Enact Holdings, Inc. (NASDAQ:ACT) Q4 2022 Earnings Call Transcript

Enact Holdings, Inc. (NASDAQ:ACT) Q4 2022 Earnings Call Transcript February 7, 2023

Operator: Good day and welcome to the Q4 2022 Enact Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to Mr. Daniel Kohl, Vice President of Investor Relations. Please go ahead.

Daniel Kohl: Thank you and good morning. Welcome to our fourth quarter earnings call. Joining me today are Rohit Gupta, President and Chief Executive Officer; and Dean Mitchell, Chief Financial Officer and Treasurer. Rohit will provide an overview of our business, our performance, and progress against our strategy. Dean will then discuss the details of our fourth quarter results before turning the call back to Rohit for closing remarks, and then we will take your questions. The earnings materials we issued after market closed yesterday contained our financial results for the fourth quarter of 2022 along with a comprehensive set of financial and operational metrics. These are available on the Investor Relations section of the company’s website at www.ir.enactmi.com under the section marked Quarterly Results.

Today’s call is being recorded and will include the use of forward-looking statements. These statements are based on current assumptions, estimates, expectations, and projections as of today’s date and are subject to risks and uncertainties which may cause actual results to be materially different. We undertake no obligation to update or revise any such statements as a result of new information. For a discussion of these risks and uncertainties, please review the cautionary language regarding forward-looking statements in today’s press release as well as in our filings with the SEC which will be available on our website. Please keep in mind the earnings materials and management’s prepared remarks today include certain non-GAAP measures. Reconciliations of these measures to the most relevant GAAP metrics can be found in the press release, our earnings presentation, and our upcoming SEC filings on our website.

With that, I’ll turn the call over to Rohit.

Rohit Gupta: Thank you, Daniel. Good morning everyone. Thank you for joining us to discuss our fourth quarter and full year results. 2022 was an exceptional year for Enact in which we delivered record performance, achieved several new milestones, and generated a total shareholder return well ahead of the market. We ended the year with record insurance in-force of $248 billion, driven by rising persistency that reached 86% in the fourth quarter and new insurance written of $66 million for the full year. Net income for the full year was a record $704 million or $4.31 per diluted share, up 28% from a year ago and return on equity was 14%. These results are the product of the continued execution of our cycle-tested growth and risk management strategy and reflect the commitment hard work and talent of Enact’s employees.

I’d like to thank all of them for their continued focus and dedication. As I mentioned, we achieved several significant milestones in 2022, reflecting progress against all aspects of our strategy. We strengthened our value proposition and ability to compete and win new business. Our investments in innovative technology-driven tools and solutions have further differentiated our platform, while also driving efficiency and enhancing decision-making. We’ve seen several benefits from these investments across our business including improved underwriting efficiency and deepened understanding of layered risk. One of our stated goals at our IPO was to expand and deepen our customer relationships and I’m pleased to say that we made meaningful progress.

Supported by our investments in the business and our enhanced financial flexibility, we have either activated or increased our new business share with 80% of our target customers since our IPO and the team is committed to building on this momentum in the new year. We continue to take actions to maintain our financial strength, flexibility, and a strong balance sheet. We ended the year with PMIERs sufficiency of 165%. We continue to execute against our credit risk transfer strategy and completed three excess-of-loss reinsurance transactions to manage our overall risk, demonstrating our ability to source cost-effective PMIERs capital, and loss protection in a period of capital markets volatility and widening spreads. And in July, we received our second upgrade from Moody’s since our IPO, recognizing our performance and the strength and flexibility of our balance sheet.

Finally, we believe that as of the end of 2022, Enact and Genworth have fully met all the conditions necessary to remove the restrictions placed on Enact by the GSE. As a result of this significant milestone and upon confirmation from the GSE, we expect the GSE restrictions on Enact will be lifted a step that will further enhance our financial flexibility and elevate our competitiveness by no longer making us subject to more stringent capital requirements than our peer group. In addition to investing in our growth, we remain focused on disciplined cost management and our expense levels for 2022 were below our target of $240 million. As part of our disciplined focus and to ensure our operations are aligned with current market dynamics, during the fourth quarter, we affected a Voluntary Separation program and renegotiated our Shared Services agreement expenses with Genworth.

We remain committed to cost discipline and operational excellence, particularly in response to a market environment that remains uncertain and are currently targeting expense levels in 2023 below what we achieved in 2022. Dean will have more to say on this during his comments. Now, let me turn to capital allocation, where our strong execution enabled us to achieve our capital return commitment for the year. Through the initiation of our regular quarterly dividend and our special cash dividend in December, we returned just over $250 million to shareholders over the course of 2022. In November, we also announced the Board’s approval of $75 million share repurchase program. Taken together, these actions reflect the strength of our balance sheet, the sustainability of our cash flows, the confidence we have in our business and our commitment to create value for our shareholders.

I’d now like to touch on our solid fourth quarter, which capped a strong year for Enact. While we have seen a slowdown in housing activity the fundamentals of our business remains resilient. As I mentioned earlier, Insurance in-force reached a new record and we wrote $15 billion of NIW, inclusive of a one-time season deal in the fourth quarter. Excluding this theme, NIW was marginally lower sequentially in a smaller market suggesting Enact gained share in the fourth quarter. As we have previously commented on market share across the industry fluctuates quarter-to-quarter, largely driven by rate engine variations, we are pleased with our NIW performance and it reflects the strength of our platform and our ability to win new business expand relationships and deliver value to our customers.

The pricing environment also remained constructive. During the quarter, we saw an increase in industry pricing and we implemented several price increases on new business and we have continued these actions into the first quarter as well. We are confident in our ability to continue to write new insurance written that generates attractive risk-adjusted returns and value for shareholders. As I’ve discussed previously, persistency is a natural hedge in our business and tends to increase as interest rates rise and new mortgage originations fall. Persistency again improved during the fourth quarter, reaching 86%. At the end of the quarter, 98% of mortgages in our portfolio, had rates at least 50 basis points below current market rates and we expect this dynamic to continue to support persistency moving forward.

Higher persistency and new insurance levels have driven record insurance in-force, which has continued to be a tailwind as the business benefits from increased duration without a corresponding increase in cost. Our delinquency rate in the fourth quarter was stable and consistent with pre-pandemic level. Importantly 90% of delinquencies had an estimated 20% or more of mark-to-market equity. Ever-to-date, home price appreciation, our approach to risk management and loss mitigation and the favorable resolution of long-term forbearance plans resulted in a net release of an additional $42 million of reserves in the fourth quarter, leading to a loss ratio of 8%. As we did last quarter, we continue to take a prudent view on loss reserves with careful consideration given to the uncertain macro environment and any other factors which may affect the future credit performance within the portfolio.

I believe it is prudent for us to be well reserved in this uncertain environment. The credit quality of our portfolio remains healthy. And while the broader housing market has slowed, we believe overall underwriting quality remains favorable. On an insurance in-force basis, the weighted average FICO score in our portfolio during the quarter was 743. The average loan-to-value ratio was 93% and our layered risk was 1.4% of risk-in-force. I’d like to now speak about the economic environment and housing market and how we are thinking about these factors in relation to our business moving forward. Overall, we believe we are well-positioned for 2023 and beyond though a smaller MI market is expected and uncertainty remains in the near-term. While employment and household balance sheets are healthy, inflation, rising borrower cost and the possibility of a recession pose risk.

Households have started to draw down the buffers of savings that had accumulated during the pandemic and revolving credit card balances have increased. That said revolving balances and household savings are both still favorable to pre-pandemic levels and the labor market is strong. And as we look to the housing market, we see strong long-term demand driven by demographics surrounding first-time homebuyers and housing supply that remains tight, which is supportive to prices. These factors are constructive for the MI industry and mortgage insurance is an important tool to help buyers qualify for a mortgage, especially in an environment of lower affordability. So while the near-term outlook is uncertain, we are confident in the long-term foundational strength of the MI industry.

Against this backdrop, we will continue to execute on our cycle-tested strategy, prudently investing in our capabilities, taking the appropriate actions to align our costs and operations with the market environment, pursuing new business that appropriately balances risk and reward and ensuring we maintain the financial strength and flexibility to both support our policyholders and create value for our shareholders. Our performance in 2022 is evidence that we have the right plans and people in place to achieve our goals. I’d like to now comment on the actions that FHFA has announced over the last few months pertaining to the elimination of upfront fees for certain borrowers and affordable mortgage products. These actions represent an important step in facilitating equitable and sustainable access to homeownership.

We continue to be encouraged by the FHFA support of core mission borrowers and believe the spirit of these changes is consistent with our mission at Enact to help people responsibly achieve and maintain the dream of homeownership. Before I close I would like to note that beyond our financial performance, we have been and will be committed to making a difference. We have spoken in the past of our mission to help those who might otherwise not be able to achieve the dream of homeownership. And in 2022 we have helped 192,000 homebuyers qualify for a mortgage. In addition, this year we were awarded the diversity, equity and inclusion, residential leadership award from the Mortgage Bankers Association, demonstrating our leadership and increasing diversity in the mortgage industry and making homeownership more accessible for underrepresented communities.

Photo by Tierra Mallorca on Unsplash

We also have formed new partnerships and created innovative recruiting programs that will help address the minority homeownership gap and bring diverse talent into mortgage finance. These examples are part of our long-standing commitment to strong ESG principles. We recently published our ESG road map, which lays out our priorities and approach to environmental, social and governance issues. We will have more to say on this front as the year progresses with the publishing of our inaugural ESG report in the first half of 2023. In closing, our business fundamentals remain solid. And while near-term dynamics are uncertain, we believe the long-term drivers of demand remain in place. Going forward, we will continue to execute and maintain the financial strength and flexibility needed to navigate and succeed in this environment.

Overall, I believe we remain well-positioned to achieve our goals and continue creating value for all our stakeholders. I will now turn it over to Dean.

Dean Mitchell: Thanks Rohit. Good morning, everyone. We delivered another solid quarter and an exceptional year performance. GAAP net income was $144 million or $0.88 per diluted share as compared to $0.94 per diluted share in the same period last year, and $1.17 per diluted share in the third quarter of 2022. Return on equity was approximately 14%. Adjusted operating income was $147 million, or $0.90 per diluted share as compared to $0.94 per diluted share in the same period last year and $1.17 per diluted share in the third quarter of 2022. Adjusted operating return on equity was approximately 14.4%. For the full year, GAAP net income was $704 million, or $4.31 per diluted share, compared to $547 million, or $3.36 per diluted share in 2021.

Adjusted operating income for 2022 totaled $708 million, or $4.34 per diluted share, compared to $551 million, or $3.38 per diluted share in 2021. Turning to key revenue drivers. New insurance written was $15 billion in the fourth quarter, compared to $15 billion in the third quarter as well and $21 billion in the fourth quarter of 2021. NIW in the quarter included a one-time seasoned transaction totaling $620 million. Excluding this opportunistic transaction, NIW decreased 4% sequentially and 32% versus the prior year driven primarily by lower mortgage originations resulting from the recent increase in interest rates. New insurance written for purchase transactions made up 97% of our total NIW in the quarter flat to last quarter. In addition monthly payment policies made up 91% of our quarterly new insurance written down from 94% last quarter primarily driven by the one-time transaction.

The overall credit risk profile of our new insurance written remains strong with loans that are underwritten to prudent market standards. Rohit discussed the natural hedge that persistency provides in our business model. With rising interest rates persistency increased again during the fourth quarter to 86%, up from 82% last quarter and 69% in the fourth quarter of 2021. Persistency reached an annualized rate of 87% in December. Given the expectation that interest rates will remain elevated in the short-term, we expect to see continued strength in persistency levels, which is a positive for the future profitability of our in-force insurance portfolio. Insurance-in-Force increased 10% in 2022 and 3% sequentially to a new record of $248 billion, driven by the combination of $66 billion of new insurance written and increased persistency.

Our base premium rate of 41 basis points was down 0.7 basis points sequentially and down 2.4 basis points year-over-year, which is favorable to the guidance we provided in 2022. As we’ve noted before, changes to base premium rate are impacted by a variety of factors and can deviate from quarter-to-quarter, which makes precise estimation difficult, which is especially true in a period of heightened economic uncertainty. As a result, we will not be providing guidance yet on our base premium rate trajectory for 2023. However, we do expect the change to be less than the 2022 decrease of 2.4 basis points. In addition to changes in base premium rate, our net earned premium rate also reflected lower single premium cancellations sequentially and year-over-year.

For the quarter single premium cancellations contributed only $2 million of net earned premium limiting its potential for meaningful future dilution. Over the past several quarters, our net earned premium rate has been the highest in the industry driven partially by our efficient CRT program. Total revenues were down 2% year-over-year in 2022 ending at approximately $1.1 billion. Revenues for the quarter were $277 million, compared to $275 million last quarter and $273 million in the same period last year. Net premiums earned were $233 million down 1% sequentially and down 2% year-over-year. The slight decline in net premiums earned reflected the lapse of older higher-priced policies as compared to our new insurance written as well as a decline in single premium cancellations and modestly higher ceded premiums year-over-year, as we continue to prudently manage our risk through our credit risk transfer program.

Investment income in the fourth quarter was $45 million, up 14% sequentially and 27% year-over-year. For the year, investment income totaled $155 million, up 10% over 2021. The recent rise in interest rates in current rate environment is providing a tailwind for our investment portfolio, as our new money yield for the quarter increased to above 6%. As of the year-end, unrealized losses in our investment portfolio decreased by $56 million to $487 million. Unless we identify opportunities that create long-term value within the portfolio, we do not expect to realize these losses as we can hold the securities to maturity where market values trend to par value. Turning to credit. Losses in the quarter were $18 million as compared to a benefit of $40 million last quarter and a provision of $6 million in the fourth quarter of 2021.

Our loss ratio for the quarter was 8% as compared to negative 17% last quarter and 3% in the fourth quarter of 2021. Losses and loss ratio in the quarter were driven by favorable peer performance on 2021 and prior delinquencies which were above our prior expectations and resulted in a $63 million reserve release in the quarter. This was partially offset by $21 million of reserve strengthening on 2022 delinquencies and incurred but not reported reserves as we take prudent action in response to the increased economic uncertainty. For the year, losses were a benefit of $94 million compared to $125 million in 2021. New delinquencies increased by approximately 1,200 sequentially to 10,300 from 9,100. This increase was driven in part by the impact of approximately 750 new delinquencies from natural disasters in FEMA-impacted areas in the current quarter.

Seasonality coupled with higher new delinquencies from recent large books that are aging and going through their normal loss development pattern also contributed. Excluding the impact of new delinquencies from natural disasters, our new delinquency rate for the quarter was 1% consistent with pre-pandemic levels and reflective of the continuation of positive credit trends. Our claim rate estimate on new delinquencies is approximately 10% for the quarter. Absent new delinquencies related to natural disasters, all 2022 new delinquencies are booked at an approximate 10% claim rate reflecting our prudent and measured approach to reserving as a result of the heightened economic uncertainty. Total delinquencies in the fourth quarter were approximately 19,900.

Excluding delinquencies from natural disasters the associated delinquency rate was 2%, which is stabilizing near pre-pandemic levels. The embedded equity position of our delinquent policies remains substantial with approximately 90% of our delinquencies at the end of the quarter having an estimated 20% or more mark-to-market equity using an index-based house price assessment. As I’ve noted in the past, this can help mitigate the frequency of claims and the potential future loss for delinquencies that ultimately progress to claims. Turning to expenses. Operating expenses in the fourth quarter were $63 million and the expense ratio was 27% versus $58 million and 25% respectively in the third quarter of 2022; and $59 million and 25% respectively in the fourth quarter of 2021.

For the full year, operating expenses totaled $239 million. As Rohit has stated, we initiated a voluntary separation program during the fourth quarter that resulted in a restructuring charge of $3 million, which is excluded from our adjusted operating income and represents a 1-percentage-point impact in quarterly expense ratio. In addition, we renegotiated the existing shared services agreement with Genworth, as we continue to migrate additional activities to Enact. By agreement, we paid $25 million to Genworth for services in 2022 and we were scheduled to pay $20 million and $15 million respectively in 2023 and 2024. These amounts have been revised to $15 million and $12.5 million respectively in 2023 and 2024. While we are still operating in an inflationary environment, our initiatives and ongoing focus on operating efficiency and cost reduction position us to target 2023 operating expenses of $225 million, which represents a 6% annual cost reduction from 2022.

Moving to capital and liquidity. Our PMIERs sufficiency remained very strong in the quarter at 165% or approximately $2.1 billion above the published PMIERs requirements compared to 174% or approximately $2.2 billion in the third quarter of 2022. At quarter end, we had approximately $1.6 billion of PMIERs capital credit and approximately $1.8 billion of loss coverage provided by our credit risk transfer program. Approximately 89% of our risk in-force is covered by our credit risk transfer program. As Rohit touched on earlier, Genworth and Enact believe we have satisfied the required financial conditions and ratings requirements for the elimination of the GSE restrictions first imposed on Enact with respect to capital after the issuance of our August 2020 senior notes.

If confirmed by the GSE, we will no longer be subject to GSE conditions and restrictions. While the restrictions were largely redundant to our current and prior PMIERs sufficiency levels, elimination of these restrictions will allow for greater financial flexibility and further enhance our competitive position. This matter is detailed in our prior disclosures, and we would direct you to the disclosure for additional information on the conditions and restrictions. Turning now to capital allocation. We continue to execute against our capital prioritization framework during the period, including our commitment to return capital to shareholders. In the fourth quarter, we paid a special cash dividend of $183 million, along with our $23 million regular quarterly dividend.

We also initiated a $75 million share repurchase program designed to balance the return of capital to the shareholders with an overall program size that is tailored to Enact’s float. As of January 31, 2023, repurchases under the program have totaled $8 million. During the quarter, EMICO, our primary mortgage insurance operating company, completed a distribution of $242 million to our holding company, Enact Holdings, Inc., to bolster its financial flexibility and support our ability to return capital to shareholders as planned. Overall, we returned over $250 million of capital to shareholders in 2022. Let me close by saying that I am very pleased with our performance in both the fourth quarter and the year. We’ve executed against our strategy and generated strong results in an uncertain environment.

Going forward, we remain focused on maintaining the financial and operational flexibility to adapt to market conditions as necessary and realize the opportunities we see ahead, while prudently managing our risk. The strength of our business, strategy and balance sheet, positioning us to continue creating value for our shareholders. With that, I’ll turn it back to Rohit.

Rohit Gupta: Thanks, Dean. We are pleased with the performance we delivered in 2022 and are proud of the value we created for all our stakeholders. As we enter the first quarter of 2023, we remain confident in our business. With a more resilient portfolio, a strong balance sheet and significant credit risk protection, we are well positioned for both the near and long term. In an uncertain time, we and the MI industry more broadly continue to play a critical part in supporting families and the many other stakeholders in the housing sector. We are incredibly proud of this and will continue to seek opportunities to contribute to the safety and soundness of the industry going forward. Operator, we are now ready for Q&A.

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Q&A Session

Operator: Thank you. And today’s first question will come from the line of Doug Harter with Credit Suisse. Your line is open.

Doug Harter: Thanks. Hoping you could talk a little bit more about the relief from the PMIERs extra charge that you have been paying. Does that change the way you think about capital return in 2023 or going forward?

Dean Mitchell: Yes, Doug, thanks for the question. Like we said in our prepared remarks, we believe we — both Genworth and Enact believe we’ve fully met the conditions necessary to lift those restrictions. They do need to be validated by the GSEs, as well as FHFA. But once that happens, those — we expect those restrictions to be lifted. I think we talked about those restrictions largely being redundant to our PMIERs sufficiency levels, when they went in place. So, from our perspective, they were below any PMIERs sufficiency levels that we were going to hold just naturally in managing the business from a prudent balance sheet perspective. I think that same approach or same perspective also exists in the elimination of the restrictions.

They’re certainly not transformational in that they’re not going to provide some windfall of release of capital that we would otherwise hold. They are useful in creating additional financial flexibility. We would say that flexibility is probably enhanced in times of heightened economic uncertainty and certainly in times of economic stress. So that’s how we’re thinking about it. And I think that’s the appropriate approach.

Rohit Gupta: Yeah. That’s the only thing I’ll add to that, I think Dean covered it pretty well. From a competitive perspective it also puts us on a level playing field in terms of how other stakeholders look at us. So, this is a very good milestone for us and glad to be at this point.

Doug Harter: Great. Thank you.

Operator: Thank you. One moment for our next question. And that will come from the line of Mihir Bhatia with Bank of America. Your line is open.

Mihir Bhatia: Hi. Good morning, and thank you for taking my question. I wanted to start by asking about the seasoned NIW that you mentioned this quarter. Can you provide any more detail on it? Like, I think you mentioned, it was like a one-time opportunistic deal, but like any more background or any color you can provide on it? Was this a competitive process? Was €“ how did it come about? Did you already know the NIW that you were taking over?

Rohit Gupta: Yeah. Good morning, Mihir. Thanks for the question. So I would say that, NIW deal that we talked about the one-time deal was a portfolio transaction with the lender, and this lender had been holding these loans on their portfolio for a period of time. So two-thirds of the deal was more than one-year seasoned, and we disclosed the magnitude of the deal in our disclosures. And essentially, they were looking for loss coverage and capital coverage. And to the best of our knowledge there were several MI companies that were involved in the process. And at the end of the day, our relationships our value proposition as well as our capital strength made us win the deal. We do expect that to be a one-time deal. These are not very frequent transactions in this current environment. Most portfolio lenders actually ensure their high LTV mortgages on a regular flow basis. But we thought from a transparency perspective, it was worthwhile to spike that out.

Mihir Bhatia: Right. Sorry, just one follow-up. So these were still high LTV loans that they were looking to ensure?