Enact Holdings, Inc. Q3 FY2023 Earnings Call

Good day, and thank you for standing by. Welcome to the Q3 2023 Enact Earnings Conference Call. At this time all participants are in a listen-only mode. After the speakers' presentation, there’ll be a question and answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Daniel Kohl, Vice President of Investor Relations. Please go ahead.

Thank you, and good morning. Welcome to our third quarter earnings call. Joining me today are Rohit Gupta, President and Chief Executive Officer; and Dean Mitchell, Chief Financial Officer and Treasurer. Rohit will provide an overview of our business performance and progress against our strategy. Dean will then discuss the details of our quarterly results before turning the call back to Rohit for closing remarks. We will then take your questions. The earnings materials we issued after market close yesterday contain our financial results for the quarter, along with a comprehensive set of financial and operational metrics. These are available on the Investor Relations section of the company's website at www.ir.enactmi.com. Today's call is being recorded and will include the use of forward-looking statements. These statements are based on current assumptions, estimates, expectations and projections as of today's date. Additionally, they are subject to risks and uncertainties, which may cause actual results to be materially different, and we undertake no obligation to update or revise such statements as a result of new information. For a discussion of these risks and uncertainties, please review the cautionary language regarding forward-looking statements in today's press release as well as in our filings with the SEC, which will be available on our website. Please keep in mind the earnings materials and management's prepared remarks today include certain non-GAAP measures. Reconciliations of these measures to the most relevant GAAP metrics can be found in the press release, our earnings presentation and our upcoming SEC filing on our website. With that, I'll turn the call over to Rohit.

Thanks, Daniel. Good morning, everyone. Our team delivered very strong results in the third quarter as we continue to execute against our strategy. We reported adjusted operating income of $164 million or $1.02 per diluted share and generated a 15% adjusted operating return on equity. Insurance-in-force reached a record $262 billion, up 8% year-over-year driven by new insurance written of $14 billion and persistency that remained elevated at 84%. We saw disciplined growth in our insured portfolio with stable new business production and higher persistent fees amid higher interest rates. Investment income continued to accelerate, and we continue to exercise expense discipline. Credit performance remained strong, accompanied by a seasonal uptick in new delinquencies and the seasoning of newer large books. We remain confident in our strategy and our business and in the continued strength of the private mortgage insurance model. The economy continues to be resilient, supported by the strong labor market and household balance sheets that remain healthy. Having said that, macro factors, including geopolitical conflicts, persistent inflation, and higher interest rates, as well as a lessening of the cash buffers consumers have had since the pandemic, continue to be risks. However, delinquency rates for prime mortgage borrowers are consistent with pre-pandemic levels. Our manufacturing quality continues to be strong, and credit risk remains well within our appetite. Even as housing activity has slowed amid higher borrowing costs, we remain confident in the long-term outlook for housing as well as demand for mortgage insurance. Home prices continue to be supported by low housing inventory and strong demand, particularly among first-time homebuyers, and mortgage insurance will remain an important tool to help buyers qualify for a mortgage. In addition, while higher interest rates have affected mortgage originations, higher persistency has continued to support insurance-in-force growth. As of September 30, only 1% of the mortgages in our portfolio had raised at least 50 basis points above the prevailing market rate. Pricing on new insurance written remained constructive in the quarter. In response to continued macroeconomic uncertainty, we increased our price on NIW, ensuring we continue to underwrite risk at the appropriate level while remaining competitive. The credit quality of our insured portfolio remains strong. The weighted average FICO score was 744, the weighted average loan-to-value ratio was 93%, and our layered risk remained level with the second quarter at 1.3% of risk in force. Our delinquency rate was 2%, up 11 basis points sequentially, flat year-over-year and consistent with pre-pandemic levels. The loss ratio in the quarter was 7%. Continued strength in the labor market, healthy household balance sheets, and our loss mitigation efforts helped drive strong cure activity, and as a result, we released $55 million of reserves. New delinquencies rose in the quarter, primarily driven by seasonality and the seasoning of newer large books. We continue to take a prudent approach to loss reserves and believe we are well reserved for a range of scenarios. We continue to operate from a position of financial strength and remain well capitalized relative to regulatory requirements. PMIERs Sufficiency at the end of the quarter remained strong at 162% or $2 billion of sufficiency, and 91% of our risk in force was covered by credit risk transfers. We remain disciplined with respect to capital allocation and focus on our three pillars: Supporting our policyholders, investing to enhance and diversify our platform, and returning capital to our shareholders. As previously announced, during the second quarter, we launched Enact Re, a reinsurer that expands our franchise through access to new business opportunities, including the GSE credit risk transfer market. I'm pleased to note that Enact Re participated in all six of the GSE deals that came to market since its launch. Between its quota share agreement with EMICO and its successful participation in the GSE transaction, and as we continue to utilize the capital initially contributed by EMICO, we are pleased with the strong underwriting and attractive risk-adjusted returns we have seen from these transactions. We continue to see Enact Re as a long-term capital and expense-efficient growth opportunity. We also continue to pursue ways to expand the Enact Re platform into new related opportunities. During the quarter, we entered into an agreement with Core Specialty through which Enact will provide underwriting advisory and expertise, market intelligence, and portfolio analysis in support of Core Specialty's entrance into the mortgage reinsurance market through GSE credit risk transfer. Core Specialty closed its first transaction during the quarter, leveraging Enact's mortgage expertise, and we look forward to continuing to support Core Specialty and expanding on this market opportunity. We also continue to return capital to our shareholders. I'm pleased to note that yesterday, we announced the Board's approval of a special cash dividend of approximately $113 million or $0.71 per share, as well as the authorization of our $0.16 per share quarterly dividend, and we continued to repurchase shares during the quarter. We remain committed to returning $300 million of capital to shareholders in 2023 through a combination of quarterly and special dividends and our share repurchase program. On the whole, our distributions to shareholders reflect our commitment to our capital allocation goals, the strength of our balance sheet, the sustainability of our cash flows and the confidence we have in our business. We are very pleased with the performance we have delivered in 2023 to date and remain confident in our business as the year comes to a close. Our portfolio is strong with significant risk protection through our CRT program, and our balance sheet is able to deliver returns. I will now turn the call over to Dean.

Thanks, Rohit. Good morning, everyone. We again delivered very strong results in the third quarter of 2023. GAAP net income was $164 million or $1.02 per diluted share as compared to $1.17 per diluted share in the same period last year and $1.04 per diluted share in the second quarter of 2023. Return on equity was 15%. Adjusted operating income was also $164 million or $1.02 per diluted share as compared to $1.17 per diluted share in the same period last year and $1.10 per diluted share in the second quarter of 2023. Adjusted operating return on equity was 15%. Turning to revenue drivers, primary insurance-in-force increased in the third quarter to a new record of $262 billion, up $4 billion or 2% sequentially and up $20 billion or 8% year-over-year. New insurance written of $14 billion was down $1 billion or 5% sequentially and down $1 billion or 4% year-over-year, primarily driven by lower mortgage originations resulting from continued elevated interest rates. Persistency remained elevated at 84% in the third quarter, flat sequentially and up 2 percentage points year-over-year. Given that approximately 1% of the mortgages in our portfolio had raised at least 50 basis points above the prevailing market rate, we anticipate continued strength in persistency which will help hedge against lower production from higher mortgage rates. Net premiums earned were $243 million, up $5 million or 2% sequentially and up $8 million or 4% year-over-year. The increase in net premiums earned sequentially was driven primarily by insurance-in-force growth and slightly lower ceded premiums. Our base premium rate was 40.2 basis points, down 0.1 basis point sequentially and 0.8 basis points year-to-date. As a reminder, the base premium rate is impacted by a variety of factors and tends to modestly fluctuate from quarter-to-quarter. Year-to-date, the decline in our base premium rate continues to stabilize and is in line with our expectations. Our net earned premium rate was 37.3 basis points, flat sequentially, reflecting changes to the base rate in addition to modestly lower ceded premiums in the current quarter. Investment income in the third quarter was $55 million, up $4 million or 8% sequentially and up $15 million or 39% year-over-year. The rise in interest rates in the current rate environment is favorable for our investment portfolio as our new money yield was over 5% and our portfolio book yield increased to 3.5% for the quarter. As of quarter end, unrealized losses in our investment portfolio increased by $58 million to $497 million. As I've mentioned, we generally do not expect to realize these losses given our ability to hold the securities to maturity. Turning to credit, losses in the quarter were $18 million as compared to a benefit of $4 million last quarter and a benefit of $40 million in the third quarter of 2022. Our loss ratio for the quarter was 7% compared to negative 2% last quarter and negative 17% in the third quarter of 2022. Our losses and loss ratio were driven by an uptick in the current quarter delinquencies, partially offset by favorable cure performance, primarily on 2022 and earlier delinquencies that remained above our expectations and resulted in a $55 million reserve release in the quarter. New delinquencies increased sequentially to 11,100 from 9,200. Our new delinquency rate for the quarter was 1.2%, reflective of ongoing positive credit trends and primarily driven by historical seasonality and the normal loss development of new large books. We continue to book new delinquencies at an approximate 10% claim rate, reflecting our prudent measured approach to reserving in this dynamic environment. Total delinquencies in the third quarter increased by approximately 1,100 to about 19,200. The associated delinquency rate increased 11 basis points to 2%. We continue to deliver solid expense performance that reflects the ongoing benefits of our cost reduction actions. Operating expenses in the quarter were $55 million, approximately flat sequentially and down $3 million or 5% year-over-year. The expense ratio for the quarter was 23%, flat compared to the second quarter of 2023 and down 2 percentage points year-over-year. We continue to expect costs for the full year to decline 6% to $225 million. Moving to capital and liquidity, we continue to operate from a position of financial strength and flexibility. Our PMIERs Sufficiency remained strong at 162% or $2 billion above PMIERs requirements, which is flat to our second quarter 2023 results. At quarter end, we had $1.5 billion of PMIERs capital credit and $2.9 billion of ceded risk provided by our third-party CRT program which currently covers 91% of our risk in force. Turning now to capital allocation, we remain committed to our capital prioritization framework, which balances maintaining a strong balance sheet, investing in our business and returning capital to shareholders. As Rohit mentioned, we are pleased with the solid initial progress we've seen from Enact Re since this launch last quarter. Enact Re continues to deploy capital and to date has participated in 4 Fannie Mae and 2 Freddie Mac reinsurance transactions. Enact Re's commercial success will drive any potential future funding, and we remain excited about its long-term growth potential. We returned a total of $32 million to shareholders during the third quarter, consisting of the $0.16 per share or $26 million quarterly dividend and share repurchases totaling $6 million. Year-to-date through October, we have repurchased $78 million in stock and have $96 million remaining on our current share repurchase authorization. As we said in the past, we will continue to deploy capital towards share buybacks opportunistically. All in all, to date, we have returned approximately $150 million to shareholders between our quarterly dividend and share repurchases, and we remain committed to returning $300 million to shareholders in 2023. Towards that end, the Board authorized our quarterly dividend of approximately $26 million or $0.16 per share and a special dividend of $113 million or $0.71 per share, both payable on December 5, 2023. Overall, we had another strong quarter and are well-positioned as we enter the final quarter of 2023. Going forward, we will remain focused on prudently managing our risk, driving cost efficiencies and maintaining a strong balance sheet while executing against our capital prioritization framework.

Thanks, Dean. Looking forward, we will continue to pursue prudent growth opportunities and disciplined capital allocation that balances financial strength and policyholder support, investment in the business, and capital returns. Overall, Enact is well positioned to continue to serve our customers and their borrowers, grow our franchise, and deliver strong performance and value creation for our shareholders. I'll close by saying thank you to our talented team for all you do and for driving us forward. Operator, we are now ready for Q&A.

And our first question comes from the line of Bose George with KBW. Your line is now open.

Hey, everyone. Good morning. On capital return going forward, is the plan to target a certain level of capital return, like the $300 million you talked about this year? And then the split between buybacks and dividends, ends up being more opportunistic? Or just what's kind of the philosophy going forward?

Yes, Bose, good morning. Thanks for the question. I think you hit it kind of on the head in terms of the mix of capital return. I think it's really going to be dictated by the opportunity provided in our share repurchase plan. The level of share buybacks will ultimately dictate ultimately what gets returned via special dividend at the end of the year. I think when we think about our quarterly dividend, we think about it across a bunch of different dimensions, certainly competitive, but also and probably most importantly, what is durable, not just in our base case forecasting. But through some level of stress, we want to make sure that the quarterly dividend has that level of durability and we have that confidence to return that through cycles.

Okay. Great. That makes sense. And then just switching to the investment portfolio, what's the time frame in which your portfolio kind of rolls into the new money yield, assuming rates remain stable going forward?

We have an effective duration of less than 4 years, approximately 3.5 years. Currently, our new money yields are around 5.5%, and we finished the quarter just below 6%. This has positively impacted the overall weighted average book yield of the portfolio, which increased by about 10 basis points sequentially. Specifically regarding your question, the portfolio's duration is about 3.5 years.

Okay. Great. Thanks.

And your next question comes from the line of Mihir Bhatia with Bank of America. Your line is open.

Good morning. Thank you for taking my question. I wanted to start maybe just on vintage performance. And I was curious on what you're seeing, particularly on the post-pandemic vintages. Are they performing in line with your expectations? I suspect it's better than what you've underwritten to. But I was just curious more in terms of your expectations and how they would perform maybe even compare them versus the 2018, 2019 vintages or where they are in their life cycle? Are there other vintage curves or the loss curves on top of the 2018, 2019? The reason I ask is because, obviously, on the unsecured lending side, we've heard a lot about FICO inflation and some underperformance from these pandemic era vintages. So I was curious if you're seeing anything similar in your book or on the housing credit side?

Yes, Mihir, thank you for the question. Rohit mentioned in his prepared remarks that our credit performance is very strong overall, which reflects our view of the current credit environment. This is evident in the portfolio metrics we've published, such as a delinquency rate of 2% and a new delinquency rate of 1.2%, both of which are indicative of pre-pandemic levels and demonstrate strong performance. Addressing your question more specifically, we don't observe any deterioration in performance across the credit spectrum, whether considering the embedded risk characteristics like FICO, LTV, and DTI, or on a vintage basis; we haven't seen any decline compared to our expectations.

And Mihir, just to add to Dean's point, I would agree that credit performance across the board continues to be very strong, as Dean said, and we don't see any deterioration in any credit cohorts. I would keep in mind that when we are talking about '18, '19 versus '22 vintages, they're just seasoning in different environments, macroeconomic environment and housing environment, so that is going to have an embedded difference. And your question was how is it performing against our expectations. And I would say that's generally in line with our expectations because our expectations incorporate the most recent economic view. But if you normalize for that, that would be the primary factor driving the difference.

Got it. Maybe going back to the capital return question a little bit. Is there a rule of thumb like in terms of what will drive that going forward? Is there a target percent of net income or anything like that that we should be thinking about as you look at 2024?

Yes. Mihir, I think it's less target-based and more principles-based. We look at things like the current macroeconomic environment, the prospective macroeconomic environment, our view on business trajectory, business results, both in an expected case and a stress case. We obviously look at the regulatory environment as well, what standards we're held to, and how those standards might change through time. So I think it's more of a triangulation of those considerations than a prescriptive formula.

Got it. Regarding the Core Specialty agreement you mentioned, I believe they have identified you on their website as managing their reinsurance in that area. Is this a new venture for them, or did they previously work with someone else before switching to you? I’m trying to grasp the strategy with Enact Re. Are you planning to secure more agreements like this where you manage for a reinsurer already involved in CRT and reinsurance, or are you also considering investing more of your own capital in this area?

Yes, Mihir, thank you for the question. I would say this is more of an outcome of using our expertise that we already have in the mortgage insurance business, and we're beginning to deploy it in the mortgage reinsurance space with GSE CRT. So Core Specialty was not participating in the mortgage reinsurance space, and we essentially started talking to them about their participation. They liked our expertise, our depth, our market intelligence, not only in the mortgage reinsurance space but also what we do every day, which is look at the front end of the market, mortgage originators, different attributes and obviously, intelligence that we use in our risk-based pricing, also in terms of depth at a very granular level and loan attribute level. So all of that led to Core Specialty using us to essentially start participating in the GSE reinsurance market. I would say that this is much more of a validation point for us versus a true kind of substantial contribution to our P&L. I would still think of Enact Re's primary goal to be participating in non-private mortgage insurance kind of space and GSE reinsurance space primarily and then adding that advisory service that we provide to Core Specialty being an add-on. If you are able to expand that to other companies who might be using somebody else or who are not in the space, I think that would be a plus and a validation of our expertise in the area.

Got it. Thank you for taking my questions. I’ll get back in queue.

Your next question comes from the line of Rick Shane with JPMorgan. Your line is open.

Good morning, guys. Thanks for taking my questions. Look, we're in a unique environment. The purchase is at historically high percentage of mortgage originations, given the constraints in homes for sale, new home purchases are disproportionately high as a percentage of purchase volumes. That means that a great deal of originations are being driven by homebuilders. Can you talk a little bit about how that impacts the business, how you look at things like rate buydowns provided by the builders, whether they're temporary or permanent, and shifts in terms of how you work with builders to drive business?

Yes, thank you, Rick. So I'll take this question. I think from our perspective, first, we agree with your points in terms of the origination market being impacted by higher rates as well as broader inflation. In this market, obviously, given the number of consumers who are locked in at very low interest rates, we also have tight inventory, which means there is more focus on new homes, and those new homes are basically driving more of the origination market. So first thing, from a market participation perspective, that is a good thing for our business. As you know, private mortgage insurance is much more tied to the purchase market, and that essentially means that gives us a bigger origination market to participate in and also provides new inventory. Now coming down to builder performance, our builder portfolio performance kind of from both perspectives, recent performance and historic performance has been very similar to our overall portfolio. Specifically on the topic of rate buydowns, we look at those programs, each program at a time and approve it for our own guidelines. Essentially, we see the same performance; consumers are appropriately qualified, there are no payment shocks. And I know that there has been a topic of permanent rate buydowns discussed. We don't see a prevalence of permanent rate buydowns; we see more short-term rate buydowns, 1 year, 2 year, which are more economical for a mortgage originator to fund compared to a permanent rate buydown, and the way the consumer is qualified gives us kind of a good performing and well-qualified loan on our books.

Okay. And so what you're suggesting is that to the extent you're seeing rate buydowns from loans available through either the originators or through the homebuilders that proportionately, you're seeing more short-term buydowns as opposed to permanent buydowns.

Yes. We are seeing short-term buydowns, and even for those short-term buydowns, the consumer is actually qualified at the full note rate, not at the bought-down rate. So if a consumer had a 1% buydown upfront, the consumer is still basically being qualified at the prevailing market rate.

Got it. Okay. For the second question, as the industry becomes more concentrated around developments from certain builders, is there any concern? Typically, purchase volume varies significantly across the country, and we expect to see regional concentrations due to migration. However, does your model indicate that if we focus more on these 25 or 100 developments, we might be increasing correlation risk within the portfolio?

Yes. So I would say in terms of concentration down to that level, we track our concentration at a state level, at an MSA level. As we have said in the past, we also have the ability to price our loans on an ongoing basis, down to the MSA level, and we do. And that view is driven by the economic conditions in that city, in that MSA, both on a current basis and our view moving forward, which includes a view into home prices and housing conditions. I would say in terms of tightness of inventory or too many homes coming to market. We subscribe to several different market views to make sure that we have a pretty well-rounded view down to the MSA level, and that's how we control our appetite. I don't believe that we see our concentration in specific developments kind of controlling our risk appetite because by the time our share of that development shows up on our books, you're talking about MI penetration on purchased loans being somewhere between 20% to 25%, and we have 16% to 18% of that portion, which means we are talking about small numbers of loans that actually make it to our portfolio from any specific development. In the builder segment, I would say our participation is very proportionate to our overall share, so it's not that we are taking on a specific subdivision for a builder and ensuring a lot of loans down to that level.

Got it. Okay, thank you very much.

And your next question comes from the line of Eric Hagen with BTIG. Your line is now open.

Good morning. A couple of follow-ups here. I mean, how much did the recent increase in interest rates you feel like play a part in the level of the special dividend that you just declared? And then can you share what kind of returns do you think you're getting in the GSE CRT deals? And maybe just how much capital you feel like it could be directed there next year?

Let me begin, Eric. Regarding the interest rate environment and the special dividend, I don't see a strong relationship between the two. I believe the special dividend was primarily influenced by the opportunities we identified for share repurchases. While interest rates do factor into our overall economic outlook, which in turn affects our expectations for business performance, I think that's the connection you may be referring to. In that context, it will certainly be something we consider as we move forward.

Okay. Yes, just curious what kind of returns you guys are expecting in GSE CRT deals.

So I think on the GSE CRT deals, we have not given any specific guidance, Eric, on type of returns. What we have said is we like the quality of underwriting, and we like the returns on those transactions. The way we actually structured Enact Re right out of the gate was Enact Re is structured in a very capital-efficient, expense-efficient way, and it leverages the ratings, as well as the scale of EMICO and our entire insurance operation. So we expect our returns to be very much in line with the market returns on those transactions. We are continuously participating in, as I said in my prepared remarks, in every deal, at least up to this point, that has been coming to market. So that hopefully shows you that we find the returns attractive.

Yes. That's helpful. Lots of attention in the market around lenders having to buy back loans from the GSEs when there's a breach in the underwriting process of any sort, scratch and dent kind of loans. Can you describe how that maybe impacts you guys and just how you see that maybe developing going forward?

Yes, Eric, that process has limited applicability for us. We have our own independent procedures for both non-delegated and delegated underwriting, where we conduct quality assurance checks at varying frequencies for different lender segments. We maintain our own assessment of loan quality for each lender and customer segment. If a lender's performance declines in terms of manufacturing quality, we collaborate with them on training and remediation. If their quality does not improve, we move them from delegated to non-delegated status. Regarding GSE buybacks, those are primarily governed by rules set by GSEs to identify loans with significant defects. There’s a whole process for early notification and buybacks, which can heavily affect lender economics, particularly since a returned loan often has a lower note rate in a high-market-rate environment. This results in a mark-to-market loss on that asset. From a quality standpoint, as I mentioned in our prepared remarks, we are pleased with the manufacturing quality in the market, and we align our processes with the GSEs and provide them with feedback. Therefore, we are satisfied with manufacturing quality and view this mainly as a secondary market issue between the GSEs and originators.

That’s all I have. Thank you, guys.

And your next question comes from the line of Geoffrey Dunn with Dowling. Your line is now open.

Thanks. Good morning. I'm curious what your thoughts are as Bermuda adopts this 15% tax rate. Obviously, there might be pluses or minuses around that. But how do you think that will affect the returns and competition in the GSE CRT market?

Good morning, Geoff. Very good question. So as we said last quarter, to clarify our expectations at Enact Re, Enact Re does not benefit from any kind of tax efficiency based in Bermuda because taxes are consolidated in the U.S. As far as Bermuda participants are concerned with the higher taxes in Bermuda, if it's implemented, those participants might need higher returns from the transactions, everything else being held constant, that could actually lead the prices to be higher and for us, that would mean higher returns. So I would expect that to be good for us. We are very happy with the quality and the return. So if there is less capacity from others and that means more capacity or higher prices for us, I think we see that as a net positive.

Okay. Following up on the previous question, can you provide details on those returns right now? Are they at least comparable to the primary U.S. business?

So Geoff, very good question. Unfortunately, we also haven't given guidance on the U.S. primary returns recently. We generally describe our returns as attractive in the primary business. The toughest thing in this environment is we see a lot of uncertainty in the market in terms of what scenario plays out. I know the market has been talking about some kind of weakness in the economy, at least the majority of the economies, for almost 18 months, and that hasn't happened. So instead of picking a point estimate and giving you returns, we believe that our returns are very much in line with our expectations. We believe the price increases we have done, including the price increases in the third quarter in the primary business, makes the primary business attractive. We do think that for the CRT business we are writing, those returns are also attractive to us, and especially, we are talking about different structures there. In the CRT market, we are writing mezzanine risk, so that obviously increases the attractiveness of those returns because in the base case scenario, those transactions are not attaching from a loss perspective.

Okay. Thanks.

And we have no further questions at this time. I will now turn the call back over to Rohit Gupta.

Thank you, Bella. And thank you, everyone. We appreciate your interest in Enact, and I look forward to seeing some of you next week at the JPMorgan Conference in Florida. Thank you.

This concludes today's conference. Thank you for your participation. You may now disconnect.