Tag: MIC

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.

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 (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.

This is part of a long-continuing series covering Genworth MI (TSX: MIC). I will give the changes that I see salient over the past few months.

The past two months of price action has seen an approximate 20% decline in common share price:

This is likely due to market perception of increased default rates in mortgages, especially in the Alberta and Saskatchewan markets (the two provinces in Canada with the most negative bias to lower oil prices). At the Q3-2014 report, Alberta has 17% of the insurance in force, while Saskatchewan is 3%. Both provinces have very low delinquency rates (0.09% and 0.12%, respectively).

This will undoubtedly climb up as property will flood the market in the wake of layoffs and capital expense reduction of the oil majors.

The frequency of mortgage defaults is strongly affected by unemployment rates, while the severity of defaults is determined by property valuations. I would expect management would touch upon the impact of Alberta and also the impact of a potential recession in Canada and how it would affect mortgage defaults. As I have mentioned in the past, Genworth’s loss ratios are at all-time lows and this is an abnormal condition.

The other item of note is that management has repurchased $32 million in shares (799,345 shares) between mid-November to early December, at an average of $40.04/share. This was probably the worst example of market timing I have seen in quite some time and was a transaction above book value. In other words, this will be a negative value transaction to shareholders.

Normally management has been a little more cautious with shareholder capital (demonstrated by their willingness to give a sizable special dividend of excess capital in the previous quarter), but this decision is relatively questionable.

Company management had a shift which I deemed relatively minor – the CEO is resigning and becoming the executive chairman of the board; while the COO is now becoming the CEO. This continuity in management would suggest no major strategic changes in the pipeline.

Tangible book value, pro-forma to the buyback, will be around $34.50/share at Q3-2014. This also includes other accumulated comprehensive income and also deferred policy acquisition costs (which is effectively an intangible asset that represents cash paid to acquire business).

At Q3-2014, they did have exposure to $32 million in energy equities and $253 million in energy fixed income investments out of a $5.6 billion portfolio. It will be interesting to see if they got hit during the quarter on energy.

On a positive note, their fixed income portfolio will very likely accrue an increase in fair value as interest rates have continued to drop over the quarter. Indeed, with the Bank of Canada’s interest rate drop, they will be experiencing even higher gains in Q1-2015.

This will pose reinvestment risk, however. Most insurance companies (and pensions) are really struggling to find high quality investments that give out yield. In the low interest rate environment, this will suppress portfolio yields and will result in more expensive policies.

A slowdown in the Canadian real estate market would have an adverse effect on premium generation. That said, with last year’s price increase by CMHC, and little in the way of market competition, I would view the company as generating more premiums than recognizing at present. For the first 3 quarters in 2014, the company took in $461 in premiums and recognized $422 million in revenues. The decline in revenue recognition should reverse in 2015 and beyond.

In balance, considering the risks in the Canadian real estate market, Genworth MI’s position, and current market valuation, I believe Genworth MI at CAD$32/share is slightly undervalued. While it is not at a low enough price for me to add shares, it is something I am comfortable holding at existing price levels. I do not see Canada’s real estate market imploding, although it is certainly going to be rough going for those that have bought million dollar homes in Alberta and finding they have been laid off in the oil patch.

Disclosure: I have been long on MIC.TO since July 2012. I sold a good chunk of my holdings in 2014 but still hold a reasonable amount today.

Genworth MI is up about 4% following their quarterly report.

Book value (including intangibles) is $34.76/share diluted, while excluding intangibles is about $34.57/share diluted (there is not a lot of baggage on the balance sheet other than deferred policy acquisition costs that gets expensed off when revenue is recognized).

Taking the tangible book value and giving a standard 20% premium over book yields about $41.48/share, which is slightly below what it is trading at present ($41.70 as I write this). There is nothing exceptional in the portfolio that would warrant an extraordinary value beyond a percentage multiple over book (unlike companies like Berkshire and Fairfax which require some careful consideration with their own portfolios).

From a perspective of price-to-book for typical insurance companies, MIC has reached its full valuation and any gains to be made from here are likely to result from minting cash through operations rather than any huge expansion of the price-to-book multiple. This statement could be incorrect as market psychology usually likes to take things to excess and also the market is still yield-hungry. MIC does deliver 3.74% at current price with a historically rising dividend which would appeal to fund managers.

Income-wise, they are still at around the P/E 10 level which also has some valuation appeal for those that invest on that basis.

I would not feel too badly about lightening up my holdings at current prices, which I might do depending on other available options.

It is unfortunate that I would only get interested once again in this company if there was a true housing crisis in Canada. Otherwise it is unlikely the market would offer a huge discount to book that was initially given back in 2012 – where the equity was trading at over a 1/3rd discount to book along with many other insurers. These inefficiencies have been mostly corrected by the marketplace and the companies that are left with discounts to book have genuine issues that result in such valuations.

Looking over my previous work on MIC, I have done a relatively good job of analyzing the firm and it has been an amazing gainer for me over the past couple years. I wish I had candidates on my list that have nearly the risk/reward ratio that this one did.