ESNT - Essent: Still Worried About Unemployment

2023-12-07 16:07:35 ET

Summary

• ESNT is holding the line despite general pressures on its business, and offsets in the investment activities are much appreciated.
• Pricing is rational, and apparently, it has become secularly more disciplined over time since the revival of the industry after the GFC.
• However, outstanding questions around employment conditions which affect mortgages and ESNT's high price relative to historical levels make it uncompelling.

Essent ( ESNT ) continues to underwrite policies, and it has acquired its way into the title insurance business, which is beginning to reflect in results post consolidation. Reserves are naturally up, but while the higher rate environment threatens the economy, it also provides for stronger yields on the reserve portfolio. Ultimately, what defines risk evolutions for Essent as a private mortgage insurer is unemployment rates. We want to provide our position on unemployment rates, and the risk that we may have to see unemployment increases in order for the Fed to meet its inflation mission. As of this moment, we would wait till the stickiness of inflation can be determined before moving in.

Earnings

Let's have a quick look at the results.

Policies in force are up, mostly thanks to consolidation it seems, but are stable, undergirded by decent S/D dynamics in the overall housing market, where despite rising rates new mortgages are still being issued.

Pricing is pretty rational in the industry. Apparently, there has been a secular trend towards more rational activity in terms of PMI pricing.

I think the pricing engines have been a significant change to the industry. And the reason is it's given all of the MIs a lot more flexibility and how they can bring price to the consumer. And I think because of that, I think in the past, investors have said, well, there's not a lot of discipline in the industry.

...Now we all file a range of rates, we can change rates much more frequently. It's really become what we said it was going to be, which is a risk management tool. It allows all the MIs to pick their spots, right? People have different geographical preferences, different parts of the capital structure, FICO. I think that's great. The lenders win, and the borrowers win.

Mark Casale, CEO of ESNT

Net investment income is up almost 50% driven by the higher yield environment. That's a little less than half of the overall 20% revenue increase. The other half is driven by growth in net premiums earned. Some of these net premiums earned are included from the title insurance business. Almost all the growth in net premiums is from the consolidation of that acquisition .

Provisions are up YoY, as they probably should be, and the new title insurance business, which involves substantial commissions to agents , has introduced some more costs too that are actually more than half of the overall premium. The overall effect is that net income is flat as the title insurance business is pretty small in terms of premiums net of commissions to agents (premiums retained), and costs have gone up, including growth in interest expense, enough to keep growth in net income flat.

It's a decent performance considering the circumstances, but reflects pressures.

Bottom Line

The higher rate environment makes operational growth difficult. It also allows for higher investment yields, but higher reserves too. The good thing is that the reserves allowances are not cash expenses, while the yields are a cash income. ESNT would like to see more security in the economy, and maybe somewhat higher rates than what we had in the COVID money printing environment.

We have some concerns though. So far we are seeing positives: there are signs of decreasing demand for labour with lower job openings . People are also quitting a little less than last month, indicating that they might be less hopeful about switching to a new job, although more people are probably retiring due to demographic factors which is inflationary.

While labour market tightness may be going down, expectations about inflation may not be going down, and that could still influence wage negotiations and lead to stickiness. Without unemployment, it will be a challenge to bring inflation down, and with unemployment the situation for ESNT becomes riskier, and reserves are likely to grow incrementally to the detriment of performance.

In other words, we have not seen data, yet that proves a soft landing is possible. There is a lot of hope, but we need to see evidence first. In particular, ESNT is close to all-time highs despite stalling growth and these outstanding concerns. We don't think the stock would buck market sentiment around rates and employment, especially when these factors directly concern ESNT's businesses, and outperform at this point in time, even if a soft landing comes as hoped, since it already seems to be priced in.

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