Essent Group Ltd. - Quarter Report: 2020 March (Form 10-Q)

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the duration, spread and severity of the COVID-19 outbreak, which is currently ongoing and still evolving; the actions taken to contain the virus or treat its impact, including government and GSE actions to mitigate the economic impact of the outbreak; the nature and extent of the forbearance and modification options available to borrowers affected by the outbreak on mortgages we insure; reserve and other accounting estimates relating to the impact of the COVID-19 outbreak; borrower behavior in response to the outbreak and its economic impact; how quickly and to what extent normal economic and operating conditions can resume, including whether any future outbreaks interrupt economic recovery; how quickly and to what extent affected borrowers can recover from the negative economic impact of the outbreak; and whether and to what extent the outbreak and related economic conditions will exacerbate other risks and uncertainties facing our business, financial condition and business strategy;

•	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 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;

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

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•	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;

•	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 or reinsurance;

•	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 restrictions on the ability of our insurance subsidiaries to pay dividends.

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(1)	Net of profit commission.

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(1)	If the reinsurance agreement is not terminated at the optional termination date, the risk margin component of the reinsurance premium increases by 50%.

(2)	If the reinsurance agreement is not terminated at the optional termination date, the reinsurance premium increases by 50%.

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(3)	Reinsurance coverage on new insurance written from January 1, 2019 through August 31, 2019.

(4)	Coverage provided immediately above the coverage provided by Radnor Re 2018-1 Ltd.

(5)	Coverage provided pari-passu to the coverage provided by Radnor Re 2019-1 Ltd.

(6)	Coverage provided pari-passu to the coverage provided by Radnor Re 2020-1 Ltd.

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

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•	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.

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(1)	Does not include the fair value of embedded derivatives, which we have accounted for separately as freestanding derivatives and included in other assets or other accrued liabilities in our condensed consolidated balance sheet. See Note 4 for more information.

(1)	Does not include the fair value of embedded derivatives, which we have accounted for separately as freestanding derivatives and included in other assets or other accrued liabilities in our condensed consolidated balance sheet. See Note 4 for more information.

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•	NIW, which is the aggregate principal amount of the new mortgages that are insured during a period. Many factors affect NIW, including, among others, the volume of low down payment home mortgage originations, the competition to provide credit enhancement on those mortgages, the number of customers who have approved us to provide mortgage insurance and changes in our NIW from certain customers;

•	Cancellations of our insurance policies, which are impacted by payments on mortgages, home price appreciation, or refinancings, which in turn are affected by mortgage interest rates. Cancellations are also impacted by the levels of claim payments and rescissions;

•	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. See Note 4 to our condensed consolidated financial statements.

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•	the overall state of the economy, which broadly affects the likelihood that borrowers may default on their loans and have the ability to cure such defaults;

•	changes in housing values, which affect our ability to mitigate our losses through the sale of properties with loans in default as well as borrower willingness to continue to make mortgage payments when the value of the home is below or perceived to be below the mortgage balance;

•	the product mix of IIF, with loans having higher risk characteristics generally resulting in higher defaults and claims;

•	the size of loans insured, with higher average loan amounts tending to increase losses incurred;

•	the loan-to-value ratio, with higher average loan-to-value ratios tending to increase losses incurred;

•	the percentage of coverage on insured loans, with deeper average coverage tending to increase losses incurred;

•	credit quality of borrowers, including higher debt-to-income ratios and lower FICO scores, which tend to increase incurred losses;

•	the level and amount of reinsurance coverage maintained with third parties;

•	the rate at which we rescind policies. Because of tighter underwriting standards generally in the mortgage lending industry and terms set forth in our master policy, we expect that our level of rescission activity will be lower than rescission activity seen in the mortgage insurance industry for vintages originated prior to the financial crisis; and

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the distribution of claims over the life of a book. As of March 31, 2020, 62% of our IIF relates to business written since January 1, 2018 and was less than three years old. As a result, based on historical industry performance, we expect the number of defaults and claims we experience, as well as our provision for losses and loss adjustment expenses ("LAE"), to increase as our portfolio seasons. See “— Mortgage Insurance Earnings and Cash Flow Cycle” below.

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(1)	The U.S. mortgage insurance portfolio reserves exclude reserves on GSE and other risk share risk in force at Essent Re of $16 thousand as of March 31, 2020.

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(1)	The U.S. mortgage insurance portfolio reserves exclude reserves on GSE and other risk share risk in force at Essent Re of $16 thousand as of March 31, 2020.

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Compensation and benefits increased in the three months ended March 31, 2020 as compared to the three months ended March 31, 2019 primarily due to increased stock compensation expense associated with shares granted in 2019 and 2020 and increased salaries and overtime associated with our increased NIW. Compensation and benefits includes salaries, wages and bonus, stock compensation expense, benefits and payroll taxes.

•	Premium taxes increased primarily due to an increase in premiums written.

•	Other expenses decreased as a result of ceding commission earned under the QSR Agreement. Other expenses include professional fees, travel, marketing, hardware, software, rent, depreciation and amortization and other facilities expenses.

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•	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.

•	claim payments under our policies;

•	interest payments and repayment of borrowings under our Credit Facility;

•	the other costs and operating expenses of our business; and

•	the payment of dividends on our common shares.

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•	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.

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(1)	Based on ratings issued by Moody’s, if available. S&P or Fitch Ratings ("Fitch") rating utilized if Moody’s not available.

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(1)	Based on ratings issued by Moody’s, if available. S&P or Fitch rating utilized if Moody’s not available.

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(1)	Certain of the above securities may include financial guaranty insurance or state enhancements. The above ratings include the effect of these credit enhancements, if applicable.

(2)	Based on ratings issued by Moody’s, if available. S&P or Fitch rating utilized if Moody’s not available.

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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.

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The risk that policy losses and loss adjustment expenses we ultimately incur as a result of COVID-19 and the related economic impact may be substantially different than the loss reserves established on our financial statements at the end of each period. In accordance with industry practice and statutory accounting rules applicable to mortgage guaranty insurance companies, we establish loss reserves only for loans reported to us in default, including forbearance-related defaults. These reserves are established using estimated claim rates and claim amounts in estimating the ultimate loss, which estimates are subject to significant uncertainty given the unprecedented nature and magnitude of the COVID-19 pandemic. In addition, because our reserving method does not account for the impact of future losses that could occur from loans that are not yet delinquent, our obligation for ultimate losses that we expect to occur under our policies in force at any period end is not reflected in our financial statements, except in the case where a premium deficiency exists. As of March 31, 2020, we have been notified by mortgage servicers of only a limited number of mortgage defaults, however, we expect the number of COVID-19-related defaults reported to us, and consequently our reserves for losses and loss adjustment expenses as a result of COVID-19, to increase significantly over time.

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A deterioration in the ability and willingness of homeowners to continue to make mortgage payments on loans that we insure, which could result in an increase in the amount of insurance regulatory and PMIERs capital we are required to hold for delinquent loans, including forbearance-related delinquencies, as well as an increase in claims ultimately made with respect to such mortgage loans. Mortgage delinquencies are typically affected by a variety of borrower-specific factors, such as job loss, illness, death and divorce, and macroeconomic factors, such as rising unemployment, market deterioration and home price depreciation, many of which are likely exacerbated by the COVID-19 pandemic.

•	A potential reduction in the number of new mortgage loans available for us to insure, and consequently, on our future volumes of new insurance written, with the degree of the impact dependent in large part on the extent and duration of the economic contraction.

•	Adverse impacts on capital, credit and reinsurance market conditions, which may limit our ability to issue ILNs, purchase reinsurance or access traditional financing methods. Such adverse impacts may increase our cost of capital and affect our ability to meet liquidity needs.

•	An increased strain on our risk management policies generally, including, but not limited to, the effectiveness and accuracy of our models, given the lack of data inputs and comparable precedent.

•	An increased risk to the value of our investments and other assets, which has the potential to result in impairment charges.

•	Adverse impacts on our daily business operations and our employees’ ability to perform necessary business functions, including as a result of illness or as a result of restrictions on movement.

•	Adverse impacts on our costs structure, including the need for increased staffing in certain segments of our business, increased spending on our business continuity efforts, such as technology, and readiness efforts for returning to our offices, which may in turn limit our ability to make investments in other areas.

•	An increased risk of an information or cyber-security incident, fraud, a failure to maintain the uninterrupted operation of our information systems or a failure in the effectiveness of our anti-money laundering and other compliance programs due to, among other things, an increase in remote work.

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