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!
Were you nimble enough this time?
I was indeed nimble and I bought some shares between the low of $26.25 and the mid 26’s.
The amount would have been higher had MIC traded even lower, but we will see if that happens.