Sunday, May 6, 2018

A current AIM International Fund Holding: Essent Group (ESNT) by Michael Healy. "Troubled Waters for Bermudan Mortgage Insurance Company"

Essent Group (ESNT, $35.61): “Troubled Waters for Bermudan Mortgage Insurance Company

By: Michael Healy, AIM student at Marquette University
Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.


Essent Group (NYSE:ESNT) is a holding company, which engages in the provision of US banking services.  The firm offers mortgage insurance, reinsurance, and risk management products.  ESNT operates in one industry segment through private mortgage insurance and all of the company’s revenues come from the United States, although the company is headquartered in Hamilton, Bermuda.   

• Private Mortgage Insurance companies experience volatility from news in March and April.

• A new Freddie Mac program rolling out in 2018 has led to pessimistic outlooks for some mortgage insurance companies.

• American housing numbers and other economic trends still keep hope alive for ESNT to reach its original AIM International Equity Fund price target.  

Key points:

On April 9, 2018 four major mortgage insurance companies dropped over 14% after Essent Group peer MGIC Investment Corp announced it would cut mortgage insurance premiums. Borrowers with the lowest credit scores could see premiums drop by 24%, according to MGIC, and higher-quality borrowers will also see a double-digit drop in premiums. In an industry as competitive as private mortgage insurance, Essent and fellow peers Radian Group and NMI holdings will be forced to follow, hurting revenues. MGIC Investment Corp pursued this tactic in an attempt to gain market share in part because the new national tax act has enabled them to cut premiums without a large consequence; in fact, the CEO maintained that after-tax returns would still increase marginally. Overall, a quick decision by MGIC sent ESNT tumbling and now they are forced to cut their premiums just to stay competitive in a rising interest rate environment, or in other words, an environment that isn’t conducive for refinancing mortgages.

Furthermore, Essent appears to have missed an opportunity to expand their relationship with government-structured entity Freddie Mac. Competitor Arch Capital confirmed in March that it is “piloting a new mortgage credit risk transfer program, deemed “IMAGIN” (Integrated Mortgage Insurance), to attract a diversified and robust capital base to the U.S. housing market, in a highly efficient structure, that will support market stability through economic cycles,” according to an article on BusinessWire dated March 13, 2018. Arch Capital will be working in conjunction with Freddie Mac. This news, like MGIC’s move in April, points to greater competition and lower future returns over time. Essent’s competition, right now, is outperforming ESNT.

From a different economic perspective, Essent appears to be in alright shape. For one, positive trends in US housing still indicate growing demand for mortgage insurance. Low unemployment rates are driving home values up across the country. Year-over-year in March housing prices have risen 8%. As millennials continue to reach ages where they wish to purchase their first home, high prices may lead a growing number of young homebuyers to utilize private mortgage insurance, especially if premiums drop across the board. With student loan debt at all-time highs, it is more than conceivable that millennials turn to mortgage insurance when buying their house, which a majority of millennials believe they should accomplish by age 30.

What has the stock done lately?

News of Arch Capital’s pilot program and MGIC slashing premiums have caused double-digit percentage drops in the stock’s value in March and April. Essent reached its 52-week high on January 23, 2018, but since then the stock is down over 28%.

Past Year Performance: In the past year, ESNT made major progress working its way up from $34/share to $49/share. However, the increasing pressure from competitors has brought the stock down closer to its 52-week low.

My Takeaway

As managers of the AIM International Equity fund, Marquette’s AIM students are going to need to keep a watchful eye on Essent. The company is affected greatly by macroeconomic factors and a slight reversal in positive housing trends, combined with Essent’s slipping market position compared to Arch Capital and MGIC, could send ESNT down further. Hindsight is 20/20, so making this statement isn’t very profound, but seeing as Essent Group reached it’s target price, ESNT should have been sold in January or February. What can we do about it now? I suggest giving it time to play out. Premium cuts across the board could convince the millennial generation to start using mortgage insurance more frequently. If Essent can hold their market share over the next coming months, they should be able to generate a positive return for the AIM International fund. The stock is down about $5/share compared to the price AIM paid in November 2017.