OSFI draft guideline on residential mortgage insurance

The OSFI has released draft guidelines (B-21) on residential mortgage insurance companies. There is a comment period up to May 23, 2014. Considering that CMHC and Genworth form substantially the entire market, I do not anticipate much comment.

Despite what the media is reporting (that it would involve a marginal tightening of the mortgage insurance market), upon reading the draft guidelines I do not see this conclusion, which is little change.

Specifically for investors, the only change that will be visible will be a slightly higher amount of disclosure than what is currently provided to the public. This includes (and the bold-print is what I believe will be new):

A breakdown of mortgage loans insured during the previous 12 months as well as the total stock of insured mortgage loans, with further separation by mortgage insurance type (i.e., transactional- vs. portfolio-insured loans), for the following categories:

* Volume: The number and outstanding balance of insured mortgage loans;
* Loan-to-Value: A breakdown according to LTV buckets of 5% increments (both estimated current and LTV at origination);
* Amortization: Amortization period ranges (e.g., 15 – 19.9 years, 20 – 24.9 years, ≥ 25 years, etc.) at origination and remaining amortization;
* Geography: Geographic breakdown by province and territory; and
* Delinquencies: Breakdown of the level of insured mortgage loan delinquencies.

FRMIs should also provide a discussion of the potential impact on insured residential mortgage loans in the event of an economic downturn.

Genworth MI is down less than a percent in today’s trading, which may or may not be caused by the above pronouncement by the OSFI. It continues to be my largest holding despite being trimmed at higher price levels.

Not much to say lately

The market has been going through some corrective headaches, likely on valuation concerns of the well-known high fliers out there (including the biotech sector, which has gone bananas). This all feels like the year 2000 over again.

I still haven’t had anything pop up on the investment radar lately. One opportunity which I did identify last year as a very likely candidate to provide two or three-bagger type gains over the next two to three years has exhibited price depreciation to the point where it is trading below tangible book value. What is even odder is that this company is pretty much top in its business niche and is unlikely to lose the competitive advantage in this niche. It is only trading down because of government regulatory fears. I might write a comprehensive research report on this company, but it is something I would not want to make freely available to the public.

Canadian social networking companies – Keek, Inc.

The whole investment world sees Twitter, Facebook, Linkedin, etc., and starts to wonder what the next hype is going to be as everybody gets financially envious at those who are bailing out en-masse with shares they have at a cost basis of pennies.

In Canada, the number of choices are quite limited. Most of the social media companies (at least in the English language) originate in the USA.

However, there is one Canadian firm, out of Toronto, that I know of which seems to have potential for hyped up valuations. That would be Keek, Inc. The company is attempting to be the Twitter of video. I have no idea whether this concept will take off or not, but I am reasonably sure it is something that teenagers with too much data on their mobile data plans would find creative ways to use.

In a rush to get public, they performed a reverse merger with Primary Petroleum Corporation (TSX: PIE, now TSX: KEK). This also temporarily solved another problem that they had, mainly a lack of cash.

Post reverse-merger, once all the dilution is taken into account, the entity will have about 400 million shares outstanding. This gives them a market capitalization for a company that has zero revenues and a burn rate of roughly $20 million a year given their financial statements for the six months ended August 2013.

The reverse merger will give them about a year’s worth of cash (from August 2013!) providing they can obtain some modest returns on the sale of the oil and gas assets that Primary Petroleum had. Between then and now, presumably they are going to count on their common share prices going to the roof in some sort of social media hype, where they can do a secondary offering for a bunch of cash.

Not that fundamentals matter with social networking companies, but it looks like they already their moment in the sun – the following two snapshots are from the management information circular:

Investors in Friendster probably know how this chart feels like.

I give Keek management full credit, however, for developing metrics that make utterly no sense in real life, like the following:

Wow!  The chart is going straight up!  I must invest!

Also, when digging into the documentation even further, I come up with gems such as the following paragraph:

In August 2013, Keek entered into an arm’s length lease agreement to lease approx. 17,947 sq. ft. at 1 Eglington Avenue, East (suite 300), Toronto, ON. The Lease Term was for 10 years and 3 months, commencing on July 1, 2013. Base rent for month 1 thru month 60 would be $15/sq. ft. with base rent for month 61 thru month 123 of $17/sq. ft. Keek was granted three months free rent for both base and additional rent for the first three months. Keek has recently decided that its office space requirements over the next five years are not expected to require 18,000 square feet and therefore has engaged a realtor to sublet the space while Keek look for alternative office space of approximately 5,000 square feet. There is no guarantee Keek will be able to sublet its existing space at values that approximate its current lease arrangements.

Oops!  Nothing like signing a long-term contract for a huge amount of space you suddenly discover you really didn’t need less than half a year later!

Sadly, I will not be investing in this story, but I could easily see others doing so and taking this up to a ridiculous level that is not rationally explainable by any business metrics relating to cash flow or revenues. However, if you had to spend a hundred dollars on the Lotto 6/49 with an average jackpot versus throwing it into Keek, you might actually get a better expected value on Keek, as long as you were allowed to liquidate your shares in the near-term future.

Tragically, I am indirectly invested through this via my Pinetree Capital debentures (TSX: PNP.DB), which I gave a rather cynical analysis on back in November 2013.  Pinetree owns about 52.8 million shares of Keek and if Keek goes to a hype valuation, I would hope Pinetree management would actually liquidate some shares so they can pay off their pesky debenture holders like myself.

Genworth MI – When do I cash out?

The largest component in my portfolio continues to be Genworth MI (TSX: MIC).

mic

The stock is trading at an all-time high today.

I acquired shares in July and August 2012 and have been patiently waiting. I took quite a large initial stake to begin with and I have done well by this decision, but the appreciation is getting to a point where the portfolio fraction is getting too concentrated. Unfortunately, I very much doubt mortgage insurance will be the next big hype in the financial marketplace unlike Twitter, Facebook and 3D printing! (Or if Marijuana is your thing, check out shares of Advanced Cannabis!)

A couple canary in the coal mine analogies include Equitable (TSX: EQB) and Home Capital (TSX: HCG) which interestingly enough, have not exhibited the deprecation that most mortgage REITs in the USA have. Just because this has not happened doesn’t mean it will not happen in the future – right now the economic climate in Canada is relatively stable, but this remains dependent on the commodity industries remaining solvent. I do note that the Canadian dollar has depreciated somewhat over the year, which would be supportive to Canadian real estate valuations. Also looking at the charts of EQB and HCG, it does not look like the canaries are in ill-health at all.

That said, my valuation metrics show that MIC is in the upper end of my fair value range and I have slowly start trimming my position in 2014. They’re almost at 20% above tangible book and I expect they will be booking about $3.60-3.80 EPS in 2014. I would estimate there is some upside left, but it isn’t a huge amount compared to what we have seen over the past 18 months, and it would be momentum-driven rather than any valuation-centric investors.

The recent CMHC announcement to increase mortgage premiums resulted in a nice one-time spike in the stock, but the market might not anticipate that this will have a dampening effect on demand for mortgage insurance itself. Time will tell. The other headwinds of concern is that loss ratios are at historical lows, and one wonders how much more potential unknown good news there is out there for the company.

Momentum and some potential for a catalyst-type event (especially with their huge cash hoard they have been sitting on) have kept me from hitting the sell button too quickly – historically my sales have had much worse timing than my entries. My exit will be slow and gradual and only if the common shares continue to appreciate – otherwise I am fairly satisfied at present to just clip dividend coupons and keep the capital in something other than cash, which has been increasingly difficult to deploy these days.

My only fear is simply one of greed – I can conceivably see momentum trading taking MIC far above what rational analysis would suggest is a fair value. Trimming the position, instead of eliminating it outright, is the rational way of addressing this – if they do shoot to the moon like they are a social media stock, I will have some participation.