Genworth MI Q2-2017: As good as it gets

Genworth MI reported their Q2-2017 results today and it was a blowout positive quarter.

The key statistic is that the reported loss ratio was down to 3% from 15% in the previous quarter – this is an accounting artifact due to the reduced reserving for losses (reserves increased $6 million compared to $30 million in paid claims). While the paid out claims is in-line with previous quarters, the difference is due to accounting for future losses – claims already in progress or claims processed have turned favourable from previous projections. The official explanation:

In the second quarter of 2017, losses on claims decreased significantly due to favourable development as there were fewer new reported delinquencies in Ontario, Alberta, Quebec and the Atlantic Provinces as compared to the incurred but not reported reserve as at March 31, 2017.

As a result, the company’s yearly guidance shifted from 25-35% loss ratio to 15-25%. Delinquent mortgages also slipped down from 2,082 to 1,809, a significant drop.

These two factors alone should be enough to boost the stock price 10% in tomorrow’s trading. Book value is about $41.34/share (which puts today’s closing price at 12% below book).

The only downside is that transactional insurance written is down 5% from the comparable quarter from last year. The portfolio insurance is down considerably but this was anticipated due to regulatory changes of the prior year. Accounting-wise, revenues recognized should continue to increase over the next few quarters as the amortization curve of the unearned premiums (previously written insurance) kicks into full swing.

Their portfolio is relatively unchanged by the increasing interest rate environment – their government and corporate debt portfolio is at a slightly decreased unrealized gain position ($100 million to $87 million), but their preferred share portfolio went from a $19 million unrealized loss to a $12 million realized gain position (which was a nice recovery from their initial investment).

One highlight which won’t get much press is that the company made a good chunk of change on unrealized gains on interest rate swaps from the last quarter. I’ve been tracking the CFO of Genworth MI, Philip Mayers, and the decisions Genworth MI has made on portfolio management has been very sharp.

The company’s reported minimum capital test ratio was 167% this quarter, and this is above their target rate of 160-165%, which means that the company may choose to engage in a share buyback or give out a special dividend if this condition persists – the upcoming quarter has a $0.44 dividend (unchanged) but the company is likely to increase this by 3-4 cents in the following quarter as they continue to build up excess capital.

All in all, this is probably the best quarter that Genworth MI has had in its history from an economic basis. Does it get better for them?

Genworth MI – Q1-2017 and Q2-2017 preview

(Update, July 20, 2017: FYI, Genworth MI reports the next quarter on August 1, 2017)

While Home Capital was going through their issues, I had neglected to report on Genworth MI’s Q1-2017 report.

It was a quarter for the company that was about as good as it gets – their reported loss ratio was significantly lower than expected (15%) and well below expectations. The number of delinquent loans creeped up slightly (2,070 to 2,082) but the loss ratio was the highlight for the quarter. Most of the increase in delinquencies occurred in Nova Scotia and Manitoba.

Portfolio insurance written was also higher than I would have expected ($38 million), but this was due to the completion of paperwork received at the end of Q4-2016. I would not expect this to continue in future quarters.

The geographical split of insurance has not changed that much – Ontario continues to be 48% of the business, while BC/AB is 31% and QC is 13%. Half of the transactional insurance business continues to be at the 5% down-payment level.

Book value continues to creep up, now to $40.42/share. Minimum capital test ratio is 162%, slightly above management’s 157% holding level, and as long as this number is between 160%-165%, management is not going to take any capital actions (i.e. special dividends or share buybacks), although I will note some insiders did purchase shares earlier in the quarter.

The market reaction to the quarterly report was initially very good, but I suspect short sellers decided it was a good time to continue putting pressure on the stock. It got all the way down to $30.50 before spiking up to $38 and now has moderated to $34.70/share, which is a 14% discount to book.

Looking ahead to Q2’s report, my expectations are a more moderate outlook – the loss ratio should creep up to 25% again, and management should be noting that Ontario’s actions to curb foreign property speculation have had an impact on the local residential market. In relation to mortgage insurance, however, if people continue paying their mortgages (they are employed), ultimately real estate pricing does not matter. I think a lot of market participants have failed to make that distinction.

The other question is the impact of increasing interest rates – this will certainly have an impact on the short-term investment portfolio of MIC – including small unrealized capital losses on short-term debt. This will more than likely be offset by gains in their preferred share portfolio, which totalled $456 million on March 31, 2017.

Price-wise, the company is currently too cheap to sell and too expensive to buy. I’ll continue collecting my dividends.

Home Capital – Don’t know why it is trading up

The power of Berkshire is strong – why would shares of (TSX: HCG) go up when the acquisition price is so dilutive to existing shareholders (selling 19.9% of the company for CAD$9.55 and another substantial chunk of equity at CAD$10.30 to a 38% ownership interest) and the company cannot even obtain a better rate on a secured line of credit than 9%?

They managed to sell $1.2 billion dollars of commercial mortgages between 97 to 99.61 cents on the dollar, which leaves the question of how much their residential portfolio is worth. How can this investment by Berkshire and the line of credit be good for anybody but Berkshire, or more specifically anybody but common shareholders?

Now that short sellers have been crushed to death, I’m going to guess the next month or so will likely represent the “top” of their stock price. Borrow rates are 75% right now so I’m not touching it.

Book value with this stock purchase, FYI, goes down to under CAD$20/share. So even on a price-to-book metric, HCG is almost trading like a regular mortgage provider – except with the very relevant fact that their cost of capital is well above what they can receive in mortgage interest! How they plan on making money by issuing 5% mortgages and loaning money from the credit facility at 9% or 10% is beyond me. Maybe they’ll make it up on volume!

There is absolutely no reason why Genworth MI should be trading up 10% on this news either. They are in much, much, much better financial shape than HCG, and shouldn’t be trading at less of a discount to book value than HCG is!

Home Capital / Equitable Group Discussion #2

A few news items which are salient as this saga continues:

1. Home Capital announced a HISA balance of CAD$521 on Friday, April 28 and a GIC balance of $12.97 billion. On May 1, this is $391 million and $12.86 billion, respectively (another $220 million gone in a day). Their stock is down 21% as I write this.

2. Equitable announced their quarterly earnings and are up 35%. This was a pre-announcement as they previously stated they would announce on May 11, 2017. They announced:

* A dividend increase.

Between Wednesday and Friday, we had average daily net deposit outflows of $75 million, with the total over that period representing only 2.4% of our total deposit base and with the most significant daily outflows being on the Wednesday. Even after those outflows, our portfolio of liquid assets remained at approximately $1 billion.

Obtained a letter of commitment for a two-year, $2.0 billion secured backstop funding facility from a syndicate of Canadian banks, including The Toronto-Dominion Bank, CIBC, and National Bank (“the Banks”). The terms of the facility include a 0.75% commitment fee, a 0.50% standby charge on any unused portion of the facility, and an interest rate on the drawn portion of the facility equal to the Banks’ cost of funds plus 1.25%. This interest rate is approximately 60 basis points over our GIC costs and competitive with the spreads on our most recent deposit note issuance, and as such will allow us to continue growing profitably.

So their credit facility cost $15 million to secure $2 billion (relative to $100 million for HCG), lasts two years (relative to 1 year for HCG), and also have a standby charge of 0.5% (which is 2.0% less than HCG), and a real rate of interest of approximately 3% (compared to HCG paying 10% for their outstanding amount, and I’m assuming the Bank’s “cost of funds plus 1.25%” works out to around 3%).

I haven’t had a chance to review their financial statements in detail yet. But securing two billion on relatively cheap terms like this is going to be a huge boost to their stock in the short run.

Very interesting.

Genworth MI (TSX: MIC) is also down a dollar or 3.5% today, which is more than the usual white noise of trading. It dipped even lower today.