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Edited Transcript of ESNT earnings conference call or presentation 3-May-19 2:00pm GMT

Q1 2019 Essent Group Ltd Earnings Call

Hamilton HM 11 May 8, 2019 (Thomson StreetEvents) -- Edited Transcript of Essent Group Ltd earnings conference call or presentation Friday, May 3, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher G. Curran

Essent Group Ltd. - SVP of Corporate Development

* Lawrence Edmond McAlee

Essent Group Ltd. - Senior VP & CFO

* Mark Anthony Casale

Essent Group Ltd. - Chairman, CEO & President

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Conference Call Participants

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* Bose Thomas George

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* Douglas Michael Harter

Crédit Suisse AG, Research Division - Director

* Edward Christopher Gamaitoni

Compass Point Research & Trading, LLC, Research Division - MD & Head of Research

* Geoffrey Murray Dunn

Dowling & Partners Securities, LLC - Partner

* John Gregory Micenko

Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research

* Mackenzie Jean Aron

Zelman & Associates LLC - VP

* Mark C. DeVries

Barclays Bank PLC, Research Division - Director & Senior Research Analyst

* Mihir Bhatia

BofA Merrill Lynch, Research Division - Research Analyst

* Philip Michael Stefano

Deutsche Bank AG, Research Division - Research Associate

* Richard Barry Shane

JP Morgan Chase & Co, Research Division - Senior Equity Analyst

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Presentation

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Operator [1]

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Good morning. My name is Christina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Essent Group Ltd. First Quarter 2019 Earnings Conference Call. (Operator Instructions) Chris Curran, Senior Vice President of Investor Relations, you may begin your conference.

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Christopher G. Curran, Essent Group Ltd. - SVP of Corporate Development [2]

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Thank you, Christina. Good morning, everyone, and welcome to our call. Joining me today are Mark Casale, Chairman and CEO; and Larry McAlee, Chief Financial Officer. Our press release, which contains Essent's financial results for the first quarter of 2019, was issued earlier today and is available on our website at essentgroup.com in the Investors section. Our press release also includes non-GAAP financial measures that may be discussed during today's call. The complete description of these measures and the reconciliation to GAAP may be found in exhibit M of our press release.

Prior to getting started, I would like to remind participants that today's discussions are being recorded and will include the use of forward-looking statements. These statements are based on current expectations, estimates, projections and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially.

For a discussion of these risks and uncertainties, please review the cautionary language regarding forward-looking statements in today's press release, the risk factors included in our Form 10-K filed with the SEC on February 19, 2019, and any other reports and registration statements filed with the SEC, which are also available on our website.

Now let me turn the call over to Mark.

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [3]

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Thanks, Chris. Good morning, everyone, and thank you for joining us. And I am pleased to report that Essent generated another strong quarter of financial results as the operating environment remains favorable and credit continues to perform well. Also during the quarter, we continued making progress in transitioning our franchise to a buy, manage and distribute model. Key highlights relating to this included the broad rollout of our risk-based pricing engine, EssentEDGE and re-ensuring our 2018 NIW with Radnor Re and a panel of reinsurers.

Our outlook on our business and housing remains positive as low unemployment and affordability continue to support a purchase mortgage environment. Combined with demographics such as the millennials coming of age and builders increasing supply for first-time homebuyers, we continue to believe in housing's longer-term fundamentals. Since our business is weighted towards the first-time homebuyer and higher MI penetration and purchase mortgages, we believe that we are well positioned in continuing to grow our business.

Now let me touch on our results. For the quarter, we earned $128 million or $1.30 per diluted share compared to $111 million or $1.13 per diluted share for the first quarter a year ago. Our annualized return on average equity for the first quarter was 21%. Our financial results continue to be driven by insurance in force, which ended the quarter at $143 billion representing a 24% increase from $115 billion at the end of the first quarter a year ago.

Finally, our balance sheet remains strong, ending the quarter with $3.4 billion in assets and $2.5 billion of GAAP equity.

On the business front, we formally rolled out EssentEDGE and remained focused on the operational interface as customer adoption is a key component in the engine's success. We believe that the engine provides value to both Essent and our customers especially as MI pricing is integrated into best execution frameworks. For us, EssentEDGE provides flexibility for more granular pricing and for our customers it provides improved efficiencies in obtaining Essent's best rate based on a borrower's credit profile.

Also during the quarter, we successfully completed a side-by-side XOL reinsurance transaction on our 2018 NIW with Radnor Re and a panel of reinsurers. The aggregate transaction initially provides $592 million of protection on top of a $254 million first-loss portion that Essent retains. After completing 4 reinsurance transactions relating to our 2017 and 2018 NIW, we now have $1.2 billion of reinsurance protection covering approximately 60% of our insured portfolio.

Looking forward, we plan on continuing to reinsure our portfolio and increase sophistication around pricing and our use of EssentEDGE. Our plan also includes evaluating reinsurance on our back book. We believe that the combination of risk-based pricing on the front end and risk distribution on the back end allows us to hedge franchise volatility during down cycles, making Essent a more sustainable franchise over the long term.

On the capital front, we continue to generate excess capital and we'll look to reinvest in both Essent Guaranty and Essent Re since they continue to grow. We are also evaluating capital distribution strategies and would look to provide more detail on this once we have 75% to 80% of our book reinsured.

Also keep in mind that PMIERs excess does not correlate directly to excess capital from a regulatory standpoint, which we view as the binding constraint. Since the founding of Essent, we've been very thoughtful on managing capital and will continue to do so based on what we believe is in the best long-term interest of our franchise, policyholders and shareholders.

Turning our attention to Washington. We believe that we will see a renewed focus on GSE and housing finance given new leadership in Congress and the FHFA and an administration that is in the second half of its term. While the probability of legislation remains low, we believe that there will be meaningful discussions and proposals on the future of housing finance and GSE conservatorship. This should also include increased scrutiny on the GSE pilot programs and that practical utility of such given the role that our industry and private capital already plays.

Now let me turn the call over to Larry.

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Lawrence Edmond McAlee, Essent Group Ltd. - Senior VP & CFO [4]

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Thanks, Mark, and good morning, everyone. I will now discuss our results for the quarter in more detail. Earned premium for the first quarter was $178 million, an increase of 3% over the fourth quarter of $173 million and an increase of 17% from $153 million in the first quarter of 2018. Note that premium ceded on our reinsurance transactions are reflected as a reduction of earned premium and were $6 million in the first quarter of 2019, $3.7 million in the fourth quarter of 2018 and $300,000 in the first quarter a year ago. The increase in premiums ceded in the first quarter is due primarily to the execution of the insurance-linked note transaction and placement of excess of loss reinsurance coverage with a panel of reinsurers on our 2018 new insurance written.

The average net premium rate for the first quarter of 2019 was 48 basis points, which was 1 basis point lower than the fourth quarter of 2018 due to the increase in ceded premiums under our reinsurance transactions. Investment income excluding realized gains was $19.9 million in the first quarter of 2019 compared to $18.6 million in the fourth quarter and $13.7 million in the first quarter a year ago. The increase in investment income of 7% over the fourth quarter of 2018 is due to a modest increase in both the balance of our investments and the yield on the portfolio.

During the first quarter, we recorded a gain of $1.4 million for the increase in fair value of embedded derivatives associated with the insurance-linked note transactions. This gain is included in other income and our consolidated statement of comprehensive income.

We remain pleased with the credit performance of our in-force book. Our provision for losses and loss adjustment expenses was $7.1 million in the first quarter of 2019 compared to a benefit of $1 million in the fourth quarter of 2018 and a provision of $5.3 million in the first quarter a year ago.

The benefit reflected in the provision for losses in the fourth quarter of 2018 includes the release of $9.9 million of the reserves associated with hurricanes Harvey and Irma that have previously been recorded in 2017. The default rate on the entire portfolio decreased 1 basis point from December 31, 2018, to 65 basis points as of March 31, 2019.

Other underwriting and operating expenses were $41 million for the first quarter of 2019 compared to $39.4 million in the fourth quarter of 2018 and $38.1 million in the first quarter a year ago. The increase in expenses over the fourth quarter is primarily due to an increase in the level of payroll taxes associated with the vesting of shares and incentive payments, which historically occurs in our first quarter.

As communicated in our earnings call in February, for the full year 2019, we expect other underwriting and operating expenses will be in the range of $160 million to $165 million. Income tax expense for the first quarter was calculated using an estimated annualized effective tax rate of 16% and was reduced in the quarter by $2 million of excess tax benefits associated with the vesting of restricted shares and share units issued to employees. For the balance of 2019, we currently forecast our effective tax rate to be 16%.

The consolidated balance of cash and investments at March 31, 2019, was $3 billion. The cash and investment balance at the holding company was $74 million. No capital contributions or dividends between the holding company and operating businesses were completed during the most recent quarter. At the end of the first quarter of 2019, we have $275 million of undrawn capacity under the revolving component of our credit facility and $225 million of term debt outstanding.

As of March 31, 2019, the combined U.S. mortgage insurance business statutory capital was $2 billion with a risk-to-capital ratio of 13.5:1 compared to 13.9:1 at year-end 2018. The risk-to-capital ratio at March 31, 2019, reflects the reduction in risk in force of $1.2 billion for the reinsurance coverage obtained from our insurance-linked note in excess of loss transactions on our 2017 and 2018 NIW.

At the end of the first quarter, Essent Re had GAAP equity of $847 million to $48.6 billion of net risk in force. In addition, Essent Guaranty's available assets exceeded its minimum required assets as computed under PMIERs by $806 million.

Now let me turn the call back over to Mark.

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [5]

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Thanks, Larry. In closing, Essent generated another strong quarter of financial results as we continue building a high credit quality and profitable mortgage insurance portfolio. The operating environment during the quarter was favorable and we remain pleased with our credit performance.

Looking ahead, we believe it has more risk as originated through EssentEDGE and it's distributed via the reinsurance markets, it will strengthen our buy, manage and distribute business model and enhance our ability to manage long-tail mortgage credit risk through the cycle.

Now let's get to your questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Douglas Harter from Credit Suisse.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [2]

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Mark, I was hoping you could talk a little bit more about the comment of wanting to get to, what was it, 75% or 80% reinsured before looking to distribute capital or return capital to shareholders. Could you just talk about kind of the thought process that goes behind that number and kind of why you're thinking that number?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [3]

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Sure, Doug. I mean it kind of goes to the old 80-20 rule. I think we really -- our goal is to remove volatility from the balance sheet and protect and box the tail, right? That's the biggest risk we have in the business. And I know we'll have a number of questions about different risks and there's many risks in the business but credit kills these businesses. And the biggest mistake the industry made in the last downturn was paying out, distributing a lot of capital right before the crisis. And I think they really went into the industry because these tools didn't exist. They went into the crisis with a uncap liability on their balance sheet. And our view is the tools are out there. The markets are strong, both with the reinsurers and with the capital markets. It's in our best interest to box that risk.

Once we do and we think 75% to 80% is a good number for us to get started, I think then we'll have a much clearer vision around excess cash flows. And the other thing we mentioned in the script, which I think is important is $1 of PMIERs is not $1 of excess capital. We had a number of reports that have kind of jumped to that conclusion. And remember, that's an asset test. And the real test around excess capital is coming from statutory. That's the real cash flow. And I think that's a smaller number than our PMIERs excess, which was I think a little bit over $800 million.

So as we look at it, you kind of have to balance those things. But I think we want to protect our portfolio first and foremost and that's the number one priority.

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Operator [4]

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Your next question comes from Phil Stefano from Deutsche Bank.

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Philip Michael Stefano, Deutsche Bank AG, Research Division - Research Associate [5]

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In thinking about that idea a little bit further in excess capital, Mark, I think you had mentioned that you're at least contemplating looking at reinsuring the back book. I mean as we think about getting to the 75% or 80%, can you help us think about the balance between new ILNs on business going forward versus reinsuring the back book to help you get there?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [6]

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Yes. Good question. I think we're looking at both, right? I think we're going to look -- continue to look at kind of the current book and forward book. And that could be an ILN and that may be most likely next year that we would -- we're kind of on a slowdown where we did 18 -- the '17 book in '18 and the '18 book in '19. We would expect to do the '19 book in '20. So the quickest way to get to that 75% to 80% is the backlog, and that's why we are evaluating it now.

Again we think the markets are reasonably strong and the appetite is strong for that type of risk. So we're looking at that currently and we'll have an update on that probably in the August call.

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Philip Michael Stefano, Deutsche Bank AG, Research Division - Research Associate [7]

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Did the appetite around the reinsurers and the alternative capital providers change at all? That you have them side-by-side now as opposed to the XOL on top of the ILN with the '17?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [8]

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No. Not at all. I think the appetite is fairly the same. As we said last year, we're testing different structures. So we're looking at it. We're testing kind of how deep each market is. We're obviously still concerned longer term about the sustainability of those markets. But I think we're trying to test different things. We have not done a quota share yet forward -- on the forward book, but that's something also we would look to do or look to evaluate, I should say. Again, we're always looking to increase our sources of capital and I think kind of testing different structures is a great way to do that.

And as I remind everyone, we're still kind of in this transition. We talked about it last year. We're really transitioning from a buy-and-hold business model, which was you really just blend everything to the balance sheet, be it both debt and equity, and you kind of hold it. You hold the risk for a long time and we're transitioning now from the buy, manage and distribute. And there's 2 keys to that. One, clearly is that reinsurance on the back end which is the distribution part of it. Just as important is the kind of EssentEDGE and the pricing engine on the front end, which now allows us to price each risk discreetly versus kind of that rate part which is a blunt instrument. So we're able to look at different ways to price the risk and also factor in any color we get on the reinsurance market. So we work to go into a slowdown and the cost of reinsurance was to rise. We now have the ability to pass that onto the front end and that's a good second set of eyes for us. As we come across the reinsurers and the folks in the capital markets, these guys know -- they know mortgage risk really well. So it's a good way for us to take their feedback and then to incorporate that learning or market color, so to speak, into the front end.

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Philip Michael Stefano, Deutsche Bank AG, Research Division - Research Associate [9]

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Okay. And one more for you. So I know you don't run the business to a new business number and operating returns is the right way to look at things. But it feels like share picked up in the quarter. Did EssentEDGE have an impact in some way that you were able to get more shots on goal or better shots on goal? Or anything you feel like the competitive dynamics that changed that allowed new business to be a bit better than maybe we were expecting.

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [10]

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Yes. I mean, again with share, it's tough for us, Phil. We don't really get these numbers to the last minute. We -- everyone report it at the last couple of days. So for us, it's hard to have a quick conclusion. I think our view is, we're still in that kind of mid-teens share. I mean we're 1 of 6. I do think with the engine and with some of the big cards out there, you are going to see some volatility in share. And I wouldn't read too much into that. I mean from our standpoint, in terms of EssentEDGE, it's gone probably better than expected in terms of just the adoption and ease of use. We're really focused, as I said in the script on the operational implementation of it, to make sure it's easy for our customers to use and it ties into with how they do their business. So it's one thing just to have a price, but you also have to make sure the loan closes. And there's not too many changes between initial price and final price and we've been focused on that. I had been on the road a lot talking to both big and smaller customers. So I think we're really more focused on that. I think the share is just kind of an output.

I would add though that we still -- we're still increasing customers. We added a little bit over 20 customers in the first quarter. So we -- and we've added more in the second quarter. So we continue to add customers. I do think the engine may be helping us add some customers. This is -- it's something a little different. It's a way to get into a client. But we don't talk about how many active customers we have anymore because I think we've reached a critical mass. But I would remind you that we're still growing in that aspect of it.

And does that have some impact on share? It could be. But again, I wouldn't focus too much on it. I would really focus more on we're continuing to grow insurance in force. And I do think just with these engines out there that the volatility of market share will continue over the near to intermediate term.

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Operator [11]

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Your next question is from Bose George from KBW.

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Bose Thomas George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [12]

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Actually just going back to the ILN, the one you guys did earlier this year, you retained some of the senior tranches. Can you just talk about the drivers of that and have you since sold them? And also just more of a philosophical question on that, just with the XOL you guys did last time as well on top of the ILN, are you still sort of experimenting with what the sweet spot is in terms of how much risk to retain?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [13]

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Yes. Absolutely. I think we retained the top layer on both deals both in '18 and in '19, Bose. So it really it's around -- think of it more of we're more focused on the attachment point. So where do we attach? And then we kind of get up to 7%, 8%, 9% depending on the appetite, how strong the bids come in. The top layer that we did last year was a test. Quite frankly, that was a little thin in terms of some of the reception. Not that we wouldn't go back to it and we can get into that. There's a little bit more detail in terms of how that operates.

We try to do this side-by-side. This year again is another test and it was actually very well received. So we don't think about it. I think we're kind of -- we look at it and say, what's the stress losses as to what extent would we have to start taking the risk back on our balance sheet? And we feel like kind of a 2.25% up to that kind of 8% or 9%. We're pretty well insulated against most economic environments. Not all of them. I think if you stressed the Great Recession, and said our claim rates are kind of 10% to 12%, which would be really high based on the credit quality of our portfolio. We're still probably breakeven ROE, maybe slightly negative, but we're not depleting the capital of that the industry had to do last time. So I think we feel pretty good with the structures, even more pleased I think with the reception and the strength. I mean the deal we did in 2018, we had 20 -- close to 20 investors. The deal we did in the first quarter this year just on the ILN was another 20 customers, 20 investors. Some new, which was nice. And then we've had probably 10-plus reinsurers in each transaction. So we're really -- when you think about kind of sources of capital and the number of different kind of investors and reinsurers, it's really another capital base.

And as I explained to people, just to put it in more context, roughly $2.5 billion of equity on our balance sheet. We have another $1.2 billion of off-balance-sheet capital that can be used to withstand kind of shocks. And again, I know the environment is great. Unemployment, saw the number this morning, it's good. Our credit quality has been excellent. But you never know. You never know the bullet is going to get you. So we look at it and say, as I said earlier, protecting that portfolio is first and foremost what we are after. And we are just -- we just believe the reinsurance markets and the evolution of them is the biggest transformational thing that happened with me and my business since we started Essent.

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Bose Thomas George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [14]

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Okay. Makes sense. And then actually just switching to the premiums. What was the premium on the new insurance written during the quarter?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [15]

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We don't disclose that, Bose. I mean I think we still think, go back to kind of the earned premium yield on the portfolio and we now do it pre-ILN or pre-reinsurance and post reinsurance. And that's kind of in -- I think, it was in the 48 basis points and that could -- that's net. That could -- that does not include any back book that we may look to do this year? And that would obviously probably reduce it by another maybe basis points. But to remind everyone, the cost of reinsurance in general longer term is about 4 to 5 basis points. So we're writing kind of in -- I've seen other MIs and we're not much different than the other MIs. It's about 4 to 5 basis points of that for the cost of reinsurance.

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Lawrence Edmond McAlee, Essent Group Ltd. - Senior VP & CFO [16]

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And also Bose, our exceeded premium in the first quarter only includes a partial quarter effect for the ILN and the XOL that we computed in the first quarter. We'll have a full quarter effect of that in the next quarter.

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Bose Thomas George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [17]

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Okay. And actually, can you just remind us what you've said about the direction of the premium sort of -- is that sort of a few more basis points down or just can you just remind us of that?

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Lawrence Edmond McAlee, Essent Group Ltd. - Senior VP & CFO [18]

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Yes. Bose, this is Larry. Based on the current insurance that we have and reinsurance that we have in place, we would expect our premium rate by the fourth quarter to decline between 1 and 2 basis points from where we were in the first quarter.

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Operator [19]

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Your next question comes from Rick Shane from JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [20]

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If the industry moves to engines and curious if you were seeing that that's driving more and more efficiency, and as a result potentially areas where you get concentrated risk in different segments because of that increased efficiency? And how you -- what safeguards you have in place to make sure that you don't get concentrated into certain pockets?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [21]

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It's a good question. And I actually think this tool is the best way to mitigate against that. We can change because of how the compliance works in terms of filing rates. We have certain customers where we can change the rate every week. And I think we're -- what we've been doing -- and we're actually taking a page work out of the credit card book. So we're just testing things. We're testing a lot of different things in terms of price elasticity in certain markets, really geographically kind of concentrated, different parts of the credit, higher LTVs, lower LTVs, higher FICOs, lower FICOs. And I think we're going to, just like we did as we talked about earlier with reinsurance, we're just going to continue to test and we're learning. And a lot of it is you're competing with 5 other players and I'm sure they're doing the same thing.

So I mean there's a lot of learning involved. I do think with the tool, you can dial up and dial down relatively quickly, not like -- not dissimilar to kind of the credit cards. And I think that's -- again as I try to make the point, the pricing power is really shifting a bit from the lenders to the mortgage insurers. Not totally, obviously there is a clearing in terms of market price with 6 participants. But with this new tool, you really have the ability to kind of zero in on things. And then the gain is going to be longer term. I think it's going to be around credit selection. It never really was that before, right? You had similar underwriting guidelines, similar pricing, the lender originated. You got your share and you got what the lender gave you. And you couldn't go back and say, "Hey, you know I'm getting too much of this or too much of that." It was kind of -- it was binary. If you didn't like it, you left. You didn't go to large clients and just kind of, you said, "Hey, you know I have certain geographies I like, there's certain I don't like. Any chance we could." There was no -- MIs had 0 power around that. And I think this is -- it's changing and also, as I said, we all have now the ability to give each borrower our best price. It may not be the lowest price. I mean another MI may have a lower price and what that is, Rick, that's good for the borrower. It's good for our lenders. It's good for the borrower and to have each of the kind of the MIs competing around price could help and also means you don't have to be the lowest price to win. So you could always be -- or you don't have to always be the lowest price, which means in times of stress, you get chance to raise your pricing. Or in terms of certain market niches, you can raise your pricing because as we get into this kind of new model around reinsurance on the back end and EssentEDGE on the front end, it's really going to be about managing average premium, right? You didn't have to do that before, too. You didn't have the ability to manage average premium other than maybe kind of modifying your singles mix with your borrower paid monthly mix. So again, I think these 2 new tools both on the front end and the back end are kind of like entering into kind of the next phase in the mortgage insurance industry.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [22]

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Yes. It'll be interesting to see how the front end and the bank end actually start interact over time because presumably, as the ILN markets become more sophisticated, you're going to be more granular in your thought process in terms of what your contributing as well, and you'll use the engines to drive that.

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [23]

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Absolutely. Absolutely. They're going to learn -- their markets are going to learn more too and they're going to have more feedback for us that we can then channel into the front end.

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Operator [24]

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Your next question comes from Jack Micenko from SIG.

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John Gregory Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [25]

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First question. Looking at the loss ratio, you came in a little bit higher than we had thought. And again, a 4% loss ratio is not a concern in any way, but was there anything in the quarter maybe around assumptions or the underlying modeling around that? Or was it just pure seasoning?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [26]

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It's pure seasoning, Jack. I mean, again, as we continue to grow insurance in force and the book starts to season, you're going to see the loss ratios go up just by pure math.

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John Gregory Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [27]

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Sure, okay. And then Mark, bigger picture, we talk about the front end and we talk about the back end. There's definitely an appetite on the back end. They're buying the milk. I guess, the question is when do some of these participants start to think about buying the cow? Does that ever occur like -- how do you think about M&A in the space given the business has changed so significantly over the last year around some of the issues that may be larger insurers have had with the business model historically?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [28]

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Yes. It's a good question. I would look at M&A in 2 different ways. I think from a new -- someone outside the industry coming in, I do think it's still not their expertise, right? If you really think about the larger kind of reinsurance companies, they would have to balance sheet to take on kind of an MI business. They still don't really have the expertise. And I think they -- if you look at some of the larger reinsurers that have participated in the MI reinsurance transactions, they really kind of fashion themselves as being in a bunch of different lines of business and they kind of come and they go as they like. They like that that's their business model. And we've recently even heard that the P&C market, the retro session part of that market has really started to dry up and rates are going up a little bit. So they could quickly turn their attention, hence, that's why we want to hold more capital too, right? You don't just want to jump and assume the sustainability of this stuff. So I think it's a relatively -- never say never. But I think right now, until the model continues to get proven out, I think the kind of the guys who participate in the business today probably are not players. Would another larger P&C be interested down the road? I think the model still has to be proven out. Like I said, we're still in the transition phase of it. So I would leave it. So from that, I would never say never but right now, I think it's probably a little early.

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John Gregory Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [29]

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Okay. Just if I could sneak one more real quick one in. Larry, PP&E jumped up pretty meaningfully quarter-to-quarter. Was there -- was that something tied to EssentEDGE or software or something? Or what -- is there -- curious on that.

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Lawrence Edmond McAlee, Essent Group Ltd. - Senior VP & CFO [30]

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Yes. Jack, good question. We adopted the new lease accounting standard this quarter so that we have a little bit of a balance sheet growth up associated with that.

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John Gregory Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [31]

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Okay. And that's the right sort of number to run then going forward?

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Lawrence Edmond McAlee, Essent Group Ltd. - Senior VP & CFO [32]

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Yes. Again, the lease accounting has a very minimal impact on us. Again, very much a balance sheet growth up. But yes, that would be a reasonable number at least to start with.

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Operator [33]

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Your next question comes from Mark DeVries from Barclays.

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Mark C. DeVries, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [34]

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Mark, could you discuss more kind of the benefits of the side-by-side transaction? Is that more an issue of just getting more discrete tranching? Or theoretically, you can get more efficient bids on different tranches as opposed to just doing kind of one -- kind of that one?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [35]

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I don't think there was -- I think the pricing was very similar. I don't think there was efficiencies. I would say market was more of, again, just trying to broaden the kind of the investor group. So you have the capital markets. I think we clearly had enough appetite, we could have done the whole thing with the capital markets. But again, I think from a reinsurance perspective, we want to continue to cultivate that investor base too, so to speak. So because you don't know when one market's going to dry up. So I think again, it's more of a test. It actually went really well. We are very pleased with the side-by-side. And Freddie Mac has been doing it for years. So it wasn't like we kind of invented that. So we just kind of followed on and I would say we're pretty pleased with it.

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Mark C. DeVries, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [36]

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Okay. Got it. And then a follow-up question on market share. I mean it was a pretty interesting quarter where there's a lot of volatility. Arch gave up a lot of share. You guys gained a lot and MI gained, Genworth gained. The legacy guys basically lost a little bit of share. And the question is could we see more volatility in share going forward as the use of these pricing engines. I think in the past, if you had kind of a standard rate card, share wouldn't move quite as much. And if so, kind of what are the implications for customer relationships, right? I mean I think customers don't love it when you -- the large lenders when you pull back on -- meaningfully on risk and things you're willing to do. How do you think about kind of managing that going forward?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [37]

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I think it'll settle out. I think it will settle out especially when some of the larger lenders move to the engine. There's been a few -- there's been a number of holdouts. Some because of the systems. It's taken them a while to -- it will take them a while to kind of get their systems in place. I mean the industry kind of just like came out with that like almost overnight, so to speak, which from a lender perspective, it was -- as they get more comfortable with the engines and the fact that every MI has a different price for every loan, I think it'll actually settle up pretty well. I think longer term -- I think in the interim, you're going to see some volatility. But I think over the longer term as MIs, everyone settles into their niche and there's really not that much difference in the pricing now. And I've read a couple of surveys where lender said they don't see a lot of difference in the pricing with MI. So longer term, we still have -- we're still going to have strong relationships with lenders just to get in from the front end. And we have one relatively large lender where they price every loan, every day best execution, but they only use 4 MIs. So you still need relationships, so to speak, just to get into the ring. And I think others will use 6, some will use 3. It's interesting how watching the lenders trying to evolve towards it but I think they're fine. I think as long as they continue to close loans and you can help them and the pricing is competitive amongst the MIs, I think the lenders will be happy. And I think again, as I said earlier, I think it's better for the borrowers. And I think when it's better for the borrowers, they tend to have more successful homeownership experiences that leads to better credit performance and that helps put more borrowers in home. So I think all in all, it's a good thing. It's just, like I said earlier, we're in transition phase. And I think it'll take a while to settle it out. And now that you guys can't see the pricing and you can only really see it kind of in our quarterly results, I think there's going to be a lot less focus on it, which again, I remind you we're still the only MI that doesn't pay a sales commission to their sales force. We've never really targeted share. It's really been about insurance in force and unit economics. And I think the industry will start going more towards that, like why would you pay a sales commission and pay more money to a salesperson if the pricing is being controlled somewhere else. So you're going to see a little bit of that.

And quite frankly, you may see if the lenders continue to consolidate, which we've seen, you may see consolidation in the MI industry. And I think that's one thing too. It's more efficient now with engines and the question is do you really need 6 mortgage insurers going after each lender? And I think that's going to settle up. But I do -- I have a feeling now that there needs to be a catalyst for that. But I think over time that could be a likely result of what's going on now.

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Mark C. DeVries, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [38]

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Okay. Got it. And then any chance you could preview for us the contours of the capital distribution plan you alluded to that we'd find out about when you get to 75% of the book reinsured?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [39]

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Yes. I think we kind of alluded to it before. I think we're going to look at both obviously, in terms of dividends and share buybacks. I think on the buyback, you're going to be very price sensitive around that and set some goalposts up. You don't really want to manage, you just -- to manage EPS. I think as these businesses get bigger, it's a harder bar to jump over. And in short term, folks like it. We do think dividends is a good and intangible demonstration of kind of this new model that we're transitioning to. And I think it kind of matches kind of cash flows that can come out of the regulated entity. So we'll consider both and we'll probably over time end up using both. But I think dividends is something we're probably a little bit more in favor of over the shorter term.

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Operator [40]

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Your next question comes from Mihir Bhatia from Bank of America.

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Mihir Bhatia, BofA Merrill Lynch, Research Division - Research Analyst [41]

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I guess, the first question, just staying with EssentEDGE. I was curious if you could just help us understand a little bit about some of the operational improvements. I think you mentioned that you are looking at that being the focus. Is it just things to developing new tools to help lenders plug into lender systems? Like what are kinds of things we're talking about there?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [42]

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Of course. I mean I think operationally, it's making sure it goes smoothly with the vendors that you're integrated in with. And then I think a lot of it is response time. How quickly are changes made? Longer term, I think it's going to be improving the type of factors that you price against. And in terms of how do you -- and I think the question there's how -- you could use more factors but how do you get them to point of sale very quickly? So that's a pretty big operational list. So I think those are -- there's always -- just like anything, you put it out the first time. And like I said last year, we spent a lot of time last year kind of testing it. I think we tested the first month with like one lender, then we did a focus group with the lender. We really try to figure out what they liked and what they didn't like.

Pricing aside. Forget the pricing for a second, It's really around did they like using the system? And then we, given the rate card change last year with we went from 2 to 4 factors. We felt like we had the time to kind of really -- to really put it out in the market and test it. We weren't interested in leading the market and being like the first one out there. That's not really how we operate. We're really more focused that are -- once it's out there, that our lenders will be pleased with it. And I think -- and we'll continue to improve it. So I think there's a number of ways that we'll, like I said, we'll continue to look at ways to make it better for the lender to use the system.

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Mihir Bhatia, BofA Merrill Lynch, Research Division - Research Analyst [43]

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Great. And then just on EssentEDGE and these pricing engines, are they -- it's so -- it's a pretty big change for the industry as a whole. So I was curious if you'd be willing to share even just -- not -- even if it's not precise numbers just general. How fast our lenders and the industry are adapting to it? Are we thinking -- and when I talk about the industry I mean just like in terms of volume of loans coming in. Is it like 50% this year or is it 75% this year type of number that we're looking at?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [44]

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Yes. I would say 95% of our lenders are using it. So -- and again a lot -- some of them use it, they don't even know they're using it because they're getting a price through a third-party vendor. And keep in mind Arch when they -- via UGI, they've had the system out there for 7 or 8 years. So the lenders actually understand it better than some of the MIs. So I think they've adopted to it quick. I think the holdup has been the larger lenders. Even when the UGI was in the market early on, the smaller midsized guys use the engine right away. The larger guys didn't have the systems to do it and they required rate cards. And now they're all switching.

Again, like I said, it's going to take some more time than others. But again, my view would be over time, all of them will be on the engine and the rate cards will disappear.

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Mihir Bhatia, BofA Merrill Lynch, Research Division - Research Analyst [45]

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Got it. And just final question. The premium rate of guidance I guess, sir, 1 to 2 basis points more that excludes any back book reinsurance? Did I get that right?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [46]

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Yes, it does. Correct.

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Operator [47]

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Your next question comes from Chris Gamaitoni from Compass Point.

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Edward Christopher Gamaitoni, Compass Point Research & Trading, LLC, Research Division - MD & Head of Research [48]

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I know it's small, but wanted to see if the bulk NIW done in the quarter was something episodic or if there's a new opportunity that's developing?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [49]

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Yes. I would look at it more like a one-off, Chris. We've done a few of them in the past. It's obviously bank balance sheet based. We've done about -- and we don't want to talk about too much but it's about 5% of our portfolio is bank balance sheet normally in the flow, but this was kind of a one-off seasoned.

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Edward Christopher Gamaitoni, Compass Point Research & Trading, LLC, Research Division - MD & Head of Research [50]

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Okay. Have you -- given the model, the overall business model, especially Essent is improving from a risk (inaudible) capital is strong, profitability is great. Have you had discussions with the rating agencies for a potential upgrade of your credit rating at Essent Guaranty?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [51]

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Yes. I mean, we did have A.M. Best A rating last year, which I think they kind of quickly understood the model, the new model. I would say yes, we actually had pretty positive discussions with both S&P and Moody's. But again, these are just discussions. Yes, I think it takes a while. I do think over time, when they look at it and run through their models, get back to my earlier example, if they are just looking at our balance sheet, $2.5 billion against the risk, that's not really the accurate way to look at it. You really have to factor in kind of the off-balance-sheet capital of $1.2 billion I think and run stresses against that. I would say they're both actively looking at it. And we'll see, time will tell. The rating agencies don't -- they're not really incented to move fast. But I believe that these -- Essent in particular, it is moving more towards a single A. whether that happens or they agree with me it's a whole different story. But I think we're showing and we're starting to look like from our balance sheet and risk protection like a single A business.

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Operator [52]

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And your next question comes from Geoffrey Dunn from Dowling & Partners.

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Geoffrey Murray Dunn, Dowling & Partners Securities, LLC - Partner [53]

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Larry, what is the full run rate ILN cost coming into the second quarter as we account for the full period of the most recent deal?

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Lawrence Edmond McAlee, Essent Group Ltd. - Senior VP & CFO [54]

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Yes. The dollar cost based on the reinsurance in place as of today would be about $9.5 million in the second quarter.

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Geoffrey Murray Dunn, Dowling & Partners Securities, LLC - Partner [55]

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Okay. And then Mark, you alluded to the bid card business out there, which we've heard a little bit more about lately. Can you talk about how that business compares to the engine business, pros and cons? And I think one notable difference is, is it still like a 6-month type of agreement where you maybe can lock in that extra business before it goes up to RFP again?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [56]

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I'm not privy to all of them. I think they run in different sectors -- I mean, different 3, 6 month, 9 month. I mean I don't know them all. There's not that many out there. I think from an EssentEDGE perspective, it depends on the credit quality to kind of look at it. I do think they're lower than where the engine is. And I'd also think they don't really give the MI the flexibility to kind of move up and down on the pricing. So again, it's not as granular kind of as the engine is. And I think over time, I think they'll start to migrate towards -- my view is that they'll start to migrate towards the engine. I think that will be the best answer for the borrower longer term. But again, sometimes its systems, habits, feeling like they get better execution this way. But over time, I think it'll all kind of morph into the engine.

I mean we see one large lender, as I mentioned earlier, that does use kind of best execution on a loan-by-loan basis. And I think they get great execution and also they have more sustainability. I mean you live by the bid, you can die by the bid. So when things go the other way, the bids clearly disappear. And we've seen lenders go out with bids and get 0 bids. So they quickly go back to the engine. We had someone go through a large bid process and then decided to go through the engine. I think our view is the engine is the better way to go because obviously, if there's a bid card, you have MIs compete on it but wouldn't you rather have every MI bid on every loan every day. I think it's better for the borrower, it's better for the lender. And clearly, it's better for the MI because it gives us a chance to bid up or bid down on the loan-by-loan basis and shape our portfolio and then you -- and again, you get different lenders or different MIs that have different credit appetites in different parts of the credit structure. I think that's a win-win for everyone. I think the cards are old and I think that over time, they'll go away.

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Geoffrey Murray Dunn, Dowling & Partners Securities, LLC - Partner [57]

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From the typically non-bank lender perspective, is there an efficiency or control issue that you think maybe limits their desire to move purely to the engine?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [58]

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I don't know. I can't -- I mean I think some of it's controlled. I think most of the conversations we've had is that they are very open to it. So again, whether they do it and what the timing is, a lot of it comes down to pricing and then incentives and also their ability to move their systems.

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Geoffrey Murray Dunn, Dowling & Partners Securities, LLC - Partner [59]

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Okay. And then can you elaborate on your comment before that PMIERs is an asset measure, it's not a capital measure. So how do we think about the cushion in terms of capital or what should we be looking at to try to measure true excess capital...

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [60]

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Yes. That's a great question. I think what we look at is kind of unassigned surplus in our regulated entity. And you take that and you add in kind of whatever the HoldCo cash is. And then we have similar excess -- kind of an excess at Essent Re. So we kind of calculate it kind of total liquidity around that. It's a little over $0.5 billion, which is different than the $800 million. And obviously, have the undrawn line too. That's just more from a liquidity perspective.

But I think we really have been focused in on kind of the unassigned surplus because that's something we can go -- we can just notify the state, they can obviously not allow it. But we don't have to have special permission for excess dividends, so we feel like that's a very liquid amount that we could use.

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Geoffrey Murray Dunn, Dowling & Partners Securities, LLC - Partner [61]

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And this is maybe more for Larry. In terms of growth of unassigned surplus, should that match the pace of growth excluding dividends of your surplus number? Or is there other math involved that affects that line?

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Lawrence Edmond McAlee, Essent Group Ltd. - Senior VP & CFO [62]

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Geoff, a little bit of math because of contingency reserves. So we put $0.50 or $0.50 of every dollar of earned premium into contingency reserves. The other 50% net of losses and expenses flows into unassigned surplus. So -- and we really won't be in position for a few more years to be releasing any contingency reserves because we have to hold them for 10 years. And really, it wasn't until 2013 that we wrote any significant amount of earned premium. So have to kind of go through the math, built into our model, $0.50 of every dollar of earned premium goes to the CR and the balance of our net income on a statutory basis will go to unassigned surplus.

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [63]

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The good news, Geoff, is this is pretty much money good. So the PMIERs -- I mean, the issue with PMIERs is it's also, remember this is it's term. So it amortizes down and you're almost -- you have to continue to do the deals in order to kind of continue to generate excess. It's fine and it's a nice measure. I think the thing that we've talked about today is a much more, I would say practical way to look at it.

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Operator [64]

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Your next question comes from Mackenzie Aron from Zelman & Associates.

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Mackenzie Jean Aron, Zelman & Associates LLC - VP [65]

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Just a question on the GSE credit risk transfer programs. And are you seeing more or less opportunity to deploy capital from Bermuda in those opportunities? And could that change under the new leadership with FHFA?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [66]

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It's hard to tell -- we're not seeing much. We kind of have our normal routine and share that we have with both Fannie and Freddie. It's worked like clockwork. It's been fantastic since we started it. So I don't see any change unless there's a change in the appetite for the reinsurers. And like I said earlier, Mackenzie, we've heard some of the reinsurers started to look back at their core business so that could cause them maybe to back away. From some of the GSE risk share, we have not seen that so maybe that will come over time. But right now, I think it's business as usual. And I think with a new leadership at GSE I think they're just kind of getting started. There's no new leadership at FHFA. I think it'll take them a while to kind of settle in and go in any real direction.

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Operator [67]

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There are no further questions at this time. I'll turn the call back over to the presenters.

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [68]

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Well, thank you, operator. Before ending our call, we'd like to thank everyone for their participation today and enjoy your weekend.

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Operator [69]

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This concludes today's conference call. You may now disconnect.