Essent Group Ltd. Common Shares

At this time, I would like to welcome everyone to the Essent Group Limited fourth quarter 2023 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. Thank you. I would now like to turn the call over to Phil Stefano, Investor Relations. Please go ahead.

Thank you, Eric. 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 Guarantee. Our press release, which contains Essence financial results for the fourth quarter and full year 2023, was issued earlier today and is available on our website at EssenceGroup.com. Our press release includes non-GAAP financial measures that may be discussed during today's call. A complete description of these measures and the reconciliation to GAAP may be found in Exhibit O of our press release. 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 fourth quarter and full year 2023 financial results. Strong credit quality and resilience in the housing and labor markets continue to drive favorable credit performance, while higher interest rates drove investment income growth and elevated persistency during the year. Heading into 2024, we remain constructive on a long-term outlook for housing as the supply and demand imbalance and favorable demographic trends should provide foundational support to home prices. Even though sentiment has improved for a soft landing on the back of strong employment and consumer spending, we continue to manage our business for a range of economic scenarios. Given the strength of our balance sheet and our buy, manage, and distribute operating model, we believe Essendon is well-positioned. And now for our results. For the fourth quarter of 2023, we reported net income of $175 million compared to $147 million a year ago. On a diluted per share basis, we earned $1.64 for the fourth quarter compared to $1.37 a year ago. For the full year, we earned $696 million, or $6.50 per diluted share, while our return on average equity was 15%. As of December 31st, our book value per share was $47.87, an increase of 16% from a year ago. As of December 31st, our U.S. mortgage insurance in force was $239 billion, a 5% increase versus a year ago. Our 12-month persistency on December 31st was 87%, and nearly 75% of our in-force portfolio has a note rate of 5.5% or lower. Despite the recent shift lower in rates, we expect persistency will remain elevated in 2024. The credit quality of our insurance and force remains strong with a weighted average FICO of 746 and a weighted average original LTV of 93%. Regulatory guardrails implemented after the global financial crisis have significantly improved industry credit quality and performance, while embedded home equity in our insurance portfolio should mitigate potential claims. During 2023, in light of higher mortgage rates and lower mortgage origination volume, we continued to focus on supporting our customers while expanding our franchise. Despite the challenging environment, we successfully activated 108 new customers and continued to leverage S&Edge to optimize our unit economics and deliver our best rates to borrowers. Our Bermuda-based reinsurance entity, S&RE, had another strong year of performance. writing high-quality GSE risk share business and expanding its fee-based MGA services. SNRE ended the year with annual third-party revenues of approximately $80 million, while our third-party risk and force was $2.2 billion. Our title operations incurred a pre-tax loss of approximately $4 million in the fourth quarter, similar to last quarter. We remained focused on integrating title while implementing risk controls and improving operational efficiency. The Essent Ventures team continues to invest in funds, gaining insights to improve our core business while enhancing financial returns. As of December 31st, the carrying value of other invested assets is $277 million, and ever to date, these investments have created $74 million of value. Cash-in investments as of December 31st were $5.7 billion, and our new money yield in the fourth quarter remained over 5%. For the full year of 2023, our investment yield was 3.5% compared to 2.6% in 2022. Net investment income was $186 million in 2023, up approximately 50% from 2022. New money yields in our investment portfolio continue to run ahead of our book yields, which should contribute to future revenue growth. As of December 31st, we are in a position of strength with $5.1 billion in gap equity, access to $1.4 million in excess of loss reinsurance, and over $1 billion of available holding company liquidity. With a full-year 2023 operating cash flow of $763 million and a mortgage insurance underrating margin of 77%, our franchise remains well-positioned from an earnings, cash flow, and balance sheet perspective. As evidence of this, in January, S&P upgraded the financial strength ratings of our two primary operating entities, EssentGuarantee and EssentRe to single A-minus. With this upgrade, we reached a milestone of single A-minus or higher financial strength ratings by all rating agencies that cover EssentGuarantee and EssentRe. During the year, we continue to execute our diversified and programmatic reinsurance strategy while retiring the majority of two-season Radnor Re ILN deals that no longer provided economic or regulatory capital credit. In the fourth quarter, we closed an excess of loss reinsurance transaction covering our 2023 NIW. At year end 2023, approximately 93% of our portfolio is reinsured. Our strong financial performance and capital position enable us to take a measured approach between capital retention, investment, and distribution. In 2023, we repurchased approximately 1.5 million shares for $66 million. Further, I'm pleased to announce that our board has approved a 12% increase in our quarterly dividend at 28 cents per share. Looking forward, we will continue to review our common dividend annually. We believe paying a dividend 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.

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 $1.64 per diluted share compared to $1.66 last quarter and $1.37 in the fourth quarter a year ago. Our U.S. mortgage insurance portfolio ended 2023 with insurance in force of $239.1 billion, an increase of $417 million from September 30th, at an increase of $12 billion or 5% compared to $227.1 billion at December 31st, 2022. Persistency at December 31st, 2023 increased to 86.9% compared to 86.6% at the end of the third quarter. The net premium yield fourth quarter 2023, or excuse me, net premiums earned for fourth quarter 2023 was $246 million and included $17.2 million of premiums earned by Essent Rio and our third party business, and $17.4 million of premiums earned by the title operations. The average base premium rate for the U.S. mortgage insurance portfolio for the fourth quarter was 40 basis points, and the net average premium rate was 35 basis points in the fourth quarter of 2023, with both consistent to last quarter. We expect that the average base premium rate for the full year 2024 will be largely unchanged from the fourth quarter rate of 40 basis points. Net income increased $3.5 million or 7% in the fourth quarter of 2023 compared to last quarter due primarily to an increase in yields on new investments and higher yields on cash and cash equivalents. Other income in the fourth quarter was $6.4 million compared to $5.6 million last quarter. The largest component of the increase was the change in fair value of embedded derivatives in certain of our third-party reinsurance agreements. In the fourth quarter, we recorded a $412,000 increase in the fair value of these embedded derivatives compared to an $898,000 decrease recorded last quarter. The provision for loss and loss adjustment expenses was $19.6 million in the fourth quarter of 2023 compared to $10.8 million in the third quarter of 2023 and $4.1 million in the fourth quarter a year ago. At December 31st, the default rate on the U.S. mortgage insurance portfolio was 1.8%, up 18 basis points from 1.62% at September 30th, 2023. For the full year 2023, we've recorded a net provision of approximately $32 million, as the increase in new defaults was materially offset by favorable reserve development from strong cure activity. Other underwriting and operating expenses in the fourth quarter were $55.2 million and include $11.6 million of title expenses. Expenses for the fourth quarter also include title premiums retained by agents of $11.5 million, which are reported separately on our consolidated income statement. Our consolidated expense ratio was 27% this quarter. Our consolidated expense ratio excluding title, which is a non-GAAP measure, was 19% this quarter. A description of our consolidated expense ratio excluding title and the reconciliation to GAAP may be found in Exhibit O of our press release. We estimate that other underwriting and operating expenses excluding title operations will be approximately $180 million for the full year 2024. The effective tax rate for full year 2023 was 15.4%. Income tax expense for the fourth quarter includes a $2.7 million net benefit associated with the recognition of a deferred tax asset for unrealized losses on the investment portfolios of Essent Group and Essent Re upon the enactment of the Bermuda corporate income tax. For 2024, we estimate that the annual effective tax rate will be approximately 15.5%, excluding the impact of any discrete items. As Mark noted, our holding company liquidity remains strong and includes $400 million of undrawn revolver capacity under our committed credit facility. At December 31st, we had $425 million of term loan outstanding with a weighted average interest rate of 7.11%, up from 7.07% at September 30th. At December 31st, 2023, our debt-to-capital ratio was 8%. At December 31st, Essent Guaranty's PMIR sufficiency ratio was strong at 170%, with $1.4 billion in excess available assets. Excluding the 0.3 COVID factor, the PMIR sufficiency ratio remained strong at 165%, with $1.3 billion in excess available assets. At quarter end, The combined U.S. mortgage insurance business statutory capital was $3.4 billion, with a risk-to-capital ratio of 10.2 to 1. Note that statutory capital includes $2.3 billion of contingency reserves at December 31st. Over the last 12 months, the U.S. mortgage insurance business has grown statutory capital by $198 million. During the fourth quarter and full year 2023, Essent Guaranty paid dividends of $55 million and $295 million, respectively, to its U.S. holding company. For 2024, the U.S. mortgage insurance companies can pay ordinary dividends of $304 million. During the fourth quarter, Essent REIT paid a dividend of $60 million to Essent Group. Also in the quarter, Essent Group paid cash dividends totaling $26.4 million to shareholders And we repurchased 302,000 shares for $15 million under the authorization approved by our board in May 2022. Now let me turn the call back over to Mark.

Thanks, Dave. In closing, we are pleased with our fourth quarter and full year 2023 financial results, which continue to reflect the strength of our operating model. Our high credit quality portfolio, combined with resilience in housing and employment, continues to translate to strong credit performance, while our franchise benefited from the impact of higher rates on investment income and persistency. Our strong operating performance continues to generate excess capital, which we will approach in a measured manner between retention, investment, and distribution to our shareholders. We believe this approach is in the best long-term interest of Essent and our stakeholders, while Essent continues to play an integral role in supporting affordable and sustainable home ownership. Now let's get to your questions. Operator?

At this time, I would like to remind everyone, in order to ask a question, press star then the number one on your telephone keypad. Your first question comes from the line of Rick Shane with JP Morgan. Please go ahead.

Hey, Mark. Thanks for taking my questions. And I appreciate your enthusiasm for taking the questions this morning. I suspect it's from my peers, not from me, that you're so excited that you want to hear the questions.

You were first on the list. Got us excited.

Oh, there you go. That's a rough day, Mark. So it's a kind of a high-level question. I was on a call yesterday where the theme of the call was rates higher for longer. And we're clearly at a crossroads, and I don't think anybody really knows what's going to happen. One of the things that I'm really wrestling with is when I think of Essent and when I think of the sector, What are the scenarios that you think are the best and what are the scenarios that you think are the worst? I mean, it can't be a heads I win, tails I win scenario. What do you worry about and what's the ideal path forward from here?

Well, remember, Rick, I mean, taking a step back, right? Rates get all of the press, but really credit is what drives our performance longer term. So if you just think through and forecast out our business over the next three to five years, The real expenses, we manage them well. You can kind of see where the insurance and force is going to grow relative to the industry. Investment income, that'll ebb and flow depending on kind of where rates are. It's the provision that really has the most volatility in it. So when I think of kind of 2024, it's hard to tell with rates in terms of where the market's going. I'm not sure it's you know, everyone said it was higher for longer until the Fed spoke in December. Then it became, you know, rates are going lower. I think from an Essendon perspective, right, I think we're well positioned in that we're probably levered a bit positively to rates going down. If they don't, you know, and the reason why is, you know, 45% of our book, Rick, is still in that 2021 vintage, which is it's a little bit over 3%. So it's not really going anywhere. So if rates go down, NIW increases, I'm not sure the persistency goes down in tandem the way kind of a normal hedge, just because of the unusual kind of lock-in effect of that portfolio. If rates stay higher for longer, yields stay high, the persistency in the book stays higher, we continue to generate cash flow. And the important thing for investors is we continue to grow book value per share, right? So, you know, I've heard a lot of things around growth. We're growing book value per share. And if you just think about investment income for a second, Rick, we grew that $60 million year over year. If you were to equate that to insurance and force, it's close to like a $20 billion increase in insurance and force. Just say $20 billion at 40 basis points of base yields. at a 35% combined ratio, which again just shows you there's different avenues for us to grow at Essent versus just kind of looking at the insurance in force. So I'm not going to say there's a heads we win, tails we win scenario. I would just say from a, you know, what are we concerned about? It's still credit. It's always credit. I'm not too worried about rates because I think, again, a lot of this is going to balance out. Credit is what, you know, we have our eye on. And I think there, as long as employment stays, you know, stays strong, I think we're in relatively good shape going into 2024.

Got it. Okay. Very helpful. Thanks, Mark.

Sure.

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

Hey, good morning, everyone. This is actually Alex on for Bose. Firstly, just wanted to get a little more color surrounding why the cure rate of 28% was lower this quarter. It looked like it had been trending down from 90% in the fourth quarter last year to 62% in 3Q. Is there anything specific that led that to decline sharply this quarter?

No, Alex. And again, I would caution investors to dig too far into new default rates, cure rates, percentage growth. We've heard a lot of those questions. And just big picture, Alex. We're at 14,000 defaults on 820,000 policies. And we've been relatively consistent around defaults. There's a lot of noise in the defaults and the claims, more in the default side because of the effect of forbearance. So take a look at forbearance. Really, the frictionless forbearance just ended a month ago. So what you're seeing is you're seeing defaults come in you know, there's certain strategic defaulters that, you know, that they're getting a year extra on forbearance and then they're curing. So there's a lot of noise between the curation of the fall rates is what it really is, is noise. And now that there is a more of a friction with forbearance in terms of what borrowers have to show, I would expect that to normalize in the coming kind of 12-ish to 18 months. It remains to be seen. But I think the message for investors is defaults are still the absolute level of defaults, and even the default rate is pretty low. I think it's 1.8 at the end of the fourth quarter. It was 1.6-something the quarter before, but still relatively good. And I think that the credit performance continues to be strong.

Got it. That makes sense. And then maybe just one more. I'm wondering if you could provide any updated color on pricing in the industry. I know you mentioned earlier that You all expect the base premium to be stable over the course of the year. But in the event the economy does have a soft landing and remains strong, is there any chance we see some downside pressure on premiums or not really?

No, I wouldn't expect that. I think, again, given the flexibility of the pricing engines, it really has given the entire industry, again, I think I mentioned this last quarter, a lot of the pricing power per se has moved to the industry versus the lenders, right? I mean, in the old rate cards, the lender had a lot of control, whether it was bidding things out or allocating based on other services. Now it's really the best rate for each borrower. All the MIs have picked their spots. and given where some of the pricing engines and data that we get in the industry, we can see a lot of the movements and the percentages, and I think everyone else can too. So we all have a pretty good beat on it, and I think we price for unit economics, and the industry kind of reached a pretty low point in early 22. Pricing came up, and we generally look at you know, 12-ish to 15% returns on a unit economic basis, I would say they're probably closer to the upper end now. It's pretty good. But I think it's well-priced, given kind of the nature of the risk. So I wouldn't, in a small market, you know, that relatively smaller market, you know, we see pretty consistent pricing. I'm not sure, you know, as the industry starts to, if there is a soft landing and the market starts to grow, I wouldn't see a lot of change in pricing. In fact, it's, It's rarely a discussion point anymore, even at the lender level. And that used to be all about pricing because they saw it. They don't really see it. They're focusing on other things. And like I said, it really allows the essence and the rest of the industry to price on risk, delivering our best rates to borrowers. And it's kind of removed that a little bit from the equation from our standpoint.

Great. Thanks for taking the questions, Mark. Appreciate it.

Sure.

Mark Barrett- As a reminder, if you would like to ask a question press star one on your telephone keypad. Mark Barrett- The next question comes from line of Doug harder with UBS please go ahead.

Doug Harder, UBS Health Services, Thanks mark. Doug Harder, UBS Health Services, You know kind of hearing what you said about the risk of reading too much into kind of one quarter, but you should talk about how. kind of the recent vintages are performing and how delinquencies and those trends are performing versus kind of more historical vintages?

Well, again, I think there's a lot of noise, Doug, with kind of the forbearance. We don't see, I'll give you, I'll tell you one thing that we see, early payment defaults, right? Early payment defaults, post-COVID, are higher than they were pre-COVID. We assign most of that to forbearance because a lot of us, they're all curing and they're not going to claim. So it's back to what I said earlier about that frictionless cost or ease of forbearance is really creating some noise in the numbers. But again, step back, Doug. Our insurance-enforced average FICO is 746. I mean, and I know you cover a lot of different businesses, specialty finance, 746 is a pretty strong credit score. And also, I would like to point out, just in the context of time, if you think about when the GSEs really started, the modern-day GSEs started right around the early 90s. That's when DU and LP started the process, and you had the standardization of the mortgage business. So if you go back from, say, 1990 to 2023, 33 years, Doug, And you look at losses on GSE mortgages generally outside of the 05 to 07 vintage, they're less than 100 basis points. So in the context of time, and this is what we insure every day. And then remember, post-crisis, you had the advent of QM, you had the strengthening of the models, you had stronger QC, you had forbearance, you brought on PMIRs, which is good capital. you know, standards for the MI industry, we insure boring GSE mortgages. And it's a boring business, and it's great, and we like it that way. But that's why when people are looking at, you know, these type of, you know, quarter-to-quarter or trends, it is a little bit more of a specialty finance type approach to the business in terms of the questions. And I would argue that that we're more like a specialty insurer. Our specialty happens to be mortgage and that's our expertise, but we're really a portfolio business. It's driven by the portfolio. And again, just when you think about the top line that's being driven off the business and just the stability of the credit. And I forgot to add that we've hedged a lot of the credit out too. So there's that added layer of protection Again, bigger picture, I think we said it in the script, over $700 million of operating cash flow. The issue for the MI industry the next few years isn't going to be the performance of the portfolio or growth or any of those sort of things. It's really going to be allocation of capital. There's a lot of capital being generated by Essin and others, and certain MIs will allocate it one way and certain MIs will do it the other way, but that's really going to be the differentiator and the business longer term from an investor perspective. So hopefully that gives you some color.

I appreciate it, Mark. Thank you.

I'll now turn the call back over to management for closing remarks. Please go ahead.

Yeah, thank you everyone for your time today and have a great weekend.

Ladies and gentlemen, that concludes today's call. Thank you all for joining and you may now disconnect.