in the first quarter of 2023 compared to a provision of $4.1 million in the fourth quarter of 2022 and a benefit of $106.9 million in the first quarter a year ago. At March 31, the default rate was 1.57%, down 9 basis points from 1.66% at December 31, largely due to favorable cure activity on prior year defaults. Other underwriting and operating expenses in the first quarter were $48.2 million, an increase of $1.3 million over the fourth quarter of 2022 and included approximately $3.4 million of transaction costs associated with our announced title business acquisition. The expense ratio was 23% this quarter, consistent with the fourth quarter of 2022. 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 announced title business acquisition and related transaction costs. During the first quarter, Essent Group paid a cash dividend totaling $26.8 million to shareholders. In March, we repurchased $16.6 million of shares under the authorization approved by our Board in May 2022. We repurchased an additional $15.1 million of shares in April 2023. As a reminder, Essent has a credit facility with committed capacity of $825 million. Borrowings under the credit facility accrue interest at a floating rate tied to a short-term index. As of March 31, we had $425 million of term loan outstanding with a weighted average interest rate of 6.52%, up from 6.02% at December 31. Our credit facility also has $400 million of undrawn revolver capacity that provides an additional source of liquidity for the company. At March 31, our debt to capital ratio was 8%. During the first quarter, Essent Guaranty paid a dividend of $90 million to its U.S. holding company. Based on unassigned surplus at March 31, the U.S. mortgage insurance companies can pay additional ordinary dividends of $292 million in 2023. As of quarter end, the combined U.S. mortgage insurance business statutory capital was $3.2 billion with a risk-to-capital ratio of 10.3:1. Note that statutory capital includes $2.2 billion of contingency reserves at March 31, 2023. Over the last 12 months, the U.S. mortgage insurance business has grown statutory capital by $148 million while at the same time paying $310 million of dividends to our U.S. holding company. Now let me turn the call back over to Mark.

Thanks, Dave. In closing, our balance sheet and liquidity remains strong while higher interest rates continue to benefit the persistency of our in-force book and investment income. Also, the quality of our portfolio continues to drive positive credit performance. Looking forward, our franchise is well positioned, and we remain confident in the strength of our operating model. Our strong financial results continue to generate excess capital, which we will deploy in a balanced manner between investment in growing our business and distribution to our shareholders. Now let's get to your questions. Operator?

[Operator Instructions] Your first question comes from the line of Mark DeVries with Barclays.

Mark, I know you don't target market share. But it looks like you clearly gained share this quarter. Just hoping to get some insight on what you think might have drove that. And let me just ask my second question because it's related. Could you also just talk about what you're seeing across the industry from a pricing dynamic perspective?

Sure, Mark. I know I'm like a broken record here, but the market share always kind of ebbs and flows quarter-to-quarter. I think we looked at -- I looked at it the other day. The last 7 years, our market share average is 16%, which is -- which I would expect it to be by the end of the year, right? I mean, it's a little high in the first quarter. But also keep in mind, Mark, it's a small market so that the delta between the #1 market share and #6 is like $5 billion, relatively tight. So little movements can change things. So nothing in particular, as I noted in the script. We continue to raise rates. And my guess is we're probably going to raise them a bit more, We have the room. It's not our goal to be #1 in market share. And we look at this really just as an opportunity again to raise pricing potentially across the board, certainly in pockets. But again, we want to move back to the middle of the pack if we can. And just in terms of unit economics, I think they're relatively good. We said we kind of target that 12% to 15% range. Given the spike in investment yields, they're probably a little bit towards -- closer to the 15%. I would have said they were much closer to the 12% a year ago. I mean, there's been a significant kind of bump up in pricing, probably to the point where we're right around 2019 type levels in terms of new production, which, I think, given kind of a 3 to 4 flattish outlook on HPA, I think it's warranted. I'd said before, we kind of want to see that pricing with a 4 handle on it. We're getting there, which is good. Longer term, that sets the industry up well to be -- to have a strong balance sheet because, remember, we're there to pay claims in times of stress. So again, we thought the pricing got pretty compressed 12, 18 months ago, and it's really started to rebound. And we would expect it to stay at this level again given, I think, the discipline in the industry is much stronger than people think. And I think that's been evidenced. And I would expect that to continue through this year. We don't see anything changing. I just -- you listened to some of the commentary for the other MIs. And again, it's just a much more of a financial led business these days if you look at where the backgrounds of the other leaders in the industry at the top of the house. So again, I'm pretty -- we're pretty encouraged from a pricing environment. And again, just when you think about the nominal cost of MI, Mark, for the borrower, still very efficient. It's still very efficient. It's a good value. We're putting folks, first-time homeowners and homes, and it's relatively tough an efficient process.

Your next question comes from the line of Bose George with KBW.

Just on investment income, the increase this quarter was just -- was pretty strong. So just kind of thinking about the cadence of the increase in investment income going forward. Can you kind of help us out with that?

Yes, Bose, good question. I think there's a couple of things going on here. We mentioned, I think, in the fourth quarter that we took an opportunity to do a little bit of repositioning in the portfolio where we have found that we had an accretive trade that we got out of some positions and reinvested at higher rates. And if you look at today's rates, and Mark commented on this on the script, that we're investing at 5% in the first quarter. Is there a lot more upside? I think over time, if you look at the yield curve, we're probably going to see nice pickups from year-on-year. But I don't know that sequentially, it will be as dramatic as what you might have seen.

Okay. Great. That's helpful. And then just actually a regulatory question, just with the changes in the GSE LLPAs and the FHA premium stuff. Any thoughts if that's going to do it much in terms of market share?

No, Bose. Again, I think we've talked about this a couple of quarters ago. We kind of see it more as offsetting penalties. So we don't see a big increase in our share, and if we do see it on the FHA side. I think it's a little early to tell. But right now, that's kind of what we're seeing.

Your next question comes from the line of Mihir Bhatia with Bank of America.

I guess on the credit side, I did want to ask, is there anything that you're being cautious on, any areas? I mean, obviously, I understand the macro is getting a little weaker. It seems like there's a little bit of DTI inflation, which is also helping price. But is there anything else on the credit side that is driving the price increases?

I think it's the normal things, right, Mihir. So think of it clearly just on the collateral side, you're going to price up in certain MSAs, where we have kind of different forward-looking views on the HPA, kind of where it's going. And like I said, it's flattish across the country over the next 3 to 4 years. But it's certainly going to be pockets, and we kind of know where the pockets are, where we're going to have to price up. In terms of just core credit, I think, again, it's around the layered risk. So it's really going to be cautious around the tails, whether that's higher DTI, lower FICO, higher LTV, very normal things that we're looking at. And again, with our pricing engine, I think we can -- we can pick things a little bit better than we could under the old model. So I think that plays into some of it, too. So not all high DTIs are created equal. Some are actually relatively good values and others you should really stay away from. So it's really kind of getting down to that loan level kind of analysis there.

Got it. And then in terms of just the market share shifts, and again, not really so concerned as you pointed out about like one quarter, your market share will be a higher, one will be lower. But more just generally, where is the growth -- where was the growth, if you will, in your portfolio on a little bit -- like we obviously just get the data at the total NIW level, but like maybe from your own internal metrics, you have a view of where your outsized growth came this quarter? Was it just across the board? Were there particular, I don't know, channels?

Our NIW was flat quarter-over-quarter. So we didn't really notice any outsized growth, per se. And some lenders go up, some lenders go down. It's also there's lender-specific. So we saw one of the larger mortgage banks in the country kind of sell their wholesale division to another player. So we've seen -- you always see turnover at the top. Another large refinance-driven shop last year really lowered origination. So there's movement around lenders. But -- and then again, it might be different lenders. Some MIs may have different pricing around certain lenders. We really don't for the most part, especially via the engine. It's all borrower-specific. So we didn't notice any patterns, per se. And again, we didn't see any spikes either given the flattish NIW between quarters.

Your next question comes from the line of Geoffrey Dunn with Dowling & Partners.

Mark, from a rough high level, I'm wondering if you could talk about pricing in a different perspective, more from a cumulative loss assumption. On its low, was pricing getting down towards a 1% cumulative on average? Or it that aggressive? And where do you think maybe the pricing is today? Or where is a 4 plus handle potentially implying a cumulative loss assumption?

Yes, good question. Again, we don't jerk around our cumulative loss assumption. So again, we're we've always been -- and obviously, now with the engine, it's much more loan levels specific. But it's always in that kind of 2% to 3% range. It's driven clearly a little bit with our HPA view. I would say when pricing kind of troughed 12, 15 months ago, we just -- I look at it more from the returns, right? So we kind of in that 12 to 15%-ish range. It was pretty much at the lower end of the range. And you can stretch to get it to that level given CRT and leverage and all those sort of things, right? You can't hide from the raw pricing. So when pricing dips into the 2s, which we saw on one large lender bid that we clearly didn't win, you have to have pretty aggressive assumptions. I'm not even sure 1% gets you there. So you have to -- it's just the cost of capital alone, Jeff, and the cost to originate. So again, we felt that's why you saw our share kind of gets so low in that third. And I think it was the fourth quarter and first quarter, again, 12, 15 months ago. So -- and we said it we thought it was too low. And again, just given the current environment, so maybe just the uncertainty in the environment last year kind of sparked folks to move pricing up. One large MI clearly had backed out of the market. And they're -- we're a bellwether on one side, they were a bellwether on the other. And they're backing out really opened up room for others to kind of increase. So I think it's been positive, right? And again, at the end of the day, we need to have the balance sheet to pay claims and make sure we have the flexibility, whether it's PMIERs or at the state level and just to chase it down like that, it's just not in the best interest longer term in the industry, to be quite honest. So that's -- I'm very -- I think we're encouraged to see where the pricing is. And again, like I said earlier on, 10 basis points, the pricing -- the absolute pricing that we're giving to the borrower today, we think it's pretty cost effective. Especially when you think about a 6% mortgage rate. So we'll see if it can continue. But I would say we're definitely encouraged to where the pricing levels are in the industry today.

Okay. And then with respect to Essent Guaranty on the statutory side, you've taken dividends up a very low level with at least the last 5 quarters. With where you are in your maturity, earnings power and understanding things like -- change with the economy, but on average, do you expect to maximize ordinary course dividend on an annual basis just as a rule of thumb? Or any kind of parameters around that to give us a better idea of cash inflows on the Holdco?

Yes Great question. I would say, given the environment, and we'll take it -- I don't know if we'll take it a quarter at a time, I guess it's a year at a time in terms of guarantee outflow. We would fully expect to max it out. So we have, I think, another 292 capacity this year. And the reason is it's easy to put it back down to. We kind of like to see the cash, and we like it for investors to see the cash at the Holdco. And then whether that gets upstream to group and goes outside the company via repurchases or dividends, it's used to reinvest along -- within at the holdings level, keep it in the U.S. I think it's a good picture for investors to see. So yes, I think given the environment this year, we would fully expect to upstream it.

Your next question comes from the line of Rick Shane with JPMorgan.

It's Melissa on for Rick today. One of our questions have already been asked, but I wanted to come back to the issue of dividends and share repurchase. Certainly, keeping in mind your point about having the balance sheet to meet claim [ needs ] going forward. I'm curious what it would take for you to get more comfortable with taking up the dividend or increasing repurchase activity. Is it really just a function of sort of getting through a cycle?

That's -- it's a good question and one that we've been thinking about. So I would say just on the dividend, we like the dividend. We think it's a good indication to shareholders of how the business has changed, right? Just given the reinsurance, the sustainability that affords us with reinsurance is pretty important. And we think it's a tangible demonstration to investors. I mean, the industry has changed significantly over the past 15 years. It doesn't get a lot of credit for it. But when you think about 95% of our book is GSE-backed, which is in the GSE's, 745 FICO. And the GSEs have made significant improvements over the past 15 years with DU and LP, their quality control and the level of guardrails they have, in addition to the qualified mortgage, right? So the qualified mortgage has kept a lot of that long tail risk business or layered risk business out of the business. And then you have just even the introduction of forbearance and how that means to the borrower. So that goes into that. So I think we're -- in terms of the kind of the cash flows of the business, we like the dividend. We kept it at $0.25 and we announced it last quarter. We're going to kind of look at that every year, right? So every year, we'll take a step back and say, do we want to take it from -- do we want to keep it at $0.25? Where do we want to take it? And then in terms of repurchases, it's really a matter of what other opportunities are out there for the business. We generally have, I would say, a retained cash and invest mentality. So whether that's in the core business, we clearly entered into the title business. We like that longer term. We think it's better for shareholders in terms of diversified revenue stream less of a monoline, per se, that's accretive to book value per share, right? It's really about maintaining returns and growing book value per share. And we look at it really as the numerator and the denominator investments, whether the core business or strategically outside the core business increase the numerator, dividends decrease the denominator as do repurchases. And I think with repurchases, we've changed -- we have altered kind of our view a little bit. I mean, last 2 years ago, we did a $250 million -- I think it ended last year, but $250 million repurchase 10b5 plan, kind of almost like a road plan. And we chew through it relatively quickly, I think, in less than a year. So that caused us to kind of take a step back. And I think now we're going to be a little bit more opportunistic about it, which will have much more of an overlay. So as we look -- and it's really going to be quarter-by-quarter what opportunities do we see kind of capital needs within the business what opportunities do we see kind of strategically outside of the business, whether that's title, ventures, other opportunities should they come up. And then quite frankly, where is the stock trading, right? So again, our view is buying the stock below book value is accretive to book value per share growth, which is very important to us. And we just thought -- we saw the opportunity in the quarter we trade within the KBE index, which is very bank-heavy, obviously. And we felt we got caught up in that and we thought it was a good opportunity to really to get the stock at attractive prices. Normally, that hasn't been our course of business. But again, just given -- again, just that's the strength of the operating cash flow. We have -- we're afforded that kind of luxury, so to speak, to kind of to invest across that, right? So whether it's dividend repurchases in the new business, I think the -- with the repurchases, that's another kind of really, I would say, another kind of tool in the toolbox that we'll look more strategically and really within kind of the normal course of business. So just like we analyze pricing and how much business we -- and how much we want to invest in the core business, this is going to be another thing that we'll look at. Special dividends is always as another tool. We haven't used that yet. But again, we're always going to look ways to grow book value per share. And obviously, we want to maximize shareholder returns.

That's really helpful. You mentioned Essent Ventures, and that's something that you talked about in the past as being a source of sort of incremental data and getting some useful information from those companies where you've provided some capital. Obviously, you've got a big -- a bigger transaction coming up. But just in terms of the current ventures portfolio, what sort of interesting data points are you guys paying attention to right now? Anything worth noting that you're seeing trending in those companies?

Yes. No, in terms of the companies, the direct investments, remember, that's relatively small. We get a lot more of our information from the funds. And there, both on the venture side and some of the couple of private equity. We're seeing clearly valuations. I think kind of that bubble has finally started to burst around ventures. So you're starting to see a much more realistic approach to valuations and really more focus we're seeing within the funds and the operating companies on getting to profitability, which shocking, is actually the goal all along. But it got to be just kind of chasing revenue and chasing exits as we like to see -- say, kind of do that '19 to '22 bubble. And it's coming down back to reality, which is good for us. So we're seeing much more discipline around kind of what's -- where the funds are going to invest in. In terms of opportunities, we're -- I think there, it's a matter of we're starting to look a little bit about, investing a little bit outside, looking at a few new funds to kind of look for some emerging kind of technologies and to see potentially how they can be used within kind of the core business and other uses within financial services.