Tag: GNW

It is quite obvious by trading action over the past month that some institution is accumulating shares of Genworth MI (TSX: MIC) and is sweeping up the supply that is being applied at existing prices. I loaded up in shares during the second half of January and bought a very small position in some out-of-the-money options (the Canadian options market is illiquid, high-spread, expensive to trade in and generally junky, but there was somebody on the ask that was not the market maker and at a reasonable price, I hit his ask). Genworth MI is once again the largest component in my portfolio.

It is difficult to understand how something trading at a greater than 1/3rd discount to tangible book value and giving a greater than 7% cash yield, and trading at a P/E of 8 can continue to trade so low unless if it can be explained by general paranoia (which exists on Canadian housing).

Insiders (as of February 22) have reported purchases of common shares of Genworth MI. They are not huge but it is something.

The reports of the Canadian housing market’s demise is clearly over-blown except in very narrow sectors that have traditionally had resource commodity concentration (looking at Fort McMurray as the prime example).

The underlying entity is incredibly profitable. The only real risk is whether the parent entity (NYSE: GNW) will sell Genworth MI out, which is a real possibility.

Such a sale, if done presently, would likely be done under book (CAD$36.82 presently). A sale at 10% under book ($33.14/share) would still be a 25-30% premium over current trading prices. The company’s P/E would still be 8 at this point and an acquisition would be instantly accretive to some other financial company.

This take-out price does not reflect my true value that the company should be trading at, which I would judge at least at book value. The Canadian economy, and thus residential mortgages servicing abilities, is not the most robust so the premium to book would be modest before I started to sell shares again. I also apply a general discount to majority-controlled entities, but suffice to say my target price is north of CAD$36.28.

Genworth Financial’s issues I do not want to get into in depth, but they have a pending May 22, 2018 debt maturity (bonds are trading at 87 cents on the dollar at the moment) and a series of maturities 2 years later (June 15, 2020, trading at 68 cents) that the market is getting panicky about. This may cause them to sell out their equity holdings in the mortgage insurance firms they have taken public (Canada and Australia), but it is a decision I do not think they would want to make lightly.

The earnings release was about what I was expecting. There was a slight increase in the expense profile but this was due to some stock-related compensation expenses (cash flow statement has it at $11.2 million for the year) but this is due to the stock itself increasing in value.

For the year, net premiums written were $511 million, while revenues recognized were $572 million. These two will have to converge eventually. This has been the trend for the past few years now – revenues recognized was $621 million back in 2010. Premiums earned in 2014 should be around the $550 million level.

The $5.4 billion portfolio continues to remain dull (a good thing) with a 3.6% yield, 3.7 year duration.

The loss ratio continues to remain exceptionally low, at 22%. Management continues to focus on Quebec and the Toronto condominium market, which is correct.

The bottom-line operating EPS is $3.60/share. Looking at tangible book value, I get a value of $32.34/share with a diluted share count of 94.9 million shares.

Balance sheet-wise, the company continues to remain over-capitalized with 222% of its required regulatory minimum capital, and well above its 190% internal target. There are regulatory changes which I have outlined earlier that the company is awaiting for before deciding what to do with its excess capital. They bought back shares when the stock was trading lower, but now they are holding onto their cash instead of buying back shares (a smart decision).

The only item of any distinction in the financials is the following paragraph:

On December 20, 2013, the Company, through its indirect subsidiary PMI Canada, entered into a retrocession agreement with Merrill Lynch Reinsurance under which the Company assumed reinsurance risk for up to $30,000 Australian dollars if the losses on claims paid by Genworth Financial Mortgage Insurance Pty Limited, an Australian company (“Genworth Australia”) exceed $700,000 Australian dollars within any one year. The term of the agreement is 3 years. Genworth Australia has the right to terminate the reinsurance agreement after the first year of coverage.

Under the excess of loss reinsurance agreement, the Company is required to collateralize its reinsurance obligations by posting cash collateral equal to the maximum exposure under the agreement in favour of Merrill Lynch Reinsurance. As at December 31, 2013, the Company has posted $30,000 Australian dollars, equivalent to $28,482 Canadian dollars, under the agreement. The collateral is recorded as collateral receivable under reinsurance agreement on the Company’s condensed consolidated interim statement of financial position.

Re-measurement adjustments arising on translation of collateral receivable under the reinsurance agreement and any reinsurance receivable balances from Australian dollars to Canadian dollars are recognized in net investment gains.

This is functionally a bet by management that the Australian real estate market is not going to crater. While I am not thrilled that the company appears to be engaging in gambling outside of the Canadian sphere, I do note that the history of paid claims in Australia appears to be considerably below this:

2013 – AUD$185 million
2012 – AUD$287 million
2011 – AUD$112 million
2010 – AUD$171 million
2009 – AUD$173 million
2008 – AUD$146 million

It would appear that it would take a disaster for Australia’s paid claims to be above the AUD$700 million threshold, but if this was the case, then why did Genworth Australia make this agreement with a sub of Genworth Canada?

Reading between the lines on the conference call, it sounds like management is tinkering around with the idea of deploying their excess capital in reinsurance of mortgage insurers. This doesn’t sound like a bad idea, until it blows up, like it almost did for the parent Genworth (NYSE: GNW) entity.

In absence of any better investment alternatives and also in absence of any looming Canadian real estate crisis, Genworth MI is still in my portfolio as a large fraction. It is or more less a proxy for a bond fund at this point and I am comfortable with the relevant risks regarding the Canadian real estate market. I also believe the equity is in the middle of what I consider to be its fair value range. If they execute as they have in 2013, the stock should go up another 10% or so on the basis of increased book value alone.

The critical sensitivity continues to be the state of the Canadian economy. Our country is export-oriented, especially in the commodity sector. As long as this remains active, we are unlikely to see spikes in unemployment that would cause mortgage defaults. Interest rates are also projected to be low and this will not create an additional shock in the market.

Genworth MI Canada (TSX: MIC) made an announcement today that reflected changes to the underlying legislation, the Protection of Residential Mortgage or Hypothecary Insurance Act and the impact on its balance sheet.

It had been accruing a government guarantee fund that was funded through gross premiums that effectively functioned as a corporate equivalent of an RRSP, with the difference being that there was an exit fee of 1% for every year the funds were deposited into the fund. Any deposits in the fund were tax deductible, but any withdrawals would be taxable.

In the new regime, this fund is now going to be collapsed, but without the exit fee. Thus, the company is basically going to book the exit fee (after taxes) as a gain, which will amount to about $135 million or about $1.37/share.

In exchange, the company is now going to contribute 2.25% of gross premiums to the federal government (as an expense and not into a guarantee fund) and their minimum capital test amount will be going up to an internal level of 185% (required is 175%) from the present 145% (required is 120%).

The implication here is that the company will be making more money in the future (all things being equal; this does not account for the decreases in real estate transaction volume that will be decreasing the premiums written in the future) and the company will have a relatively large amount of capital freed up to examine other options, including dividends or share buybacks. Management was previously burnt by spending $160 million on June 30, 2011 on a share buyback at $26/share. In light of the fact the company is trading well under book value, it would not surprise me to see them consider another one, or they could give out another dividend.

Investors would be cautioned that MIC will likely do what is in the best interests of Genworth (NYSE: GNW) as they own 57.5% of the company.

Shares of MIC are up 3.6% at present.