Category: Equity

Genworth MI reports Q4-2016

Genworth MI (TSX: MIC) reported their fourth quarter a couple weeks ago. This post is a little late in the game (and irritatingly, a conference call transcript has not been made available and I have had to suffer the indignity of actually listening to the conference call). By virtue of the Canadian housing market not imploding over the quarter, the company likely exceeded market expectations, which registered a 10% price spike since their announcement.

Here are some of my takeaways:

* Loss ratio is exceptionally low, at 18% for the quarter. Management projects 25-35% for 2017 as they identified that Fort McMurray and Quebec were abnormally low in Q4-2016 and that a more normalized loss ratio is to be expected in BC and Ontario (which have been quite dormant in terms of mortgage defaults).

* Book value is up a little bit to $39.28, which is $2.46 more than the previous year. The market value continues to converge to book.

* Premiums written, Q4-2015 to Q4-2016, was down about 20%. Portfolio insurance is down as expected per the rule changes, and transactional insurance is down due to the changes in the mortgage rules. The new capital requirements and new premium changes will kick in at the end of March which will offset reduced volume with price increases.

* Investment portfolio continues to be managed in line with previous quarters, in addition to the losses incurred by the preferred share portfolio seemingly normalizing (and if rates continue to rise, discounted rate-reset shares should fare quite well in that environment).

* Regulatory ceiling for private mortgage insurance was raised from $300 billion to $350 billion, which makes this a non-factor for the next while (a low risk that did not materialize).

* New capital requirements result in a “recalibration” of the minimum capital test ratio. The company is internally targeting 160-165%, and each percentage point is about $25 million in capital. Once they head over 165% then the surplus will likely be distributed via buybacks or dividends – it does not look like anything special is going to happen on this front in 2017 as they will be using retained earnings in order to buffer the capital levels. The new OFSI regulations have grandfathering components with respect to the capital requirements which should mathematically ease in the new capital requirements (especially with the evaluation and testing of the mortgage books acquired 2016 and earlier), but the MCT ratio is not likely to materially climb higher to the point where one can start thinking of extra dividends or buybacks.

* Insiders have exercised options and dumped stock after the earnings release, which is a negative signal.

I will warn readers that I have also lightened my own position in Genworth MI in the days ahead (i.e. after they announced) of the earnings announcement, my first sale since the second half of 2015. The last quarter was undoubtedly a good one for the company. I still have a large position in the stock, but I was reducing my position strictly for reasons that it had gotten too concentrated and I want to reduce my overall portfolio leverage. There is still a lot of runway for Genworth MI to run up to the low 40’s as they have everything going correct for them fundamentally and are generating a lot of cash in a semi-protected business environment. The whole country has been so bearish on Canadian housing that they forget to realize there are considerable pockets of profitability and Genworth MI is one of the spaces where there is money that continues to be made – I am guessing that the short sellers have gotten killed on this one.

Market is predicting Genworth Financial’s merger with China Oceanwide will fail

The market is projecting that Genworth’s (NYSE: GNW) US$5.43/share cash merger with China Oceanwide will fail:

The issue revolves around the insurance unit that contains their long-term care insurance liabilities – the theory would be that the Genworth is unlikely to obtain state approvals without taking the full burden of the LTC division.

The salient part of a piece of nearly unreadable verbiage from the finalized merger proxy form is the following:

In addition, it is a condition to the obligations of Asia Pacific and Merger Sub to consummate the merger that certain affiliates of Genworth shall have received regulatory approval (or non-disapproval, in certain instances) from the Delaware Department of Insurance and the Virginia Bureau of Insurance to effect the U.S. Life Restructuring, including the unstacking and the following intercompany reinsurance and recapture transactions between GLAIC and GLIC: (i) a reinsurance transaction pursuant to which GLIC will reinsure certain long-term care insurance business from GLAIC (which we refer to as the “Long Term Care Reinsurance Transaction”); (ii) separate reinsurance transactions pursuant to which GLAIC will reinsure from GLIC (A) certain universal life insurance business and term life insurance business, (B) certain company-owned life insurance business and (C) certain single-premium deferred annuity business, single-premium immediate annuity business, structured settlement annuity business and fixed annuity business (which we refer to as the “Life Restructuring Reinsurance Transactions”); and (iii) a transaction pursuant to which GLIC will recapture from GLAIC certain single-premium deferred annuity business that is currently reinsured by GLAIC from GLIC (which we refer to as the “Recapture Transaction”). GLIC and GLAIC have received approvals for the Long Term Care Reinsurance Transaction from the Delaware Department of Insurance and the Virginia Bureau of Insurance and completed the transaction effective November 1, 2016. Genworth made regulatory filings with respect to the unstacking with the Delaware Department of Insurance on December 21, 2016 and the Virginia Bureau of Insurance on January 3, 2017. Genworth made regulatory filings with respect to the Life Restructuring Reinsurance Transactions and the Recapture Transaction with the Delaware Department of Insurance and the Virginia Bureau of Insurance on December 16, 2016. In addition, the merger agreement provides that Genworth, in consultation with China Oceanwide and applicable insurance regulators, may explore the feasibility of the transfer of GLAIC’s 34.5% ownership interest in GLICNY to GLIC and, if approval from such regulators is received, to pursue such transfer.

If, for whatever reason, you believe these applications will succeed, then there is a very easy method to turn $3.30/share into $5.43/share in less than six months. Won’t tell you what I think, but I’ve been digging.

CMHC increasing mortgage insurance premiums

CMHC announced this morning they will be increasing mortgage insurance premiums on March 17, 2017.

The changes are significant for those interested in mortgages with a 10-20% down-payment:

Loan-to-Value Ratio Standard Premium (Current) Standard Premium (Effective March 17, 2017)
Up to and including 65% 0.60% 0.60%
Up to and including 75% 0.75% 1.70%
Up to and including 80% 1.25% 2.40%
Up to and including 85% 1.80% 2.80%
Up to and including 90% 2.40% 3.10%
Up to and including 95% 3.60% 4.00%
90.01% to 95% – Non-Traditional Down Payment 3.85% 4.50%

The changes were a result of the OFSI changing the capital holding requirements of mortgage insurance institutions in Canada (affecting CMHC, Genworth MI and Canada Guaranty) and I have telegraphed this well in advance in my previous analyses of Genworth MI.

It is quite probable that Genworth MI will follow suit and this will result in a substantial increase in premiums written for the company in the 2nd to 4th quarter of 2017. The market has not picked up on this at all.

Bombardier credit market completely out of the woods now

Bombardier’s bonds have traded considerably higher since their latest 8.75% bond issue (maturing December 2021) which is now trading at a premium to par.

They have to be looking at this and thinking about securing further long-term funding. It also gives them a lot more negotiating power with the Canadian government, who wants to inject some more money into the corporation (whether they need it or not) for political reasons.

Floating rate preferred shares are yielding 8%, while the fixed rate is yielding 9% (quite the premium to pay for a floating rate). Given the difference between the bond market and the preferred share market, I still believe the preferred shares are trading slightly cheap to what they actually should be.

The equity is also receiving quite a bid as of late, despite the massive warrants overhang in their earlier year government fundings. If they receive another large order for C-Series aircraft (something slightly larger than Air Tanzania), it is quite likely the stock will rise even further.

Details of Genworth Financial merger

There are lots of juicy details of the merger proposal with Genworth Financial in their preliminary proxy filing. In particular there are some hints that Genworth MI in Canada will get sold off whether this merger is successful or not.

Despite all short-sellers and naysayers believing that the Canadian housing market is going to crap, Genworth MI continues to appreciate post-Trump and is still trading 10% below their book value. They’ll continue to be mystified when the stock will break through its all-time highs it reached back in November 2014:

Not coincidentally, that’s when I last sold shares. I will note the price has been adjusted multiple times due to their rather large dividend (currently $1.76/share), and whether the Genworth Financial merger is successful or not, it is quite probable that Genworth MI Canada will be sold for as much as can be sought for it, because doing so before the Canadian housing market collapses is the only smart thing to do.

In terms of valuation, one can make a good claim for over CAD$40/share.

The market is also not appreciating at all the notion that mortgage insurance rates will be headed higher in early 2017 due to capital changes. The last time mortgage insurance rates went higher, the stock went up about 10%.

They are also somewhat buoyed by the “good politics, bad policy” decision by the BC government to extend a 5-year interest-free loan, matching dollar-for-dollar on the first 5% of a downpayment (for an insured mortgage). It would be a poor decision for a prospective buyer in BC to not take advantage of this, but they would need to pay mortgage insurance to do so.