Genworth MI Q2-2016 results review

Genworth MI (TSX: MIC) reported their 2nd quarter earnings results.

The results are reasonably positive for investors and a shade higher than what the market expectation would be.

Diluted book value per share goes to $38.23, up a dollar from the previous quarter (higher than net income minus dividends due to portfolio fluctuations).

Premiums written were $249 million, up significantly from $205 million in the Q2-2015, but this number was artificially higher due to the closing of the July 1, 2016 regulatory window for the issuance of portfolio insurance (i.e. future portfolio insurance issuances are likely to be significantly lower). Portfolio insurance written has been averaging about $24 million for the previous four quarters, but this quarter was $78 million. Transactional insurance (the type of insurance most people associate with mortgage insurance) was down 7% to $170 million.

Portfolio insurance has been quite profitable as the constituents of the loans are low loan-to-value ratio material – although the premiums received by the company are relatively low to the loans insured, these premiums are basically free money exchanged to entities so those other entities can free up the capital to make other loans. The government announced they were going to put a halt to this activity in the 2013 Budget as entities (e.g. HCG, EQB, etc.) were basically using government guarantees to increase their ability to perform higher amounts of mortgage lending. Now the lenders will have to take higher risk, which would potentially dampen the credit market for residential housing.

Other items of note include the following (quotations are from their MD&A):

The Company has reviewed the proposed methodology for calculating SCRIs and observed that Calgary, Edmonton, Toronto, Vancouver and Victoria would breach their respective prescribed SCRI thresholds at the end of the first quarter of 2016. These metropolitan areas represent approximately 35% to 40% of transactional new insurance written in the first six months of 2016.

Calgary, Edmonton and Vancouver would have been in breach of the prescribed SCRI thresholds since 2010 or earlier and are currently more than 15% above the respective SCRI threshold. The anticipated changes from the proposed new capital framework, including the proposed supplementary capital requirement may impact the regulatory capital requirements for the Company however the final impact will not be known until OSFI publishes the supplementary capital requirements. The Company expects that transactional and portfolio insurance premium rates may have to be increased for affected metropolitan areas as a result of the implementation of the new capital framework in 2017.

If the regulatory framework continues to tighten (i.e. more capital required for “hotter” markets), this would result in increased mortgage insurance rates and hence higher premiums written for future transactions – or perhaps premium surcharges for “hot” metropolitan areas. Not surprisingly, Vancouver is the epicentre of this.

During the quarter the Company entered into a $100 million senior unsecured revolving credit facility, which matures on May 20, 2019.

This was very mysterious. Genworth is solvent, their nearest debt maturity is not until June 15, 2020 ($275 million) and they have plenty of capital that they are using as a buffer until federal regulations are finalized. So why go through the bother to open up a credit facility? Odd.

(Update, August 3, 2016: Remarks were made in the conference call:

CFO: “It’s not earmarked at this time for any specific activity. It’s more in light of build-in financial flexibility to ensure that we’re nimble and whether this is core business opportunities in the MI business, for example, you saw the levels of bulk insurance as we did last quarter. If in the future other opportunities were to present themselves in our core business, and it require incremental capital, we certainly have long-term plans to fund that capital. We may use the facility for short-term need but it’s clearly not intended for a long-term portion of our capital structure.”)

The loss range for 2016 has been revised to 25% to 35%.

The company’s initial projections for losses were 25-40% for the year, but the upward range of this was lowered to 35%. For the first two quarters of the year the loss ratio averaged 22%. This is obviously a good sign for investors.

In order to help improve housing affordability, on July 25, 2016 the B.C. government introduced a four-pronged plan that includes an additional land transfer tax on foreign buyers. As of August 2nd, foreign individuals and corporations will be subject to an additional 15% land transfer tax on the purchase of residential property in Metro Vancouver. The company does not expect these changes to have a material impact on its business, as foreign borrowers are typically not eligible for high loan-to-value mortgage insurance.

I will parenthetically add that foreign buyers typically do not take out mortgages for properties either – these are cash payments as the real estate title is the vessel for storing cash offshore. Foreign investors would not have a requirement for mortgage insurance.

Also, delinquency rates have lowered from quarter-to-quarter. While Alberta and Saskatchewan have higher delinquencies, they have lowered significantly in Quebec. I would also estimate that the severity of the real estate market decrease in Alberta was less pronounced than projected.

Not everything is rosy, however. There are a couple other storm clouds worth noting:

1. The company has lost a considerable amount of money on its preferred shares. They have $49 million in unrealized losses as of the end of June on their preferred shares, which is down from $51 million at the end of March, but this is very sloppy pickings by their asset managers.

2. Private mortgage insurers are approaching a $300 billion cap:

The maximum outstanding insured exposure for all private insured mortgages permitted by the PRMHIA is $300 billion. The Company estimates, that as of March 31, 2016, the outstanding principal amount of insured mortgages under PRMHIA was $197 billion for Genworth-insured mortgages and $241 billion for all privately insured mortgages. While the federal government has increased the cap to ensure that the private sector can continue to compete with CMHC in the past as the total of the outstanding principal mortgage amounts has approached the legislative cap, there is no guarantee that this will continue. The Company estimates that the private sector will remain below the cap for the remainder of 2016 and the first half of 2017 based on the current market share of the private mortgage insurers and the forecasted size of the mortgage originations market.

The inability to capture more of the mortgage insurance market beyond $300 billion, needless to say, would be a negative – the company would have to run off the book and only acquire insurance at the rate that it expires. I am also not sure how Genworth would coordinate with the other private insurance company (Canada Guaranty) to collectively stay under the $300 billion mark. This is a line item that would need to be addressed in legislation, specifically the 2017 Budget, and I would not view the current government to be supportive of private industry in mortgage insurance markets.

Finally, I will observe that the company is unlikely to buy back shares or declare special dividends until such a point that the regulatory framework for capital holdings is solidified.

Overall, my conclusion still remains unchanged that Genworth MI appears to be somewhat undervalued at present (trading at 89% of book value, with a strong balance sheet and low loss ratios). The market is clearly pricing them lowly due to the increasing speculation of over-valuation of real estate pricing in Canada, in addition to the balance sheet issues faced by their parent company. Genworth MI appears to be very aware of the Canadian real estate issues at hand. As I have been long-since speculating, given the issues that are going on in the parent company (Genworth Financial), Genworth MI is a likely candidate to be taken over if Genworth Financial finds the correct (and willing) purchaser. The take-out price would most certainly be higher than the current market price.

Genworth MI update

I did not write an update to Genworth MI’s first quarter as it was relatively routine (albeit a slightly negative quarter in terms of premiums written). This decrease was due to the corporation being more conscious of what they were underwriting, in addition to slowdowns in oil-producing regions. Financially they continue to be wildly profitable, with a combined ratio of 42% and continuing to build book value (sitting at $37.23, about a 10% discount to market).

The company’s stock price has not gone anywhere over the past couple months:

mic

I look at peer companies, both in the financing and REIT domains and see nothing catastrophic occurring there.

There are a few interesting undercurrents that Genworth MI is facing, including:

1. Issues at the Genworth Financial parent company (this may result in financial pressure on their holdings – indeed, one scenario for Genworth MI is that they will be liquidated, hopefully at book or a premium to book value!);
2. The new Liberal government elected in Canada may introduce some curbs or regulatory burdens (via OFSI) which would encumber the insurance operation and/or empower CMHC;
3. Impact of oil prices and on the Alberta/Saskatchewan housing markets, although delinquencies have not risen beyond expectations to date;
4. The general insanity that can be found in the Vancouver/Toronto housing markets;
5. Provincial governments enacting curbs on transaction volumes and generally suppressing volumes that would otherwise stimulate the mortgage insurance market.

In addition, there are known regulatory changes concerning portfolio insurance transactions that were effective July 1, 2016 which would serve to decrease premiums received in what would be a fairly low-risk insurance market (such loans have loan-to-values ratios of less than 80%). Fortunately, these transactions have typically only been 10-20% of the premiums written in any single quarter.

About CMHC, they continue to deliver worse results than Genworth MI (quarterly reports for CMHC here) and their fraction of insurance covered in the Canadian market continues to decrease – a question remains whether they will attempt to take more market share, which would serve to deflate Genworth MI’s future premiums written.

With their present insurance book, as long as there is no general property market crash, they will continue to book revenues as mortgages are amortized and converge to at least book value. They also will be generating an excess of capital which management can decide to repurchase shares or declare a special dividend (which they typically do in the second half of the year). At present prices both are acceptable options although I really thought they should have bought back shares in January and February.

Genworth MI is still valued cheaply, but of course was not the screaming bargain it was when it was below $25 earlier this year. There is still capital appreciation yet to be had. In the meantime, shareholders are paid to wait.

Genworth MI

It is quite obvious by trading action over the past month that some institution is accumulating shares of Genworth MI (TSX: MIC) and is sweeping up the supply that is being applied at existing prices. I loaded up in shares during the second half of January and bought a very small position in some out-of-the-money options (the Canadian options market is illiquid, high-spread, expensive to trade in and generally junky, but there was somebody on the ask that was not the market maker and at a reasonable price, I hit his ask). Genworth MI is once again the largest component in my portfolio.

It is difficult to understand how something trading at a greater than 1/3rd discount to tangible book value and giving a greater than 7% cash yield, and trading at a P/E of 8 can continue to trade so low unless if it can be explained by general paranoia (which exists on Canadian housing).

Insiders (as of February 22) have reported purchases of common shares of Genworth MI. They are not huge but it is something.

The reports of the Canadian housing market’s demise is clearly over-blown except in very narrow sectors that have traditionally had resource commodity concentration (looking at Fort McMurray as the prime example).

The underlying entity is incredibly profitable. The only real risk is whether the parent entity (NYSE: GNW) will sell Genworth MI out, which is a real possibility.

Such a sale, if done presently, would likely be done under book (CAD$36.82 presently). A sale at 10% under book ($33.14/share) would still be a 25-30% premium over current trading prices. The company’s P/E would still be 8 at this point and an acquisition would be instantly accretive to some other financial company.

This take-out price does not reflect my true value that the company should be trading at, which I would judge at least at book value. The Canadian economy, and thus residential mortgages servicing abilities, is not the most robust so the premium to book would be modest before I started to sell shares again. I also apply a general discount to majority-controlled entities, but suffice to say my target price is north of CAD$36.28.

Genworth Financial’s issues I do not want to get into in depth, but they have a pending May 22, 2018 debt maturity (bonds are trading at 87 cents on the dollar at the moment) and a series of maturities 2 years later (June 15, 2020, trading at 68 cents) that the market is getting panicky about. This may cause them to sell out their equity holdings in the mortgage insurance firms they have taken public (Canada and Australia), but it is a decision I do not think they would want to make lightly.

Genworth MI – 4th quarter 2015 report

Genworth MI (TSX: MIC) reported their 4th quarter and year-end earnings yesterday.

I have been covering Genworth MI since 2012. While I liquidated a significant portion of the company in 2014, as a result of the price depreciation exhibited over the past three months I have taken the liberty to once again make MIC the largest position in my portfolio (at prices from 22 to 25 a share) as I believe it is trading well below my estimate of their fair value. Companies trading at a discount of over 1/3rd of their tangible book value and at a P/E of 6 either are fraudulent (which is clearly not the case with Genworth MI) or have external sources of perceived stress causing such an intense discount.

Financial Statement Review

I will pick off some salient details of their report.

1. From year-to-year the balance sheet saw an increase of about CAD$450 million of real assets (cash, bonds, preferred shares, common stock) relative to the end of 2014. Roughly half of this was through an increase in deferred premiums (money collected for mortgage insurance that is held on the liability column of the balance sheet until it is recognized as actual revenue in accordance to a model for historical loss experience) and a good chunk through retained earnings.

2. Premiums written were up to $809 million for the year, compared to $640 million the year before (a 26% growth). You can thank the CMHC for this. Alberta went down from 26% in 2014 to 22% in 2015.

3. They continued to add to their preferred share portfolio; they sold their common shares and moved to preferred shares, which is still sitting on an unrealized loss position of $33 million on a $281 million cost base; this is better than Q3-2015 which was $42 million unrealized loss and $236 million, respectively. Given the existing valuation state of the Canadian preferred share market, shifting to preferred shares is a value-added decision especially when considering the positive tax consequences of inter-corporate dividend income for insurance companies. 92% of their portfolio is rated “P2” and the remainder is “P3”.

4. The company repurchased $50 million of shares and outstanding shares is down from 93.1 million at the end of 2014 to 91.8 million on December 2015.

5. The company’s debt maturing in 4.5 years has a yield to maturity of roughly 3.5% (traded at 109 cents on the dollar at year end). Their maturity at 8.25 years out was trading at a very slight premium and is YTM 4.2%. Back on November 6, the company was exploring a debenture offering. Their cost of raising debt capital seems to be relatively low, so it is curious why they never proceeded with it.

6. Delinquencies have not materially picked up in Q4-2015 (rate still is 0.1%).

7. Minimum capital test ratio goes from 227% to 233%. Management has pledged repeatedly that their target is “modestly above 220%” in terms of capital management. It is getting to the point where they will likely execute on another share buyback, and considering the huge discount to book value, they should consider a dutch auction at around CAD$25 to get those shares very cheaply off the books instead of dealing with a thin marketplace (recognizing that Genworth Financial owns 57% of the shares outstanding). As they have 13% in excess of 220%, this translates into about $203 million in excess capital.

If they managed to buy back 8 million shares for $200 million, they’d be able to increase book value by over a dollar a share! At existing valuations it would make complete sense for them to go private, but since Genworth Financial is facing huge financial challenges, they’re not the entity that is going to do it. This is a contributor to the depressed share price of Genworth MI (the market knows that Genworth Financial is facing pressure to sell the entire asset for a pittance).

8. The company expects lower amounts of mortgage originations in 2016. This will negatively impact premiums written in 2016. They did take 4% market share from CMHC in 2015, however, which may offset the decrease in originations.

9. Loss ratio is expected to be between 25-40%, which is more than the 20-30% guidance given for the 2015 year. Loss ratio guidance has always typically been conservative in nature. Considering the combined ratio for 2015 has been around 40%, an extra 10% on the loss side would put it at 50% and thus not anywhere close to endangering the profitability of the company.

Extra thoughts concerning valuation

Stated book value per diluted share is $36.82 – this is 35% less than the current market value of $23.91/share. If the company continues to book premiums written at $800 million in 2016 and maintain a combined ratio of 50% (30% loss, 20% expense), this would still be quite an undervalued entity.

I see two issues of market price stress:

1. The perception that the Canadian housing market will collapse and cause a huge wave of defaults which would bring mortgage insurers down like what happened in the USA in 2008;

2. Parent Genworth Financial’s issues spilling over onto Genworth MI – Genworth Financial needs money out of their subsidiaries and the trickle-down effect of dividends will not cut it for them. They can consider capital transactions (share buybacks) and keep their proportionate stake which enables them to bleed money out of the company at an accelerated pace, but this would still not be adequate for their situation. The market is likely taking the MIC subsidiary down in value on the implied assumption of a fire-sale of the 57% stake in the company. Of course, Genworth Financial would have to be completely desperate to do it at a 35% discount to book value (not to mention a P/E of 6), but the question here would be: Would they be willing to sell the whole thing at book?

Genworth MI Q3-2015 report

Late last month, Genworth MI (TSX: MIC) reported their 3rd quarter results for 2015.

The headline results were quite positive – premiums written were up from $217 to $260 million in 2015 vs. 2014 for the same quarter. As a result of premiums written increasing, revenues (premiums earned) will also be booked at an increasing rate for years to come. The loss and expense ratios remained in-line (at 21% and 19%, respectively) which still give an extraordinarily low combined ratio of 40%.

Management during the conference call pre-emptively went out of its way to explain the situation in Alberta and how they are well prepared for the upcoming onslaught of the double-whammy of increased unemployment (triggering mortgage defaults) and lowering property prices (triggering an increase of loss severity when mortgage claims do occur).

Balance-sheet wise, there were a couple negative developments. One is that the company dipped into preferred shares (selling their common share portfolio at the beginning of the year and investing in preferred shares) and are currently (as of September 30, 2015) sitting on an unrealized loss position of $42 million or 18% under the cost they paid for them (which in the preferred share market is huge!). It is currently 3.4% of their investment portfolio.

The company announced it is increasing its dividend to 42 cents per share quarterly instead of 39 cents, which is consistent with previous years’ behaviour to increment the dividend rate. They did telegraph on the conference call that they will likely not be repurchasing shares with their minimum capital test ratio at 227% even though their goal is to be “modestly above 220%”. The diluted shares outstanding has dropped from 95.6 million to 92.2 million from the end of Sepetember 2014 to 2015, but as I have discussed before, I generally view these period when market value is considerably under book value to be a golden opportunity to repurchase shares instead of issue dividends.

Conflicting with this apparent excess capital is the recent announcement that they are considering a debenture offering, which would allow them to raise more cheap capital. Would this be for leveraging purposes? They were quite successful at their last capital raising attempt – $160 million of debt raised on April 1, 2014 at a coupon of 4.242% and maturity of 10 years. Current market indications suggest they would receive roughly the same yield and maturity terms if they attempted another debt financing. Raising another $250 million in debt financing and attempting a dutch auction tender at around CAD$33/share seems to be a possibility at this stage.

Finance wise, it seems like a win-win: Raise money at 4.5%, fully tax-deductible interest expense. Use to repurchase shares that yield 5.1% (which is not a tax deductible cash outlay for the company). At a corporate tax rate of 26.5%, it is a gain of 1.8% after taxes! Remains to be seen if this is what they are thinking.

This might also be because the Genworth MI subsidiary is 57% owned by subsidiaries of Genworth Financial (NYSE: GNW), which are facing financial challenges of their own – perhaps this will be an inexpensive way for Genworth Financial to raise a cheap $140 million of equity financing and still not give up any ownership in their prize profit-generating subsidiary?

Valuation-wise, Genworth MI is still trading at 15% below diluted book value which still puts it in value range, but this market valuation is clearly influenced on negative market perceptions of the Canadian real estate market – Genworth MI has still not recovered fully from the aftermath of the effects of the drop of crude oil prices. Still, if they effected a buyback at around CAD$33/share, it would still be accretive to their book value!

The company did dip below (dividend-adjusted) CAD$27/share on a couple occasions on single days in late July and August, but I was nowhere near nimble enough to capitalize on that freak trading activity. At such valuations (25% below book value) it would be difficult to not re-purchase shares that I sold in 2014 when MIC was trading at and above $40. The fundamentals of the company are that of a bond fund asset management, sprinkled with the profit generator of Canadian home mortgage insurance.

The other elephant in the room is questioning the effects of the change in the federal government – the new mandate for CMHC might be to get it more involved in mortgage insurance instead of being (relatively) non-interventionist like the previous Conservative government. This might functionally increase the competitive space for Genworth, but it remains to be seen what the Liberal Party’s intentions are with CMHC. The only line in the Liberal Platform is the following:

We will direct the Canada Mortgage and Housing Corporation and the new Canada Infrastructure Bank to provide financing to support the construction of new, affordable rental housing for middle- and low-income Canadians.

This does not appear to conflict with the profitability of Genworth MI. But one can never depend on any new majority government to stay strictly within their platform points!

Canadian Housing Financing Market

There are three companies that come to mind that are directly related to Canadian residential housing financing: Genworth MI (TSX: MIC), Home Capital Group (TSX: HCG), and Equitable Group (TSX: EQB).

I’ve done extensive research on all of them in the past and I am research-current with all three companies. I do own shares of MIC from the summer of 2012.

The first, which should be no surprise to regular readers here, deals with mortgage insurance. The second and third deal with direct financing of home mortgages (both first-line and refinancing). If a mortgage is required to be insured (which is usually the case for higher ratio mortgages and refinancings) then CMHC and Genworth MI get involved and charge a premium in exchange for the lender being able to give out a lower rate of interest.

HCG today announced that its mortgage originations were down from the previous year and its stock price cratered roughly 15% as of the time of this writing.

Genworth MI is down about 4% in sympathy, although Equitable Group is in the “white noise” range for the markets (i.e. relatively unchanged).

A downturn in mortgage originations will materially affect HCG and EQB’s profitability, while this has more of a muted effect on Genworth MI as cash proceeds from mortgage insurance are not accounted for as revenues until they are recognized according to prior experience (net of expected default losses).

The takeaway to this message is that if Genworth MI gets disproportionately trashed in the upcoming days, it is likely unwarranted as the fundamental profitability in Genworth MI is not through volume, but rather the solvency of the lenders in question. Genworth MI also has the advantage of being able to run off its insurance book and still receive a boost in market value as it is trading below book value, while HCG and EQB are trading above book value.

Option implied volatility does suggest that institutional interest suspects further volatility. Tread carefully as always!

Genworth MI repurchases shares

Genworth MI (TSX: MIC) recently disclosed that they repurchased 1,454,196 shares in mid-May for roughly $34.38 per share, a repurchase representing $50 million.

The buyback algorithm they employed was less than subtle, mainly the repurchase of 137,210 shares per day for 10 days and 82,096 shares for the last day. As 57% of the shares outstanding are owned by Genworth (NYSE: GNW), they supplied 57% of the liquidity for these transactions. 620,818 shares were taken out of the public float.

This repurchase was executed at slightly less than book value, which means it will be mildly beneficial to book value per share – my estimates are that based off of end of Q1-2015, the transaction would add 3 cents of book value per diluted share.

Of course, the transaction will be hugely accretive to earnings – the buyback represents 1.56% of shares outstanding, which means this will add a couple pennies a share to the quarterly EPS figures. In addition, the buyback also means that the company will not have to give out an extra $2.3 million a year in dividends.

At the end of Q1, the company had $200 million in surplus of its own internal buffer, which is 220% of the minimum capital test required to operate. The company reported 233%.

As the company typically book about $90 million in income a quarter, the buyback likely represents a “cash neutral” policy of balancing dividends (est. $36 million in this upcoming quarter) and share buybacks, at least with its current market value. If their market value remains suppressed below book value and they keep executing buybacks on a quarterly basis, I foresee higher equity prices in the future.

Long-time readers here will remember that I disagreed strongly with management’s decision to repurchase shares at $40/share back in 2014. May 2015’s repurchase I completely agree with – a shame they could not execute it in March, but still, they (and shareholders) will receive good value for this $50 million repurchase.

I continue holding Genworth MI shares since mid-2012.

Genworth MI Q1-2015 review and analysis

Genworth MI (TSX: MIC) reported their 1st quarter earnings results yesterday. The report can be summed up as a relatively boring, “steady as she goes” type quarter, which is somewhat surprising considering the general predictions that the degradation in the Alberta real estate market would cause considerable stress in the sector.

The bottom line earnings took the book value to $36/share.

While the market is signalling there is going to be further losses later this year, the first quarter result had a loss ratio of 22%, which is generally on-level with prior quarters – the company projects 20% to 30% for the year.

Despite the winter quarter being the slowest quarter of the year, year-over-year statistics show a marked increase in unit volume (23,951 in 2014 vs. 32,760 in 2015) and also the net premiums written ($84 million to $130 million). The Q1-2015 net premiums written was also goosed up by the recent CMHC mortgage insurance premium increases. On June 1, 2015, there is another CMHC premium increase on higher ratio mortgages which will also result in a $25-30 million increase in net written premiums.

The company’s insurance in force exposure is 18% in Alberta for “transactional” type mortgages, which are mostly those with 20% or less down-payment. Delinquency rates continue to be very low (0.11% nationally) without any pronounced increases other than a mild rise in Quebec. Ontario has a 0.05% delinquency rate.

On the balance sheet, the company’s investment portfolio yielded 3.4%, but they had some interesting commentary, stating “At this time, the Company believes that the capital adjusted return profile of common shares is less favorable than in the prior year”. As a result of this and also minimum capital test guidelines, they have increased their allocation to preferred shares. Similar to last quarter, they also went out of their way to specify that 75% their energy company investments (in bonds and debentures) were in pipelines and distribution, and the other 25% were in “integrated oil and gas companies with large capitalizations”. The bond portfolio has a mean duration of 3.8 years.

The company has capital that is 233% of the minimum capital test (currently $1.52 billion required) and the internal target with buffer is 220%. This leaves $200 million available for the company to either repurchase shares or distribute in a special dividend. They announced their regular quarterly dividend of CAD$0.39/share with the quarterly release but did not give any indications as to what else they will do with the excess capital.

At a current market price of (roughly) CAD$35/share, I generally believe the company’s valuation is slightly on the low side of my fair value range estimate. I would not start to think of divesting until CAD$40, but an actual sale decision would likely be at higher prices.

I still hold shares from MIC, purchased back in the middle of 2012. Seeing the recent price drop to CAD$28/share would have been a decent opportunity to add more shares and I doubt we will see that again unless if there is a profound economic malaise that hits Canada. If we can survive US$50 oil, our economy is more robust than most think (noting that the rest of the commodity markets have also plummeted). MIC also continues to be a stealthy way to purchase Canadian real estate and also a proxy for a bond fund at a very low management expense ratio. The yield in today’s income starved market is a bonus.

Genworth MI and Canadian real estate speculation

It is fairly obvious by looking at the graph of Genworth MI (TSX: MIC) that institutions are dumping stock in fears that mortgage default rates are going to spike up as a result of economic calamity in Alberta. The CEO of Genworth talking about “heightened vigilance” isn’t helping matters any.

While this might be true, it appears that other real estate metrics are relatively in tune. My cursory scans of the REIT market (e.g. Riocan, H&R, Calloway, all apartment trusts, etc.) doesn’t show any erosion in that marketplace. Banks (e.g. BMO, BNS, etc.) are showing some equity erosion since the middle of 2014, but I’d suspect this is more due to yield curve compression and partially due to the solvency risk posed by syndicate loans to various oil and gas companies.

Other direct lenders, mainly Equitable and Home Capital, have both seen erosion but it is not significant to the point where one would think there is going to be a complete and utter collapse in the fundamentals.

Genworth MI appears to be the whipping boy in the real estate industry. If such fears are warranted, then one would think that REITs and other related stocks would also get proportionately taken down.

So the question now is whether the market is wrong about REITs or wrong about Genworth. Assuming the negative momentum for Genworth MI continues, one would guess that looking at the financial metrics and historical charts (and then-fundamentals of the company at that time) that it is conceivable the stock can get down to about $22-23/share as a floor. This is based on the discount assigned to the stock during the mid 2012-2013 period and the fundamentals of the company at the time.

Today is a little different in that the company has less shares outstanding and has more equity on the balance sheet.

Assuming the Canadian real estate market does not completely nose dive, an investor would still be looking at around 20% downside on existing technical momentum, but fundamentally there is still significant value as the firm is trading deeply below book value at present (right now at a 20% discount). It is like purchasing a leveraged bond fund at a significant discount.

The combined ratio (this is the loss ratio plus the expense ratio) during the depths of the 2008-2009 economic meltdown, did not go above 62%. Delinquency rates never got above 0.30%. Today, it is 39% and 0.10%, respectively. Yes, these numbers will increase as people start defaulting on their Alberta homes, but I simply do not see at present those numbers getting worse than it was in the 2008-2009 era.

I am watching this carefully and may choose to add to my position.

Genworth MI Q4-2014, Canadian housing market

Genworth MI (TSX: MIC) reported their Q4 results a couple days ago. This report was a little more interesting than previous ones simply because there has been a relatively large shift in sentiment concerning the Canadian housing market due to the collapse in crude oil pricing (and its impact on Alberta and Saskatchewan).

The actual result was less relevant than the future guidance of the company.

Specifically, the guidance was that the loss ratio anticipated in 2015 would be between the 20-30% range, while the long-range guidance was for a loss ratio of 30-35%.

As I have pointed out on multiple occasions, the loss metrics for Genworth MI over the past couple years has been extraordinarily favourable, with the pinnacle of loss ratios in Q2-2014 of 12%. Q4-2014 was moderate, with 26%.

Cited was the economic slowdown in Alberta, but they appear to have a fairly solid grip on the upcoming cataclysm that will be occurring to employment in Alberta and Sasketchewan. Approximately 27% of the insurance written in 2014 was in Alberta, although 17% of the insurance in force is from the province.

By virtue of the fact that zero-down loans are no longer done, direct comparisons to 2008 would appear to be less muted, although there will obviously be an increase in losses coming in 2015 from Alberta and Saskatchewan for the company. The question is how bad they will be.

That said, the company still has an incredible amount of room to maneuver with. Their loss ratio for fiscal 2014 was 20% and expense ratio of 19%.

Realize accounting-wise that all of their cash is collected up-front and then revenues are recognized according to a financial model that allocates premiums written (deferred revenues on cash received) to actual revenues (removal of deferred revenues). The revenue recognized is not cash. Instead, the company must earn cash on future premiums collected (somewhat pyramid-schemish!) but also the receipt of investment income.

Investment income is obtained through a portfolio that is 41% corporate debt, 49% government debt, 3% equity and 2% asset-backed bonds, and the remainder 5% is cash and short-term cash equivalents. The total value of this portfolio is $5.4 billion earning an investment yield of approximately 3.5% and a duration of 3.7 years. As interest rates continue to plummet, this investment yield will likely decrease (although they do have a good chunk of unrealized gains due to the rate drop). Reinvestment will become continually a higher challenge for this insurer and many others.

Investment income for the year was $195 million.

In terms of book value, they ended the year approximately at $35.12/share according to my calculations.

Valuation-wise, they are somewhat below my fair value estimate, but not at the point where I would buy more shares. Market sentiment may take them further down and if it does so, I may consider adding to my position. The company itself may decide to repurchase shares (at a much better price than its previously botched buyback of 1.87 million shares at CAD$40/share) which I would approve of simply because repurchases would cause book value to increase. The company holds a minimum capital buffer of 220% over the regulatory requirements (currently at 225%) and they have indicated that they will hold a modest amount of capital above this percentage. I suspect the majority of excess will go towards a share buyback later in the year.

If the company streamed off its entire net income to dividends, they would be giving a 12% yield at present.

I generally do not believe that there will be a precipitous collapse in the Canadian housing market unless if there is an overall recession that affects more than a single commodity industry. In addition, most equities that I see that have significant exposure to Alberta’s economy are trading significantly lower than they were half a year ago. I do have a name in mind (below book value as well) when I write this, but my inability to predict when Alberta will get “hot” again is not assisting with an investment decision.