Genworth MI trading at all-time highs


Since their quarterly report at the end of April 29, Genworth MI is trading at all-time highs. I haven’t had a chance yet to listen to the conference call, but I would expect management signaled that the foreseeable future is relatively stable and that their loss ratio estimates are on the conservative side.

The question is – how much better can things get? No defaults at all in the Canadian mortgage market?

Assuming all things are equal to today, one would expect Genworth to earn about $3.80/share this year and next year this would be slightly higher due to mortgage insurance premium increases. The mortgage premium increase will attribute for a $35 million increase in written premiums in 2014 and $70 million in 2015. This will effectively equalize their current differential between written and earned premiums; earned premiums have been higher than written premiums for the last five years.

Doing some math would lead an equity investor to expect approximately a 10% total return, minus market valuations (P/E, P/B expansion) and other external events (competition, real estate volumes, etc.).

Considering your typical bond investor is going to be lucky to make a decent 5% yield with a A- to BBB risk profile (your typical US$ BBB-rated 5-year bond yield is currently at 5.8%), and Genworth MI’s rating is A-, there is a healthy equity premium associated with the company that would still justify holding the shares. Genworth MI itself just issued 10-year debentures at about 4.25% for 10 years recently. However, the company has long since passed the point where it is bargain territory.

Genworth MI itself is a glorified bond fund, with about $5 billion in assets invested with an average yield of 3.6% and duration of 3.7 years. This, along with the liabilities associated with the mortgage insurance business, is valued at $3.7 billion presently. Given the “if all things are equal” projection, it does make financial sense for the company to still invest in its own equity since there is a good yield spread of about 5% still to be harvested. If you give a “natural” equity premium of 3% then there is 2% left to run – i.e. around $44/share.

I hope momentum and yield investors (speaking of which, is about 3.6% at current prices) actually does that. If and when they do, I will take that opportunity to unload shares.

What is keeping back the market from bidding up the share price are all the obvious factors concerning the general perceptions of over-valuation in the Canadian real estate market and macroeconomic factors, including the Fairfax doomsday scenario. If the commodity sector starts to sneeze and prices decline, then it will have an impact on employment, which will subsequently have an impact on the overall health of the mortgage credit market.

Right now Genworth MI is priced for some fairly rosy days ahead of itself and this bodes well for the general Canadian economy. Are investors right? How long will this last? I don’t know.

Genworth MI, on account of its appreciation over the past 20 months, is still a significant component in my portfolio.