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Edited Transcript of ESNT earnings conference call or presentation 8-Feb-19 3:00pm GMT

Q4 2018 Essent Group Ltd Earnings Call

Hamilton HM 11 Feb 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Essent Group Ltd earnings conference call or presentation Friday, February 8, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher G. Curran

Essent Group Ltd. - SVP - IR

* 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

* 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 Lindsay, and I will be your conference operator today. At this time, I would like to welcome everyone to the Essent Group Ltd. Fourth Quarter 2018 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 Group Ltd. - SVP - IR [2]

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Thank you, Lindsay. 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 fourth quarter and for full year 2018 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 their reconciliation to GAAP may be found in Exhibit L 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 20, 2018, 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. Earlier today, we released our fourth quarter and full year results, and I am pleased to report that 2018 was a very successful year for the Essent franchise. During the year, we continue to grow our high credit quality and profitable mortgage insurance portfolio, while also increasing net income and generating strong returns.

In addition, we began to take steps to strengthen Essent's business model by increasing our sophistication around risk origination and risk distribution. Key highlights pertaining to this include the successful pilot of our EssentEDGE risk-based pricing engine and executing 2 reinsurance transactions on our 2017 book of business.

Now let me touch on our results. Our insurance in force grew 25% to $138 billion at year-end compared to $110 billion at the end of 2017. For the quarter, we earned $129 million or $1.31 per diluted share. On a full year basis, we earned $467 million or $4.77 per diluted share. Our results for both periods reflect a $9.9 million or $0.08 per diluted share reduction in our loan loss provision. This reduction relates to updated expectations on defaults associated with Hurricanes Harvey and Irma that hit the U.S. in 2017. Larry will discuss reserves in more detail in a few minutes.

Our balance sheet remains strong, ending the year with $3.1 billion in assets and $2.4 billion of GAAP equity. Also we grew adjusted book value per share 24% to $24.29 at year-end 2018 from $19.64 as of December 31, 2017. As a reminder, senior management's long-term incentive compensation is driven by annual growth rates and book value per share. We believe that book value per share growth is a key metric in demonstrating value to our shareholders.

Our outlook for our business remains positive, as we believe that demographics such as the millennials coming of age and purchasing homes for the first time continue to drive demand and support housings' longer-term fundamentals. As a reminder, purchase mortgages are positive for our franchise as the MI penetration rate on these is 3 to 4x that of refi mortgages. With low unemployment rates, affordable 30-year fixed-rate mortgages and builders increasing supply for first-time homebuyers, we remain optimistic heading into 2019.

On the industry front, we continue to see utilization of risk-based pricing engines, and we recently announced the rollout of our engine, EssentEDGE. While EssentEDGE mimics our current pricing, we believe it provides flexibility to increase or decrease rates allowing us to better shape our portfolio. The engine also provides the capability of pricing more credit attributes at the loan level, unlike the current rate card structure, which is based on broad FICO, LTV and DTI ranges. While not all of our customers are using EssentEDGE, we believe that over time most lenders will enhance to our front-end processes and technologies to access our engine.

As noted in our press release, we successfully executed an excess of loss transaction with a panel of our insurers during the fourth quarter. The reinsurances on 2017 NIW and attaches above the existing Radnor Re insurance linked note transaction completed in March of 2018. The ILN transaction was for $424 million of protection on approximately $10 billion of risk and the XOL transaction adds $165 million layer on top of the ILN.

On a combined basis, as of year-end 2018, the ILN and XOL provides $589 million of protection on top of a $225 million first loss layer that we retain. We are very pleased to have completed these transactions and plan on executing additional reinsurance transactions going forward.

From Essent's beginning, we have taken a long-term approach to ensuring and managing mortgage credit risk. Given the cyclical and long-tail nature of the MI business, we recognize the limitation of a buy-and-hold approach. Accordingly, we continue to evolve into a more sophisticated risk manager by distributing risk and diversifying our sources of capital. This allows us to hedge against adverse stress scenarios and mitigate housing cycle volatility, while making Essent a stronger and more stable counter party.

In addition, distributing risks to the capital markets and reinsurers is not only a edge to our cycle-dependent franchise, but can also be accretive to returns by freeing up capital at a lower cost without adding financial leverage to the balance sheet. We believe that this strategy, along with future earnings, should generate excess capital going forward. Our objective in best deploying excess capital will be to strike a balance between return objectives and strong capital levels, while also giving consideration to what is in the best long-term interest of our franchise, policyholders and shareholders.

On the Washington front, we continue to believe that Essent and our industry are well positioned to support a well-functioning and robust housing finance system. We also believe that this position will strengthen as we execute upon our buy, manage and distribute strategy. We look forward to working closely with new FHFA leadership, and we will continue to support USMI and engage with policymakers and promote the benefits of private mortgage insurance and our strengthening business model.

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. Good morning, everyone. I will now discuss our results for the quarter in more detail. Earned premium for the fourth quarter was $173 million, an increase of 4% over the third quarter of $167 million and an increase of 17% from $148 million in the fourth quarter of 2017.

Note that premium ceded on our reinsurance transactions are reflected as a reduction of earned premium and were $3.7 million in the fourth quarter and $3.2 million in the third quarter of 2018. The increase in premiums ceded in the fourth quarter is due to the placement of our excess of loss reinsurance coverage, which was effective November 1. We had no reinsurance in place or premiums ceded in 2017.

The average net premium rate for the fourth quarter was 49 basis points, which was 1 basis point lower than the third quarter of 2018 due to the increase in premiums ceded under the XOL transaction, a lower level of single cancellation income and the impact of lower BPMI pricing implemented in 2018. We expect our average net premium rate to decrease to approximately 47 basis points by the fourth quarter of 2019. This reduction in the premium rate is anticipated to be driven by the BPMI pricing changes enacted in 2018 and an increase in premiums ceded based on our expectation that we will increase the percentage of our insurance portfolio that is covered by reinsurance.

Investment income, excluding realized gains, was $19 million in the fourth quarter of 2018 compared to $17 million in the third quarter and $12 million in the fourth quarter a year ago. The increase in investment income of 12% over the third quarter of 2018 and 58% over the fourth quarter of 2017 is due to an increase in the balance of our investments as well as an increase in the yield under our portfolio. The yield increased from 2.2% in the fourth quarter of 2017 to 2.8% in the fourth quarter of 2018, primarily as a result of the impact of the increase in market interest rates for new assets purchased and an increase in the average duration of the portfolio. We remain pleased with the credit performance of our in force book. Our provision for losses and loss adjustment expenses was a benefit of $1 million in the fourth quarter of 2018 compared to a provision of $5.5 million in the third quarter and $17.5 million in the fourth quarter a year ago. The provision in the fourth quarters of 2018 and 2017 were both impacted by Hurricanes Harvey and Irma.

In the fourth quarter of 2017, we reported a reserve of $11.1 million associated with the increase of 2,288 defaults in the areas impacted by the hurricanes. Based on favorable cure activity and our expectation of the ultimate losses to be paid, the provision for losses and loss adjustment expense in the fourth quarter of 2018 includes the release of $9.9 million of the reserve previously recorded in 2017. The default rate on the entire portfolio increased 5 basis points from September 30, 2018, to 66 basis points at December 31.

Other underwriting operating expenses were $39.4 million for the fourth quarter of 2018 compared to $36.9 million in the third quarter and $36.5 million in the fourth quarter a year ago. We continue to leverage our platform as evidenced by the reduction in our expense ratio from 27.5% in 2017 to 23.2% in 2018. For the full year 2019, we estimate that other underwriting and operating expenses to be in the range of $160 million to $165 million.

Our estimated annual effective tax rate as of the end of the third quarter was 16.2%. As of the year-end, our final effective tax rate for 2018 was 16%. As a result, our effective tax rate for the fourth quarter was 15.5%. We estimate that our effective tax rate for 2019 will be in the range of 16% to 16.5%.

The consolidated balance of cash and investments at December 31, 2018, was $2.9 billion. The cash and investment balance at the holding company was $78 million. No capital contributions or dividends between the holding company and operating businesses were completed during the most recent quarter.

At year-end 2018, we have $275 million of undrawn capacity under the revolving component of our credit facility and $225 million of term debt outstanding. As of December 31, 2018, the combined U.S. mortgage insurance business statutory capital was $1.9 million with a risk-to-capital ratio of 13.9:1 compared to 14.1:1 at the end of the third quarter. The risk-to-capital ratio at year-end 2018 reflects a reduction in risk in force of $589 million for the reinsurance coverage obtained from our insurance linked note and excess of loss transactions.

At the end of the fourth quarter, Essent Re had GAAP equity of $799 million, supporting $8.3 billion of net risk in force. In addition, Essent Guaranty's available assets exceeded its minimum required assets as computed under PMIERs by $362 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 credit performance and our market presence. Looking forward, our outlook on our business remains positive, and we believe that increased utilization of risk-based pricing and reinsurance will make Essent a stronger company.

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 the line of Mark DeVries with Barclays.

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

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Was just hoping to get your updated thoughts on your ability/interest in return in capital here?

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

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Yes. Mark, I think, as we look at the end of the quarter or the end of the year, we feel like the excess that we have, PMIERs $360 million, we have HoldCo cash, we have a little excess at Essent Re, we're probably in the strongest capital position that we've been in since we started the company. That being said, a lot of that excess has been driven by the insurance linked note transaction that we did earlier this year -- earlier last year. And it really only covers 30% of our insurance in force. So once we complete a deal in the 2018 book, which we would expect to do in 2019, I think a lot more visibility in the kind of the sustainability of that excess, Mark. So once we do that, and I think we'll look at all factors. So first and foremost, we would look to reinvest in the business and I'll remind you that we grew insurance in force 25% year-over-year. So there's still opportunities to be deployed in the business in the states. Bermuda continues to grow, and we really like some of the opportunities in Bermuda, like we said, it's another platform for us to grow and take on U.S. mortgage risks. So there's opportunities there, and there's potentially opportunities outside the company. That being said, we will look to and we'll evaluate capital distribution. I think, we've been pretty thoughtful life to date in terms of how we -- how efficient we've been around the use of capital, both equity and debt. We're going to -- we'll apply that same thoughtfulness to capital distribution. So I would stay tuned, but it's something that's on our radar screen, and we'll be able to update you more in May, assuming we can get a deal done in the first half of the year. Once we get that deal done around the reinsurance, I think, we'll be able to give you more visibility around that question.

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

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Okay. And given how attractively priced the reinsurance is that you can get through the ILN market, do you think it'll make sense to ensure up to 100% of your risk?

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

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I think at some point, that's the plan, Mark. I think that's the plan. I think we're more concerned obviously with future books. The past books are relatively pretty strong, right, especially from a mark-to-market LTV standpoint. But if you look and say 2017, '18 and say the 2019 book, that's going to be 80% of insurance in force by the end of this year. So we're more focused on the newer production, but the plan over time and again, we've said this before, we would look to at the end of each year, reinsure that book. So over the course of the next few years, we would expect to have 100% of the book reinsured.

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Operator [6]

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Our next question comes from the line of Bose George with KBW.

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Bose Thomas George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [7]

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So just following up on that question on capital. I mean, it looks like you guys have a deal in the market, an island transaction. So I mean, to the extent that happens, I mean, could we hear something on capital sooner? Or do you still think there could be -- it's something that you have to assess maybe a little later in the year?

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

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Well, again, we can't really comment on the deal. And I think once -- again, our plan is to reinsure the '18 book during the first half of 2019. And once that deal gets done, I think, we'll have more visibility that we'll be able to share. I'm not saying there's any answers, Bose, to be sure, but I do think we are evolving. As we continue to generate excess capital, we're going to look for opportunities to put that to work again in the business or potentially distributed shareholders. So we'll be thoughtful about it. I wouldn't -- I think, once we have that deal, if we're able to complete that transaction, we would be 50% of the book, a little bit over 50% of the book will be insured. So we'll have more visibility, but again we're going to be thoughtful about it. And I think, we've been good stewards of capital. So I think that's the real message for investors to take away, as we're going to be really thoughtful about this and we're going to do what's in the best interest of shareholders. There's no doubt about that. There's just no rush to do it and give answers. I know every quarter folks want to hear answers, but I would say, we feel like we're in a good capital position. Remember capital begets opportunities. We just want to make sure that we get -- we feel better around the insurability of the portfolio and able to execute those transactions. And once we do, we'll send a pretty clear signal to the market.

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Bose Thomas George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [9]

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Okay. Makes sense. And then actually just on the XOL transaction that you guys did, can you just talk about is there an incremental capital benefit to adding the XOL on top of the ILN?

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

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Yes, it's a good question. I mean, it does add incremental capital release both from an economic capital and we believe from a rating agency. There is no PMIERs credit for that. So our thought with the XOL was we wanted to tap into an additional source of capital, which is the reinsurance -- the reinsurers, which we hadn't done to date. We also wanted to test higher up in the structure. So we feel we're pretty well covered now from, say, 2% in a quarter to closer to kind of 9-plus percent. So that's -- we feel in terms of, people have asked us what does that mean in the stress scenario? It's a pretty good result. So base case is our 2% to 3% claim rate. If we were to hit a mild recession, mild plus maybe with a 5% claim rate, our returns would still be in the mid-teens, right, because we wouldn't -- 5% claim rate we'd hit into the reinsurance. If we were to take that 2017 book and put it through the great recession, we think that claim rate would be right around, say, 12%, which is a little lower than the great recession. But keep in mind, it's a better credit quality book. That's the case. We're probably still low single-digit return set, that's a pretty strong statement. And I think that's the real takeaway with reinsurance is it's removing not only the volatility from some of our earnings, but removing the volatility from the balance sheet. I think that's a key. So when we talk about [rapiding] into capital distribution, we want to make sure that stuff is set first before we -- the worse scenario would be -- we do -- we start to talk about capital distribution and we haven't protected the balance sheet. And that's our #1 goal. Credit kills these businesses, and we will go in, not sure when we'll go into the next recession, but I'd much rather going to a recession knowing that we have protection on the book.

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Bose Thomas George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [11]

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Okay. Makes sense. And then actually just the run rate cost on that XOL, that's about $1.5 million a quarter. Is that right?

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

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No, not only XOL, I would say, I would look at all in. Bose, a simpler way to look at it is probably approximately 5 basis points on the cost of those transactions. So if you think about -- that'll work its way into the portfolio over time. It clearly impacted some of that in 2018, but I think that's a simpler way for you guys to think about it.

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Bose Thomas George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [13]

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Yes, okay. And the 48 basis point guidance that you gave us for the year, the net number, it incorporates the cost of this transaction as well as the sort of the lower NIW premium stuff coming in, right?

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

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Yes, it is. It's a combination of a pricing change that hit us way halfway through the year and the reinsurance. I think, the number was 47 that we gave in terms of the guidance. So 49 in 2018 trending down to 47 by the end of this year.

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Lawrence Edmond McAlee, Essent Group Ltd. - Senior VP & CFO [15]

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Correct.

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Operator [16]

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Our next question comes from the line of Rick Shane with JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [17]

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Mark, can you hear me?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [18]

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Yes, I can, Rick.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [19]

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I apologize I got dropped off the line for a second. So if got queued up and got kicked at, I apologize. Look, I heard the questions about return of capital and realized that there are some events that need to occur before you approach that, but love to talk philosophically about how you think about the difference between dividend and repurchase. Obviously, repurchase is accretive to earnings with the stock trading and the premium to book. It does dilute book value a bit. Just want to see how you would think about that going forward.

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [20]

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Yes. It's something -- I think, we're going to look at both very carefully, and I don't think we have a good answer for you today. I do think dividends is a strong demonstration of kind of the cash flow generation of the businesses. And I think, it'll become more readily apparent as we move forward and continue to generate that excess capital. I think in terms of repurchase, I think it's more opportunistic. I don't think you want to get on into a program where you increasingly buy back shares at an increasingly high share price. That's dangerous. I think, we lose capital flexibility there. And again these are balance sheet businesses, strong capital begets opportunities, and you don't want to get into that type of game. I don't think that's in the best interest for shareholders long term. That's short term, I think, some folks may like it, but again we're building this business for the long term. And remember we're all -- the senior management team is all shareholders. So we're pretty focused on providing shareholder value in addition to building a really good business. So again, it's something we'll be thoughtful about and just like we did when we raised equity and we raised -- we build our line of credit, some of it's going to depend on market conditions and it's something that'll be under evaluation, is under evaluation now and obviously is going to be an increasingly bigger part of the Essent story going forward.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [21]

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Got it. Yes, look, I think, ultimately, these are high-quality questions you get to ask yourself.

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

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Yes. It's a good problem to have, to be honest.

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Operator [23]

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Our next question comes from the line of Doug Harter with Crédit Suisse.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [24]

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Can you talk about your outlook for expenses? And how much lower you think the expense ratio can ting up?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [25]

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Yes. Sure. I mean, again, we're much more focused, Doug, on the nominal expenses. So we gave the guidance of $165 million. In terms of expense ratio, I think it's going to be the math. And don't forget we're in an environment where the premiums are coming down, right? We have those -- the compression in premium that hit last year with the rate card change, which for all intents and purposes was mitigated by the reduction in taxes. So the returns were similar, and then we're obviously ceding premium for the reinsurance, which we think is a great trade-off. This is going to impact on the expense ratio. So the old story of premiums being, as they continue to grow and expenses continue to go down, it's going to be a little bit different. So I don't know if it's going to be as important of a gauge. I still think, we're still in that 35 to 40 kind of guidance when you put it all together. However, I don't -- I wouldn't expect a continual decline as you may have in the past. I mean, there's a little bit of moving around of some of the factors. The important takeaway though is returns are still strong, and I think that's the one. I wouldn't get too caught up in the ratios, but I think the big ratio is where the -- what's the return on equity and we still feel like that's firmly in the mid-teens.

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Operator [26]

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

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Philip Michael Stefano, Deutsche Bank AG, Research Division - Research Associate [27]

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So Mark, as we think about the building of capital and the opportunities coming out of Bermuda, I feel like it's been a while since we talked about the internal quota share. Are there any updated thoughts around that? Is 25% still the right number? Now that you've had a chance to digest the tax reform, I was hoping to revisit that.

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

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Yes. I mean, I think, we're still in the camp of the 25%, Phil. Remember, we're still subject or could be in and around the V Tax in the calculation. And we feel like with the 25% quota share, we are -- we have a nice margin of safety with that. And there's really no -- there's no really -- there's no desire or intent to kind of grow that. So a very good question. I think that the real story around Bermuda is the continued growth in the third-party business. And again, it's relatively small compared to our U.S. business, but that's not to take away from how well it's done and we've done well over 50 GSE risk share deals. We started to build out the MGA and are starting to help larger reinsurance companies deploy capital. It's a real platform for us to take on that risk and some nice optionality in terms of the market. So if the market were to soften, I think there could be more opportunity to write business there in Bermuda. It could be some impact on the reinsurance, but those things are always linked. So we like kind of the optionality that our Bermuda platform brings.

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Philip Michael Stefano, Deutsche Bank AG, Research Division - Research Associate [29]

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Got it. And then, Mark, earlier in -- I can't remember if it was your prepared remarks or response to the question, you said something about additional reinsurance transactions and maybe I'm parsing the words too much, but is this going higher in the tower with additional XOL? Or is this just putting ILNs and XOL on additional vintages as we look forward?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [30]

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Yes, it's more towards additional vintages. We're -- yes, I think, we're done on the 2017 book and it's -- our focus now is to reinsure the 2018 book.

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Philip Michael Stefano, Deutsche Bank AG, Research Division - Research Associate [31]

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Got it, okay. One more quick one on EssentEDGE. I've asked some of your competitors, and nobody wants to venture number on this, but I'm going to keep banging. How many pricing inputs and metrics are you guys currently utilizing? Is there a right number that you think about being the tipping point of getting pricing "right"?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [32]

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That's a great question. We'll be pretty upfront. We use approximately 12 to 15 factors around the model. And it's the same factors we've used historically, Phil, to assess losses and to assess our economic capital. We just never really had the ability to pass that on the pricing because remember, up until last June, the rate cards were only comprised of 2 factors and then after June, it went all the way up to 4 factors. So we never really had the ability to kind of be more granular on the pricing. So we think that 12 to 15 -- can't really get into the factors, but we do think it's more meaningful and allow us to deliver more granular pricing. Initially that it'll mimic the rate card pricing, more or less there'll be some -- as more granular, there'll be some ups in some places where it'll be higher, some places it'll be lower. But the goal right now is to keep it right around very similar pricing. The important point around the edge and this gets lost is the flexibility that it provides to both increase or decrease pricing. It just didn't have that flexibility of the rate card. You have to go to 50 states, you have to refile and you also have very difficult decisions with lenders. We've been doing this now for close to 10 years at Essent, and I've always found when we lower rate cards to the lenders, it's very well received. That's never not well received. It doesn't really go that way the other side. And I think as you go into a potential slowdown, the industry experiences back in '08, it's very difficult to pass on price increases. And I think now with the flexibility of the engine and the fact that we're pricing each borrower separately, should we see a slowdown or here's a good example of how it's linked to the reinsurance. If we go and reinsure parts of future books and that cost is higher, well, that's when market is telling us something around credit and maybe we're not aware of. Now we have a mechanism to link that back to the front-end in a more granular basis. So we don't have to have a hard discussion with the lender, which is very difficult when you're among 6 competitors. So there's a little bit of gamesmanship there at the lender level that it's very hard to get across, but if it's through the engine you may decide there are certain regions you don't like. There is a certain pocket of LTVs or DTIs or whatever FICO ranges that you're not as comfortable with given where you think HPA is going in this region. You now have the ability to adjust pricing. And I think that is -- that's good spirit, that's the real big picture. I think when we talk about getting more sophisticated around risk origination, that's what we mean with EssentEDGE. This is a risk tool. It's not a market share tool. It's not a pricing tool. Originally, when the engines hit the market back in 2010 and '11, when UGI first had it, it was a way to pass on lower price. And that was the way to do it; it was priced well below the card. That's not the case anymore. I think you're going to find engines that have higher prices in certain pockets and other ones have lower. Each MI, I think, eventually will have their own kind of credit appetite. And as you think going forward, Phil, it's going to be credit. Credit selection is going to be a key differentiator in terms of the MI business. That's never really been the case before. It's all been the same rates, the same underwriting guidelines and I think we're relatively well equipped to be in this new world and how you work that in the new factors and all so forth is -- will be seen how successful some guys can be, but I think the flexibility of it is really the important takeaway.

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Philip Michael Stefano, Deutsche Bank AG, Research Division - Research Associate [33]

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Mark, your candor around the edge and recessionary returns is refreshing, and I hope that some of your peers are also so forthcoming with information. We appreciate it.

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [34]

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You're welcome.

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Operator [35]

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

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Mackenzie Jean Aron, Zelman & Associates LLC - VP [36]

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Mark, I guess, just the last question from me, it's just related to on your outlook. As you look into 2019 on volume, what the opportunity could be this year given what we're seeing on the origination? And then secondly, with rates doing what they've done year-to-date, can persistency continue to improve and just what should we be expecting for the year on these 2 metrics?

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

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Sure. Hope, all is well is with you. We are -- in terms of persistency, I think, the guidance this year is still in the low 80s. I mean, we're a tick higher than that in 2018, but I think that's good guidance. Longer term, it's hard for us to give guidance anything above 80%. I always think 80% is a good long-term guidance. In terms of NIW, clearly I think the market was impacted in the fourth quarter. There was a pretty sudden rise in rates, Mackenzie. And I think it took a while for consumers to adjust to that, which I think is natural and then you historically go into the fourth quarter slowdown. I think our view on 2019 NIW right now, I think, we believe it will be similar to 2018. I think once we see where the spring season goes, that'll give us some more visibility into that, but right now we're not seeing much to say it's going to be different. And remember, we are levered to the first-time homebuyer. And as you guys know, you cover builders, the builders are still -- in fact, a lot of builders are increasing their supply around the first-time homeowners. So our average loan size is $230,000 and when you look at some of these newer homes, they are in that $200,000 to $225,000 range. So it's -- I think we're actually well positioned from that and we've always said, we believe because of the demographics that housing will be bigger and it'll continue to grow. We never said it will be in a straight line. So there's always going to be fits and stops and those stops could be quarters. They could be a year. But longer term, we still think the fundamentals around housing and the ability for it to continue to grow are still in place. So I think that's why we say we remain optimistic for 2019, but, I guess, we'll see when the spring season hits.

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Mackenzie Jean Aron, Zelman & Associates LLC - VP [38]

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Okay. Good to hear, and we certainly agree with that. Just one quick one on the modeling. Does the tax guidance, does that include the expected tax benefit from stock comp in the first quarter?

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Lawrence Edmond McAlee, Essent Group Ltd. - Senior VP & CFO [39]

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No. Mackenzie, this is Larry. That's really a great question. That's a discrete event that we would recognize in the first quarter. We expect that to be relatively moderate this year. Last year was a little bit larger because of the vesting of certain shares in the first quarter of the year, but we would estimate the impact of that to be between $0.01 to $0.02 per share in the first quarter.

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Operator [40]

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Our next question comes from the line of John Micenko with SIG.

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John Gregory Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [41]

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Mark, when you talked about EssentEDGE a couple of times both in prepared and Q&A, you mentioned the word mimic and I'm curious, I think just on pilot, so does mimic mean you're just sort of running it and testing it and seeing what adoption looks like? Or was that meant to say, "Hey, we're not letting our customers arb us on price in our engine versus the rate card," and maybe that has broader implications for what may be the market -- what's happening in the marketplace, just curious?

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

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Maybe, yes to all of the above. We're certainly just testing. And we're very -- we set this last year with the pilot. We're very focused on adoption by lenders and getting the ease of use. Yes, we don't really want to turn it into an arb. So it's very similar to the overall, I would say, premium rate. I think that's the thing to focus on, Jack. We're targeting earned premium rate. So certain pockets may be lower, sales meaning some may be higher, but there shouldn't be much difference from a lender perspective around the card versus the engine at this point in our life cycle. And we felt when the rate cards changed last year in June with the addition of DTI and the multiple borrowers, we felt like that, that captured a lot of kind of the inherent risks that were the differences between the cards and the engines. And it's given us a lot of time now. So we can get the engine out there, get it adopted, get lenders using it. And again longer term, it's the more the lenders use it, the more you have that flexibility that I spoke about earlier. So again, there's an operational component to this and -- that we're very well aware of and the lender market didn't change overnight. I mean, lenders still have to close loans and so under our underwriting and how well we do that is still part of the business. So the edge is really just another tool, of which we can help lenders grow their businesses. So we're not really in it to gain share with it or change pricing that drastically. We'll continue to test and look at additional factors. So we would expect the engine to evolve over time. It's kind of like a journey. And you think about the credit card business evolved over time too in terms of how they use different factors. So I think it's very, very early in its life cycle. But as I said earlier, longer term, I do think it shift some of the pricing power from the lenders to the MIs, and I think that's -- it's a subtle point, but it's going to be a real valuable point, especially in times of stress.

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John Gregory Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [43]

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Okay. And then you also said as part of the capital conversation earlier in the Q&A, opportunities outside of Essent. Can you elaborate more on how you're thinking about what that means?

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

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Yes. We always look at things outside of Essent. I think that's we're in the capital allocation business. I wouldn't pay that much mind to it, to be honest, unless a really good opportunity came up. We're really focused on the 2 existing businesses. I think that's our -- that's the best place to deploy capital, and we're not going to deploy capital outside Essent just for the sake of doing it. We would certainly rather distribute it to shareholders versus do it just to diversify. That's we're very focused on returns. So it's -- this is -- we've built the business on being focused. So really focused on the 2 core businesses. If an opportunity for big stack pitch came down in the middle of the play jack, we're going to do it, but that's something they happen -- they don't happen very frequently. So we're more focused on the business that we have. And I think capital distribution, like I said earlier, something that's really under careful evaluation.

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Operator [45]

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Our next question comes from Mihir Bhatia with Bank of America.

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Mihir Bhatia, BofA Merrill Lynch, Research Division - Research Analyst [46]

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Just starting real quick. Just had a question on your LTV. 95-plus LTV seems to have stabilized in the last few quarters around 17%. Is that a good number going forward?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [47]

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Yes. I think it is. I mean, it's really been driven by the GSEs, and there's 2 takeaways there. One, the coverage is less than our 95. So the coverage is only 25%. So there's actually -- there's a risk mitigant there. The other mitigant is, at least makes me feel good is, the FICOs are still at relatively high level. It's not quite where the overall portfolio is, but relatively high levels and the performance has been pretty good. So unless since the GSEs are really driving that, unless we're at a price up for it, which I know we have the capability within the engine now to do, we may look to do it. But right now, I think we feel pretty comfortable. We feel pretty comfortable with that limit, but again as the edge gets rolled down to the market there, we may look to shake that if we see something in originations that we don't like, but right now we've been pretty comfortable with it.

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Mihir Bhatia, BofA Merrill Lynch, Research Division - Research Analyst [48]

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Great. And then just, I guess, similar topic a bit. How much -- can you comment maybe on the state of the non-GSE market? Is that something that you all are seeing a little bit more growth in? Is that a market you all are participating in? Or is it still mostly -- I mean, it is mostly all GSE, but I'm just curious on how nonagency is evolving as rates go up? And maybe there's a little more pressure from the originators to do something?

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

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Yes, it's a good question. I actually break it into 2 parts. 5% of our business is non-GSE, but that is 100% bank balance sheet and that's mainly jumbos or professional loan programs and that is gone. I think, we're very pleased with that business. Depending on what goes out to GSE reform, could that shift a little bit more loans to the bank balance sheet? Again, I think, we're relatively well equipped there. In terms of non-QM, clearly a lot of chatter in the market around non-QM. I still think it's relatively small compared to the size of the mortgage market. For all intents and purposes, it's almost FHA fallout. So this is a borrower now that probably can't get an FHA loan, certainly can't get a conventional loan and they're looking kind of at the non-QM market. That's not. And again, I think, advice we give to the lenders is, it's really about efficiencies and leveraging their cost structure. Once you get into some of those products, it's very difficult. It does soak up some capacity, but it's probably not the best way. I think from a risk stand -- for the lender meaning and I think from a risk standpoint, it's not something we're really have -- we've really focused on. And again, there just such a good conventional business out there in the bank balance sheet. And like we said, we're very pleased with our market presence. We don't feel the need to stretch and you can even see that in our FICOs, I mean, very limited kind of percentage of our portfolio is below 680. I think the non-QM for us is not something we're really on our radar screen.

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Operator [50]

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Our next question comes from Bose George with KBW.

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Bose Thomas George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [51]

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Just I had a quick follow-up on the comments you made on the tax rate. So does your annual tax rate still end up being around 15%? So if the first quarter is $0.01 or $0.02 impact, so that's something like 14% and then the others are slightly higher. Is that how it's going to work?

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Lawrence Edmond McAlee, Essent Group Ltd. - Senior VP & CFO [52]

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Bose, no. Just I'll clarify. So the annual effective tax rate, excluding discrete items, we expect to be in the 16% to 16.5% range. In the first quarter, we'll have a discrete tax accounting benefit associated with the shares of our planned invest in the first quarter and the excess benefit on that we expect to be $0.01 to $0.02 per share. So in the first quarter, we'll have a rate -- an income tax expense of between 16% to 16.5% of pretax income plus -- or that'll be reduced by a benefit of about $0.01 to $0.02 per share. For the remaining 3 quarters, we expect our rate to be 16% to 16.5%. Does that answer the question?

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Mark Anthony Casale, Essent Group Ltd. - Chairman, CEO & President [53]

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On a blended rate though, it would be a little lower.

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Bose Thomas George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [54]

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Yes. No, that makes sense, yes.

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Operator [55]

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There are no further questions in queue at this time. I'll turn the call back over to management for closing comments.

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

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

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Operator [57]

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