IPO Report: Essent Group (ESNT)

Essent Group ($ESNT) is an established and growing private mortgage insurance company, with no legacy issues.

Eight other companies are IPOing scheduled for this week. The full IPO calendar can be found at IPOpremium.

Since writing its first policy in May 2010, ESNT has grown to an estimated 12.0% market share based on new insurance written, or NIW, for the three months ended June 30, 2013, up from 8.6% and 3.9% for the years ended December 31, 2012 and 2011, respectively.

For the six months ended June 30 ’13 vs June 30’12 revenue was up 194% to $89 million from $30 million.  Profit margin was up to 52% from a loss of -48%.

ESNT scheduled at $286 million IPO with a market capitalization of $1.2 billion at a price range mid-point of $14.50 for Thursday, October 31, 2013.

S-1 filed October 21, 2013

Manager, Joint Managers: Goldman Sachs, J.P. Morgan, Barclays and Credit Suisse

Co-Managers: BofA Merrill Lynch, Dowling & Partners Securities, Keefe, Bruyette & Woods, Macquarie Capital, Wells Fargo Securities

Valuation

Glossary

Relative to RDN and MTG ESNT is priced at a price-to-book value discount and is making money while RDN and MTG are both losing money.

Conclusion

ESNT appears to be fast increasing revenue & profits and is gaining market share.  The rating on ESNT is buy.

Business

ESNT is an established and growing private mortgage insurance company.

ESNT was 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.

ESNTs believes its growth has been driven largely by the unique opportunity it offers lenders to partner with a well-capitalized mortgage insurer, unencumbered by legacy business, that provides fair and transparent claims payment practices, and consistency and speed of service.

Market share

Since writing its first policy in May 2010, ESNT has grown to an estimated 12.0% market share based on new insurance written, or NIW, for the three months ended June 30, 2013, up from 8.6% and 3.9% for the years ended December 31, 2012 and 2011, respectively.

Private mortgage insurance

Private mortgage insurance plays a critical role in the U.S. housing finance system. Essent and other private mortgage insurers provide credit protection to lenders and mortgage investors by covering a portion of the unpaid principal balance of a mortgage in the event of a default. In doing so, ESNT provides private capital to mitigate mortgage credit risk, allowing lenders to make additional mortgage financing available to prospective homeowners.

Private mortgage insurance helps extend affordable home ownership by facilitating the sale of low down payment loans into the secondary market.

Two U.S. Federal government-sponsored enterprises, Fannie Mae and Freddie Mac, which is referred to collectively as the GSEs (Government Sponsored Entities), purchase residential mortgages from banks and other lenders and guaranty mortgage-backed securities that are offered to investors in the secondary mortgage market.

The GSEs are restricted by their charters from purchasing or guaranteeing low down payment loans, defined as loans with less than a 20% down payment, that are not covered by certain credit protections.

Private mortgage insurance satisfies the GSEs' credit protection requirements for low down payment loans, supporting a robust secondary mortgage market in the United States.

Products

In general, there are two principal types of private mortgage insurance, primary and pool.

Primary Mortgage Insurance

Primary mortgage insurance provides protection on individual loans at specified coverage percentages. Primary mortgage insurance is typically offered to customers on individual loans at the time of origination on a flow basis. Substantially all of ESNT’s policies are primary mortgage insurance.

Customers that purchase ESNT’s primary mortgage insurance select a specific coverage level for each insured loan. To be eligible for purchase by a Government Sponsored Entity (GSE) — Fannie Mae and Freddie Mac — a low down payment loan must comply with the coverage percentages established by that GSE. For loans not sold to the GSEs, the customer determines its desired coverage percentage.

Generally, ESNT’s risk across all policies written is approximately 24% of the underlying primary insurance in force, but may vary from policy to policy between 6% and 35% coverage.

ESNT files its premium rates with the insurance departments of the 50 states and the District of Columbia. Premium rates cannot be changed after the issuance of coverage and premiums applicable to an individual loan are based on a broad spectrum of risk variables including coverage percentages, LTV, loan and property attributes, and borrower risk characteristics.

Pool Insurance

Pool insurance is typically used to provide additional credit enhancement for certain secondary market mortgage transactions. Pool insurance generally covers the excess of the loss on a defaulted mortgage loan that exceeds the claim payment under the primary coverage, if such loan has primary coverage, as well as the total loss on a defaulted mortgage loan that did not have primary coverage.

Pool insurance may have a stated aggregate loss limit for a pool of loans and may also have a deductible under which no losses are paid by the insurer until losses on the pool of loans exceed the deductible.

In another variation, generally referred to as modified pool insurance, policies are structured to include both an exposure limit for each individual loan, as well as an aggregate loss limit or a deductible for the entire pool. To date, ESNT has not written any pool insurance and has written a de minimis amount of modified pool insurance.

Contract underwriting services

In addition to offering mortgage insurance, ESNT provides contract underwriting services on a limited basis.

As a part of these services, ESNT assesses whether data provided by the customer relating to a mortgage application complies with the customer's loan underwriting guidelines.

These services are provided for loans that require private mortgage insurance, as well as for loans that do not require private mortgage insurance.

Under the terms of ESNT’s contract underwriting agreements with customers and subject to contractual limitations on liability, ESNT agrees to indemnify the customer against losses incurred in the event that ESNT makes an underwriting error and such error materially restricts or impairs the saleability of a loan, results in a material reduction in the value of a loan or results in the customer being required to repurchase a loan.

The indemnification may be in the form of monetary or other remedies, subject to per loan and annual limitations.

Competition

The private mortgage insurance industry is highly competitive. Private mortgage insurers The private MI industry currently consists of seven active private mortgage insurers, including Essent and affiliates of each of CMG Mortgage Insurance Company (which is in the process of being acquired by Arch Capital Group), Genworth Financial Inc., Mortgage Guaranty Insurance Corporation, National Mortgage Insurance Corporation, Radian Guaranty, Inc. and United Guaranty Corporation.

ESNT and other private mortgage insurers compete directly with Federal and state governmental and quasi-governmental agencies that provide mortgage insurance, principally, the FHA and, to a lesser degree, the VA.

The FHA's share of the mortgage insurance market increased following the financial crisis and has decreased as the private MI industry recovers. In addition to competition from the FHA and the VA, ESNT and other private mortgage insurers currently face limited competition from state-sponsored mortgage insurance funds in several states, including California and New York.

From time to time, other state legislatures and agencies consider expanding the authority of their state governments to insure residential mortgages.

ESNT’s industry also competes with alternatives to mortgage insurance, which includes products designed to eliminate the need for private mortgage insurance, such as "piggyback loans", which combine a first lien loan with a second lien. In addition, ESNT competes with investors willing to hold credit risk on their own balance sheets without credit enhancement and, in some markets, with alternative forms of credit enhancement such as structured finance products and derivatives.

5% stockholders

PBRA (Cayman) Company and certain affiliates, 23%
The Goldman Sachs Group, Inc., 11%
Commonwealth Annuity and Life Reinsurance Company Limited, 11%
Valorina LLC, 11%
Aldermanbury Investments Limited, 9%
RenaissanceRe Ventures Ltd., 8%
PPF Holdings II Ltd., 8%
Wellington Management Company, LLP and certain of its advisory clients, 7%

Use of proceeds

ESNT expects to net $226 million from the sale of 17 million shares;  Shareholders intend to sell 2.7 million shares.

Proceeds are allocated for general corporate purposes, which may include capital contributions to support the growth of its insurance subsidiaries. ESNT will have broad discretion over the way that it uses the net proceeds of this offering.