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.
Summary
•
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.
