Essent Group Ltd.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

Essent Group Ltd. is a Bermuda-based company providing private mortgage insurance, reinsurance, and risk management products primarily in the US.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Essent Group Ltd. (ESNT), a Bermuda-based holding company, is a leading provider of private mortgage insurance (PMI) in the U.S., offering coverage for mortgage loans made to home buyers with smaller down payments. Unlike government-backed insurance, private mortgage insurance is sold by a variety of private insurance companies. It is designed to protect lenders against the risk of borrower default and facilitates the purchase of homes by a wider range of customers. Essent’s core business focuses on providing credit protection for mortgages.

Essent also offers other services, including reinsurance and risk management consulting.

Their financial statements reveal that the company is publicly traded on the New York Stock Exchange under the ticker symbol “ESNT.”

Revenue Distribution:

Essent’s primary revenue source is premium income from mortgage insurance policies. The insurance policies they underwrite is usually tied to the loans they insure.
The company’s revenue is highly reliant on the volume of mortgage originations, as well as the premium rates they charge.
A significant portion of their business is concentrated in the U.S. housing market and their operations are affected by macroeconomic and regulatory factors that impact the industry.
The company’s mortgage insurance business is generally split between single-premium coverage and monthly coverage.

Industry Trends:

The mortgage insurance industry is cyclical and directly tied to the health of the housing market.
Rising interest rates and economic downturns can reduce mortgage originations, leading to less demand for private mortgage insurance, as can increases in default rates.
Regulatory changes can influence the industry, like changes to loan origination requirements or risk-based capital requirements.
Technological advancements and changing customer preferences are forcing the mortgage insurance industry to adapt and become more efficient.

Margins & Competitors:

Margins in the mortgage insurance sector are influenced by premium rates, claims experience, and operating expenses. These factors influence their net profit margins and ROIC.
The mortgage insurance sector is dominated by a few large players like Essent, MGIC, and Radian, with intense competition for volume and price.
Competition also exists between the private mortgage insurance market and government mortgage insurance programs such as FHA and VA.
Lower profitability can occur through greater competition in the form of price pressures as well as increasing costs in the event of increasing claims.

What Makes ESNT Different?

Essent is a fairly new entrant to the industry compared to other large legacy providers. That can also be a positive as they use newer tech, and have less legacy baggage.
The company has shown impressive ability in growing their book of business, while managing risk well.
Essent has also had a focus on technology and operational efficiency that has helped them remain competitive.
The company has been able to capitalize on the decline in other competitors and to quickly fill the gap, and increase its market share.

Financial Analysis

Recent Performance and Trends:

ESNT’s recent financials show a mix of positive trends and certain challenges. In the most recent earnings call (Q3 2022), the company mentioned that new insurance written and earned premiums increased, showing their ability to grow premiums while focusing on newer insurance policies.
The company’s earnings per share have seen increases, though management has hinted that the mortgage rates have begun to affect originations, and the company is expected to face difficulties for the rest of the year (2023).
In terms of the company’s financial leverage, it is noted that its financial leverage has stayed low and they maintain a focus on having financial strength as a core part of their business.
The company is seeing growth in their mortgage insurance portfolio, while remaining disciplined in their underwriting.
The business has a focus on being able to maintain the quality of its book as they continue to grow.
In recent results, the company reported they saw increases in net premiums written over prior quarters, which they attribute to increased persistency in their business.

Income Statement Analysis:

Essent reports its earnings using metrics such as net premium earned and adjusted operating income. They also provide metrics such as return on equity, combined ratio, and loss and LAE ratio.
Net premium written in the latest quarter (June 30, 2024) came at 187.5 million compared to 208.5 million the prior year.
Total revenue came in at 231.1 million compared to 241.5 million the previous year. A slight decrease year over year.
Net income came in at 136.2 million vs 163.7 million. Also down year over year.
The company’s primary expenses are claims and operating expenses, including amortization and depreciation.
They try to remain efficient with operating expenses, although some fluctuations may occur. The claim rate appears to be a crucial metric that changes the net income of the company significantly.
From the latest report, it seems clear that the company’s expense related to losses, and LAE, is significantly higher than the year prior.

Balance Sheet Analysis:

The company has reported that the net investments available for sale are at $4.3 billion.
It reports a total of $5.7 billion in total assets, and $5.1 billion in total liabilities and equity.
The company has about $176 million in cash, which would help it in any downturn.
The company has shown consistent increases in book value each year.
The company maintains a reasonably good capital position and continues to follow GAAP accounting standards.

Cash Flow Analysis:

From their most recent statement of cash flows, it is clear that cash flows from operations increased due to increases in premiums earned.
The company’s cash flow from investing decreased since investments available for sale decreased.
Cash used for financing decreased year-over-year due to decreases in shares repurchased, offset slightly by higher dividends paid.

Recent Concerns/Controversies:

In the Q3 2022 earnings call, management mentioned the possibility of the mortgage rate increase affecting new mortgage originations. That is a potential headwind in the future, that the company has said they are actively addressing.
There was a notable decrease in net income in their most recent results, caused in part by an increase in expenses, and reduction in premiums written.
The company has recently made a strategic pivot and a major acquisition of a title insurance business, which while positive, means there is greater uncertainty into how that new acquisition will be integrated and function.

Moat Analysis

Moat Rating: 2 / 5

Sources of Moat: Essent’s moat is best classified as narrow at best. The main source of their current moat comes from the switching costs that are involved in changing mortgage insurers as well as their reputation that they have built over the past decade. These have resulted in fairly strong rates of customer retention, as is evident in the company’s consistent book growth.
Durability of Moat: Even though switching costs create high barriers for customer churn, those do not prevent new competitors from entering the industry at a higher cost, or cause changes in pricing from regulatory pressures. Overall, I rate their moat as relatively small, which limits long-term predictability. Their current returns on invested capital are still quite high, though, so it is a good business to invest in.

Risks to the Moat & Business Resilience:

Competition: The mortgage insurance industry is highly competitive, with several large players vying for market share. Competitive pressures could lead to lower premium rates and reduced margins, eroding the company’s profits.
Interest Rate and Economic Cycles: Since the company relies heavily on the mortgage origination market, it will be highly volatile when interest rates go up or when the economy contracts. This will lead to lower revenues, and higher claims and expenses.
Regulatory Changes: Changes in government policy, credit standards, and capital requirements could limit the business and increase operational costs.
Technological Disruption: The industry’s reliance on manual processes and legacy systems could leave the company more vulnerable to tech startups.

Business Resilience:

Essent has been able to show resilience and has grown its revenues. They will likely continue to generate positive cash flows.
The company’s low debt levels and focus on strong capital positions help it to remain resilient in the face of adverse market conditions.
They have a focus on maintaining a solid risk profile for the mortgages they insure, which means they are less likely to be affected by sudden market downturns.
The company’s current ability to create and take advantage of the opportunities will be important to remain resilient over the long term.

Understandability Rating: 2 / 5

The business model is quite complex, as the company’s operations are intertwined with mortgage underwriting, interest rates, and macroeconomic conditions.
The nature of insurance and reinsurance adds to complexity.
There can be several obscure metrics that the company reports which are not easy to understand.
The high reliance on macroeconomic conditions adds a layer of complexity.
The company also recently acquired a new business that will make their business model harder to understand.

Balance Sheet Health Rating: 4 / 5

The company maintains low leverage and has strong capital.
It holds a good amount of cash in hand which will help it in case of any market turmoil.
The business has been able to consistently grow its book value.
They have the ability to generate great cash flow, which should help them maintain a good balance sheet and financial health.
They will also need to continue watching expenses as those have risen recently.

Conclusion

Essent Group Ltd. is a solid company in a very tricky and cyclical business. The company has a narrow moat based on brand loyalty and switching costs which is fairly stable but susceptible to outside forces. They are largely dependent on the health of the housing market and regulatory pressures. Their financials are quite good for the time being and they have a good balance sheet. However, their long-term profitability is linked heavily to their competitive advantage and their position in the housing market. They also have recently acquired a new division which will add uncertainty to the overall valuation of the business for the near future. Overall, the company presents a good investment as long as the price is correct.