ESNT Essent Group Ltd

ESSENT GROUP LTD.

(Exact name of registrant as specified in its charter)

  

Bermuda		Not Applicable
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)
Clarendon House 2 Church Street Hamilton HM11, Bermuda (Address of principal executive offices and zip code)   (441) 297-9901 (Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ý   No o

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232-405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files.)  Yes ý   No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. 

Large accelerated filer	x		Accelerated filer	o
Non-accelerated filer	o		Smaller reporting company	o
			Emerging growth company	o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o   No  ý

The number of the registrant’s common shares outstanding as of November 2, 2018 was 98,139,176 .

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Table of Contents

Essent Group Ltd. and Subsidiaries

 

Form 10-Q

 

Index

 

PART I.		FINANCIAL INFORMATION	1
Item 1.		Financial Statements (Unaudited)	1
		Condensed Consolidated Balance Sheets (Unaudited)	1
		Condensed Consolidated Statements of Comprehensive Income (Unaudited)	2
		Condensed Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)	3
		Condensed Consolidated Statements of Cash Flows (Unaudited)	4
		Notes to Condensed Consolidated Financial Statements (Unaudited)	5
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.		Quantitative and Qualitative Disclosures About Market Risk	40
Item 4.		Controls and Procedures	40
PART II.		OTHER INFORMATION	41
Item 1.		Legal Proceedings	41
Item 1A.		Risk Factors	41
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds	41
Item 6.		Exhibits	42
SIGNATURES			43

 

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Unless the context otherwise indicates or requires, the terms “we,” “our,” “us,” “Essent,” and the “Company,” as used in this Quarterly Report on Form 10-Q, refer to Essent Group Ltd. and its directly and indirectly owned subsidiaries, including our primary operating subsidiaries, Essent Guaranty, Inc. and Essent Reinsurance Ltd., as a combined entity, except where otherwise stated or where it is clear that the terms mean only Essent Group Ltd. exclusive of its subsidiaries.

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q, or Quarterly Report , includes forward-looking statements pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts or present facts or conditions, such as statements regarding our future financial condition or results of operations, our prospects and strategies for future growth, the introduction of new products and services, and the implementation of our marketing and branding strategies. In many cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or the negative of these terms or other comparable terminology.

 

The forward-looking statements contained in this  Quarterly Report  reflect our views as of the date of this Quarterly Report about future events and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause events or our actual activities or results to differ significantly from those expressed in any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future events, results, actions, levels of activity, performance or achievements. A number of important factors could cause actual results to differ materially from those indicated by the forward-looking statements, including, but not limited to, those factors described below, in Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Quarterly Report , and in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2017 filed with the Securities and Exchange Commission. These factors include, without limitation, the following:

 

•	changes in or to Fannie Mae and Freddie Mac, which we refer to collectively as the GSEs, whether through Federal legislation, restructurings or a shift in business practices;

•	failure to continue to meet the mortgage insurer eligibility requirements of the GSEs;

•	competition for our customers on the basis of price, terms and conditions or otherwise, or the loss of a significant customer;

 

•	lenders or investors seeking alternatives to private mortgage insurance;

•	increase in the number of loans insured through Federal government mortgage insurance programs, including those offered by the Federal Housing Administration;

•	decline in the volume of low down payment mortgage originations;

•	uncertainty of loss reserve estimates;

•	decrease in the length of time our insurance policies are in force;

•	deteriorating economic conditions;

•	the impact of recently enacted U.S. Federal tax reform on us, our shareholders and our operations;

•	the definition of “Qualified Mortgage” reducing the size of the mortgage origination market or creating incentives to use government mortgage insurance programs;

•	the definition of “Qualified Residential Mortgage” reducing the number of low down payment loans or lenders and investors seeking alternatives to private mortgage insurance;

•	the implementation of the Basel III Capital Accord, which may discourage the use of private mortgage insurance;

•	management of risk in our investment portfolio;

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•	fluctuations in interest rates;

•	inadequacy of the premiums we charge to compensate for our losses incurred;

•	dependence on management team and qualified personnel;

•	disturbance to our information technology systems;

•	change in our customers’ capital requirements discouraging the use of mortgage insurance;

•	declines in the value of borrowers’ homes;

•	limited availability of capital;

•	unanticipated claims arise under and risks associated with our contract underwriting program;

•	industry practice that loss reserves are established only upon a loan default;

•	disruption in mortgage loan servicing;

•	risk of future legal proceedings;

•	customers’ technological demands;

•	our non-U.S. operations becoming subject to U.S. Federal income taxation;

•	becoming considered a passive foreign investment company for U.S. Federal income tax purposes; and

•	potential inability of our insurance subsidiaries to pay dividends.

 

Readers are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on these forward-looking statements. All of the forward-looking statements we have included in this Quarterly Report  are based on information available to us on the date of this Quarterly Report . We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as otherwise required by law.

 

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PART I — FINANCIAL INFORMATION

 

Item 1.   Financial Statements (Unaudited)

 

Essent Group Ltd. and Subsidiaries

Condensed Consolidated Balance Sheets (Unaudited)

 

		September 30,				December 31,
(In thousands, except per share amounts)		2018				2017
Assets
Investments
Fixed maturities available for sale, at fair value (amortized cost: 2018 — $2,527,850; 2017 — $1,994,200)		$	2,473,840			$	1,992,371
Short-term investments available for sale, at fair value (amortized cost: 2018 — $191,911; 2017 — $312,714)		191,912				312,694
Total investments available for sale		2,665,752				2,305,065
Other invested assets		24,865				500
Total investments		2,690,617				2,305,565
Cash		29,797				43,524
Accrued investment income		17,125				12,807
Accounts receivable		35,597				29,752
Deferred policy acquisition costs		16,159				15,354
Property and equipment (at cost, less accumulated depreciation of $53,005 in 2018 and $50,466 in 2017)		7,387				6,979
Prepaid federal income tax		185,935				252,157
Other assets		10,806				8,230
Total assets		$	2,993,423			$	2,674,368
Liabilities and Stockholders’ Equity
Liabilities
Reserve for losses and LAE		$	53,355			$	46,850
Unearned premium reserve		292,331				259,672
Net deferred tax liability		155,349				127,636
Credit facility borrowings (at carrying value, less unamortized deferred costs of $1,513 in 2018 and $1,409 in 2017)		223,487				248,591
Securities purchases payable		21,741				14,999
Other accrued liabilities		32,021				36,184
Total liabilities		778,284				733,932
Commitments and contingencies (see Note 7)
Stockholders’ Equity
Common shares, $0.015 par value:
Authorized - 233,333; issued and outstanding - 98,128 shares in 2018 and 98,434 shares in 2017		1,472				1,476
Additional paid-in capital		1,107,206				1,127,137
Accumulated other comprehensive loss		(47,449		)		(3,252		)
Retained earnings		1,153,910				815,075
Total stockholders’ equity		2,215,139				1,940,436
Total liabilities and stockholders’ equity		$	2,993,423			$	2,674,368

 

See accompanying notes to condensed consolidated financial statements.

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Essent Group Ltd. and Subsidiaries

 

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
(In thousands, except per share amounts)		2018				2017				2018				2017
Revenues:
Net premiums written		$	175,221			$	155,055			$	508,850			$	408,415
Increase in unearned premiums		(8,546		)		(17,115		)		(32,659		)		(26,261		)
Net premiums earned		166,675				137,940				476,191				382,154
Net investment income		16,646				10,626				45,494				28,461
Realized investment gains, net		524				564				1,160				1,763
Other income		1,153				1,073				3,384				3,023
Total revenues		184,998				150,203				526,229				415,401
Losses and expenses:
Provision for losses and LAE		5,452				4,313				12,574				9,776
Other underwriting and operating expenses		36,899				37,035				111,451				109,053
Interest expense		2,500				1,456				7,568				3,361
Total losses and expenses		44,851				42,804				131,593				122,190
Income before income taxes		140,147				107,399				394,636				293,211
Income tax expense		24,136				29,006				55,801				76,102
Net income		$	116,011			$	78,393			$	338,835			$	217,109
Earnings per share:
Basic		$	1.19			$	0.83			$	3.48			$	2.35
Diluted		1.18				0.82				3.46				2.31
Weighted average shares outstanding:
Basic		97,438				94,185				97,388				92,285
Diluted		98,013				96,094				97,944				94,104
Net income		$	116,011			$	78,393			$	338,835			$	217,109
Other comprehensive income (loss):
Change in unrealized (depreciation) appreciation of investments, net of tax (benefit) expense of ($1,352) and $752 in the three months ended September 30, 2018 and 2017 and ($7,963) and $6,462 in the nine months ended September 30, 2018 and 2017		(8,201		)		1,978				(44,197		)		15,298
Total other comprehensive (loss) income		(8,201		)		1,978				(44,197		)		15,298
Comprehensive income		$	107,810			$	80,371			$	294,638			$	232,407

 

See accompanying notes to condensed consolidated financial statements.

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Condensed Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)

 

(In thousands)		Common Shares				Additional Paid-In Capital				Accumulated Other Comprehensive Income (Loss)				Retained Earnings				Treasury Stock				Total Stockholders’ Equity
Balance at January 1, 2017		$	1,397			$	918,296			$	(12,255	)		$	436,335			$	—			$	1,343,773
Net income														379,747								379,747
Other comprehensive income										8,068												8,068
Issuance of common shares, net of issuance cost of $1,802		75				197,623																197,698
Issuance of management incentive shares		8				(8		)														—
Stock-based compensation expense						18,688																18,688
Cumulative effect of ASU 2016-09 adoption						111								(72		)						39
Treasury stock acquired																		(7,577		)		(7,577		)
Cancellation of treasury stock		(4		)		(7,573		)										7,577				—
Reclassification of certain income tax effects resulting from tax reform										935				(935		)						—
Balance at December 31, 2017		$	1,476			$	1,127,137			$	(3,252	)		$	815,075			$	—			$	1,940,436
Net income														338,835								338,835
Other comprehensive loss										(44,197		)										(44,197		)
Issuance of management incentive shares		6				(6		)														—
Stock-based compensation expense						11,269																11,269
Treasury stock acquired																		(31,204		)		(31,204		)
Cancellation of treasury stock		(10		)		(31,194		)										31,204				—
Balance at September 30, 2018		$	1,472			$	1,107,206			$	(47,449	)		$	1,153,910			$	—			$	2,215,139

 

See accompanying notes to condensed consolidated financial statements.

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Essent Group Ltd. and Subsidiaries

 

Condensed Consolidated Statements of Cash Flows (Unaudited)

 

		Nine Months Ended September 30,
(In thousands)		2018				2017
Operating Activities
Net income		$	338,835			$	217,109
Adjustments to reconcile net income to net cash provided by operating activities:
Gain on the sale of investments, net		(1,160		)		(1,763		)
Depreciation and amortization		2,539				2,955
Stock-based compensation expense		11,269				13,980
Amortization of premium on investment securities		10,701				8,752
Deferred income tax provision		35,676				49,032
Change in:
Accrued investment income		(4,318		)		(2,351		)
Accounts receivable		(5,842		)		(7,657		)
Deferred policy acquisition costs		(805		)		(1,431		)
Prepaid federal income tax		66,222				(52,185		)
Other assets		(2,439		)		21
Reserve for losses and LAE		6,505				3,437
Unearned premium reserve		32,659				26,261
Other accrued liabilities		(3,888		)		(4,139		)
Net cash provided by operating activities		485,954				252,021
Investing Activities
Net change in short-term investments		120,782				(164,165		)
Purchase of investments available for sale		(861,042		)		(567,335		)
Proceeds from maturity of investments available for sale		82,746				51,440
Proceeds from sales of investments available for sale		241,865				197,623
Purchase of other invested assets		(24,751		)		—
Distributions from other invested assets		386				—
Purchase of property and equipment		(2,947		)		(2,661		)
Net cash used in investing activities		(442,961		)		(485,098		)
Financing Activities
Issuance of common shares, net of costs		—				198,212
Credit facility borrowings		15,000				125,000
Credit facility repayments		(40,000		)		(50,000		)
Treasury stock acquired		(31,204		)		(7,329		)
Payment of issuance costs for credit facility		(516		)		(2,596		)
Net cash (used in) provided by financing activities		(56,720		)		263,287
Net (decrease) increase in cash		(13,727		)		30,210
Cash at beginning of year		43,524				27,531
Cash at end of period		$	29,797			$	57,741
Supplemental Disclosure of Cash Flow Information
Income tax payments		$	(18,600	)		$	(28,300	)
Interest payments		(7,051		)		(3,120		)
Noncash Transactions
Repayment of borrowings with term loan proceeds (see Note 6)		$	(100,000	)		$	(125,000	)

 

See accompanying notes to condensed consolidated financial statements.

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Essent Group Ltd. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

In these notes to condensed consolidated financial statements, “Essent”, “Company”, “we”, “us”, and “our” refer to Essent Group Ltd. and its subsidiaries, unless the context otherwise requires .

 

Note 1. Nature of Operations and Basis of Presentation

 

Essent Group Ltd. (“ Essent Group ”) is a Bermuda-based holding company, which, through its wholly-owned subsidiaries, offers private mortgage insurance and reinsurance for mortgages secured by residential properties located in the United States. Mortgage insurance facilitates the sale of low down payment (generally less than 20% ) mortgage loans into the secondary mortgage market, primarily to two government-sponsored enterprises (“ GSEs ”), Fannie Mae and Freddie Mac .

The primary mortgage insurance operations are conducted through Essent Guaranty, Inc. (“Essent Guaranty”), a wholly-owned subsidiary approved as a qualified mortgage insurer by the GSEs and is licensed to write mortgage insurance in all 50 states and the District of Columbia. A significant portion of our premium revenue relates to master policies with certain lending institutions. For the nine months ended September 30, 2018 one lender represented 10% of our total revenue. The loss of this customer could have a significant impact on our revenues and results of operations.

Essent Guaranty reinsures 25% of GSE-eligible new insurance written to Essent Reinsurance Ltd. (“Essent Re”), an affiliated Bermuda domiciled Class 3A Insurer licensed pursuant to Section 4 of the Bermuda Insurance Act 1978 that provides insurance and reinsurance coverage of mortgage credit risk. Essent Re also provides insurance and reinsurance to Freddie Mac and Fannie Mae. In 2016, Essent Re formed Essent Agency (Bermuda) Ltd., a wholly-owned subsidiary, which provides underwriting services to third-party reinsurers. In accordance with certain state law requirements, Essent Guaranty also reinsures that portion of the risk that is in excess of 25% of the mortgage balance with respect to any loan insured, after consideration of other reinsurance, to Essent Guaranty of PA, Inc. (“Essent PA”), an affiliate.

In addition to offering mortgage insurance, we provide contract underwriting services on a limited basis through CUW Solutions, LLC ("CUW Solutions"), a Delaware limited liability company, that provides, among other things, mortgage contract underwriting services to lenders and mortgage insurance underwriting services to affiliates.

We have prepared the condensed consolidated financial statements included herein pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). We have condensed or omitted certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (“ GAAP ”) pursuant to such rules and regulations. In the opinion of management, the statements include all adjustments (which include normal recurring adjustments) required for a fair statement of financial position, results of operations and cash flows for the interim periods presented. These statements should be read in conjunction with the consolidated financial statements and notes thereto, including Note 1 and Note 2 to the consolidated financial statements, included in our Annual Report on Form 10-K for the year ended December 31, 2017 , which discloses the principles of consolidation and a summary of significant accounting policies. The results of operations for the interim periods are not necessarily indicative of the results for the full year. We evaluated the need to recognize or disclose events that occurred subsequent to September 30, 2018 prior to the issuance of these condensed consolidated financial statements.

Within the Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2017, the financing activities were revised to reflect the repayment of credit facility borrowings with term loan proceeds of $125 million as a non-cash transaction to be consistent with the December 31, 2017 presentation. The term loan proceeds were directly applied at closing to pay down credit facility borrowings. This revision did not impact net cash provided by financing activities or the net increase in cash or any other financial statements or disclosures for the nine months ended September 30, 2017.

Certain amounts in prior years have been reclassified to conform to the current year presentation.

 

Note 2 . Recently Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") ASU 2014-09, Revenue from Contracts with Customers (Topic 606) . This update is intended to provide a consistent approach in recognizing revenue. In accordance with the new standard, recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, the new standard requires that reporting companies disclose the nature, amount, timing,

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Essent Group Ltd. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

and uncertainty of revenue and cash flows arising from contracts with customers. In December 2016, the FASB clarified that all contracts that are within the scope of Topic 944, Financial Services-Insurance , are excluded from the scope of ASU 2014-09. The Company adopted this ASU effective January 1, 2018. The adoption of this ASU did not have a material effect on the Company's consolidated operating results or financial position.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities . This update requires certain equity investments (except those accounted for under the equity method of accounting or result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. An entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. A qualitative assessment for impairment is required for equity investments without readily determinable fair values. This update also requires public entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. In addition, an entity is required to evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale investment securities in combination with the entity’s other deferred tax assets. The Company adopted this ASU effective January 1, 2018. The adoption of this ASU did not have a material effect on the Company's consolidated operating results or financial position.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) . This update will require organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. The new guidance will also require additional disclosures about the amount, timing and uncertainty of cash flows arising from leases. The provisions of this update are effective for annual and interim periods beginning after December 15, 2018. We anticipate adopting this standard on January 1, 2019 using the retrospective adoption approach as of the adoption date and electing certain practical expedients allowed under the standard. The adoption of this ASU is not expected to have a material effect on the Company's consolidated operating results or financial position.

In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments (Topic 326) . This update is intended to provide financial statement users with more information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The amendments in this ASU replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The new guidance requires financial assets measured at amortized cost to be presented at the net amount expected to be collected through the use of an allowance for credit losses. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance rather than as a write-down of the amortized cost of the securities. The provisions of this update are effective for annual and interim periods beginning after December 15, 2019. While the Company is still evaluating this ASU, we do not expect it to impact our accounting for insurance losses and loss adjustment expenses ("LAE") as these items are not within the scope of this ASU.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement . The amendments in this update modify the disclosure requirements for fair value measurements by removing, modifying, or adding certain disclosures. The provisions of this update are effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted for the removed disclosures. The Company is evaluating the impact the adoption of this ASU will have on the consolidated financial statements and related disclosures.

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Essent Group Ltd. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 3 . Investments

 

Investments available for sale consist of the following :

September 30, 2018 (In thousands)		Amortized Cost				Unrealized Gains				Unrealized Losses				Fair Value
U.S. Treasury securities		$	275,423			$	—			$	(10,190	)		$	265,233
U.S. agency securities		33,651				—				(974		)		32,677
U.S. agency mortgage-backed securities		588,499				117				(21,990		)		566,626
Municipal debt securities(1)		462,546				2,096				(7,136		)		457,506
Non-U.S. government securities		44,964				87				(253		)		44,798
Corporate debt securities(2)		720,722				295				(14,687		)		706,330
Residential and commercial mortgage securities		102,093				547				(991		)		101,649
Asset-backed securities		299,952				280				(1,211		)		299,021
Money market funds		191,911				1				—				191,912
Total investments available for sale		$	2,719,761			$	3,423			$	(57,432	)		$	2,665,752

December 31, 2017 (In thousands)		Amortized Cost				Unrealized Gains				Unrealized Losses				Fair Value
U.S. Treasury securities		$	231,905			$	2			$	(4,102	)		$	227,805
U.S. agency securities		33,669				—				(555		)		33,114
U.S. agency mortgage-backed securities		462,986				567				(7,516		)		456,037
Municipal debt securities(1)		457,418				9,098				(1,261		)		465,255
Corporate debt securities(2)		610,516				4,249				(3,037		)		611,728
Residential and commercial mortgage securities		78,974				791				(358		)		79,407
Asset-backed securities		167,638				467				(183		)		167,922
Money market funds		263,808				—				(11		)		263,797
Total investments available for sale		$	2,306,914			$	15,174			$	(17,023	)		$	2,305,065

		September 30,			December 31,
(1) The following table summarizes municipal debt securities as of :		2018			2017
Special revenue bonds		66.3	%		63.6	%
General obligation bonds		28.6			30.7
Certificate of participation bonds		3.7			4.4
Tax allocation bonds		0.9			0.8
Special tax bonds		0.5			0.5
Total		100.0	%		100.0	%

		September 30,			December 31,
(2) The following table summarizes corporate debt securities as of :		2018			2017
Financial		37.7	%		45.9	%
Consumer, non-cyclical		21.4			16.2
Communications		12.4			7.3
Energy		6.9			7.8
Consumer, cyclical		5.5			5.3
Industrial		5.4			6.3
Utilities		4.7			5.3
Technology		3.5			3.9
Basic materials		2.5			2.0
Total		100.0	%		100.0	%

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(In thousands)		Amortized Cost				Fair Value
U.S. Treasury securities:
Due in 1 year		$	1,995			$	1,977
Due after 1 but within 5 years		173,681				170,686
Due after 5 but within 10 years		70,168				65,030
Due after 10 years		29,579				27,540
Subtotal		275,423				265,233
U.S. agency securities:
Due in 1 year		—				—
Due after 1 but within 5 years		33,651				32,677
Subtotal		33,651				32,677
Municipal debt securities:
Due in 1 year		27,808				27,768
Due after 1 but within 5 years		91,977				91,050
Due after 5 but within 10 years		174,111				172,250
Due after 10 years		168,650				166,438
Subtotal		462,546				457,506
Non-U.S. government securities:
Due in 1 year		—				—
Due after 1 but within 5 years		19,770				19,790
Due after 5 but within 10 years		25,194				25,008
Subtotal		44,964				44,798
Corporate debt securities:
Due in 1 year		76,859				76,455
Due after 1 but within 5 years		375,792				369,276
Due after 5 but within 10 years		259,457				252,293
Due after 10 years		8,614				8,306
Subtotal		720,722				706,330
U.S. agency mortgage-backed securities		588,499				566,626
Residential and commercial mortgage securities		102,093				101,649
Asset-backed securities		299,952				299,021
Money market funds		191,911				191,912
Total investments available for sale		$	2,719,761			$	2,665,752

		Three Months Ended September 30,								Nine Months Ended September 30,
(In thousands)		2018				2017				2018				2017
Realized gross gains		$	574			$	605			$	1,883			$	2,035
Realized gross losses		50				41				723				272

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		Three Months Ended   September 30,								Nine Months Ended   September 30,
(In thousands)		2018				2017				2018				2017
Net premiums written:
Direct		$	178,379			$	155,055			$	515,887			$	408,415
Ceded		(3,158		)		—				(7,037		)		—
Net premiums written		$	175,221			$	155,055			$	508,850			$	408,415
Net premiums earned:
Direct		$	169,833			$	137,940			$	483,228			$	382,154
Ceded		(3,158		)		—				(7,037		)		—
Net premiums earned		$	166,675			$	137,940			$	476,191			$	382,154

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						Maximum Exposure to Loss
(In thousands)		Total VIE Assets				On - Balance Sheet				Off - Balance Sheet				Total
Radnor Re 2018-1 Ltd.		$	424,412			$	—			$	20,958			$	20,958
Total		$	424,412			$	—			$	20,958			$	20,958

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Performance level			Compounded Annual Book Value Per Share Growth			Nonvested Common Shares Earned
			<15	%		0	%
Threshold			15	%		25	%
			16	%		50	%
			17	%		75	%
Maximum			≥18	%		100	%

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Note 9 . Earnings per Share (EPS)

 

The following table reconciles the net income and the weighted average common shares outstanding used in the computations of basic and diluted earnings per common share:

 

		Three Months Ended   September 30,								Nine Months Ended   September 30,
(In thousands, except per share amounts)		2018				2017				2018				2017
Net income		$	116,011			$	78,393			$	338,835			$	217,109
Less: dividends declared		—				—				—				—
Net income available to common shareholders		$	116,011			$	78,393			$	338,835			$	217,109
Basic earnings per share		$	1.19			$	0.83			$	3.48			$	2.35
Diluted earnings per share		$	1.18			$	0.82			$	3.46			$	2.31
Basic weighted average shares outstanding		97,438				94,185				97,388				92,285
Dilutive effect of nonvested shares		575				1,909				556				1,819
Diluted weighted average shares outstanding		98,013				96,094				97,944				94,104

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(1)	Included in net realized investment gains on our condensed consolidated statements of comprehensive income.

•	Level 1 — Quoted prices for identical instruments in active markets accessible at the measurement date.

•	Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and valuations in which all significant inputs are observable in active markets. Inputs are observable for substantially the full term of the financial instrument.

•	Level 3 — Valuations derived from one or more significant inputs that are unobservable.

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•

Investments available for sale — Investments available for sale are valued using quoted market prices in active markets, when available, and those investments are classified as Level 1 of the fair value hierarchy. Level 1 investments available for sale include investments such as U.S. Treasury securities and money market funds. Investments available for sale are classified as Level 2 of the fair value hierarchy if quoted market prices are not available and fair values are estimated using quoted prices of similar securities or recently executed transactions for the securities. U.S. agency securities, U.S. agency mortgage-backed securities, municipal debt securities, non-U.S. government securities, corporate debt securities, residential and commercial mortgage securities and asset-backed securities are classified as Level 2 investments.

Assets and Liabilities Measured at Fair Value

 

All assets measured at fair value are categorized in the table below based upon the lowest level of significant input to the valuations. All fair value measurements at the reporting date were on a recurring basis.

 

September 30, 2018 (In thousands)		Quoted Prices in Active  Markets for Identical Instruments (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)				Total
Recurring fair value measurements
Financial Assets:
U.S. Treasury securities		$	265,233			$	—			$	—			$	265,233
U.S. agency securities		—				32,677				—				32,677
U.S. agency mortgage-backed securities		—				566,626				—				566,626
Municipal debt securities		—				457,506				—				457,506
Non-U.S. government securities		—				44,798				—				44,798
Corporate debt securities		—				706,330				—				706,330
Residential and commercial mortgage securities		—				101,649				—				101,649
Asset-backed securities		—				299,021				—				299,021
Money market funds		191,912				—				—				191,912
Total assets at fair value		$	457,145			$	2,208,607			$	—			$	2,665,752

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(In thousands)		2018				2017
Essent Guaranty
Statutory net income		$	275,130			$	194,131
Statutory surplus		832,403				684,421
Contingency reserve liability		853,422				623,934
Essent PA
Statutory net income		$	7,087			$	7,959
Statutory surplus		48,390				45,047
Contingency reserve liability		47,294				41,593

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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion should be read together with the “Selected Financial Data” and our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K as of and for the year ended December 31, 2017 as filed with the Securities and Exchange Commission and referred to herein as the “Annual Report,” and our condensed consolidated financial statements and related notes as of and for the three and nine months ended September 30, 2018 included in Part I, Item 1 of this Quarterly Report on Form 10-Q, which we refer to as the “ Quarterly 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” in this Quarterly Report and Part I, Item 1A “Risk Factors” in our Annual Report. 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. We were formed to serve the U.S. housing finance industry at a time when the demands of the financial crisis and a rapidly changing business environment created the need for a new, privately funded mortgage insurance company. We believe that our success in acquiring customers and growing our insurance in force has been driven by the unique opportunity we offer lenders to partner with a well-capitalized mortgage insurer, unencumbered by business originated prior to the financial crisis, that provides fair and transparent claims payment practices, and consistency and speed of service. Essent Guaranty, Inc. ("Essent Guaranty"), our wholly-owned insurance subsidiary, is licensed to write coverage in all 50 states and the District of Columbia. The financial strength of Essent Guaranty is rated Baa1 with a stable outlook by Moody’s Investor Services (“ Moody's ”) and BBB+ with a stable outlook by S&P Global Ratings (“ S&P ”). On September 5, 2018, A.M. Best assigned Financial Strength Ratings of A (Excellent) with a stable outlook to Essent Guaranty.

 

Our holding company is domiciled in Bermuda and our U.S. insurance business is headquartered in Radnor, Pennsylvania. We operate additional underwriting and service centers in Winston-Salem, North Carolina and Irvine, California. We have a highly experienced, talented team with 394 employees as of September 30, 2018 . We generated new insurance written, or NIW, of approximately $13.9 billion and $36.1 billion for the three and nine months ended September 30, 2018 , respectively, compared to approximately $13.2 billion and $32.6 billion for the three and nine months ended September 30, 2017 , respectively. As of September 30, 2018 , we had approximately $131.2 billion of insurance in force. Our top ten customers represented approximately 42.8% , 45.8% , 35.1% and 36.6% of NIW on a flow basis for the nine months ended September 30, 2018 and the years ended December 31, 2017 , 2016 and 2015 , respectively.

 

We also offer mortgage-related insurance and reinsurance through our wholly-owned Bermuda-based subsidiary, Essent Reinsurance Ltd., which we refer to as "Essent Re." As of September 30, 2018 , Essent Re provided insurance or reinsurance relating to GSE risk share and other reinsurance transactions covering approximately $612.7 million of risk, including in connection with Freddie Mac's Agency Credit Insurance Structure ("ACIS") and Fannie Mae's Credit Insurance Risk Transfer ("CIRT") programs. Essent Re has also reinsured 25% of Essent Guaranty’s GSE-eligible mortgage insurance NIW originated since July 1, 2014 under a quota share reinsurance agreement. The insurer financial strength rating of Essent Re is BBB+ with a stable outlook by S&P . On September 5, 2018, A.M. Best assigned Financial Strength Ratings of A (Excellent) with a stable outlook to Essent Re.

 

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. See Part I, Item 1 “Business—Regulation” and Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Legislative and Regulatory Developments” in our Annual Report for a discussion of the laws and regulations to which we are subject as well as legislative and regulatory developments affecting the housing finance industry.

 

Effective December 31, 2015, Fannie Mae and Freddie Mac, at the direction of the Federal Housing Finance Agency ("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

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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. As of September 30, 2018 , Essent Guaranty, our GSE-approved mortgage insurance company, was in compliance with the PMIERs. See additional discussion in “— Liquidity and Capital Resources —Private Mortgage Insurer Eligibility Requirements.”

The GSEs released the revised PMIERs ("PMIERs 2.0") on September 27, 2018 and have indicated that the PMIERs 2.0 framework will take effect on March 31, 2019. Essent expects to remain in full compliance with the existing and revised PMIERs, as applicable, prior to and after March 31, 2019.

 

Factors Affecting Our Results of Operations

 

Net Premiums Written and Earned

 

Premiums associated with our U.S. mortgage insurance business are based on insurance in force ("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 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 and the competition to provide credit enhancement on those mortgages;

 

•	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;

 

•	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 March 2018, Essent Guaranty entered into a third-party reinsurance agreement. See Note 4 to our condensed 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 September 30, 2018 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 nine months ended September 30, 2018 , monthly and single premium policies comprised 84.1% and 15.9% of our NIW, respectively.

Premiums associated with our GSE and other risk share transactions are based on the level of risk in force.

 

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 84.0% at September 30, 2018 . 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

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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 of September 30, 2018 . 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

 

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. This fee is adjusted monthly based on the number of Triad’s mortgage insurance policies in force and, accordingly, will decrease over time as Triad’s existing policies are cancelled. The services agreement was automatically extended until November 30, 2019.

 

Other income also includes revenues associated with contract underwriting services and underwriting 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 services to third-party reinsurers is dependent upon the number of customers who have engaged us for this service and the number of transactions underwritten for these customers.

 

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;

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•	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. The average age of our insurance portfolio is young with 77% of our IIF as of September 30, 2018 having been originated since January 1, 2016 . 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, 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 (“LAE”), 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 Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies” included in our Annual Report for further information.

 

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 September 30, 2018 , 77% of our IIF relates to business written since January 1, 2016 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. Specifically, on August 26, 2017, Hurricane Harvey made landfall in southeastern Texas and on September 10, 2017, Hurricane Irma made landfall in southern Florida and caused property damage in certain counties. Loans in default identified as hurricane-related defaults totaled 2,288 as of December 31, 2017. The number of hurricane-related defaults declined to 301 as of September 30, 2018 primarily due to hurricane-related loans in default that cured. Based on 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. The impact on our reserves in future periods will be dependent upon the performance of the hurricane-related defaults and our expectations for the amount of ultimate losses on these delinquencies.

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 4 to our condensed 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 59% and 61% of other underwriting and operating expenses for the three and nine months ended September 30, 2018 , respectively, compared to 63% of other underwriting and operating expenses for each of the three and nine months ended September 30, 2017 ,

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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. In addition, as a result of the increase in our IIF, we expect that our net premiums earned will grow faster than our underwriting and other expenses resulting in a decline in our expense ratio for the full year 2018 as compared to 2017.

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 to Essent’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. Our U.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 in Bermuda, which does not have a corporate income tax. Effective July 2014, Essent Re began to reinsure 25% of GSE-eligible new insurance written of Essent Guaranty, an affiliate. Essent Re also provides insurance and reinsurance to Freddie Mac and Fannie Mae.

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 three and nine months ended September 30, 2018 and 2017 for our U.S. mortgage insurance portfolio. In addition, this table includes RIF at the end of each period.

 

		Three Months Ended September 30,								Nine Months Ended September 30,
(In thousands)		2018				2017				2018				2017
IIF, beginning of period		$	122,501,246			$	95,494,390			$	110,461,950			$	83,265,522
NIW		13,913,191				13,221,038				36,099,983				32,623,467
Cancellations		(5,164,480		)		(4,779,121		)		(15,311,976		)		(11,952,682		)
IIF, end of period		$	131,249,957			$	103,936,307			$	131,249,957			$	103,936,307
Average IIF during the period		$	127,052,216			$	99,790,653			$	119,685,365			$	92,353,836
RIF, end of period		$	32,361,782			$	25,807,358			$	32,361,782			$	25,807,358

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The following is a summary of our IIF at September 30, 2018 by vintage:

 

($ in thousands)		$				%
2018 (through September 30)		$	35,189,027			26.8	%
2017		38,894,605				29.6
2016		26,510,429				20.2
2015		14,202,260				10.8
2014		8,726,281				6.7
2013 and prior		7,727,355				5.9
		$	131,249,957			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; and (5) premiums ceded under third-party reinsurance agreements. For the three and nine months ended September 30, 2018 , our average net premium rate was 0.50% and 0.51% , respectively, as compared to 0.53% for each of the three and nine months ended September 30, 2017 . In June 2018, we announced a reduction in pricing on our published rates effective for future NIW. We anticipate that the pricing reductions will reduce our average net premium rate in future periods.

 

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.”

 

Risk-to-Capital

 

The risk-to-capital ratio has historically been used as a measure of capital adequacy in the U.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 our U.S. insurance companies is computed based on accounting practices prescribed or permitted by the Pennsylvania Insurance Department. See additional discussion in “— Liquidity and Capital Resources — Insurance Company Capital.”

 

As of September 30, 2018 , our combined net risk in force for our U.S. insurance companies was $25.1 billion and our combined statutory capital was $1.8 billion , resulting in a risk-to-capital ratio of 14.1 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.

 

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Results of Operations

 

The following table sets forth our results of operations for the periods indicated:

 

Summary of Operations		Three Months Ended September 30,								Nine Months Ended September 30,
(In thousands)		2018				2017				2018				2017
Revenues:
Net premiums written		$	175,221			$	155,055			$	508,850			$	408,415
Increase in unearned premiums		(8,546		)		(17,115		)		(32,659		)		(26,261		)
Net premiums earned		166,675				137,940				476,191				382,154
Net investment income		16,646				10,626				45,494				28,461
Realized investment gains, net		524				564				1,160				1,763
Other income		1,153				1,073				3,384				3,023
Total revenues		184,998				150,203				526,229				415,401
Losses and expenses:
Provision for losses and LAE		5,452				4,313				12,574				9,776
Other underwriting and operating expenses		36,899				37,035				111,451				109,053
Interest expense		2,500				1,456				7,568				3,361
Total losses and expenses		44,851				42,804				131,593				122,190
Income before income taxes		140,147				107,399				394,636				293,211
Income tax expense		24,136				29,006				55,801				76,102
Net income		$	116,011			$	78,393			$	338,835			$	217,109

 

Three and Nine Months Ended September 30, 2018 Compared to the Three and Nine Months Ended September 30, 2017

 

For the three months ended September 30, 2018 , we reported net income of $116.0 million , compared to net income of $78.4 million for the three months ended September 30, 2017 . For the nine months ended September 30, 2018 , we reported net income of $338.8 million , compared to net income of $217.1 million for the nine months ended September 30, 2017 . The increase in our operating results in 2018 over the same periods in 2017 was primarily due to the increase in net premiums earned associated with the growth of our IIF, the increase in net investment income and the decrease in income taxes primarily due to the reduction of the U.S. statutory corporate income tax rate, partially offset by increase s in the provision for losses and LAE and interest expense.

Net Premiums Written and Earned

 

Net premiums earned increase d in the three months ended September 30, 2018 by 21% , compared to the three months ended September 30, 2017 primarily due to the increase in our average IIF from $99.8 billion at September 30, 2017 to $127.1 billion at September 30, 2018 , partially offset by a decrease in average net premium rate from 0.53% for the three months ended September 30, 2017 to 0.50% for the three months ended September 30, 2018 . Net premiums earned increase d in the nine months ended September 30, 2018 by 25% compared to the nine months ended September 30, 2017 due to the increase in our average IIF from $92.4 billion at September 30, 2017 to $119.7 billion at September 30, 2018 , partially offset by a decrease in the average net premium rate from 0.53% in the nine months ended September 30, 2017 to 0.51% in the nine months ended September 30, 2018 . The decrease in the average net premium rate during the three and nine months ended September 30, 2018 is primarily due to an increase in premiums ceded under third-party reinsurance agreements and a decrease in premiums earned on the cancellation of non-refundable single premium policies in the respective periods.

 

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Net premiums written increase d in the three months ended September 30, 2018 by 13% , compared to the three months ended September 30, 2017 primarily due to the increase in average IIF for the three months ended September 30, 2018 , as compared to the same period in 2017 , partially offset by an increase in premiums ceded under third-party reinsurance agreements, a decrease in the premium rate and a decrease in new single premium policies written in the three months ended September 30, 2018 . Net premiums written increase d in the nine months ended September 30, 2018 by 25% , compared to the nine months ended September 30, 2017 primarily due to the increase in average IIF for the nine months ended September 30, 2018 , as compared to the same period in 2017 , partially offset by an increase in premiums ceded under third-party reinsurance agreements in the nine months ended September 30, 2018 .

In the three months ended September 30, 2018 and 2017 , unearned premiums increase d by $8.5 million and $17.1 million , respectively. The change in unearned premiums was a result of net premiums written on single premium policies of $28.8 million and $36.5 million , respectively, which was partially offset by $20.3 million and $19.4 million , respectively, of unearned premium that was recognized in earnings during the periods. In the nine months ended September 30, 2018 and 2017 , unearned premiums increased by $32.7 million and $26.3 million , respectively. This was a result of net premiums written on single premium policies of $91.8 million and $80.3 million , respectively, which was partially offset by $59.1 million and $54.0 million , respectively, of unearned premium that was recognized in earnings during the periods.

Net Investment Income

 

Our net investment income was derived from the following sources for the periods indicated:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
(In thousands)		2018				2017				2018				2017
Fixed maturities		$	16,476			$	10,982			$	44,615			$	29,964
Short-term investments		910				330				2,959				463
Gross investment income		17,386				11,312				47,574				30,427
Investment expenses		(740		)		(686		)		(2,080		)		(1,966		)
Net investment income		$	16,646			$	10,626			$	45,494			$	28,461

 

The increase in net investment income for the three and nine months ended September 30, 2018 as compared to the same periods in 2017 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 $2.7 billion for the three months ended September 30, 2018 from $2.0 billion for the three months ended September 30, 2017 . The average cash and investment portfolio balance was $2.5 billion for the nine months ended September 30, 2018 compared to $1.8 billion for the nine months ended September 30, 2017 . The increase in the average cash and investment portfolio in both periods was primarily due to investing cash flows from operations and proceeds from the public offering of common shares completed in August 2017. The pre-tax investment income yield increased from 2.3% and 2.2% in the three and nine months ended September 30, 2017 , respectively, to 2.6% and 2.5% in the three and nine months ended September 30, 2018 , respectively, primarily due to an increase in market interest rates, an increase in the portion of our investment portfolio invested in spread and duration assets and higher yields on new investments. 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.

 

Other Income

 

Other income includes fees earned for information technology and customer support services provided to Triad, contract underwriting revenues and underwriting services to third-party reinsurers. The increase in other income for the three and nine months ended September 30, 2018 as compared to the same periods in 2017 , was primarily due to the increase in underwriting services to third-party reinsurers, partially offset by decreases in contract underwriting revenues and Triad service fees associated with the reduction in the number of Triad's mortgage insurance policies in force. The fees earned from Triad will continue to decrease over time as Triad's existing policies are cancelled.

 

Provision for Losses and Loss Adjustment Expenses

 

The provision for losses and LAE was $5.5 million and $4.3 million in the three months ended September 30, 2018 and 2017 , respectively, and $12.6 million and $9.8 million in the nine months ended September 30, 2018 and 2017 , respectively. The increase in the provision for losses and LAE in the three and nine months ended September 30, 2018 as

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compared to the same periods in 2017 was primarily due to the increase in the number of non-hurricane-related insured loans in default in each period. Loans in default identified as hurricane-related defaults were 301 as of September 30, 2018 as compared to 801 as of June 30, 2018 and 2,288 as of December 31, 2017. The following table presents a rollforward of insured loans in default for the periods indicated:

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2018			2017			2018			2017
Beginning default inventory		3,519			1,776			4,783			1,757
Plus: new defaults		2,285			1,592			5,980			3,897
Less: cures		(2,201	)		(1,145	)		(7,043	)		(3,322	)
Less: claims paid		(64	)		(68	)		(179	)		(176	)
Less: rescissions and denials, net		(1	)		(2	)		(3	)		(3	)
Ending default inventory		3,538			2,153			3,538			2,153

 

The increase in the number of defaults at September 30, 2018 compared to September 30, 2017 was primarily due to the increase in our IIF and policies in force, the hurricane-related defaults remaining in the default inventory, along with further seasoning of our insurance portfolio.

 

The following table includes additional information about our loans in default as of the dates indicated:

 

		As of September 30,
		2018				2017
Case reserves (in thousands)		$	48,765			$	29,024
Total reserves (in thousands)		$	53,355			$	31,579
Ending default inventory		3,538				2,153
Average case reserve per default (in thousands)		$	13.8			$	13.5
Average total reserve per default (in thousands)		$	15.1			$	14.7
Default rate		0.61		%		0.46		%
Claims received included in ending default inventory		49				40

 

The increase in the average case reserve per default was primarily due to the level of reserves for hurricane-related defaults. In the fourth quarter of 2017, we recorded a provision for losses and LAE associated with hurricanes Harvey and Irma. The reserve for losses and LAE on hurricane-related defaults was $11.1 million at September 30, 2018 and December 31, 2017 representing our best estimate of ultimate claim costs for hurricane-related defaults based on the information available at each period end. Also contributing to the change in the average case reserve per default were 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 tables provide a reconciliation of the beginning and ending reserve balances for losses and LAE and a detail of reserves and defaulted RIF by the number of missed payments and pending claims:

 

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		Three Months Ended September 30,								Nine Months Ended September 30,
(In thousands)		2018				2017				2018				2017
Reserve for losses and LAE at beginning of period		$	50,016			$	29,798			$	46,850			$	28,142
Add provision for losses and LAE occurring in:
Current period		8,671				7,150				25,199				19,266
Prior years		(3,219		)		(2,837		)		(12,625		)		(9,490		)
Incurred losses and LAE during the current period		5,452				4,313				12,574				9,776
Deduct payments for losses and LAE occurring in:
Current period		409				146				620				243
Prior years		1,704				2,386				5,449				6,096
Loss and LAE payments during the current period		2,113				2,532				6,069				6,339
Reserve for losses and LAE at end of period		$	53,355			$	31,579			$	53,355			$	31,579

 

		As of September 30, 2018
($ in thousands)		Number of Policies in Default			Percentage of Policies in Default			Amount of Reserves				Percentage of Reserves			Defaulted RIF				Reserves as a Percentage of Defaulted RIF
Missed payments:
Three payments or less		1,886			53	%		$	10,498			22	%		$	101,755			10	%
Four to eleven payments		1,252			36			24,531				50			68,670				36
Twelve or more payments		351			10			11,795				24			20,160				59
Pending claims		49			1			1,941				4			2,212				88
Total case reserves		3,538			100	%		48,765				100	%		$	192,797			25
IBNR								3,657
LAE and other								933
Total reserves for losses and LAE								$	53,355

		As of September 30, 2017
($ in thousands)		Number of Policies in Default			Percentage of Policies in Default			Amount of Reserves				Percentage of Reserves			Defaulted RIF				Reserves as a Percentage of Defaulted RIF
Missed payments:
Three payments or less		1,228			57	%		$	7,935			27	%		$	68,317			12	%
Four to eleven payments		690			32			12,948				45			38,003				34
Twelve or more payments		195			9			6,105				21			10,087				61
Pending claims		40			2			2,036				7			2,376				86
Total case reserves		2,153			100	%		29,024				100	%		$	118,783			24
IBNR								2,177
LAE and other								378
Total reserves for losses and LAE								$	31,579

 

During the three months ended September 30, 2018 , the provision for losses and LAE was $5.5 million , comprised of $8.7 million of current year losses partially offset by $3.2 million of favorable prior years’ loss development. During the three months ended September 30, 2017 , the provision for losses and LAE was $4.3 million , comprised of $7.2 million of current year losses partially offset by $2.8 million of favorable prior years’ loss development. In both periods, the 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.

During the nine months ended September 30, 2018 , the provision for losses and LAE was $12.6 million , comprised of $25.2 million of current year losses partially offset by $12.6 million of favorable prior years’ loss development. During the nine months ended September 30, 2017 , the provision for losses and LAE was $9.8 million , comprised of $19.3 million of current year losses partially offset by $9.5 million of favorable prior years’ loss development. In both periods, the 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.

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The following table includes additional information about our claims paid and claim severity as of the dates indicated:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
($ in thousands)		2018				2017				2018				2017
Number of claims paid		64				68				179				176
Amount of claims paid		$	2,029			$	2,468			$	5,848			$	6,155
Claim severity		69		%		76		%		70		%		81		%

 

Other Underwriting and Operating Expenses

 

Following are the components of our other underwriting and operating expenses for the periods indicated:

 

		Three Months Ended September 30,														Nine Months Ended September 30,
		2018							2017							2018							2017
($ in thousands)		$				%			$				%			$				%			$				%
Compensation and benefits		$	21,615			59	%		$	23,198			63	%		$	67,465			61	%		$	69,029			63	%
Other		15,284				41			13,837				37			43,986				39			40,024				37
		$	36,899			100	%		$	37,035			100	%		$	111,451			100	%		$	109,053			100	%
Number of employees at end of period																				394							398

 

The significant factors contributing to the change in other underwriting and operating expenses are:

 

•

Compensation and benefits decreased in the three and nine months ended September 30, 2018 , as compared to the three and nine months ended September 30, 2017 primarily due to a decrease in stock compensation expense associated with the full vesting of grants issued in 2013 and 2014, partially offset by an increase in payroll taxes associated with the vesting of these grants. Compensation and benefits includes salaries, wages and bonus, stock compensation expense, benefits and payroll taxes.

•	Other expenses increased as a result of the continued expansion of our business. Other expenses include premium taxes, travel, marketing, hardware, software, rent, depreciation and amortization and other facilities expenses.

Interest Expense

For the three and nine months ended September 30, 2018 , we incurred interest expense of $2.5 million and $7.6 million , respectively, as compared to $1.5 million and $3.4 million for the three and nine months ended September 30, 2017 , respectively, associated with an increase in the weighted average interest rates and average amounts outstanding under the Credit Facility. For the three and nine months ended September 30, 2018 , the average amount outstanding under the Credit Facility was $225.0 million and $245.4 million , respectively, as compared to $164.9 million and $137.6 million for the three and nine months ended September 30, 2017 , respectively. As of September 30, 2018 and 2017 , the borrowings under the Credit Facility had a weighted average interest rate of 4.15% and 3.24%, respectively.

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Income Taxes

 

Our subsidiaries in the United States file a consolidated U.S. Federal income tax return. For interim reporting periods, we use an annual effective tax rate method required under GAAP to calculate the income tax provision. Our income tax expense was $24.1 million and $29.0 million for the three months ended September 30, 2018 and 2017 , respectively, and $55.8 million and $76.1 million for the nine months ended September 30, 2018 and 2017 , respectively. Income tax expense for each of the three and nine months ended September 30, 2018 was calculated using an estimated annual effective tax rate of 16.2% , as compared to 27.0% for each of the three and nine months ended September 30, 2017 . For the three and nine months ended September 30, 2018 , income tax expense 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. For the nine months ended September 30, 2018 and 2017 , income tax expense was reduced by excess tax benefits associated with the vesting of common shares and common share units of $9.6 million and $3.1 million , respectively. 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 U.S. federal income tax returns are treated as discrete items in the reporting period in which they occur and are not considered in determining the annual effective tax rate. The decrease in the annual effective tax rate for 2018 reflects the reduction of the U.S. statutory corporate income tax rate from 35% to 21% and the expected portion of our consolidated earnings to be generated in Bermuda. Bermuda does not have a corporate income tax.

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; and

•	the other costs and operating expenses of our business.

 

As of September 30, 2018 , we had substantial liquidity with cash of $29.8 million , short-term investments of $191.9 million and fixed maturity investments of $2.5 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 on May 17, 2021. At September 30, 2018 , net cash and investments at the holding company were $77.2 million .

On May 2, 2018, we amended the Credit Facility to increase the committed capacity by $125 million to $500 million, including the issuance of $100 million of additional term loans, the proceeds of which were used to pay down borrowings outstanding under the revolving component of the Credit Facility. See Note 6 to our condensed consolidated financial statements.

In December 2014, Essent Guaranty became a member of the Federal Home Loan Bank of Pittsburgh (the “FHLBank”). In November 2018, Essent Guaranty entered into additional agreements with the FHLBank providing Essent Guaranty with secured borrowing capacity with the FHLBank. Such borrowings may be used by Essent Guaranty to provide supplemental liquidity. Essent Guaranty currently has no outstanding borrowings with the FHLBank.

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.

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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.

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 September 30, 2018 , Essent Guaranty had unassigned surplus of approximately $127.1 million . During the nine months ended September 30, 2018 , Essent Guaranty paid to its parent, Essent US Holdings, Inc. ("Essent Holdings"), a $40 million dividend which was used to pay down the borrowings remaining under the revolving component of the Credit Facility. Essent Guaranty of PA, Inc. (“Essent PA") had unassigned surplus of approximately $9.4 million as of September 30, 2018 . 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 September 30, 2018 , Essent Re had total equity of $749.2 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 condensed consolidated financial statements. At September 30, 2018 , 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:

 

		Nine Months Ended September 30,
(In thousands)		2018				2017
Net cash provided by operating activities		$	485,954			$	252,021
Net cash used in investing activities		(442,961		)		(485,098		)
Net cash (used in) provided by financing activities		(56,720		)		263,287
Net (decrease) increase in cash		$	(13,727	)		$	30,210

 

Operating Activities

 

Cash flow provided by operating activities totaled $486.0 million for the nine months ended September 30, 2018 , as compared to $252.0 million for the nine months ended September 30, 2017 . The increase in cash flow provided by operating activities of $233.9 million in 2018 was primarily due to increases in premiums collected and net investment income, and a net decrease in United States Mortgage Guaranty Tax and Loss Bonds (“T&L Bonds”), partially offset by increases in expenses paid.

 

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Investing Activities

 

Cash flow used in investing activities totaled $443.0 million for the nine months ended September 30, 2018 , primarily related to investing cash flows from the business. Cash flow used in investing activities totaled $485.1 million for the nine months ended September 30, 2017 , primarily related to investing cash flows from the business, proceeds from the public offering of common shares in August 2017 and net increased borrowings under the Credit Facility in 2017.

 

Financing Activities

 

Cash flow used in financing activities totaled $56.7 million for the nine months ended September 30, 2018 , primarily related to treasury stock acquired from employees to satisfy tax withholding obligations and $25 million of net repayments of borrowings under the Credit Facility. Cash flow provided by financing activities totaled $263.3 million for the nine months ended September 30, 2017 , primarily related to proceeds from the public offering of common shares completed in August 2017 and $75 million of net increased borrowings under the Credit Facility, partially offset by treasury stock acquired from employees to satisfy tax withholding obligations.

 

Insurance Company Capital

 

We compute a risk-to-capital ratio for our U.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 three months ended March 31, 2018, Essent Holdings made capital contributions to Essent Guaranty of $15 million to support new and existing business. During the three months ended June 30, 2018, Essent Guaranty paid a dividend to Essent Holdings of $40 million which was used to pay down the borrowings remaining under the revolving component of the Credit Facility. During the nine months ended September 30, 2017 , Essent Holdings made capital contributions to Essent Guaranty of $50 million to support new business.

In March 2018, Essent Guaranty entered into a fully collateralized reinsurance agreement with Radnor Re 2018-1 Ltd. ("Radnor Re"), an unaffiliated special purpose insurer domiciled in Bermuda, that provides for up to $424.4 million of aggregate excess-of-loss reinsurance coverage at inception for new defaults on a portfolio of mortgage insurance policies issued between January 1, 2017 and December 31, 2017. The aggregate excess of loss reinsurance coverage decreases over a ten-year period as the underlying covered mortgages amortize. This reinsurance coverage also reduces net risk in force and PMIERs Minimum Required Assets. See Note 4 to our condensed consolidated financial statements.

 

Our combined risk-to-capital calculation for our U.S. insurance subsidiaries as of September 30, 2018 is as follows:

 

Combined statutory capital: ($ in thousands)
Policyholders’ surplus	$	881,196
Contingency reserves	900,716
Combined statutory capital	$	1,781,912
Combined net risk in force	$	25,124,809
Combined risk-to-capital ratio	14.1:1

 

For additional information regarding regulatory capital, see Note 12 to our condensed consolidated financial statements. Our combined statutory capital equals the sum of statutory capital of Essent Guaranty plus Essent PA, after eliminating the impact of intercompany transactions. The combined risk-to-capital ratio equals the sum of the net risk in force of Essent Guaranty and Essent PA 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

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practices prescribed or permitted by the Pennsylvania Insurance Department and the National Association of Insurance Commissioners Accounting Practices and Procedures Manual. Such practices vary from accounting principles generally accepted in the United States.

 

Essent Re has entered into risk GSE and other risk share transactions, including insurance and reinsurance transactions with Freddie Mac and Fannie Mae. Essent Re also executed a quota share reinsurance transaction with Essent Guaranty to reinsure 25% of Essent Guaranty’s GSE-eligible NIW effective July 1, 2014. As of September 30, 2018 , Essent Re had total stockholders’ equity of $749.2 million and net risk in force of $7.8 billion .

 

Financial Strength Ratings

 

The insurer financial strength rating of Essent Guaranty, our principal mortgage insurance subsidiary, is rated Baa1 with a stable outlook by Moody's and BBB+ with a stable outlook by S&P . The insurer financial strength rating of Essent Re is BBB+ with a stable outlook by S&P . On September 5, 2018, A.M. Best assigned Financial Strength Ratings of A (Excellent) with stable outlooks to Essent Guaranty and Essent Re.

 

Private Mortgage Insurer Eligibility Requirements

 

Effective December 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. As of September 30, 2018 , Essent Guaranty, our GSE-approved mortgage insurance company, was in compliance with the PMIERs. As of September 30, 2018 , Essent Guaranty's Available Assets were $1.82 billion and its Minimum Required Assets were $1.46 billion based on our interpretation of the PMIERs.

The GSEs released PMIERs 2.0 on September 27, 2018 and have indicated that the PMIERs 2.0 framework will take effect on March 31, 2019. If PMIERs 2.0 had been in effect as of September 30, 2018, Essent Guaranty’s excess of Available Assets over Minimum Required Assets would be substantially unchanged from the amount computed under PMIERs 1.0. Essent expects to remain in full compliance with the existing and revised PMIERs, as applicable, prior to and after March 31, 2019.

 

Financial Condition

 

Stockholders’ Equity

 

As of September 30, 2018 , stockholders’ equity was $2.2 billion , compared to $1.9 billion as of December 31, 2017 . This increase was primarily due to net income generated in 2018 , partially offset by an increase in accumulated other comprehensive loss related to an increase in our unrealized investment losses.

Investments

 

The total fair value of our investments was $2.7 billion as of September 30, 2018 and $2.3 billion as of December 31, 2017 . In addition, our total cash was $29.8 million as of September 30, 2018 , compared to $43.5 million as of December 31, 2017 . The increase in investments was primarily due to investing net cash flows from operations during the nine months ended September 30, 2018 .

 

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Investments Available for Sale by Asset Class

 

Asset Class		September 30, 2018							December 31, 2017
($ in thousands)		Fair Value				Percent			Fair Value				Percent
U.S. Treasury securities		$	265,233			9.9	%		$	227,805			9.9	%
U.S. agency securities		32,677				1.2			33,114				1.4
U.S. agency mortgage-backed securities		566,626				21.3			456,037				19.8
Municipal debt securities(1)		457,506				17.2			465,255				20.2
Non-U.S. government securities		44,798				1.7			—				—
Corporate debt securities(2)		706,330				26.5			611,728				26.5
Residential and commercial mortgage securities		101,649				3.8			79,407				3.5
Asset-backed securities		299,021				11.2			167,922				7.3
Money market funds		191,912				7.2			263,797				11.4
Total Investments Available for Sale		$	2,665,752			100.0	%		$	2,305,065			100.0	%

		September 30,			December 31,
(1) The following table summarizes municipal debt securities as of :		2018			2017
Special revenue bonds		66.3	%		63.6	%
General obligation bonds		28.6			30.7
Certificate of participation bonds		3.7			4.4
Tax allocation bonds		0.9			0.8
Special tax bonds		0.5			0.5
Total		100.0	%		100.0	%

		September 30,			December 31,
(2) The following table summarizes corporate debt securities as of :		2018			2017
Financial		37.7	%		45.9	%
Consumer, non-cyclical		21.4			16.2
Communications		12.4			7.3
Energy		6.9			7.8
Consumer, cyclical		5.5			5.3
Industrial		5.4			6.3
Utilities		4.7			5.3
Technology		3.5			3.9
Basic materials		2.5			2.0
Total		100.0	%		100.0	%

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Investments Available for Sale by Rating

 

Rating(1)		September 30, 2018							December 31, 2017
($ in thousands)		Fair Value				Percent			Fair Value				Percent
Aaa		$	1,314,053			49.3	%		$	1,160,200			50.3	%
Aa1		131,368				4.9			115,237				5.0
Aa2		187,542				7.0			123,551				5.4
Aa3		130,983				4.9			127,785				5.6
A1		223,943				8.4			205,369				8.9
A2		171,217				6.4			157,651				6.8
A3		148,670				5.6			148,246				6.4
Baa1		167,283				6.3			115,178				5.0
Baa2		127,092				4.8			87,869				3.8
Baa3		33,953				1.3			43,024				1.9
Below Baa3		29,648				1.1			20,955				0.9
Total Investments Available for Sale		$	2,665,752			100.0	%		$	2,305,065			100.0	%

(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		September 30, 2018							December 31, 2017
($ in thousands)		Fair Value				Percent			Fair Value				Percent
< 1 Year		$	598,900			22.5	%		$	628,958			27.3	%
1 to < 2 Years		259,820				9.7			164,856				7.2
2 to < 3 Years		250,341				9.4			280,177				12.2
3 to < 4 Years		217,233				8.2			263,799				11.4
4 to < 5 Years		461,890				17.3			263,273				11.4
5 or more Years		877,568				32.9			704,002				30.5
Total Investments Available for Sale		$	2,665,752			100.0	%		$	2,305,065			100.0	%

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Top Ten Investments Available for Sale Holdings

 

		September 30, 2018
Rank ($ in thousands)		Security		Fair Value				Amortized Cost				Unrealized Gain (Loss)(1)				Credit Rating(2)
1		U.S. Treasury 2.625% 7/15/2021		$	35,943			$	36,126			$	(183	)		Aaa
2		U.S. Treasury 5.250% 11/15/2028		27,540				29,579				(2,039		)		Aaa
3		U.S. Treasury 2.625% 6/30/2023		26,116				26,337				(221		)		Aaa
4		Fannie Mae 4.500% 5/1/2048		19,885				20,019				(134		)		Aaa
5		U.S. Treasury 1.500% 8/15/2026		18,307				20,410				(2,103		)		Aaa
6		Fannie Mae 4.000% 5/1/2056		14,681				14,594				87				Aaa
7		Fannie Mae 3.000% 12/1/2032		13,065				13,109				(44		)		Aaa
8		U.S. Treasury 2.000% 1/15/2021		11,280				11,436				(156		)		Aaa
9		Fannie Mae 1.500% 6/22/2020		11,051				11,306				(255		)		Aaa
10		Freddie Mac 4.000% 7/1/2037		10,824				11,194				(370		)		Aaa
Total				$	188,692			$	194,110			$	(5,418	)
Percent of Investments Available for Sale				7.1		%

(1)

As of September 30, 2018 , for securities in unrealized loss positions, 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 condensed consolidated financial statements, which summarizes the aggregate amount of gross unrealized losses by asset class in which the fair value of investments 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, 2017
($ in thousands)		Security		Fair Value
1		U.S. Treasury 5.250% 11/15/2028		$	29,358
2		U.S. Treasury 1.500% 8/15/2026		19,067
3		U.S. Treasury 0.000% 1/4/2018		14,999
4		Freddie Mac 4.000% 7/1/2037		12,639
5		Fannie Mae 1.500% 6/22/2020		11,165
6		Ginnie Mae 4.000% 7/20/2045		10,964
7		Freddie Mac 2.500% 10/1/2030		10,877
8		Ginnie Mae 4.000% 8/20/2045		10,666
9		Freddie Mac 3.000% 9/1/2046		10,173
10		U.S. Treasury 2.250% 11/15/2025		9,949
Total				$	139,857
Percent of Investments Available for Sale				6.1		%

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The following tables include municipal debt securities for states that represent more than 10% of the total municipal bond position as of September 30, 2018 :

 

($ in thousands)		Fair Value				Amortized Cost				Credit Rating (1), (2)
Texas
State of Texas		$	8,694			$	8,823			Baa1
The Texas A&M University System		5,917				6,120				Aaa
City of Houston		5,761				5,788				Aa3
University of Houston System		3,221				3,290				Aa2
La Joya Independent School District		2,377				2,399				Aaa
City of El Paso		2,369				2,385				Aa2
Dallas/Fort Worth International Airport		2,305				2,214				A1
City of Austin		2,248				2,185				Aa3
Harris County Cultural Education		2,004				2,000				A1
North Texas Municipal Water District		1,928				2,021				Aaa
Carrollton-Farmers Branch Independent School District		1,869				1,902				Aaa
Alamo Community College District		1,570				1,576				Aaa
Tarrant Regional Water District		1,490				1,497				Aaa
Fort Worth TX W&S Revenue		1,489				1,532				Aa1
City of College Station		1,373				1,414				Aa1
City of Garland		1,363				1,393				Aa1
Bryan Independent School District		1,248				1,314				Aaa
City of San Antonio		1,239				1,212				A1
Spring Independent School District		1,167				1,225				Aaa
City of Corpus Christi		1,115				1,099				A1
Harris County Toll Road Authority		1,059				1,074				Aa2
Pharr-San Juan-Alamo Independent School District		1,043				1,068				Aaa
Port Arthur Independent School District		960				978				Aaa
San Jacinto Community College District		840				839				Aa3
County of Fort Bend		798				823				Aa1
Austin-Bergstrom Landhost Enterprises, Inc.		589				603				A3
		$	56,036			$	56,774

(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 .

 

Off-Balance Sheet Arrangements

 

Radnor Re 2018-1 Ltd. is a special purpose variable interest entity that is not consolidated in our condensed consolidated financial statements because we do not have the unilateral power to direct those activities that are significant to its economic performance. As of September 30, 2018 , our estimated off-balance sheet maximum exposure to loss from Radnor Re was $21.0 million , representing the estimated net present value of investment earnings on the assets in the reinsurance trust. See Note 4 to our condensed consolidated financial statements for additional information.

Critical Accounting Policies

 

As of the filing date of this report, there were no significant changes in our critical accounting policies from those discussed in our 2017 Form 10-K. See Note 2 to our condensed consolidated financial statements for recently issued accounting standards under evaluation.

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Item 3.   Quantitative and Qualitative Disclosures About Market Risk

 

We own and manage a large investment portfolio of various holdings, types and maturities. Investment income is one of our primary sources of cash flow supporting operations and claim payments. The assets within the investment portfolio are exposed to the same factors that affect overall financial market performance. While our investment portfolio is exposed to factors affecting markets worldwide, it is most sensitive to fluctuations in the drivers of U.S. markets.

 

We manage market risk via defined investment policy implemented by our treasury function with oversight from our board of directors and our senior management. Important drivers of our market risk exposure monitored and managed by us include but are not limited to:

 

•

Changes to the level of interest rates.  Increasing interest rates may reduce the value of certain fixed-rate bonds held in the investment portfolio. Higher rates may cause variable-rate assets to generate additional income. Decreasing rates will have the reverse impact. Significant changes in interest rates can also affect persistency and claim rates which may in turn require that the investment portfolio be restructured to better align it with future liabilities and claim payments. Such restructuring may cause investments to be liquidated when market conditions are adverse.

 

•	Changes to the term structure of interest rates.  Rising or falling rates typically change by different amounts along the yield curve. These changes may have unforeseen impacts on the value of certain assets.

•	Market volatility/changes in the real or perceived credit quality of investments.  Deterioration in the quality of investments, identified through changes to our own or third-party (e.g., rating agency) assessments, will reduce the value and potentially the liquidity of investments.

•	Concentration Risk.  If the investment portfolio is highly concentrated in one asset, or in multiple assets whose values are highly correlated, the value of the total portfolio may be greatly affected by the change in value of just one asset or a group of highly correlated assets.

•	Prepayment Risk.  Bonds may have call provisions that permit debtors to repay prior to maturity when it is to their advantage. This typically occurs when rates fall below the interest rate of the debt.

 

Market risk is measured for all investment assets at the individual security level. Market risks that are not fully captured by the quantitative analysis are highlighted. In addition, material market risk changes that occur from the last reporting period to the current are discussed. Changes to how risks are managed will also be identified and described.

 

At September 30, 2018 , the effective duration of our investment portfolio, including cash, was 3.7  years, which means that an instantaneous parallel shift (movement up or down) in the yield curve of 100 basis points would result in a change of 3.7 % in fair value of our investment portfolio. Excluding cash, our investment portfolio effective duration was 4.0  years, which means that an instantaneous parallel shift (movement up or down) in the yield curve of 100 basis points would result in a change of 4.0 % in fair value of our investment portfolio.

Item 4.   Controls and Procedures

 

Disclosure Controls and Procedures

 

Our management carried out an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report . Based on this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective as of September 30, 2018 , the end of the period covered by this Quarterly Report .

 

Changes in Internal Control Over Financial Reporting

 

During our most recent fiscal quarter, there has not been any change in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

 

Item 1.   Legal Proceedings

 

We are not currently subject to any material legal proceedings.

 

Item 1A.   Risk Factors

 

Risk factors that affect our business and financial results are discussed in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017 . There have been no material changes in our risk factors from those previously disclosed in our Annual Report. You should carefully consider the risks described in our Annual Report, which could materially affect our business, financial condition or future results. The risks described in our Annual Report are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, and/or operating results. If any of the risks actually occur, our business, financial condition, and/or results of operations could be negatively affected.

 

Item 2.      Unregistered Sales of Equity Securities and Use of Proceeds

 

Repurchases of Securities

 

The table below sets forth information regarding repurchases of our common shares during the three months ended September 30, 2018 . All of the shares represent common shares that were tendered to the Company by employees in connection with the vesting of restricted shares to satisfy tax withholding obligations. We do not consider these transactions to be a share buyback program. 

Period		Total Number of Shares Purchased			Average Price Paid Per Share				Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs			Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
July 1 - July 31, 2018		1,716			$	35.82			—			—
August 1 - August 31, 2018		—			N/A				—			—
September 1 - September 30, 2018		—			N/A				—			—
Total		1,716							—			—

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Item 6.   Exhibits

 

(a)                                  Exhibits:

 

Exhibit No.		Description
31.1		Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101†		The following financial information from this Quarterly Report on Form 10-Q for the quarter ended September 30, 2018, formatted in XBRL (Extensible Business Reporting Language) and filed electronically herewith: (i) the Condensed Consolidated Balance Sheets (Unaudited); (ii) the Condensed Consolidated Statements of Comprehensive Income (Unaudited); (iii) the Condensed Consolidated Statements of Changes in Stockholders’ Equity (Unaudited); (iv) the Condensed Consolidated Statements of Cash Flows (Unaudited); and (v) the Notes to Condensed Consolidated Financial Statements (Unaudited), tagged as blocks of text.

†		Pursuant to applicable securities laws and regulations, this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under those sections.

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, on the date indicated.

 

		ESSENT GROUP LTD.
Date: November 9, 2018		/s/ MARK A. CASALE
		Mark A. Casale
		President, Chief Executive Officer and Chairman (Principal Executive Officer)
Date: November 9, 2018		/s/ LAWRENCE E. MCALEE
		Lawrence E. McAlee
		Senior Vice President and Chief Financial Officer (Principal Financial Officer)
Date: November 9, 2018		/s/ DAVID B. WEINSTOCK
		David B. Weinstock
		Vice President and Chief Accounting Officer (Principal Accounting Officer)

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