ESSENT GROUP LTD. The following discussion should be read in conjunction with the "Selected Financial Data" and our financial statements and related notes thereto included elsewhere in this report. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from management's expectations. Factors that could cause such differences are discussed in the sections entitled "Special Note Regarding Forward-Looking Statements" and "Risk Factors." We are not undertaking any obligation to update any forward-looking statements or other statements we may make in the following discussion or elsewhere in this document even though these statements may be affected by events or circumstances occurring after the forward-looking statements or other statements were made.
Overview
We are an established and growing private mortgage insurance company.Essent Guaranty, Inc. , our wholly-owned insurance subsidiary which we refer to as "Essent Guaranty ," is licensed to write coverage in all 50 states and theDistrict of Columbia . The financial strength ratings ofEssent Guaranty are A3 with a stable outlook by Moody's Investors Service ("Moody's"), BBB+ with a stable outlook by S&P Global Ratings ("S&P") and A (Excellent) with a stable outlook byA.M. Best . Our holding company is domiciled inBermuda and ourU.S. insurance business is headquartered inRadnor, Pennsylvania . We operate additional underwriting and service centers inWinston-Salem, North Carolina andIrvine, California . We have a highly experienced, talented team with 387 employees as ofDecember 31, 2019 . For the years endedDecember 31, 2019 , 2018 and 2017, we generated new insurance written, or NIW, of approximately$63.6 billion ,$47.5 billion and$43.9 billion , respectively. As ofDecember 31, 2019 , we had approximately$164.0 billion of insurance in force. Our top ten customers represented approximately 42.8%, 43.5% and 45.8% of our NIW on a flow basis for the years endedDecember 31, 2019 , 2018 and 2017, respectively. We also offer mortgage-related insurance and reinsurance through our wholly-ownedBermuda -based subsidiary,Essent Reinsurance Ltd. , which we refer to as "Essent Re." As ofDecember 31, 2019 , Essent Re provided insurance or reinsurance relating to GSE risk share and other reinsurance transactions covering approximately$895.4 million of risk. Essent Re also reinsures 25% ofEssent Guaranty's NIW under a quota share reinsurance agreement. The financial strength ratings of Essent Re are BBB+ with a stable outlook by S&P and A (Excellent) with a stable outlook byA.M. Best .
Legislative and Regulatory Developments
Our results are significantly impacted by, and our future success may be affected by, legislative and regulatory developments affecting the housing finance industry. Key regulatory and legislative developments that may affect us include:
Housing Finance, GSE Reform and GSE Qualified Mortgage Insurer Requirements
Because a substantial majority of our current and expected future business is the provision of mortgage insurance on loans sold to the GSEs, changes to the business practices of the GSEs or any regulation relating to the GSEs may impact our business and our results of operations. TheFederal Housing Finance Agency ("FHFA") is the regulator and conservator of the GSEs with authority to control and direct their operations. The FHFA has directed, and is likely to continue to direct, changes to the business operations of the GSEs in ways that affect the mortgage insurance industry. It is likely that Federal legislation will be necessary to resolve the conservatorship of the GSEs, and such legislation could materially affect the role and charter of the GSEs and the operation of the housing finance system. In 2011, theU.S. Department of the Treasury recommended options for winding down the GSEs and using a combination of Federal housing policy changes to contract the government's footprint in housing finance and restore a larger role for private capital. Since 2011, members ofCongress have introduced several bills intended to reform the secondary market and the role of the GSEs, although no comprehensive housing finance or GSE reform legislation has been enacted to date. InMarch 2019 , theTrump Administration directed theU.S. Treasury Department to develop a plan, as soon as practicable, for administrative and legislative reforms for the housing finance system, with reforms to reduce taxpayer risk, expand the private sector's role, modernize the government housing programs and achieve sustainable homeownership. The directive outlines numerous goals and objectives, including but not limited to, the end of conservatorship of the GSEs, increased competition and participation of the private sector in the mortgage market including by authorizing the FHFA to approve additional guarantors of conventional mortgages in the secondary market, appropriate capital and liquidity 54 -------------------------------------------------------------------------------- requirements for the GSEs and evaluation of the "QM Patch" that exempts the GSEs from certain requirements of the QM rules. InSeptember 2019 , theU.S. Department of the Treasury released its plan to reform the housing finance system, seeking to achieve the following reform goals: (i) ending the conservatorships of the GSEs upon the completion of specified reforms; (ii) facilitating competition in the housing finance market; (iii) establishing regulation of the GSEs that safeguards their safety and soundness and minimizes the risks they pose to the financial stability ofthe United States ; and (iv) providing that the federal government is properly compensated for any explicit or implicit support it provides to the GSEs or the secondary housing finance market. Any changes to the charters or statutory authorities of the GSEs would require Congressional action to implement.Congress , however, has not enacted any legislation to date. See "Business-Regulation-Federal Mortgage-Related Laws and Regulations-Housing Finance Reform," "Risk Factors-Risks Relating to Our Business-Legislative or regulatory actions or decisions to change the role of the GSEs in theU.S. housing market generally, or changes to the charters of the GSEs with regard to the use of credit enhancements generally and private mortgage insurance specifically, could reduce our revenues or adversely affect our profitability and returns," and "-Changes in the business practices of the GSEs, including actions or decisions to decrease or discontinue the use of mortgage insurance or changes in the GSEs' eligibility requirements for mortgage insurers, could reduce our revenues or adversely affect our profitability and returns." EffectiveDecember 31, 2015 , Fannie Mae and Freddie Mac, at the direction of the FHFA, implemented new coordinated Private Mortgage Insurer Eligibility Requirements, which we refer to as the "PMIERs." The PMIERs represent the standards by which private mortgage insurers are eligible to provide mortgage insurance on loans owned or guaranteed by Fannie Mae and Freddie Mac. The PMIERs include financial strength requirements incorporating a risk-based framework that require approved insurers to have a sufficient level of liquid assets from which to pay claims. The PMIERs also include enhanced operational performance expectations and define remedial actions that apply should an approved insurer fail to comply with these requirements. A revised PMIERs framework, which we refer to as "PMIERs 2.0," became effective onMarch 31, 2019 . As ofDecember 31, 2019 ,Essent Guaranty , our GSE-approved mortgage insurance company, was in compliance with PMIERs 2.0.
Dodd-Frank Act
Various regulatory agencies have produced, and are now in the process of developing additional, new rules under the Dodd-Frank Act that are expected to have a significant impact on the housing finance industry, including the Qualified Mortgage, or QM, definition and the risk retention requirement and related Qualified Residential Mortgage, or QRM, definition.
QM Definition
Under the Dodd-Frank Act, theConsumer Financial Protection Bureau ("CFPB") is authorized to issue regulations governing a loan originator's determination that, at the time a loan is originated, the consumer has a reasonable ability to repay the loan. The Dodd-Frank Act provides a statutory presumption that a borrower will have the ability to repay a loan if the loan has characteristics satisfying the QM definition. Under theCFPB's final rule regarding QMs, which we refer to as the "QM Rule," a loan is deemed to be a QM if it has certain loan features, satisfies extensive documentation requirements and meets limitations on fees and points and APRs. The QM Rule provides a "safe harbor" for QM loans with annual percentage rates, or APRs, below the threshold of 150 basis points over the Average PrimeOffer Rate , or APOR, and a "rebuttable presumption" for QM loans with an APR above that threshold. We expect that most lenders will be reluctant to make non-QM loans because they will not be entitled to the presumption against civil liability under the Dodd-Frank Act, and mortgage investors may be reluctant to purchase mortgages or mortgage-backed securities that are not QMs due to potential assignee liability for such loans. As a result, we believe that the QM regulations have a direct impact on establishing a subset of borrowers who can meet the regulatory standards and directly affect the willingness of lenders and mortgage investors to extend mortgage credit and therefore the size of the residential mortgage market. To the extent the use of private mortgage insurance causes a loan not to meet the definition of a QM, the volume of loans originated with mortgage insurance may decline. In addition, the impact of the mortgage insurance premiums on the calculation of points and fees for purposes of QM may influence the use of mortgage insurance, as well as our mix of premium plans and therefore our profitability. See "-Factors Affecting Our Results of Operations-Persistency and Business Mix" and "Risk Factors-Risks Relating to Our Business-Our business prospects and operating results could be adversely impacted if, and to the extent that, theConsumer Financial Protection Bureau's ("CFPB") final rule defining a qualified mortgage ("QM") reduces the size of the origination market or creates incentives to use government mortgage insurance programs."
Risk Retention Requirements and QRM Definition
The Dodd-Frank Act provides for an originator or issuer risk retention
requirement on securitized mortgage loans that do not meet the definition of a
QRM. The QRM regulations align the definition of a QRM loan with that of a QM
loan. If,
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however, the QRM definition is changed (or the QM definition is amended) in a
manner that is unfavorable to us, such as to give no consideration to mortgage
insurance in computing LTV or to require a large down payment for a loan to
qualify as a QRM, the attractiveness of originating and securitizing loans with
lower down payments may be reduced, which may adversely affect the future demand
for mortgage insurance. See "Business-Regulation-Federal Mortgage-Related Laws
and Regulation-Dodd-Frank Act-Qualified Residential Mortgage Regulations-Risk
Retention Requirements" and "Risk Factors-Risks Relating to Our Business-The
amount of insurance we write could be adversely affected by the Dodd-Frank Act's
risk retention requirements and the definition of Qualified Residential Mortgage
("QRM")."
FHA Reform
We compete with the single-family mortgage insurance programs of the FHA, which
is part of the Department of Housing and Urban Development . The most recent FHA
report to Congress dated November 14, 2019 on the financial status of the FHA's
Mutual Mortgage Insurance Fund , or MMIF, showed the capital reserve ratio of the
MMIF at 4.84%, above the Congressionally mandated required minimum level of 2%.
As a result of the financial improvements in the condition of the MMIF over the
past few years and the stated desire to support the housing recovery, the FHA
reduced its mortgage insurance premiums by 50 basis points in January 2015 . See
"Risk Factors-Risks Relating to Our Business-The amount of insurance we may be
able to write could be adversely affected if lenders and investors select
alternatives to private mortgage insurance."
Tax Reform
OnDecember 22, 2017 , the "Tax Cuts and Jobs Act" ("TCJA") was enacted. The provisions of TCJA include broad tax reforms that are applicable to the Company, including a reduction in theU.S. corporate tax rate from 35% to 21% effectiveJanuary 1, 2018 . This change in tax rates required us to remeasure our deferred tax assets and liabilities as of the enactment date resulting in a one-time$85.1 million income tax benefit in the accompanying consolidated statement of comprehensive income for the year endedDecember 31, 2017 . In addition, TCJA includes a base erosion and anti-abuse tax ("BEAT"). The BEAT is an alternative tax which must be paid if it is greater than the Company's regular tax liability. This alternative base erosion tax, if applicable, may limit or eliminate the tax benefit associated with certain base erosion payments. Premiums ceded byEssent Guaranty under the quota share reinsurance agreement to Essent Re are considered base erosion payments under TCJA. The Company may be subject to the BEAT tax in future periods depending on the earnings of the Company'sU.S. insurance companies and the level of premiums ceded to Essent Re. See "Risk Factors-Risks Relating to Taxes-ProposedU.S. tax legislation could have an adverse impact on us or holders of our common shares."The U.S. Internal Revenue Service and Department of the Treasury issued proposed regulations onJuly 10, 2019 relating to the tax treatment of passive foreign investment companies ("PFICs"). The proposed regulations, if adopted, would provide guidance on various PFIC rules, including changes resulting from the 2017 Tax Cuts and Jobs Act. The Company is evaluating the potential impact of these proposed regulations to its shareholders and business operations. See "Risk Factors-Risks Relating to Taxes-U.S. Persons who hold our shares will be subject to adverse tax consequences if we are considered to be a passive foreign investment company ("PFIC") forU.S. Federal income tax purposes."
Factors Affecting Our Results of Operations
Net Premiums Written and Earned
Premiums associated with ourU.S. mortgage insurance business are based on insurance in force, or IIF, during all or a portion of a period. A change in the average IIF during a period causes premiums to increase or decrease as compared to prior periods. Average net premium rates in effect during a given period will also cause premiums to differ when compared to earlier periods. IIF at the end of a reporting period is a function of the IIF at the beginning of such reporting period plus NIW less policy cancellations (including claims paid) during the period. As a result, premiums are generally influenced by:
• NIW, which is the aggregate principal amount of the new mortgages that are
insured during a period. Many factors affect NIW, including, among others,
the volume of low down payment home mortgage originations, the competition
to provide credit enhancement on those mortgages, the number of customers
who have approved us to provide mortgage insurance and changes in our NIW
from certain customers;
• Cancellations of our insurance policies, which are impacted by payments on
mortgages, home price appreciation, or refinancings, which in turn are
affected by mortgage interest rates. Cancellations are also impacted by
the levels of claim payments and rescissions;
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• Premium rates, which represent the amount of the premium due as a
percentage of IIF. Premium rates are based on the risk characteristics of
the loans insured, the percentage of coverage on the loans, competition
from other mortgage insurers and general industry conditions; and
• Premiums ceded or assumed under reinsurance arrangements. Prior to March
2018 , we had not ceded any premiums under third-party reinsurance
contracts. In 2018 and 2019,
reinsurance agreements. See Note 5 to our consolidated financial
statements.
Premiums are paid either on a monthly installment basis ("monthly premiums"), in
a single payment at origination ("single premiums"), or in some cases as an
annual premium. For monthly premiums, we receive a monthly premium payment which
is recorded as net premiums earned in the month the coverage is provided.
Monthly premium payments are based on the original mortgage amount rather than
the amortized loan balance. Net premiums written may be in excess of net
premiums earned due to single premium policies. For single premiums, we receive
a single premium payment at origination, which is recorded as "unearned premium"
and earned over the estimated life of the policy, which ranges from 36 to
156 months depending on the term of the underlying mortgage and loan-to-value
ratio at date of origination. If single premium policies are cancelled due to
repayment of the underlying loan and the premium is non-refundable, the
remaining unearned premium balance is immediately recognized as earned premium
revenue. Substantially all of our single premium policies in force as of
December 31, 2019 were non-refundable. Premiums collected on annual policies are
recognized as net premiums earned on a straight-line basis over the year of
coverage. For the years ended December 31, 2019 and 2018, monthly premium
policies comprised 89% and 85% of our NIW, respectively.
Premiums associated with our GSE and other risk share transactions are based on the level of risk in force and premium rates on the transactions.
Persistency and Business Mix
The percentage of IIF that remains on our books after any 12-month period is defined as our persistency rate. Because our insurance premiums are earned over the life of a policy, higher persistency rates can have a significant impact on our profitability. The persistency rate on our portfolio was 77.5% atDecember 31, 2019 . Generally, higher prepayment speeds lead to lower persistency. Prepayment speeds and the relative mix of business between single premium policies and monthly premium policies also impact our profitability. Our premium rates include certain assumptions regarding repayment or prepayment speeds of the mortgages. Because premiums are paid at origination on single premium policies, assuming all other factors remain constant, if loans are prepaid earlier than expected, our profitability on these loans is likely to increase and, if loans are repaid slower than expected, our profitability on these loans is likely to decrease. By contrast, if monthly premium loans are repaid earlier than anticipated, our premium earned with respect to those loans and therefore our profitability declines. Currently, the expected return on single premium policies is less than the expected return on monthly policies.
Net Investment Income
Our investment portfolio was predominantly comprised of investment-grade fixed income securities and money market funds as ofDecember 31, 2019 . The principal factors that influence investment income are the size of the investment portfolio and the yield on individual securities. As measured by amortized cost (which excludes changes in fair market value, such as from changes in interest rates), the size of our investment portfolio is mainly a function of increases in capital and cash generated from or used in operations which is impacted by net premiums received, investment earnings, net claim payments and expenses. Realized gains and losses are a function of the difference between the amount received on the sale of a security and the security's amortized cost, as well as any "other-than-temporary" impairments recognized in earnings. The amount received on the sale of fixed income securities is affected by the coupon rate of the security compared to the yield of comparable securities at the time of sale. Other Income Other income includes revenues associated with contract underwriting services and underwriting consulting services to third-party reinsurers. The level of contract underwriting revenue is dependent upon the number of customers who have engaged us for this service and the number of loans underwritten for these customers. Revenue from underwriting consulting services to third-party reinsurers is dependent upon the number of customers who have engaged us for this service and the level of premiums associated with the transactions underwritten for these customers. 57 -------------------------------------------------------------------------------- In connection with the acquisition of our mortgage insurance platform, we entered into a services agreement with Triad Guaranty Inc. and its wholly-owned subsidiary,Triad Guaranty Insurance Corporation , which we refer to collectively as "Triad," to provide certain information technology maintenance and development and customer support-related services. In return for these services, we receive a fee which is recorded in other income. Prior toDecember 1, 2019 , this fee was adjusted monthly based on the number of Triad's mortgage insurance policies in force and, accordingly, decreased over time as Triad's existing policies were cancelled. EffectiveDecember 1, 2019 , the services agreement was amended providing for a flat monthly fee throughNovember 30, 2021 . The services agreement provides for two subsequent one-year renewals at Triad's option.
As more fully described in Note 5 to our consolidated financial statements, the premiums ceded under certain reinsurance contracts with unaffiliated third parties varies based on changes in market interest rates. Under GAAP, these contracts contain embedded derivatives that are accounted for separately as freestanding derivatives. The change in the fair value of the embedded derivatives is reported in earnings and included in other income.
Provision for Losses and Loss Adjustment Expenses
The provision for losses and loss adjustment expenses reflects the current expense that is recorded within a particular period to reflect actual and estimated loss payments that we believe will ultimately be made as a result of insured loans that are in default.
Losses incurred are generally affected by:
• the overall state of the economy, which broadly affects the likelihood
that borrowers may default on their loans and have the ability to cure
such defaults;
• changes in housing values, which affect our ability to mitigate our losses
through the sale of properties with loans in default as well as borrower
willingness to continue to make mortgage payments when the value of the
home is below or perceived to be below the mortgage balance;
• the product mix of IIF, with loans having higher risk characteristics
generally resulting in higher defaults and claims;
• the size of loans insured, with higher average loan amounts tending to
increase losses incurred;
• the loan-to-value ratio, with higher average loan-to-value ratios tending
to increase losses incurred;
• the percentage of coverage on insured loans, with deeper average coverage
tending to increase losses incurred;
• credit quality of borrowers, including higher debt-to-income ratios and
lower FICO scores, which tend to increase incurred losses;
• the level and amount of reinsurance coverage maintained with third parties;
• the rate at which we rescind policies. Because of tighter underwriting
standards generally in the mortgage lending industry and terms set forth
in our master policy, we expect that our level of rescission activity will
be lower than rescission activity seen in the mortgage insurance industry
for vintages originated prior to the financial crisis; and
• the distribution of claims over the life of a book. As of December 31 ,
2019, 76% of our IIF relates to business written since
was less than three years old. As a result, based on historical industry
performance, we expect the number of defaults and claims we experience, as
well as our provision for losses and loss adjustment expenses ("LAE"), to
increase as our portfolio seasons. See "-Mortgage Insurance Earnings and
Cash Flow Cycle" below.
We establish loss reserves for delinquent loans when we are notified that a
borrower has missed at least two consecutive monthly payments ("Case Reserves"),
as well as estimated reserves for defaults that may have occurred but not yet
been reported to us ("IBNR Reserves"). We also establish reserves for the
associated loss adjustment expenses, consisting of the estimated cost of the
claims administration process, including legal and other fees. Using both
internal and external information, we establish our reserves based on the
likelihood that a default will reach claim status and estimated claim severity.
See "-Critical Accounting Policies" for further information.
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We believe, based upon our experience and industry data, that claims incidence
for mortgage insurance is generally highest in the third through sixth years
after loan origination. As of December 31, 2019 , 76% of our IIF relates to
business written since January 1, 2017 and was less than three years old.
Although the claims experience on new insurance written by us to date has been
favorable, we expect incurred losses and claims to increase as a greater amount
of this book of insurance reaches its anticipated period of highest claim
frequency. The actual default rate and the average reserve per default that we
experience as our portfolio matures is difficult to predict and is dependent on
the specific characteristics of our current in-force book (including the credit
score of the borrower, the loan-to-value ratio of the mortgage, geographic
concentrations, etc.), as well as the profile of new business we write in the
future. In addition, the default rate and the average reserve per default will
be affected by future macroeconomic factors such as housing prices, interest
rates and employment.
During the third quarter of 2017, certain regions of the U.S. experienced
hurricanes which have impacted our insured portfolio's performance. Loans in
default identified as hurricane-related defaults totaled 2,288 as of December
31, 2017 . In the year ended December 31, 2018 , 2,150 of the 2,288 defaults
previously identified as hurricane-related cured. Based on our experience to
date and prior industry experience, we expect the ultimate number of
hurricane-related defaults that result in claims will be less than the
default-to-claim experience of non-hurricane-related defaults. In addition,
under our master policy, our exposure may be limited on hurricane-related
claims. For example, we are permitted to exclude a claim entirely where damage
to the property underlying a mortgage was the proximate cause of the default and
adjust a claim where the property underlying a mortgage in default is subject to
unrestored physical damage.
Third-Party Reinsurance
We use third-party reinsurance to provide protection against adverse loss
experience and to expand our capital sources. When we enter into a reinsurance
agreement, the reinsurer receives a premium and, in exchange, agrees to insure
an agreed upon portion of incurred losses. These arrangements have the impact of
reducing our earned premiums, but also reduce our risk in force ("RIF"), which
provides capital relief, and may include capital relief under the PMIERs
financial strength requirements. Our incurred losses are reduced by any incurred
losses ceded in accordance with the reinsurance agreement. For additional
information regarding reinsurance, see Note 5 to our consolidated financial
statements.
Other Underwriting and Operating Expenses
Our other underwriting and operating expenses include components that are substantially fixed, as well as expenses that generally increase or decrease in line with the level of NIW.
Our most significant expense is compensation and benefits for our employees, which represented 57%, 60% and 63% of other underwriting and operating expenses for the years endedDecember 31, 2019 , 2018 and 2017, respectively. Compensation and benefits expense includes base and incentive cash compensation, stock compensation expense, benefits and payroll taxes. Underwriting and other expenses include legal, consulting, other professional fees, premium taxes, travel, entertainment, marketing, licensing, supplies, hardware, software, rent, utilities, depreciation and amortization and other expenses. We anticipate that as we continue to add new customers and increase our IIF, our expenses will also continue to increase.
Interest Expense
Interest expense is incurred as a result of borrowings under our secured credit facility (the "Credit Facility"). Borrowings under the Credit Facility may be used for working capital and general corporate purposes, including, without limitation, capital contributions toEssent's insurance and reinsurance subsidiaries. Borrowings accrue interest at a floating rate tied to a standard short-term borrowing index, selected at the Company's option, plus an applicable margin. Income Taxes Income taxes are incurred based on the amount of earnings or losses generated in the jurisdictions in which we operate and the applicable tax rates and regulations in those jurisdictions. OurU.S. insurance subsidiaries are generally not subject to income taxes in the states in which we operate; however, our non-insurance subsidiaries are subject to state income taxes. In lieu of state income taxes, our insurance subsidiaries pay premium taxes that are recorded in other underwriting and operating expenses.Essent Group Ltd. and its wholly-owned subsidiary, Essent Re, are domiciled inBermuda , which does not have a corporate income tax. Essent Re reinsures 25% ofEssent Guaranty's NIW under a quota share reinsurance agreement. Essent Re also provides insurance and reinsurance to Freddie Mac and Fannie Mae. 59 --------------------------------------------------------------------------------
The amount of income tax expense or benefit recorded in future periods will be dependent on the jurisdictions in which we operate and the tax laws and regulations in effect.
Mortgage Insurance Earnings and Cash Flow Cycle
In general, the majority of any underwriting profit (premium revenue minus losses) that a book generates occurs in the early years of the book, with the largest portion of any underwriting profit realized in the first year. Subsequent years of a book generally result in modest underwriting profit or underwriting losses. This pattern generally occurs because relatively few of the claims that a book will ultimately experience typically occur in the first few years of the book, when premium revenue is highest, while subsequent years are affected by declining premium revenues, as the number of insured loans decreases (primarily due to loan prepayments), and by increasing losses.
Key Performance Indicators
Insurance In Force
As discussed above, premiums we collect and earn are generated based on our IIF, which is a function of our NIW and cancellations. The following table includes a summary of the change in our IIF for the years endedDecember 31, 2019 , 2018 and 2017 for ourU.S. mortgage insurance portfolio. In addition, this table includes our RIF at the end of each period. Year Ended December 31, ($ in thousands) 2019 2018 2017 IIF, beginning of period$ 137,720,786 $ 110,461,950 $ 83,265,522 NIW 63,569,183 47,508,525 43,858,322 Cancellations (37,284,116 ) (20,249,689 ) (16,661,894 ) IIF, end of period$ 164,005,853 $ 137,720,786 $ 110,461,950
Average IIF during the period
$ 38,947,857 $ 33,892,869 $ 27,443,985
The following is a summary of our IIF at
($ in thousands) $ % 2019$ 59,475,337 36.3 % 2018 35,318,382 21.5 2017 29,606,165 18.1 2016 19,022,616 11.6 2015 9,896,050 6.0 2014 and prior 10,687,303 6.5$ 164,005,853 100.0 %
Average Net Premium Rate
Our average net premium rate is dependent on a number of factors, including: (1) the risk characteristics and average coverage on the mortgages we insure; (2) the mix of monthly premiums compared to single premiums in our portfolio; (3) cancellations of non-refundable single premiums during the period; (4) changes to our pricing for NIW; and (5) premiums ceded under third-party reinsurance agreements. For the years endedDecember 31, 2019 , 2018 and 2017, our average net premium rate was 0.49%, 0.50% and 0.53%, respectively. In 2018 and 2019,Essent Guaranty entered into third-party reinsurance agreements, and in 2018, we reduced pricing on our published rates effective for future NIW. We anticipate that the continued use of third-party reinsurance and the 2018 pricing reductions on future NIW will reduce our average net premium rate in future periods. 60
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Persistency Rate
The measure for assessing the impact of policy cancellations on IIF is our persistency rate, defined as the percentage of IIF that remains on our books after any twelve-month period. See additional discussion regarding the impact of the persistency rate on our performance in "-Factors Affecting Our Results of Operations-Persistency and Business Mix."
The risk-to-capital ratio has historically been used as a measure of capital adequacy in theU.S. mortgage insurance industry and is calculated as a ratio of net risk in force to statutory capital. Net risk in force represents total risk in force net of reinsurance ceded and net of exposures on policies for which loss reserves have been established. Statutory capital for ourU.S. insurance companies is computed based on accounting practices prescribed or permitted by thePennsylvania Insurance Department . See additional discussion in "-Liquidity and Capital Resources-Insurance Company Capital ." As ofDecember 31, 2019 , our combined net risk in force for ourU.S. insurance companies was$29.5 billion and our combined statutory capital was$2.3 billion , resulting in a risk-to-capital ratio of 12.6 to 1. The amount of capital required varies in each jurisdiction in which we operate; however, generally, the maximum permitted risk-to-capital ratio is 25.0 to 1. State insurance regulators are currently examining their respective capital rules to determine whether, in light of the financial crisis, changes are needed to more accurately assess mortgage insurers' ability to withstand stressful economic conditions. As a result, the capital metrics under which they assess and measure capital adequacy may change in the future. Independent of the state regulator and GSE capital requirements, management continually assesses the risk of our insurance portfolio and current market and economic conditions to determine the appropriate levels of capital to support our business.
Results of Operations
The following table sets forth our results of operations for the periods
indicated:
Year Ended December 31,
Summary of Operations
(In thousands) 2019 2018 2017
Revenues:
Net premiums written $ 760,845 $ 685,287 $ 570,186
Decrease (increase) in unearned premiums 16,580 (35,795 ) (40,056 )
Net premiums earned 777,425 649,492 530,130
Net investment income 83,542 64,091 40,226
Realized investment gains, net 3,229 1,318 2,015
Other income 3,371 4,452 4,140
Total revenues 867,567 719,353 576,511
Losses and expenses:
Provision for losses and LAE 32,986 11,575 27,232
Other underwriting and operating expenses 165,369 150,900 145,533
Interest expense 10,151 10,179 5,178
Total losses and expenses 208,506 172,654 177,943
Income before income taxes 659,061 546,699 398,568
Income tax expense 103,348 79,336 18,821
Net income $ 555,713 $ 467,363 $ 379,747 Year Ended
For the year endedDecember 31, 2019 , we reported net income of$555.7 million , compared to net income of$467.4 million for the year endedDecember 31, 2018 . The increase in our operating results in 2019 over 2018 was primarily due to the increase in net premiums earned associated with the growth of our IIF and the increase in net investment income, partially 61 --------------------------------------------------------------------------------
offset by increases in the provision for losses and loss adjustment expense, other underwriting and operating expenses and income taxes.
Net Premiums Written and Earned
Net premiums earned increased in the year endedDecember 31, 2019 by 20% compared to the year endedDecember 31, 2018 due to the increase in our average IIF from$123.4 billion in 2018 to$152.0 billion in 2019, partially offset by the decrease in the average net premium rate from 0.50% for the year endedDecember 31, 2018 to 0.49% for the year endedDecember 31, 2019 . The decrease in the average net premium rate during the year endedDecember 31, 2019 is primarily due to an increase in premiums ceded under third-party reinsurance agreements along with changes in the mix of the mortgages we insure and changes in our pricing, partially offset by an increase in premiums earned on the cancellation of non-refundable single premium policies. In the year endedDecember 31, 2019 , ceded premiums increased to$35.5 million , from$10.8 million in the year endedDecember 31, 2018 due to new third-party reinsurance agreements entered in 2019 and a full year of premiums ceded under third-party reinsurance agreements entered in 2018. Net premiums written increased in the year endedDecember 31, 2019 by 11% over the prior year. The increase was due primarily to the increase in average IIF for the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 , partially offset by a decrease in new single premium policies written, an increase in premiums ceded under third-party reinsurance agreements, changes in the mix of mortgages we insure and changes in our pricing. In the year endedDecember 31, 2019 , unearned premiums decreased by$16.6 million as a result of net premiums written on single premium policies of$93.5 million which was offset by$110.1 million of unearned premium that was recognized in earnings during the year. In the year endedDecember 31, 2018 , unearned premiums increased by$35.8 million as a result of net premiums written on single premium policies of$114.9 million which was partially offset by$79.1 million of unearned premium that was recognized in earnings during the year. Included in unearned premium recognized was$42.5 million and$17.7 million related to policy cancellations for the year endedDecember 31, 2019 and 2018, respectively. Net Investment Income Our net investment income was derived from the following sources for the periods indicated: Year Ended December 31, (In thousands) 2019 2018 Fixed maturities$ 82,194 $ 63,053 Short-term investments 5,049 3,873 Gross investment income 87,243 66,926 Investment expenses (3,701 ) (2,835 ) Net investment income$ 83,542 $ 64,091 The increase in net investment income to$83.5 million for the year endedDecember 31, 2019 as compared to$64.1 million for the year endedDecember 31, 2018 was due to the increase in the weighted average balance of our investment portfolio and the increase in the pre-tax investment income yield. The average cash and investment portfolio balance increased to$3.1 billion during the year endedDecember 31, 2019 from$2.6 billion during the year endedDecember 31, 2018 , primarily as a result of investing cash flows generated from operations. The pre-tax investment income yield increased from 2.6% in the year endedDecember 31, 2018 to 2.8% in the year endedDecember 31, 2019 primarily due to an increase in the portion of our investment portfolio invested in spread and duration assets. The pre-tax investment income yields are calculated based on amortized cost and exclude investment expenses. See "-Liquidity and Capital Resources" for further details of our investment portfolio.
Provision for Losses and Loss Adjustment Expenses
The increase in the provision for losses and LAE in 2019 as compared to 2018 was primarily due to increases in the number of insured loans in default in the current period. The provision for losses and LAE in 2018 includes a$9.9 million reduction recorded in the fourth quarter of 2018 associated with the performance of previously identified hurricane-related defaults and our expectations of the amount of ultimate losses on the remaining delinquencies. The provision for losses and LAE in 2019 was also impacted by changes in the age and composition of the insured loans in default. 62 --------------------------------------------------------------------------------
The following table presents a rollforward of insured loans in default for our
Year Ended December 31,
2019 2018
Beginning default inventory 4,024 4,783
Plus: new defaults 13,304 8,727
Less: cures (10,985 ) (9,226 )
Less: claims paid (377 ) (254 )
Less: rescissions and denials, net (19 ) (6 )
Ending default inventory 5,947 4,024
The increase in the number of defaults at
The following table includes additional information about our loans in default
as of the dates indicated for our
As of December 31,
2019 2018
Case reserves (in thousands) (1)$ 63,180 $
45,308
Total reserves (in thousands) (1)$ 69,183 $
49,464
Ending default inventory 5,947
4,024
Average case reserve per default (in thousands)$ 10.6 $ 11.3 Average total reserve per default (in thousands)$ 11.6 $ 12.3 Default rate 0.85 %
0.66 % Claims received included in ending default inventory 129 63
_______________________________________________________________________________
(1) The
other risk share risk in force at Essent Re of
The decrease in the average case reserve per default was primarily due to changes in the composition (such as mark-to-market loan-to-value ratios, risk in force, and number of months past due) of the underlying loans in default and improvements in economic fundamentals.
The following table provides a reconciliation of the beginning and ending reserve balances for losses and LAE:
Year Ended December 31 ,
(In thousands) 2019 2018
Reserve for losses and LAE at beginning of year
- -
Net reserve for losses and LAE at beginning of year 49,464 46,850 Add provision for losses and LAE occurring in: Current year 50,562
36,438
Prior years (17,576 ) (24,863 ) Incurred losses and LAE during the current year 32,986
11,575
Deduct payments for losses and LAE occurring in: Current year 1,288
1,310
Prior years 11,871
7,651
Loss and LAE payments during the current year 13,159
8,961
Net reserve for losses and LAE at end of year 69,291
49,464
Plus: Reinsurance recoverables 71
-
Reserve for losses and LAE at end of year$ 69,362 $ 49,464 63
-------------------------------------------------------------------------------- The following tables provide a detail of reserves and defaulted RIF by the number of missed payments and pending claims for ourU.S. mortgage insurance portfolio: As of December 31, 2019 Number of Percentage of Reserves as a Policies in Policies in Amount of Percentage of Defaulted Percentage of ($ in thousands) Default Default Reserves Reserves RIF Defaulted RIF Missed payments: Three payments or less 3,310 56 %$ 15,793 25 %$ 177,238 9 % Four to eleven payments 2,035 34 28,006 44 108,743 26 Twelve or more payments 473 8 13,549 22 27,152 50 Pending claims 129 2 5,832 9 6,777 86 Total case reserves (1) 5,947 100 % 63,180 100 %$ 319,910 20 IBNR 4,738 LAE 1,265 Total reserves for losses and LAE (1) $
69,183
_______________________________________________________________________________
(1) The
other risk share risk in force at Essent Re of $179 as of December 31, 2019 .
As of December 31, 2018
Number of Percentage of Reserves as a
Policies in Policies in Amount of Percentage of Defaulted Percentage of
($ in thousands) Default Default Reserves Reserves RIF Defaulted RIF
Missed payments:
Three payments or less 2,254 56 % $ 12,005 27 % $ 119,666 10 %
Four to eleven payments 1,350 33 20,031 44 72,222 28
Twelve or more payments 357 9 10,523 23 20,419 52
Pending claims 63 2 2,749 6 3,182 86
Total case reserves 4,024 100 % 45,308 100 % $ 215,489 21
IBNR 3,398
LAE 758
Total reserves for losses and LAE $ 49,464
During the year endedDecember 31, 2019 , the provision for losses and LAE was$33.0 million , comprised of$50.6 million of current year losses partially offset by$17.6 million of favorable prior years' loss development. During the year endedDecember 31, 2018 , the provision for losses and LAE was$11.6 million , comprised of$36.4 million of current year losses partially offset by$24.9 million of favorable prior years' loss development. In both periods, the favorable prior years' loss development was the result of a re-estimation of amounts ultimately to be paid on prior year defaults in the default inventory, including the impact of previously identified defaults that cured. In 2018, the favorable prior years' loss development includes a$9.9 million reduction of loss and LAE reserves associated with hurricane-related defaults that cured.
The following table includes additional information about our claims paid and claim severity as of the dates indicated:
Year Ended December 31,
($ in thousands) 2019 2018
Number of claims paid 377 254
Amount of claims paid $ 12,613 $ 8,559
Claim severity 74 % 73 %
64--------------------------------------------------------------------------------
Other Underwriting and Operating Expenses
Following are the components of our other underwriting and operating expenses
for the periods indicated:
Year Ended December 31,
2019 2018
($ in thousands) $ % $ %
Compensation and benefits $ 93,660 57 % $ 90,084 60 %
Premium taxes 17,572 10 15,376 10
Other 54,137 33
45,440 30
Total other underwriting and operating expenses
Number of employees at end of period 387
385
The significant factors contributing to the change in other underwriting and operating expenses are:
• Compensation and benefits increased primarily due to an increase in stock
compensation expense associated with shares granted in 2018 and 2019 and
increased overtime associated with our increased NIW. Compensation andbenefits includes salaries, wages and bonus, stock compensation expense,
benefits and payroll taxes.
• Premium taxes increased primarily due to an increase in premiums written.
• Other expenses increased as a result of the continued expansion of our
business. Other expenses include professional fees, travel, marketing,
hardware, software, rent, depreciation and amortization and other
facilities expenses.
Interest Expense
For each of the years ended December 31, 2019 and 2018, we incurred interest
expense of $10.2 million . Interest expense was essentially unchanged primarily
due to an increase in the weighted average interest rate on amounts outstanding
under the Credit Facility, partially offset by a decrease in the average amounts
outstanding under the Credit Facility. For the year ended December 31, 2019 , the
average amount outstanding under the Credit Facility was $225.0 million as
compared to $240.3 million for the year ended December 31, 2018 . For the years
ending December 31, 2019 and 2018, the borrowings under the Credit Facility had
a weighted average interest rate of 4.26% and 3.93%, respectively.
Income Taxes
Our subsidiaries inthe United States file a consolidatedU.S. Federal income tax return. Our income tax expense was$103.3 million for the year endedDecember 31, 2019 compared to$79.3 million for the year endedDecember 31, 2018 . Income tax expense for the year endedDecember 31, 2019 was calculated using an effective tax rate of 16.0%. For the year endedDecember 31, 2019 , income tax expense was reduced by excess tax benefits associated with the vesting of common shares and common share units of$2.2 million . Income tax expense for the year endedDecember 31, 2018 , was calculated using an effective tax rate of 16.0% and includes$1.5 million of expense associated with accrual to return adjustments associated with the completion of the 2017 U.S. federal income tax return. Income tax expense for the year endedDecember 31, 2018 was reduced by excess tax benefits associated with the vesting of common shares and common share units of$9.6 million . The tax effects associated with the vesting of common shares and common share units and the accrual to return adjustments associated with the completion of 2017 U.S. federal income tax return are treated as discrete items in the reporting period in which they occur and are not considered in determining the annual effective tax rate.
At
Year Ended
Pursuant to the FAST Act Modernization and Simplification of Regulation S-K,
discussions related to the changes in results of operations for the year ended
December 31, 2018 compared to the year ended December 31, 2017 have been
omitted. Such omitted discussion can be found under Item 7 of our Annual Report
on Form 10-K for the year ended December 31, 2018 filed with the Securities and
Exchange Commission on February 19, 2019 .
65
--------------------------------------------------------------------------------Liquidity and Capital Resources
Overview
Our sources of funds consist primarily of:
• our investment portfolio and interest income on the portfolio;
• net premiums that we will receive from our existing IIF as well as
policies that we write in the future;
• borrowings under our Credit Facility; and
• issuance of capital shares.
Our obligations consist primarily of:
• claim payments under our policies;
• interest payments and repayment of borrowings under our Credit Facility;
• the other costs and operating expenses of our business; and
• the payment of dividends on our common shares.
As ofDecember 31, 2019 , we had substantial liquidity with cash of$71.4 million , short-term investments of$315.4 million and fixed maturity investments of$3.0 billion . We also had$275 million available capacity under the revolving credit component of our Credit Facility, with$225 million of term borrowings outstanding under our Credit Facility. Borrowings under the Credit Facility contractually mature onMay 17, 2021 . AtDecember 31, 2019 , net cash and investments at the holding company were$98.4 million . In addition,Essent Guaranty is a member of theFederal Home Loan Bank of Pittsburgh (the "FHLBank") and has access to secured borrowing capacity with the FHLBank to provideEssent Guaranty with supplemental liquidity.Essent Guaranty had no outstanding borrowings with the FHLBank atDecember 31, 2019 . Management believes that the Company has sufficient liquidity available both at the holding company and in its insurance and other operating subsidiaries to meet its operating cash needs and obligations and committed capital expenditures for the next 12 months. While the Company and all of its subsidiaries are expected to have sufficient liquidity to meet all their expected obligations, additional capital may be required to meet any new capital requirements that are adopted by regulatory authorities or the GSEs, or to provide additional capital related to the growth of our risk in force in our mortgage insurance portfolio, or to fund new business initiatives including the insurance activities of Essent Re. We continually evaluate opportunities based upon market conditions to further increase our financial flexibility through the issuance of equity or debt, or other options including reinsurance or credit risk transfer transactions. There can be no guarantee that any such opportunities will be available on acceptable terms or at all.
At the operating subsidiary level, liquidity could be impacted by any one of the following factors:
• significant decline in the value of our investments;
• inability to sell investment assets to provide cash to fund operating needs;
• decline in expected revenues generated from operations;
• increase in expected claim payments related to our IIF; or
• increase in operating expenses.
66
--------------------------------------------------------------------------------
Our U.S. insurance subsidiaries are subject to certain capital and dividend
rules and regulations prescribed by jurisdictions in which they are authorized
to operate and the GSEs. Under the insurance laws of the Commonwealth of
Pennsylvania , the insurance subsidiaries may pay dividends during any
twelve-month period in an amount equal to the greater of (i) 10% of the
preceding year-end statutory policyholders' surplus or (ii) the preceding year's
statutory net income. The Pennsylvania statute also requires that dividends and
other distributions be paid out of positive unassigned surplus without prior
approval. At December 31, 2019 , Essent Guaranty , had unassigned surplus of
approximately $327.1 million . Essent Guaranty of PA, Inc. had unassigned surplus
of approximately $13.9 million as of December 31, 2019 . Essent Re is subject to
certain dividend restrictions as prescribed by the Bermuda Monetary Authority
and under certain agreements with counterparties. In connection with a quota
share reinsurance agreement with Essent Guaranty , Essent Re has agreed to
maintain a minimum total equity of $100 million . As of December 31, 2019 , Essent
Re had total equity of $939.4 million . In connection with its insurance and
reinsurance activities, Essent Re is required to maintain assets in trusts for
the benefit of its contractual counterparties. See Note 3 to our consolidated
financial statements. At December 31, 2019 , our insurance subsidiaries were in
compliance with these rules, regulations and agreements.
Cash Flows
The following table summarizes our consolidated cash flows from operating, investing and financing activities:
Year Ended December 31,
(In thousands) 2019 2018 2017
Net cash provided by operating activities $ 589,848 $ 625,321 $ 368,573
Net cash used in investing activities (545,076 ) (546,905 ) (690,142 )
Net cash (used in) provided by financing activities (38,368 ) (56,994 ) 337,562
Net increase in cash $ 6,404 $ 21,422 $ 15,993
Operating Activities
Cash flow provided by operating activities totaled $589.8 million for the year
ended December 31, 2019 , as compared to $625.3 million for the year ended
December 31, 2018 and $368.6 million for the year ended December 31, 2017 . The
decrease in cash flow from operations of $35.5 million in 2019 was primarily due
to an increase in United States Mortgage Guaranty Tax and Loss Bonds ("T&L
Bonds") purchased and an increase in expenses paid, partially offset by
increases in premiums collected and net investment income. The increase in cash
flow from operations of $256.7 million in 2018 was primarily a result of
increases in premium collected and net investment income, and a net decrease in
T&L Bonds, partially offset by increases in expenses paid.
Investing Activities
Cash flow used in investing activities totaled$545.1 million for the year endedDecember 31, 2019 and primarily related to investing cash flows from the business. Cash flow used in investing activities totaled$546.9 million for the year endedDecember 31, 2018 and$690.1 million for the year endedDecember 31, 2017 and primarily related to investing cash flows from the business in both periods, proceeds from the public offering of common shares inAugust 2017 and net increased borrowings under the Credit Facility in 2017.
Financing Activities
Cash flow used in financing activities totaled$38.4 million for the year endedDecember 31, 2019 and primarily related to our inaugural quarterly cash dividend paid in September, quarterly cash dividend paid in December and treasury stock acquired from employees to satisfy tax withholding obligations. Cash flow used in financing activities totaled$57.0 million for the year endedDecember 31, 2018 and primarily related to treasury stock acquired from employees to satisfy tax withholding obligations and net repayments of borrowings under the Credit Facility. Cash flow provided by financing activities totaled$337.6 million for the year endedDecember 31, 2017 and primarily related to proceeds from the public offering of common shares completed inAugust 2017 and$150 million of net increased borrowings under the Credit Facility, partially offset by treasury stock acquired from employees to satisfy tax withholding obligations. 67 --------------------------------------------------------------------------------
We compute a risk-to-capital ratio for ourU.S. insurance companies on a separate company statutory basis, as well as for our combined insurance operations. The risk-to-capital ratio is our net risk in force divided by our statutory capital. Our net risk in force represents risk in force net of reinsurance ceded, if any, and net of exposures on policies for which loss reserves have been established. Statutory capital consists primarily of statutory policyholders' surplus (which increases as a result of statutory net income and decreases as a result of statutory net loss and dividends paid), plus the statutory contingency reserve. The statutory contingency reserve is reported as a liability on the statutory balance sheet. A mortgage insurance company is required to make annual contributions to the contingency reserve of 50% of net premiums earned. These contributions must generally be maintained for a period of ten years. However, with regulatory approval, a mortgage insurance company may make early withdrawals from the contingency reserve when incurred losses exceed 35% of net premiums earned in a calendar year. During the year endedDecember 31, 2019 , no capital contributions were made to ourU.S. insurance subsidiaries. During the year endedDecember 31, 2018 ,Essent Holdings made capital contributions toEssent Guaranty of$15 million to support new and existing business andEssent Guaranty paid a dividend toEssent Holdings of$40 million which was used to repay the borrowings remaining under the revolving component of the Credit Facility.Essent Guaranty has entered into reinsurance agreements that provide excess of loss reinsurance coverage for new defaults on portfolios of mortgage insurance policies issued in 2015 through 2018. The aggregate excess of loss reinsurance coverages decrease over a ten-year period as the underlying covered mortgages amortize. EffectiveSeptember 1, 2019 ,Essent Guaranty entered into a quota share reinsurance agreement with a panel of third-party reinsurers (the "QSR Agreement"). Under the QSR Agreement,Essent Guaranty will cede premiums earned related to 40% of risk on eligible single premium policies and 20% of risk on all other eligible policies writtenSeptember 1, 2019 throughDecember 31, 2020 , in exchange for reimbursement of ceded claims and claims expenses on covered policies, a 20% ceding commission, and a profit commission of up to 60% that varies directly and inversely with ceded claims. These reinsurance coverages also reduces net risk in force and PMIERs Minimum Required Assets. See Note 5 to our consolidated financial statements. Our combined risk-to-capital calculation for ourU.S. insurance subsidiaries as ofDecember 31, 2019 was as follows: Combined statutory capital: ($ in thousands) Policyholders' surplus$ 1,085,592 Contingency reserves 1,250,236 Combined statutory capital$ 2,335,828 Combined net risk in force$ 29,460,191 Combined risk-to-capital ratio 12.6:1 For additional information regarding regulatory capital see Note 16 to our consolidated financial statements. Our combined statutory capital equals the sum of statutory capital ofEssent Guaranty plusEssent Guaranty ofPA, Inc. , after eliminating the impact of intercompany transactions. The combined risk-to-capital ratio equals the sum of the net risk in force ofEssent Guaranty andEssent Guaranty ofPA, Inc. divided by combined statutory capital. The information above has been derived from the annual and quarterly statements of our insurance subsidiaries, which have been prepared in conformity with accounting practices prescribed or permitted by thePennsylvania Insurance Department and theNational Association of Insurance Commissioners Accounting Practices and Procedures Manual . Such practices vary from accounting principles generally accepted inthe United States . Essent Re has entered into GSE and other risk share transactions, including insurance and reinsurance transactions with Freddie Mac and Fannie Mae.Essent Re also reinsures 25% ofEssent Guaranty's NIW under a quota share reinsurance agreement. During the year endedDecember 31, 2019 , Essent Re paid dividends toEssent Group Ltd. of$55 million to increase holding company liquidity.Essent Group Ltd. made no capital contributions to Essent Re during the years endedDecember 31, 2019 and 2018. As ofDecember 31, 2019 , Essent Re had total stockholders' equity of$939.4 million and net risk in force of$10.3 billion .
Financial Strength Ratings
The financial strength ratings ofEssent Guaranty , our principal mortgage insurance subsidiary, are A3 with a stable outlook by Moody's, BBB+ with a stable outlook by S&P and A (Excellent) with a stable outlook byA.M. Best . The financial strength ratings of Essent Re are BBB+ with a stable outlook by S&P and A (Excellent) with a stable outlook byA.M. Best . 68 --------------------------------------------------------------------------------
Private Mortgage Insurer Eligibility Requirements
EffectiveDecember 31, 2015 , Fannie Mae and Freddie Mac, at the direction of the FHFA, implemented new coordinated Private Mortgage Insurer Eligibility Requirements, which we refer to as the "PMIERs." The PMIERs represent the standards by which private mortgage insurers are eligible to provide mortgage insurance on loans owned or guaranteed by Fannie Mae and Freddie Mac. The PMIERs include financial strength requirements incorporating a risk-based framework that require approved insurers to have a sufficient level of liquid assets from which to pay claims. This risk-based framework provides that an insurer must hold a substantially higher level of required assets for insured loans that are in default compared to a performing loan. The PMIERs also include enhanced operational performance expectations and define remedial actions that apply should an approved insurer fail to comply with these requirements. In 2018, the GSEs released revised PMIERs framework ("PMIERs 2.0") which became effective onMarch 31, 2019 . As ofDecember 31, 2019 ,Essent Guaranty , our GSE-approved mortgage insurance company, was in compliance with the PMIERs 2.0. As ofDecember 31, 2019 ,Essent Guaranty's Available Assets were$2.34 billion and its Minimum Required Assets were$1.50 billion based on our interpretation of the PMIERs 2.0. Financial Condition Stockholders' Equity As ofDecember 31, 2019 , stockholders' equity was$3.0 billion compared to$2.4 billion as ofDecember 31, 2018 . This increase was primarily due to net income generated in 2019 and increases in accumulated other comprehensive income related to an increase in our unrealized investment gains.
Investments
As ofDecember 31, 2019 , investments totaled$3.4 billion compared to$2.8 billion as ofDecember 31, 2018 . In addition, our total cash was$71.4 million as ofDecember 31, 2019 , compared to$64.9 million as ofDecember 31, 2018 . The increase in investments was primarily due to investing net cash flows from operations during the year endedDecember 31, 2019 . Investments Available for Sale by Asset Class
Asset Class December 31, 2019 December 31, 2018 ($ in thousands) Fair Value Percent Fair Value Percent U.S. Treasury securities$ 242,206 7.2 %$ 289,892 10.5 % U.S. agency securities 33,605 1.0 32,997 1.2U.S. agency mortgage-backed securities 848,334 25.3 637,178 23.1 Municipal debt securities(1) 361,638 10.8 483,879 17.5 Non-U.S. government securities 54,995 1.7 45,001 1.6 Corporate debt securities(2) 880,301 26.3 725,201 26.3 Residential and commercial mortgage securities 288,281 8.6 121,838 4.4 Asset-backed securities 326,025 9.7 284,997 10.3 Money market funds 315,362 9.4 139,083 5.1 Total Investments Available for Sale$ 3,350,747 100.0 %$ 2,760,066 100.0 %
_______________________________________________________________________________
December 31, December 31,
(1) The following table summarizes municipal debt securities
as of : 2019 2018
Special revenue bonds 74.5 % 69.0 %
General obligation bonds 21.3 26.0
Certificate of participation bonds 3.4 3.6
Tax allocation bonds 0.8 0.9
Special tax bonds - 0.5
Total 100.0 % 100.0 %
69
--------------------------------------------------------------------------------
December 31, December 31,
(2) The following table summarizes corporate debt securities
as of : 2019 2018
Financial 34.4 % 37.1 %
Consumer, non-cyclical 20.1 20.7
Communications 10.3 12.6
Energy 8.3 5.7
Consumer, cyclical 7.6 7.6
Utilities 6.2 5.0
Technology 4.8 3.1
Industrial 4.2 4.7
Basic materials 4.1 3.5
Total 100.0 % 100.0 %
Investments Available for Sale by Rating
Rating(1) December 31, 2019 December 31, 2018
($ in thousands) Fair Value Percent Fair Value Percent
Aaa $ 1,817,905 54.2 % $ 1,362,781 49.4 %
Aa1 109,122 3.3 124,435 4.5
Aa2 145,282 4.3 196,218 7.1
Aa3 159,599 4.8 143,315 5.2
A1 206,643 6.2 222,073 8.0
A2 183,780 5.5 199,238 7.2
A3 191,933 5.7 146,300 5.3
Baa1 232,490 6.9 162,695 5.9
Baa2 179,664 5.4 140,168 5.1
Baa3 65,119 1.9 26,805 1.0
Below Baa3 59,210 1.8
36,038 1.3
Total Investments Available for Sale
_______________________________________________________________________________
(1) Based on ratings issued by Moody's, if available. S&P or Fitch Ratings
("Fitch") rating utilized if Moody's not available.
Investments Available for Sale by Effective Duration
Effective Duration December 31, 2019 December 31, 2018 ($ in thousands) Fair Value Percent Fair Value Percent < 1 Year$ 1,038,782 31.0 %$ 529,545 19.2 % 1 to < 2 Years 306,148 9.1 285,060 10.3 2 to < 3 Years 348,708 10.4 251,763 9.1 3 to < 4 Years 361,147 10.8 278,804 10.1 4 to < 5 Years 443,382 13.2 429,005 15.6 5 or more Years 852,580 25.5
985,889 35.7
Total Investments Available for Sale
70
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Top Ten Investments Available for Sale Holdings
December 31, 2019
Rank Amortized Unrealized Credit
($ in thousands) Security Fair Value Cost Gain (Loss)(1) Rating(2)
Fannie Mae 3.500%
1 1/1/2058 $ 30,112 $ 29,781 $ 331 Aaa
U.S. Treasury 5.250%
2 11/15/2028 29,480 28,858 622 Aaa
Freddie Mac 4.000%
3 11/1/2048 28,530 28,501 29 Aaa
U.S. Treasury 2.625%
4 6/30/2023 20,465 19,710 755 Aaa
U.S. Treasury 1.500%
5 8/15/2026 17,161 17,445 (284 ) Aaa
Fannie Mae 4.500%
6 5/1/2048 16,972 16,301 671 Aaa
Freddie Mac 4.500%
7 4/1/2049 16,585 16,506 79 Aaa
U.S. Treasury 2.625%
8 7/15/2021 14,978 14,738 240 Aaa
Freddie Mac 4.000%
9 5/15/2050 14,700 14,603 97 Aaa
Fannie Mae 4.000%
10 5/1/2056 13,079 12,276 803 Aaa
Total $ 202,062 $ 198,719 $ 3,343
Percent of Investments Available for Sale 6.0 %
_______________________________________________________________________________
(1) As of
management believes decline in fair values is principally associated with the
changes in the interest rate environment subsequent to their purchase. Also,
see Note 3 to our consolidated financial statements, which summarizes the
aggregate amount of gross unrealized losses by asset class in which the fair
value of investments available for sale has been less than cost for less than
12 months and for 12 months or more.
(2) Based on ratings issued by Moody's, if available. S&P or Fitch rating
utilized if Moody's not available.
Rank December 31, 2018
($ in thousands) Security Fair Value
1 U.S. Treasury 2.625% 7/15/2021 $ 36,323
2 U.S. Treasury 5.250% 11/15/2028 28,213
3 U.S. Treasury 2.625% 6/30/2023 26,637
4 Fannie Mae 4.500% 5/1/2048 19,419
5 U.S. Treasury 1.500% 8/15/2026 18,924
6 Fannie Mae 4.000% 5/1/2056 14,287
7 Fannie Mae 3.000% 12/1/2032 12,797
8 Fannie Mae 4.500% 11/1/2048 12,130
9 U.S. Treasury 2.000% 1/15/2021 11,382
10 Fannie Mae 1.500% 6/22/2020 11,133
Total $ 191,245
Percent of Investments Available for Sale 6.9 %
71
--------------------------------------------------------------------------------
The following tables includes municipal securities for states that represent
more than 10% of the total municipal bond position as of
Amortized Credit
($ in thousands) Fair Value Cost Rating (1), (2)
Texas
Texas A&M University $ 6,269 $ 5,970 Aaa
State of Texas 5,788 5,555 Aaa
City of Houston TX Combined Utility
System Revenue 5,108 4,674 Aa2
University of Houston 3,355 3,236
Aa2
City of Austin TX Electric Utility Revenue 2,354 2,156
Aa3
Dallas/Fort Worth International Airport 2,345 2,186
A1
City of Houston TX 2,238 2,127
Aa3
North Texas Municipal Water District 2,050 1,971 Aaa North Texas Tollway System 1,890 1,768 A2 City of Dallas TX 1,845 1,684 Aa3 Tarrant Regional Water District 1,549 1,461
Aaa
City of Fort Worth TX Water & Sewer System Revenue 1,542 1,489
Aa1
City of San Antonio TX Airport System 1,315 1,197
A1
City of Corpus Christi TX Utility System Revenue 1,162 1,083
A1
Harris County Toll Road Authority 1,073 1,042 Aa2 County of Fort Bend TX 851 807 Aa1 Central Texas Turnpike System 674 641 Baa1Austin-Bergstrom Landhost Enterprises , Inc. 632 593
A3
San Jacinto Community College District 588 550 Aa3
$ 42,628 $ 40,190
Amortized Credit
($ in thousands) Fair Value Cost Rating (1), (2)
New York
City of New York NY $ 7,056 $ 6,530 Aa1
State of New York Personal Income Tax
Revenue 6,965 6,616 Aa1
ThePort Authority ofNew York and New Jersey 6,008 5,608
Aa3
New York City Transitional Finance Authority Future Tax Secured Revenue 4,724 4,456
Aa1
Metropolitan Transportation Authority 4,358 4,085 A1
TSASC, Inc. 2,422 2,201 A2
County of Nassau NY 2,202 2,018 A2
Long Island Power Authority 1,891 1,773 A2
New York City Transitional Finance
Authority Building Aid Revenue 1,550 1,484 Aa2
Town of Oyster Bay NY 1,102 1,052 Aa2
Carousel Center Co., LP 134 133 Ba2
$ 38,412 $ 35,956 _______________________________________________________________________________
(1) Certain of the above securities may include financial guaranty insurance or
state enhancements. The above ratings include the effect of these credit
enhancements, if applicable.
(2) Based on ratings issued by Moody's, if available. S&P or Fitch rating
utilized if Moody's not available.
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Contractual Obligations
As of
Payments due by period
Less than More than
($ in thousands) Total 1 year 1 - 3 years 3 - 5 years 5 years
Credit facility borrowings $ 225,000 $ - $ 225,000 $ - $ -
Estimated loss and LAE payments(1) 69,362 37,973 30,722 667 -
Operating lease obligations 13,866 2,985 6,002 4,086 793
Unfunded investment commitments 102,967 41,000 37,750 16,877 7,340
Total $ 411,195 $ 81,958 $ 299,474 $ 21,630 $ 8,133 _______________________________________________________________________________
(1) Our estimate of loss and LAE payments reflects the application of accounting
policies described below in "-Critical Accounting Policies-Reserve for Losses
and Loss Adjustment Expenses." The payments due by period are based on
management's estimates and assume that all of the loss and LAE reserves
included in the table will result in payments.
We lease office space in Pennsylvania , North Carolina , California and Bermuda
under leases accounted for as operating leases. A portion of the space leased in
North Carolina has been subleased to Triad; minimum lease payments shown above
have not been reduced by minimum sublease rental income of $0.1 million due in
2020 under the non-cancelable sublease.
Off-Balance Sheet Arrangements
Essent Guaranty has entered into fully collateralized reinsurance agreements ("Radnor Re Transactions") with unaffiliated special purpose insurers domiciled inBermuda . The Radnor Re special purpose insurers are special purpose variable interest entities that are not consolidated in our consolidated financial statements because we do not have the unilateral power to direct those activities that are significant to their economic performance. As ofDecember 31, 2019 , our estimated off-balance sheet maximum exposure to loss from the Radnor Re entities was$21.3 million , representing the estimated net present value of investment earnings on the assets in the reinsurance trusts. See Note 5 to our consolidated financial statements for additional information.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operation are based upon our consolidated financial statements, which have been prepared in conformity withU.S. generally accepted accounting principles ("GAAP"). In preparing our consolidated financial statements, management has made estimates, assumptions and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. In preparing these financial statements, management has utilized available information, including our past history, industry standards and the current and projected economic and housing environment, among other factors, in forming its estimates, assumptions and judgments, giving due consideration to materiality. Because the use of estimates is inherent in GAAP, actual results could differ from those estimates. In addition, other companies may utilize different estimates, which may impact comparability of our results of operations to those of companies in similar businesses. A summary of the accounting policies that management believes are critical to the preparation of our consolidated financial statements is set forth below.
Insurance Premium Revenue Recognition
Mortgage guaranty insurance policies are contracts that are generally
non-cancelable by the insurer, are renewable at a fixed price, and provide for
payment of premium on a monthly, annual or single basis. Upon renewal, we are
not able to re-underwrite or re-price our policies. Consistent with industry
accounting practices, premiums written on a monthly basis are earned as coverage
is provided. Premiums written on an annual basis are amortized on a pro rata
basis over the year of coverage. Primary mortgage insurance written on policies
covering more than one year are referred to as single premium policies. A
portion of the revenue from single premium policies is recognized in earned
premium in the current period, and the remaining portion is deferred as unearned
premium and earned over the expected life of the policy. If single premium
policies related to insured loans are cancelled due to repayment by the
borrower, and the premium is non-refundable, then the remaining unearned premium
related to each cancelled policy is recognized as earned premium upon
notification of the cancellation.
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Unearned premium represents the portion of premium written that is applicable to
the estimated unexpired risk of insured loans. Rates used to determine the
earning of single premium policies are estimates based on an analysis of the
expiration of risk.
Reserve for Losses and Loss Adjustment Expenses
We establish reserves for losses based on our best estimate of ultimate claim
costs for defaulted loans using the general principles contained in ASC No. 944,
in accordance with industry practice. However, consistent with industry
standards for mortgage insurers, we do not establish loss reserves for future
claims on insured loans which are not currently in default. Loans are classified
as defaulted when the borrower has missed two consecutive payments. Once we are
notified that a borrower has defaulted, we will consider internal and
third-party information and models, including the status of the loan as reported
by its servicer and the type of loan product to determine the likelihood that a
default will reach claim status. In addition, we will project the amount that we
will pay if a default becomes a claim (referred to as "claim severity"). Based
on this information, at each reporting date we determine our best estimate of
loss reserves at a given point in time. Included in loss reserves are reserves
for incurred but not reported ("IBNR") claims. IBNR reserves represent our
estimated unpaid losses on loans that are in default, but have not yet been
reported to us as delinquent by our customers. We will also establish reserves
for associated loss adjustment expenses, consisting of the estimated cost of the
claims administration process, including legal and other fees and expenses
associated with administering the claims process. Establishing reserves is
inherently subjective as it requires estimates that are susceptible to
significant revision as more information becomes available. Our estimates of
claim rates and claim sizes will be strongly influenced by prevailing economic
conditions, such as the overall state of the economy, current rates or trends in
unemployment, changes in housing values and/or interest rates, and our best
judgments as to the future values or trends of these macroeconomic factors.
Losses incurred are also generally affected by the characteristics of our
insured loans, such as the loan amount, loan-to-value ratio, the percentage of
coverage on the insured loan and the credit quality of the borrower.
Income Taxes
Deferred income tax assets and liabilities are determined using the asset and liability (or balance sheet) method. Under this method, we determine the net deferred tax asset or liability based on the tax effects of the temporary differences between the book and tax bases of the various assets and liabilities and give current recognition to changes in tax rates and laws. Changes in tax laws, rates, regulations and policies, or the final determination of tax audits or examinations, could materially affect our tax estimates. We evaluate the realizability of the deferred tax asset and recognize a valuation allowance if, based on the weight of all available positive and negative evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. When evaluating the realizability of the deferred tax asset, we consider estimates of expected future taxable income, existing and projected book/tax differences, carryback and carryforward periods, tax planning strategies available, and the general and industry specific economic outlook. This realizability analysis is inherently subjective, as it requires management to forecast changes in the mortgage market, as well as the related impact on mortgage insurance, and the competitive and general economic environment in future periods. Changes in the estimate of deferred tax asset realizability, if applicable, are included in income tax expense on the consolidated statements of comprehensive income. ASC No. 740 provides a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In accordance with ASC No. 740, before a tax benefit can be recognized, a tax position is evaluated using a threshold that it is more likely than not that the tax position will be sustained upon examination. When evaluating the more-likely-than-not recognition threshold, ASC No. 740 provides that a company should presume the tax position will be examined by the appropriate taxing authority that has full knowledge of all relevant information. If the tax position meets the more-likely-than-not recognition threshold, it is initially and subsequently measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. This analysis is inherently subjective, as it requires management to forecast the outcome of future tax examinations and the amount of tax benefits that will ultimately be realized given the facts, circumstances, and information available at the reporting date. New information may become available in future periods that could cause the actual amount of tax benefits to vary from management's estimates.
Investments
Our fixed maturity and short-term investments are classified as available for
sale and are reported at fair value. The related unrealized gains or losses are,
after considering the related tax expense or benefit, recognized as a component
of accumulated other comprehensive income (loss) in stockholders' equity.
Realized investment gains and losses are reported in income based upon specific
identification of securities sold. Each quarter we perform reviews of all of our
investments in order to determine whether declines in fair value below amortized
cost were considered other-than-temporary in accordance with
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--------------------------------------------------------------------------------applicable guidance. In evaluating whether a decline in fair value is other-than-temporary, we consider several factors including, but not limited to:
• our intent to sell the security or whether it is more likely than not that
we will be required to sell the security before recovery;
• extent and duration of the decline;
• failure of the issuer to make scheduled interest or principal payments;
• credit ratings from third-party rating agencies and changes in these
credit ratings below investment-grade;
• current credit spreads, downgrade trends, industry and asset sector
trends, and issuer disclosures and financial reports to determine if
credit ratings from third-party credit agencies are reasonable; and
• adverse conditions specifically related to the security, an industry, or a
geographic area.
Under the current guidance a debt security impairment is deemed
other-than-temporary if we either intend to sell the security, or it is more
likely than not that we will be required to sell the security before recovery or
we do not expect to collect cash flows sufficient to recover the amortized cost
basis of the security. During the years ended December 31, 2019 , 2018 and 2017,
the unrealized losses recorded in the investment portfolio principally resulted
from fluctuations in market interest rates and credit spreads. Each issuer is
current on its scheduled interest and principal payments. We recorded
other-than-temporary impairments of $0.3 million and $0.1 million in the years
ended December 31, 2019 and 2017, respectively, for securities in an unrealized
loss position. The impairments resulted from our intent to sell these securities
subsequent to the reporting date. There were no other-than-temporary impairments
in the year ended December 31, 2018 .
For information on our material holdings in an unrealized loss position, see "-Financial Condition-Investments."
Recently Issued Accounting Pronouncements
There are no recently issued accounting standards that are expected to have a
material effect on our financial condition, results of operations or cash flows.
See Note 2 of our consolidated financial statements.
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