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

Q2 2019 Essent Group Ltd Earnings Call

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

TEXT version of Transcript

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Corporate Participants

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* Christopher G. Curran

Essent Guaranty, Inc. - 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

* Edward Christopher Gamaitoni

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

* Geoffrey Murray Dunn

Dowling & Partners Securities, LLC - Partner

* HyungJun Choe

Crédit Suisse AG, Research Division - Research Analyst

* 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 Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Essent Group Ltd. Second Quarter 2019 Earnings Call. (Operator Instructions)

Mr. Chris Curran, Senior Vice President of Investor Relations, you may begin your conference.

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Christopher G. Curran, Essent Guaranty, Inc. - SVP of Corporate Development [2]

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Thank you, Rob. 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 second 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. 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, we continue to be pleased with our progress in transitioning Essent to a buy, manage and distribute operating model as we increased utilization of EssentEDGE and successfully obtained reinsurance on our 2015 and 2016 vintages with Radnor Re.

We believe that the combination of risk-based pricing on the front end and risk distribution on the back end allows us to mitigate franchise volatility during down cycles, making Essent a stronger and more sustainable franchise.

Our outlook on our business remains positive as affordable interest rates accompanied by positive demographics and strong employment continue to bode well for the housing market. Key metrics such as homebuilder sentiment and new and existing home sales have rebounded from the declines experienced in 2018. In addition, there's been some moderation in home prices, which, in conjunction with lower rates, contributes to improvements in affordability.

Now let me touch on our results. For the quarter, we earned $136 million or $1.39 per diluted share compared to $112 million or $1.14 per diluted share for the second quarter a year ago. Our annualized return on an average equity for the second quarter was 21%.

Our financial results continue to be driven by our insurance in force, which ended the quarter at $153 billion, representing a 25% increase from $123 billion at the end of the second quarter a year ago. Finally, our balance sheet remains strong, ending the quarter with $3.5 billion in assets and $2.7 billion of GAAP equity.

On the business front, our industry remains competitive with all participants deploying risk-based pricing engines. During the quarter, we saw increased utilization of EssentEDGE with approximately 95% of our customers now using it. 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 borrowers' credit and loan profiles.

Also during the quarter, we successfully completed our third insurance-linked note transaction covering our 2015 and 2016 NIW. This transaction initially provides $334 million of protection on top of a $208 million first loss portion that Essent retains. Now after completing 5 reinsurance transactions on our 2015 through 2018 NIW, we have $1.5 billion of reinsurance protection covering approximately 70% of our portfolio.

Given our strong operating performance and use of reinsurance, we continue to generate excess capital. As a result, our Board of Directors has declared a quarterly dividend of $0.15 per share to be paid on September 16, 2019. We believe that a dividend is a tangible demonstration of one of the benefits of a buy, manage and distribute operating model. Also, a dividend of this size affords us the opportunity to maintain adequate levels of capital, continue investing in the business and take advantage of other potential growth opportunities.

Since the founding of Essent, we have been very thoughtful on managing capital, and we'll continue to do what we believe is in the best long-term interest of our franchise, policyholders and shareholders.

On the Washington front, given new leadership in Congress and at the FHFA, there's been increased focus on GSE reform. However, given the delay in the administration's housing finance reform proposal, the market is taking a wait-and-see approach along with Congress, which does not appear to be creating a separate plan for reform.

While the FHFA has been vocal on GSE reform, timing remains unclear as to when and if the GSEs will be released from conservatorship. From our standpoint, we remain confident that Essent is well positioned to be successful across a broad range of alternatives being discussed.

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 the results for the quarter in more detail. Earned premium for the second quarter was $188 million, an increase of 6% over the first quarter of $178 million and an increase of 20% from $157 million in the second quarter of 2018. The increase in earned premiums over the first quarter was in line with our 6% increase in average insurance in force.

The average net premium rate for the second quarter was 49 basis points, which was 1 basis point higher than the first quarter of 2019, due principally to an increase in singles cancellation income of $4.5 million in the quarter to $8.8 million. The favorable impact of singles cancellation income on the net premium rate for the second quarter was partially offset by an increase in ceded premiums on our reinsurance transactions from $6 million in the first quarter of 2019 to $8.4 million in the second quarter.

The increase in premiums ceded results from the full quarter impact of the reinsurance transactions which closed in the first quarter. The execution of the insurance-linked note transaction on our 2015 and 2016 new insurance written, which was consummated in late June, had minimal impact from ceded premiums or our average net premium rate in the second quarter.

Looking forward to the third quarter, we do expect that the amount of singles cancellation income will decline from the strong level experienced in the second quarter. As a result, based on the reinsurance we currently have in place and our expectation of pricing for new business, we expect our average net premium rate to be in the range of 46 to 47 basis points for the balance of 2019.

Investment income, excluding realized gains, was $20.6 million in the second quarter of 2019 compared to $19.9 million in the first quarter and $15.1 million in the second quarter a year ago. The increase in investment income of 4% over the first quarter of 2019 is due to a modest increase in the balance of our investments.

We recorded a gain of $1.2 million in the second quarter compared to a gain of $1.4 million in the first quarter for the increase in fair value of embedded derivatives associated with the insurance-linked note transactions. These gains are included in other income in our consolidated statements of comprehensive income.

We remain pleased with the credit performance of our in-force book. Our provision for losses and loss adjustment expenses was $5 million in the second quarter compared to a provision of $7 million in the first quarter of 2019 and a provision of $2 million in the second quarter a year ago.

The default rate on the entire portfolio increased 1 basis point from March 31, 2019, to 66 basis points as of June 30. Historically, the second quarter represents the lowest quarter with respect to our provision for losses and loss adjustment expenses.

Other underwriting and operating expenses were $41.5 million for the second quarter of 2019 compared to $41 million in the first quarter and $36.4 million in the second quarter a year ago. Income tax expense for the first half of the year was calculated using an estimated annual effective tax rate for 2019 of 16.1% and was reduced by $2 million of excess tax benefits associated with divesting of restricted share and share units issued to employees.

The consolidated balance of cash investments at June 30, 2019, was $3.2 billion. The cash and investment balance at the holding company was $72 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 second 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 June 30, 2019, the combined U.S. mortgage insurance business statutory capital was $2.1 billion with a risk-to-capital ratio of 13.6:1 compared to 13.5:1 at the end of the first quarter of 2019. The risk-to-capital ratio at June 30 reflects a reduction in risk in force of $1.5 billion for reinsurance coverage. At the end of the second quarter, Essent Re had get GAAP equity of approximately $900 million to [report] a $9.3 billion of net risk in force. In addition, Essent Guaranty's available assets exceeded its minimum required assets as computed under PMIERs by over $900 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 performance as the operating and credit environments were favorable. Also we remain pleased with our progress in transitioning our franchise to a buy, manage and distribute model, and we're excited to announce the dividend, which reflects one of the benefits of such an operating model.

Looking ahead, we believe that as more risk is originated through EssentEDGE and is distributed through the reinsurance market -- markets, it will strengthen our franchise, making us a stronger company for our customers, policyholders and shareholders.

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) Your first question comes from the line of Mark DeVries from Barclays.

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Mark C. DeVries, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [2]

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I was pleased to see the announcement of dividend. You guys are obviously still

[Audio Gap]

fair amount of capital with a very strong interest risk growth that are bringing some of that up with the ILN. How should we think about growth in excess capital (inaudible) kind of preference for how would look to deploy that?

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

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Mark, you're breaking up pretty badly, so I'll take a stab at your question. Just in terms of the dividends, I think the first message, we said it in the script, the first message is this really is an indication of our confidence in the sustainability of the cash flows. It's not -- I wouldn't tie it as much to excess capital as people think.

For example, if we had the same amount of excess capital but didn't have any reinsurance, we would not be distributing capital to shareholders. It would be too big of a risk given that the liability would be uncapped on our balance sheet. This is really -- this is an output of the reinsurance strategy. Now that 70% of the book is reinsured, we feel confident that we've removed a lot of the volatility around the tail. That's why we went back into the 2015 and '16 book in the past quarter.

Now that, that tail, we feel really -- we've really boxed that risk, that gives us more confidence to be able to distribute dividends and cash at this time from the company.

Longer term, I would expect the growth in capital distribution really to reflect the growth in operating cash flow. Again, look at the cash flow that's coming out of the stat -- our statutory capital out of the regulated entities. That's really going to give you the clue as to how much capital we're going to distribute over time. Don't look at PMIERs. PMIERs is $900 million. But PMIERs really is not the binding constraint. The binding constraint is coming from the operating entities where the cash flows can come out of there and we feel comfortable to pay that. And the fact that we're hedging the book, again, gives us the confidence to pay that dividend.

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Mark C. DeVries, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [4]

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Okay. And Mark, after investing in the business, how would you look to deploy that additional growth and excess cash flow? Would you look first to continue to grow the dividend? Or would buybacks be on the table?

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

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Again, I would look and say the amount of the dividend is reflective of what we think is a material amount and also it leaves us adequate capital to continue to invest in the businesses, look at potential new opportunities. As you heard me say in the past, Mark, capital begets opportunities and you can't judge that on a quarter-by-quarter basis.

So we're going to look at it that way, and we're not going to be forced into kind of capital distribution. And you guys take -- as the market or really the analyst take a look at PMIERs and equate that excess for cash to be distributed, PMIERs could change, Mark. Keep in mind that. It's not the binding constraint. And we just think there's plenty of opportunities. The insurance in-force book grew 25% year-over-year. Housing continues to be, I believe, a tailwind. And we think there's going to be opportunities both inside the business, potential GSE reform. Deeper cover are always on the table. We think there's plenty of ways to invest the capital to continue to grow the business. We're achieving returns. I believe in the second quarter it was 21%. Plenty of opportunity to reinvest kind of around in the core business. In the future, if those opportunities don't really exist, we'll certainly look at capital distributions, be it dividends or buybacks. But right now, I think the message for the dividend was the sustainability of the cash flows versus a capital distribution story.

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Mark C. DeVries, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [6]

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Okay. Understood. And then just as far as your composition of capital, how are you guys thinking about potentially levering up the balance sheet a little more using some of your undrawn capacity?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [7]

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Again, Mark, we're not looking to lever up the balance sheet. These businesses are long and there's a lot of levers within the insurance in-force portfolio. So again, I think there's plenty -- we have plenty of capital to continue to look to reinvest the business without trying to create lever. There's embedded levers also in the ILNs. A typical ILN deal, Mark, is 4 to 5 years, which equates to a senior -- kind of a senior -- a senior note obviously at a lower cost with the added protection of a hedge. So I'd look at that really as kind of a debt replacement versus going and adding additional leverage at the HoldCo.

We would only hear that if there was an opportunity [outsized] that we could look to grow the franchise versus, again, using it to create higher returns. The returns are high enough already at 21%.

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Operator [8]

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Your next question comes from the line of Phil Stefano from Deutsche Bank.

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

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I was hoping to talk through just thoughts around funding the dividend. I know there's some excess capital that's in Essent Re. When I do my own assigns here plus roll-forward, it looks like the contingency reserve starts coming back and maybe 2023, 2024, that really starts to ramp up more significantly. But there's the ability to upstream from Essent Guaranty to the HoldCo to cover that, and maybe you could talk about kind of what you want to hold at the holding company just for kind of normal operating expenses.

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

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Yes. It's a really good question, Phil. I'm -- you're focused on the right issue, which is really where the cash is coming from and the sustainability of that cash flow. Right now, I mean, just given the size of the dividend, we have the cash at HoldCo to pay it. Going forward, we believe there's ample capacity of the dividend of cash both from Essent Re and from Essent Guaranty, and we'll kind of look at that.

In terms of HoldCo cash, we don't have a ton of operating expenses at the HoldCo. They're minimal, right? Most of them are embedded in the operating entities. That being said, we'll probably look into that $50 million to $100 million range as kind of a good number, and then we'll leave the cash and the operating entities and bring them up as needed.

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Philip Michael Stefano, Deutsche Bank AG, Research Division - Research Associate [11]

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And when I think about your ability to do normal dividends out of Essent Guaranty versus -- but the fungibility out of Essent Re in Bermuda, is there a difference between the 2? Or you can kind of pull the trigger when you're ready?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [12]

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They're pretty equal. There's probably -- I mean, there's a lot of flexibility within Essent Guaranty. There's probably even a little bit more of flexibility within Essent Re. And they don't have any of the friction since it's already in Bermuda, so it's -- but we have a lot of flexibility in both though. Good question.

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Philip Michael Stefano, Deutsche Bank AG, Research Division - Research Associate [13]

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Okay. One last one. With these ILN coverages that you're putting in place, are these giving you any insight into pricing? And so when the quota shares started to happen in the sector, the expectation, at least in my mind, was that the reinsurers were going to provide a second set of eyes on your primary pricing. Do the investors in the ILN business, do they care? Are they looking at it?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [14]

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They absolutely care, and they're looking at it pretty closely in terms of key metrics around FICO, geographic concentration, LTVs, DTIs. They definitely care. We haven't seen much yet to cause us to change the pricing. It hasn't been as reflective in terms of kind of where we set the attachment point or -- certainly hasn't happened in the pricing.

But you touched on a good point. I think that's one of the reasons we like the ILN market. It is a second set of eyes. You have a group of investors that know mortgage credit risk really well, just as well as we do, to be honest. So we're looking for, as things start to turn, I think we look at that as maybe a bit of a leading indicator, which we can then roll into kind of the upfront engine and be able to alter price to meet that higher cost of goods sold, so to speak.

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Operator [15]

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Your next question comes from the line of Sam Choe from Crédit Suisse.

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HyungJun Choe, Crédit Suisse AG, Research Division - Research Analyst [16]

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I'm filling in for Doug Harter today. So I guess I'm just thinking about the credit quality of the postcrisis vintages. We talk about the seasoning of that, and I'm seeing that incurred losses for new defaults have been trending lower. So I'm just trying to tie the 2 together and just wanted your thoughts on how we should think about credit quality going forward, especially in the second half of this year?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [17]

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Yes. Couple of things, Sam. One, the credit quality continues to be excellent and default rates in the 60 to 65 basis point range. Incurred loss ratios, low single digits across all those vintages. I wouldn't expect that to change in the second half of the year given where the economy is. And also, remember the strength of the book. We have an average FICO now of the mid-740s; average LTV of 91, 91.5. A lot of embedded mark-to-market LTV on the older book. We continue to think credit will be -- probably perform better than our expectations. So again, I think -- so from that standpoint, the expected loss around the credit is pretty benign.

One would ask then why did you go out and reinsure the previous books if you'd felt credit was so good, which is a fair question. And the real answer is you don't know. This is a business that's subject to macroeconomic catastrophic risks, our hurricane or earthquake is a recession, and you just never know when that's going to come. So I think the combination of really understanding the credit on the front-end and making sure losses were within that 2% to 3% expected case, that helps our reinsurance partners feel comfortable that we're looking at it and feel good about it.

So I think the combination, short term, we feel good about the credit. Longer term, we still feel pretty good given where the economy is, but we wanted to have that added protection, again, to remove the volatility around those cash flows. Historically, this business really was, where do you think credit is going to be in the next 3 to 6 months? It's a lot like how the credit card guys are. They're still in that mode where people kind of look at -- the investors tend to back away when they think the market is going to soften. And I think with our reinsurance in place and we'll have to go through a cycle for people to realize that, you're going to see a lot less volatility in the cash flows. And I think that's positive -- very positive for the franchise.

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HyungJun Choe, Crédit Suisse AG, Research Division - Research Analyst [18]

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Got it. And one more for me. So I mean you guys talked about EssentEDGE, and I guess now we've had about 2, 3 quarters of that coming into effect. Just wanted more color on how that has been benefiting the NIW production and your positioning from a competitive standpoint?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [19]

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Yes. I mean, it's only been in place for 2 quarters and little less than 2 quarters when you think. It kind of got rolled into -- didn't really get rolled until middle of January and some of the other guys were a little further behind. But pretty much they're all in place now, as I said in the script. There's no real learning from it. And I -- we're not -- this is not really a market share tool. We're not using this to bring on more market share. We're doing it really to help us shape the portfolio and be prepared when the market enters into, again, a softer time period because these -- again, as you heard me say this a bunch of times, credit kills these businesses.

So our ability to alter pricing both up and down in the long term is really going to be what's critical. So what are we doing now to do that? We're testing. We have a lot of different pricing strategies that are in the market; some higher, some lower. Really looking at price elasticity across broad range of geographies, LTV bands, FICO bands. And we're really in the learning process. We're not after that next loan. This market is so big that there's plenty of market share for everyone. So we're really looking at this to learn a lot.

And then, over time, it's really can we introduce additional factors. There are other factors in a borrower's credit profile that are going to be more indicative of their future performance. And we're testing those, and we're trying to develop that.

And as you heard me say before, we're probably a year or 2 into a 5-year transition around the business. Again, the dividend was a statement that we believe that the transition is going very well, but we have plenty to learn. We continue to test different reinsurance structures and, again, we're testing a lot on the front-end. I'm very encouraged just in terms of the lenders adopting to it, and I think that helps because I think that will help us continue to test. But it's really early in terms of looking and saying this is going to be a way to build out share. That's never really been kind of our MO.

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Operator [20]

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Your next question comes from the line of Mackenzie Aron with Zelman & Associates.

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Mackenzie Jean Aron, Zelman & Associates LLC - VP [21]

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I think just one question for me. Curious, Mark, your thoughts about the QM patch and the attention it's been given the last couple of weeks with the CFPB's announcement, how you think it could impact the business? And what you're thinking the most likely outcome could be there?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [22]

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I think the most likely outcome period -- the most likely outcome from the comment period will be a balance, MacKenzie, between promoting homeownership and protecting the taxpayer. I really do -- I think we'll get to a good answer. And I don't really believe there'll be much impact, if any, on kind of industry NIW. I just think we'll get to a good answer. You probably have 18 to -- anywhere from 18 to 30 months before it gets implemented. I think the CFPB has requested the comment period. I think USMI has some pretty good thoughts on it, and I believe others will have it. So I think we're going to get to a good place. I think it's a little bit overblown as is typical sometimes and understandable given how material it is. But I think when we get down to it, we'll wind up in a good place.

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Mackenzie Jean Aron, Zelman & Associates LLC - VP [23]

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Okay. And actually just a quick numbers one. Did you give the dollar amount of the single premium cancellations this quarter?

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Lawrence Edmond McAlee, Essent Group Ltd. - Senior VP & CFO [24]

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Yes. MacKenzie, it's Larry. It was at $8.8 million, which compares to about $4.3 million in the prior quarter.

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Operator [25]

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

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Mihir Bhatia, BofA Merrill Lynch, Research Division - Research Analyst [26]

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Congrats on the quarter and the dividend. I guess just to start with, just a follow-up on the QM discussion. Do you think the FHA's definition of QM will change also as a result of what the CF -- where the CFPB ends up?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [27]

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I can't answer that. I don't know. But I do think there'll be a coordinated effort. I would say that's the one impression we've gotten in the change of leadership at FHFA and FHA. It's much better coordinated. So I would expect a coordinated response versus the QM patch expires, the GSEs and everything goes to FHA. I just don't see that as happening. But it's a really good question. Just I don't see that as a realistic outcome.

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Mihir Bhatia, BofA Merrill Lynch, Research Division - Research Analyst [28]

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Got it. And then just can you help us size just the percent of either your NIW or just if you don't want to give that -- be that specific, what you guys think is really dependent on QM, right? Because I think one of the issues has been right now because of QM, there's a feeling out there that sometimes loan officers, when they get to look at it as qualified, they'll stop working the file. What is the actual impact rather than 20%, 30% numbers we've seen off this QM currently?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [29]

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I mean, yes. No, I understand that. I don't -- it's hard for me to answer that question. I mean, I've heard that. And we do see that where lenders will stop calculating income. I would put my money more on they're going to have -- they're going to come out with a realistic solution. I wouldn't get tied-in into how we calculate income. And first of all, debt to income is not the most predictive indicator anyway. It's more residual income. I mean debt to income is a gross number where after tax is probably a better number.

My feeling is I'd rather see the industry move towards that anyway, and maybe that will be part of the solution. Again, 18 to 30 months, you have a lot of time to work through a real solution. And I would bank more on that versus trying to get into -- trying to quantify. You're going to quantify something where the rules going to end up changing and it's not going to matter, so I wouldn't get too caught up in that.

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Mihir Bhatia, BofA Merrill Lynch, Research Division - Research Analyst [30]

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Got it. And then if I could switch topics a little bit, just on the competitive environment. I think again, similarly, last couple of weeks, there's been an article or 2 about some special discounting going on maybe in the bulk bid business. Are you seeing that? Can you just comment on the overall pricing environment in general? Is it stable? Has the move to black-box pricing had any kind of impact?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [31]

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Yes. The returns are stable. They continue to be stable. We had 21% return on equity in the second quarter. The unit economics of the business, which is the business that we write -- our expected return on the business we write today are still in that kind of mid-teens, and that's kind of that 13% to 16% range, given kind of an expected claim rate.

In terms of pricing, there hasn't been much change since the rate cards dropped last year. And whether it's -- you read an article or 2, you just don't have the context. I would continue to look at the earned premium yield coming off our portfolio, and clearly, that will go down as some of the newer rates work their way into the portfolio. But you're relatively -- I think you've been around for a couple of years. There's -- there was LPMI discounting 6 years ago and we'd get -- people would call up and say, "What's going on with the LPMI bid cards?" And there's always something. And I just think it's a competitive industry. Every player -- we have some really smart competitors. Everyone's looking for a way to continue to build their franchise.

I just wouldn't -- I would just take a step back and say let's look at the big picture. You're on a run rate now with $300 billion NIW for the business and default rates at 60 basis points. You have clear and transparent standards around capital. You have this new technology around ILNs and reinsurance that's -- it's really probably the biggest change industry has had in 20 years. And again, I would look -- again, I would just try to keep this at a higher level. Again, premium rates continue to be strong.

Don't forget, there are places where people discount. There are other places where there's ability to raise price. And I think, again, the unit economics of the business, which is what we really focus on, we continue to be kind of at our return levels.

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Mihir Bhatia, BofA Merrill Lynch, Research Division - Research Analyst [32]

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That's very helpful. And the last question for me just on the OpEx guidance. I think, at the start, earlier this year, you had said $160 million to $165 million for full year. Is that good? Or given the strong NIW, maybe a little bit higher? Just what do you think of that?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [33]

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No, we are still -- it's still in that -- I'd still -- that's a good range still. We're holding to that.

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Operator [34]

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Your next question comes from the line of Bose George from KBW.

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Bose Thomas George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [35]

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Just want to ask about market share. I know you don't like to focus on it that much, but just with everyone reporting, we have your share at 18.6%. The guidance you've kind of talked about historically is 14% to 16%. So any thoughts there? Also, do you think the share is still bouncing around a bit with the introduction of the pricing engines?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [36]

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Yes, I think it's still bouncing around. I think you have the big cards out there. There's a few big players that do that, and that kind of moves the share kind of back and forth in addition to the engine, which I think is probably creating some volatility.

All in, we're holding steadfast, Bose. I still think kind of that mid-teens share is really where we'll end up longer term. It ebbs and flows, but we don't read too much into it. I mean, I was looking at it a couple of days ago and we were probably 14% 8 quarters ago. So it kind of -- it ebbs and flows. I think some of our -- we continue to add customers. I think that's the one message with EDGE that's pretty good. We had a 20% in the first quarter. We had a 35% in the second quarter. So I think there are certain lenders. There was 1 MI that had the engine out. And I think there are certain lenders that liked the engine. So as new -- as other guys come out with the engines, that allows us to break in to some accounts. That's obviously -- the MI buy-in for that is very immaterial, but that tends to grow over time. We continue to grow the franchise.

Again, we don't disclose a lot of the stuff in terms of users but it continues to grow, which again is a positive angle to it. And again, just from a market share in general, with the market close to $100 billion for the second quarter, I think that there is enough for everyone to do well.

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Bose Thomas George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [37]

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Okay. Great. Makes sense. And then just in terms of other growth opportunities, I know growth opportunities remain strong in the U.S. But just curious if you're interested in growth opportunities in some other jurisdictions like Canada or Australia?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [38]

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Yes. I mean, I think, in the past, we've expressed interest and have looked at both Australia and Canada, mostly from a reinsurance perspective. That's been our angle. And we continue to like those markets, I think, just in terms of the strong regulatory environments, good housing, interesting borrower characteristics. Really, longer term, it's something we'll continue to look at. That's one opportunity.

And like I said earlier, I think there's enough opportunity even around GSE reform. There are certain ways there that you could put more capital to work. And third, and we talked about this in the past call is, there's always potential consolidation in the MI industry. And there's always potential and you want to keep dry powder around for that because I think longer term, as you look at lenders consolidating, moving more towards kind of best execution pricing, I think kind of the model of MI in terms of the business model upfront will begin to evolve over time too.

And I think there, there's a case to consolidate and really to leverage costs, which I think will be benefit from an investor standpoint. You can never predict these type of things. There always needs to be a catalyst and there's long range, but if you put yourself in my shoes, you want to make sure you have the capital to take advantage of those opportunities. And there could be other ones that we haven't that could come across our desks.

So I think we look a lot of different things. We don't -- we haven't acted on any of them yet. But that's why you have capital. The minute you distribute a ton of capital, there's some folks that, short term, are very happy. But really -- it really handcuffs us longer term. And I operate the business -- I'm operating the business as if I'm going to run it for the next 15 to 20 years. Whether I personally do that or not is not the point, but I think you have to have a longer range of view. 75% of my compensation is growth in book value per share, so we're going to continue to look for ways to grow book value per share and you have to have a long horizon. Having a long horizon gives you the ability and the patience to make decisions over the long course versus just trying to make them on a short-term basis.

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Operator [39]

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Your next question comes from the line of Jack Micenko from SIG.

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John Gregory Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [40]

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Mark, wanted to get inside the Board's head a little bit on the dividend thinking. I guess, on consensus numbers for this year, you're coming in around 11% payout, no.

(technical difficulty)

about $60 million a year. How do you -- what's the thought process as we look forward? Is it -- are you thinking more payout ratio? Or is it more dollars? And if it's dollars, what's the driver if it's not some sort of ratio calculation?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [41]

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Yes, I think it's more of a payout ratio. Jack is on here looking and saying how much cash are you producing and what portion of that cash do you feel comfortable remitting to the shareholders? So I would focus on that. I wouldn't focus necessarily on the 10 or 11. I think we have a number in mind longer term that we'll shoot for. But I think, again, the key part is the dividend today was -- and we talked about this probably last August when we just had our first deal and people asked us about capital distribution, and I think the response was normal, right? We said we wanted to make sure we had more of the book reinsured. We wanted to make sure we box that volatility when -- run out and distribute capital before we felt comfortable. Getting back to my comment earlier where if we hadn't done any ILNs with the same amount of capital, we wouldn't have given back a nickel. It would've been -- it wouldn't have been the prudent thing to do.

But now, 70% of the book, we felt this was a message that we feel good around the sustainability of those cash flows. And then over time, I think the answer is it depends, Jack. I mean, if there's opportunities to invest, and I just went through some of the potential opportunities, they could pan out or not pan out. And if they don't pan out, what are you going to do? You're probably going to look for -- I don't think the payout ratio would change much as we get to -- we'll probably get to a steady-state, but then you would -- of course, you would look at buyback depending on price and where the stock is trading and all those sort of things. It would be -- it wouldn't be prudent not to do that.

I just -- the message today is we're off to a good start. The model is in a transition phase. We feel like we have a lot of capital, continuing to grow that capital, and we still believe there's choices to put that capital to work. And I think we've done a pretty good job of having good returns on equity, and I think the view is we'll continue to exhaust those opportunities.

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John Gregory Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [42]

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Okay. Got it. On the June ILN, given that was a seasoned book of business, was execution, was pricing any better relative to some of the prior deals where the vintages were more recent?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [43]

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Yes, it was better slightly. I mean this is all -- all the deals have kind of traded and priced pretty close to each other, but I would say on the margin, it was better.

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John Gregory Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [44]

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Okay. Just one more for Larry. Larry, does investment income grow if we have, let's just say, call it, 50 bps of cuts between now and the end of 2020? Just because we see a big NIW quarter this quarter and insurance in force keeps growing, that portfolio probably -- does growth outpace rates in the portfolio for the foreseeable future?

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Lawrence Edmond McAlee, Essent Group Ltd. - Senior VP & CFO [45]

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Yes, Jack, it does. We will continue to grow. Cash flows, as Mark mentioned earlier, are very strong. So the growth of the portfolio would outpace those types of cuts and rates. And we do have a portion in the portfolio that's been locked in. The duration of portfolio is about 3.5. So we do have cash flows and bonds that have been locked in at the sort of 3-, 4- and 5-year maturities. So yes, we would expect to continue to grow the absolute dollars of investment income independent of any further rate cuts.

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Operator [46]

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Your next question comes from the line of Chris Gamaitoni from Compass Point.

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Edward Christopher Gamaitoni, Compass Point Research & Trading, LLC, Research Division - MD & Head of Research [47]

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Can you hear me?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [48]

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Yes.

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Edward Christopher Gamaitoni, Compass Point Research & Trading, LLC, Research Division - MD & Head of Research [49]

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All right. So I don't know what happened. Larry, I wanted to follow up on that last question. What's the current reinvestment yields you're seeing in the investment portfolio?

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Lawrence Edmond McAlee, Essent Group Ltd. - Senior VP & CFO [50]

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The reinvestment yield -- okay, so the new assets during the quarter, Chris, were about 2.7%. And the yield on the portfolio as a whole is 2.8% in the quarter.

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Edward Christopher Gamaitoni, Compass Point Research & Trading, LLC, Research Division - MD & Head of Research [51]

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That's helpful. And now with 70% of the book reinsured, is there any commentary that you can provide us on kind of how you think the portfolio would perform during a significant stress event, Moody's, whatever scenario you want to reference?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [52]

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Sure, Chris. I mean, I kind of look at it in terms of kind of columns left to right. So if you think about the base case on the left column, 2% to 3% claim rate, which is our normal forecast. Obviously, the mid-teen ROEs would be sustainable due to recession -- moderate recession where the claim rate rises to 5%. And same thing, the mid-teens ROEs. And the reason is you're going to attach it 2.25% and the ARB attachment goes all the way up to 7% or 8%. So all those losses now are absorbed by the reinsurance so you maintain those midteen ROEs.

Go to a crisis now and they only had 10% claim rate we'll use, for example, which is not as quite - is right where maybe the Great Recession could be given where -- I mean, claim rates would be given where we have higher FICOs than we had in the past. There, I think we're still clock in at low-single digits. And again, I think that's because we would attach at 2.25%. We detach at 7% or 8%, so we'd have a little -- we'd have the first loss and we'd have a little bit above the detachment. So I think we feel pretty good in terms of just how the portfolio would perform during a stress scenario. Another way to look at it, Chris, is just look at the amount of shareholders equity we have on the balance sheet, $2.7 billion. We have another $1.5 billion of off balance sheet, which I mentioned in the script. So that's $4.2 billion against a roughly $150 billion book. That's close to 3% capital. So we feel pretty good from a capital standpoint.

So again, as we think about the ways to withstand a recession or something really severe, I think looking at it both ways is -- both the ways is how we look at it. We obviously run the model, but then I kind of look at it from a real high level and how much capital we are going to have in times of stress, and I think that we feel pretty good from that standpoint.

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Operator [53]

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

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [54]

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Look, just one very high-level question. One of the big themes that's been outlined for the industry over time is the opportunity as millennials enter the first-time homebuyer market. I'm curious given what you guys are seeing if that's actually really manifesting at this point? Or is that still sort of a theoretical development?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [55]

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I think it's more than -- I think it's well on its way, Rick. As you can see, just in terms of homeownership rates, I think ticked down a little bit in the past quarter, but had been up. A big portion of new homeowners has been first-time homeowners. And I think just look at the overall level of originations, I mean, and look at where builders are and how they're building. I read something that White House put out a press release about a month ago saying for every 10 households being formed, only 7 homes are being built in the country. So clearly, supply is still lacking. But I think the demand thesis, which we laid out now, I think this is right in our first quarter of going public that we believe demand for housing would be stronger than people think. I think that's playing out well.

And I think it's a good point that you bring up. Again, from a secular standpoint, we have a decent tailwind. And I think that we do follow the fortunes of housing. So when you think -- and we've talked a lot about of the detail here, which is critical. But when you take a step back and look from a macro standpoint, we do have housing, and we see it -- I see it just traveling around the country when I visit clients just that I call that third ring. The first ring was post-World War II, the first suburbs. They obviously got filled up. The second ring was in the '80s. And now the third ring is really where you're pushing further out from the city limits. You're starting to see that really develop.

So the millennials, really, they have to live somewhere, and I think that's -- so you're starting to see this third ring around the cities really start to develop. And I think that will play out. I think -- again, I think it's going to play out for a while and it could be over the next 3 to 5 years until the amount of the supply catches up with the demand on the housing side.

Again, that's not a straight line up. That's the caution, right? I mean rates went up in the fourth quarter last year. That's going to cause a pause. So it's been my view that the market will continue to go higher, just won't go in a straight line. There'll be stops and starts, and there'll be panics when it happens because -- just like it was in the fourth quarter last year.

But again, I think longer term, I think that's a little underappreciated is where we stand that the MI's position in kind of a secular growth of housing.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [56]

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Well, it's interesting that you talk about that third ring as we move to a more flexible workforce, either gig economy or work from home, as bandwidth continues to improve. That makes the third ring a lot more accessible as well.

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [57]

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It really does. I mean, I think, in the second ring, which I was fortunate enough to live in, you've knocked down a farm, scraped off all the grass and you were there with 60 homes by yourself. There was nothing really around you. And now you're right, that third ring, they're bringing kind of these mini towns, and you see a lot of amenities such as Starbucks. And you're right, the ability of the worker to work remotely saves that long commute into the city. So it's becoming much, much livable out there. A lot more walking areas, mix of townhomes and single families, so it's actually -- I think it's very attractive for young families. And obviously, they'll start to build very nice schools too.

Remember, families are attracted to schools. That's the #1 reason why young couples with kids move out of cities because they want to go into good schools and all the good schools are in the suburbs. So you're starting to see -- we'd see it in the Philadelphia area. That expansion west. And first you see the developments, then you see the housing. And these play out over a long time. This isn't like a 3-year -- these are 5-, 10-, 15-year phenomenon. So we're seeing that. And I see it in a lot of other places. But you're right. It's -- I think it bodes well for -- certainly for the mortgage industry and certainly and obviously for the MI business because we follow the fortunes.

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Operator [58]

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Your next question comes from the line of Geoffrey Dunn from Dowling & Partners.

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

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Mark, with 70% plus of the book now covered and that number likely going up when you do the '19 book, I'm curious if you have any update on thoughts on cat cover reinsurance. Is that a market that is developing at all? That you're looking at more given where the XOL coverage is today?

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

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Yes, I do. We did it on the '17 book. We went out and did a reinsurance cover, and that was -- it wasn't easy to place. It's a little thin up there from a reinsurance perspective. I think a more logical execution for that, Geoff, is in the capital markets. I do think and that's something we're looking at. Remember, we continue to test these various structures. I wouldn't be surprised if we look at moving higher up in the structure, maybe in our next deal or 2. So again, it's something we will continue to look at. Because I think you want to -- you want to almost take it off the table in terms of potential kind of detachment. And I think the pricing there, the capital markets are out there, you can do it. I believe one of our competitors did go higher, and it seemed like it priced pretty well.

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

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That actually feeds into my second question, which is what dictates the attachment points in the new business? Obviously, [National's] came in below 2% on its latest deal. And then obviously, there's the back-end detachment. So if you could address both sides of the ILNs, if you could, please?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [62]

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Yes, I think our model is, obviously, it's hard to raise. You have to -- you're hedging your model risk I think when you get to the higher attachment points. And I think that's something -- some of it is just a comfort level, and it really just comes down to what the cost of it is. I think on the attachment points, I think there's a little bit of price there too. And I think our view is, I think they're all kind of in the same neighborhood, so kind of in that 2% to 2.5% range. I don't know if there's a lot of science between one or the other, but I think it really is going to come down to cost. And that's how we look at it, which is we're not -- we feel comfortable in that 2% to 3% claim rate.

So I think the only reason you go higher than where we are now is if the market kind of forced it. And that could certainly happen, right? You can get into -- in the next 18 to 24 months where the ILN investors start to see a slowdown and they start to think the attachment point is going to get a hit, so the first thing they're going to want to do is raise it. That's what I would do. And I think there, what we would -- and I think our -- one of our responses to that would be now that we're holding that additional risk, is there a means through the pricing engines to reflect that higher cost, so to speak, in upfront pricing?

Again, that's just -- the industry never had that before. The industry had 1 price increase in 2008, and it was a large one. It's really 2 price increases. There was the removal of captives and there was a 20% increase just across-the-board via the rate cards. It was like one fell swoop. It's too little, too late. But the industry didn't have the tools then to raise pricing. I think here, it will be in a much more incremental basis, and that's what we're testing today. We're testing lower prices and higher prices because you're looking to that blended premium. So I think that's, again, when I think about the engines, the biggest message there is the ability now to price at the loan level and just the flexibility to both increase and decrease price over time. And I think there is a pretty strong linkage between what we're doing on the reinsurance side and how we're going to price on the front-end.

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Operator [63]

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

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [64]

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

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Operator [65]

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Ladies and gentlemen, thank you for your participation. This concludes today's conference call, and you may now disconnect.