Essent Group Ltd. (NYSE:ESNT) Q4 2022 Earnings Call Transcript

Essent Group Ltd. (NYSE:ESNT) Q4 2022 Earnings Call Transcript February 10, 2023

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 Fourth Quarter and Year-End 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. Thank you. 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, Interim 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 fourth quarter and full year 2022 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 Form10-K filed with the SEC on February 16, 2022, 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 fourth quarter and full year 2022 financial results. Our strong performance, which reflects the earnings power of our business benefited from better-than-expected credit performance, along with increased persistency and investment income as a result of higher rates. These results demonstrate the strength of our economic engine in generating high-quality earnings. Heading into 2023, we remain confident in our buy, manage and distribute operating model despite some economic uncertainty. While our franchise is levered to the economy in housing, we continue to manage the business considering a range of scenarios. As for the economy, the consumer has shown resilience and unemployment has been relatively stable.

With regards to housing, we remain constructive over the longer term as we continue to believe that low inventory and demographic-driven demand should support home prices. And now for our results. For the fourth quarter of 2022, we reported net income of $147, million as compared to $181 million a year ago. On a diluted per share basis, we earned $1.37 for the fourth quarter, compared to$1.64 a year ago. For the full year, we earned $831 million or $7.72 per diluted share, while our return on average equity was 19%. At December 31, our insurance in force was $227 billion, a 10% increase compared to a year ago. Our 12-month persistency on December 31 was 82% and the weighted average note rate of our book is approximately 3.8%. While there has been some relief to affordability pressure since rates peaked last November, recent mortgage rates should continue to translate to an elevated level of persistency.

At the same time, the credit quality of our insurance in force remains strong with a weighted average FICO of 746 and a weighted average of original LTV of 92%. On the business front, we activated 150 new customers in 2022 as we continue to drive lender penetration and growing the Essent franchise. In addition, based on expected credit normalization, we increased rates during the year. Our pricing engine, EssentEdge, enables us to efficiently raise rates in targeting adequate risk-adjusted returns and pricing long-tail mortgage credit risk and we believe that Edge is mutually beneficial, delivering our best price to borrowers while helping to optimize our unit economics. Our Bermuda-based reinsurance entity, Essent Re had another strong year of performance, writing high-quality and probable GSE risk share business and continuing to provide fee-based MGA services to our reinsurer clients.

As mentioned last quarter, the current environment is providing Essent Re with improved pricing and opportunities to move up in the structure to optimize returns. Essent Re ended the year with third-party annual revenues of approximately $69 million and third-party risk in force of approximately $2 billion. Since 2014, Essent Re has earned over $275 million of net income from its third-party business. Essent Ventures, our strategic investment unit was formed to enhance financial returns while gaining insights to improve our core business. Ever to date, these investments have created $85 million of value, of which $64 million have been returned as realized proceeds. As of December 31, the carrying value of other invested assets is $258 million.

Photo by Maria Ziegler on Unsplash

It was through these efforts in Essent Ventures that we identified our planned title transaction. Title Insurance is a natural complement to our mortgage insurance business with relatively stable underwriting performance and efficient capital requirements. This acquisition adds a team of seasoned title professionals to Essent and provides a platform to leverage our capital position, lender network and operational expertise in a well-established adjacent sector. Cash and investments as of December 31 were over $5 billion and the annualized investment yield for the fourth quarter was 3%. For the full year 2022, our investment yield was 2.6%, compared to 2% in 2021. As a reminder, for every one point increase in the investment yield, there is a roughly one point increase in ROE.

As of December 31, we are in a position of strength with $4.5 billion in GAAP equity, access to $2.5 billion in excess of loss reinsurance and over $1 billion of available holding company liquidity. With a full year 2022 operating cash flow of $589 million, our franchise remains well-positioned from an earnings, cash flow and balance sheet perspective. At year-end 2022, approximately 98% of our portfolio is reinsured. In the fourth quarter, we closed a quota share transaction with a panel of highly rated reinsurers to provide forward protection for our 2023 business. We will look to continue executing upon our diversified and programmatic reinsurance strategy that mitigates earnings volatility from economic cycles and provides capital relief.

In 2022, we returned nearly 1/4 of our earnings to shareholders in the form of dividends and share repurchases. We remain committed to a balanced approach between capital distribution and capital deployment, including investing $100 million for our planned title acquisition that I previously mentioned. Further, given our strong financial performance during the year, I am pleased to announce that our Board has approved a $0.02 per share increase in our common dividend to $0.25. Moving forward, we will review our common dividend annually as we continue to believe that maintaining and steadily increasing dividends is a meaningful demonstration of the confidence we have in the stability of our cash flows, and the strength of our operating model.

Now let me turn the call over to Dave.

Dave Weinstock: Thanks, Mark, and good morning, everyone. Let me review our results for the quarter in a little more detail. For the fourth quarter, we earned $1.37 per diluted share, compared to $1.66 last quarter and $1.64 in the fourth quarter a year ago. We ended 2022 with insurance in force of $227.1 billion, an increase of $4.5 billion from September 30, and an increase of $19.9 billion or 10%, compared to $207.2 billion at December 31, 2021. Persistency at December 31, 2022 increased to 82.1%, compared to 77.9% at the end of the third quarter. Net premium earned for the fourth quarter of 2022 was $207 million and included $14.6 million of premiums earned by Essent Re on our third-party business. For full year 2022, our net earned premium rate for the U.S. mortgage insurance business was 37 basis points.

The average net premium rate in the fourth quarter was34 basis points, a decrease of one basis point from the third quarter. We expect that the net earned premium rate for the full year 2023 will be largely unchanged from the fourth quarter rate of 34 basis points. Net investment income increased $5.2 million or 16% in the fourth quarter of 2022, compared to last quarter due primarily to yields on new investments and floating rate securities resetting the higher rates. Other income in the fourth quarter includes a $6.5 million loss due to a decrease in the fair value of embedded derivatives and certain of our third-party reinsurance agreements, which compares to a $5.2 million gain on the valuation of embedded derivatives last quarter. The provision for loss and loss adjustment expenses was $4.1 million in the fourth quarter of 2022, compared to 3.

– excuse me $4.3 million in the third quarter and a benefit of $3.4 million in the fourth quarter a year ago. At December31, the default rate was 1.66%, up 11 basis points from 1.55% at September 30, largely due to traditional default seasonality. For the full year 2022, we recorded a net benefit of approximately $175 million, due largely to cure activity on defaults reported in the second and third quarters of 2020. Other underwriting and operating expenses in the fourth quarter were $46.9 million, up $4.8 million from the third quarter, largely due to an increase in professional fees. The expense ratio was 20% for the full year 2022, and compares to 19% in 2021. We estimate that the other underwriting and operating expenses will be approximately $175 million for the full year 2023, excluding any expenses associated with the announced title business acquisition and related transaction costs.

The effective tax rate for full year 2022, including discrete items was 15.9%. For 2023, we estimate that the annual effective tax rate will be approximately 15.5%, excluding the impact of any discrete items. During the fourth quarter, Essent Group paid a cash dividend totaling $24.6 million to shareholders. Also in the quarter, Essent Guaranty paid a dividend of $55 million and Essent Guaranty of PA paid a dividend of $5 million to the U.S. holding company. As of January 1, 2023, the U.S. mortgage insurance companies can pay ordinary dividends of $318 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 10.2:1. Note that statutory capital includes $2.1 billion of contingency reserves as of December 31, 2022.

Over the last 12 months, the U.S. mortgage insurance business has grown statutory capital by $226 million, while at the same time paying $320 million of dividend to our U.S. holding company. As a reminder, Essent has a credit facility with committed capacity of $825 million. Borrowings under the credit facility accrued interest and a floating rate tied to a short-term index. As of December 31, we had $425 million of term loan outstanding with a weighted average interest rate of 6.02%, up from 4.39% at September 30. Our credit facility also has $400 million of undrawn revolver capacity that provides an additional source of liquidity for the company. At December 31, our debt to capital ratio was 8.7%. Also at December 31, Essent Guaranty’s PMIERs sufficiency ratio was strong at 174% with $1.4 billion in excess available assets.

Excluding the 0.3 COVID factor, the PMIER’s efficiency ratio remained strong at 165% with $1.3 billion in excess available assets. Now let me turn the call back over to Mark.

Mark Casale: Thanks, Dave. In closing, we are pleased with our fourth quarter and full year 2022 financial results, which reflect our focus on optimizing unit economics to generate high-quality earnings and strong returns. Looking through the one-time tailwind of COVID reserve development on earnings, the underlying results for 2022 are solid. The high credit quality of our portfolio and strong employment drove credit performance and higher interest rates benefited the persistency of our in-force book and investment income. Our strong operating performance continues to generate excess capital, which we will deploy in a balanced manner between investment and growing our franchise and distribution to our shareholders. We believe this measured approach 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: Your first question comes from the line of Mark DeVries from Barclays. Your line is open.

Mark DeVries: Yeah, thanks. I was hoping to get some color, if you can provide any, on the title acquisition kind of what your expectations are for earnings contribution? And how you think about investing in that business and growing it from here?

Mark Casale: Yes, Mark, I would take a step back. I think our €“ I would say shorter term, I am not going to project any kind of earnings around this over a period of time and we’ll obviously update everyone every quarter. I would €“ we look at this very similar to the platform we bought off of Triad back in 2009 it really, it was like our ticket into the mortgage insurance business and we see similar parallels with the acquisition of both BNC and Ante. They are good platforms, really strong talented people, relatively small, obviously, in terms of the industry. And we look at €“ first off, we’re going to invest €“ continue to invest in the infrastructure in both, put more capital into the underwriter, try to improve the ratings, invest in people and then look for ways where we can provide some synergies.

Clearly, a lot of synergies just in terms of back office, right, in terms of finance and legal and some of those things, which were €“ we have a pretty good handle on, And then over time, in terms of our technology platform and digging in on the operational side to look for ways to grow. So it’s settled, Walter Wisden is saying control profitability growth. So we’re going to look at it over €“ this is like a 3, 5, 10 year plan, Mark. It’s not something we’re going to come out of the gate with earnings. It’s a new industry for us. It’s an industry we understand well because it’s an adjacent sector, but we’re going to take our time. We’re going to continue to apply kind of that hard work and operational expertise to it. And I think over time, we’ll be able to grow it.

But it’s definitely, from our standpoint, big picture, it’s complementary to the MI business. So the MI business has credit risk, regulatory risk, operational risk, titles more operational risk, regulatory risk and kind of capital and credit are on the lower end. So longer term, we think it’s very complementary. There is clearly some overlap with lenders, but it’s €“ you are looking at €“ as we look to grow Essent, right, you heard say over the years, we want to grow Essent. We love the mortgage insurance business and we’ve grown it, and we think we can continue to grow it as housing grows, but the pond is only so deep. So when you look at Title with annualized revenues in the $20 billion to $25 billion kind of range, it’s a big market and our view is it’s something for us to €“ as we look at that next phase of Essent and building other operating engines, we thought this was a good pond to go into.